Read the following statements carefully : Statement 1 : During deflationary gap, the Central Bank of a country

Question 83 of 104

Q. Read the following statements carefully : Statement 1 : During deflationary gap, the Central Bank of a country may increase the repo rate. Statement 2 : The government can reduce the deflationary gap by purchasing Government Securities (G-Sec) in the open market. In the light of the given statements, choose the correct option from the following : (A) Statement 1 is true and Statement 2 is false. (B) Statement 1 is false and Statement 2 is true. (C) Both Statements 1 and 2 are true. (D) Both Statements 1 and 2 are false.

Chhattisgarh CgbseCBSE Class XII Board 2025MCQ· 1mImportance★★★★★

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Concept understanding — Aggregate Demand Equilibrium

Aggregate Demand Equilibrium: The Economy's Balancing Act

Think of a seesaw. On one side sits everything people, firms, and the government want to buy. On the other side sits everything firms produce. When the seesaw is perfectly level — when total spending exactly matches total output — the economy is in equilibrium. That's the core idea.

But why should you care? Because when the seesaw tilts, real things happen. If spending exceeds output, prices rise (inflation). If output exceeds spending, factories shut down and people lose jobs. Equilibrium is the sweet spot where neither happens.

The Precise Meaning

In macroeconomics, Aggregate Demand (AD) is the total planned spending on final goods and services in an economy during a given period. Aggregate Supply (AS) is the total output firms plan to produce.

Equilibrium occurs where:

AD = AS

At this point, what buyers intend to spend exactly equals what sellers intend to produce. No unwanted inventories pile up, and no shortages force prices up. The economy is "at rest."

Y = C + I + G + (X - M)

This is the AD identity from your NCERT textbook. It tells you that total spending in the economy comes from four sources: households, firms, government, and foreigners (net of what we buy from them).

How Equilibrium Actually Works

Imagine a simple economy with only households and firms. Households earn income $Y$ from firms. They spend part of it on consumption $C$ and save the rest $S$ . Firms produce output and also invest $I$ (buying machines, building factories).

Equilibrium condition becomes:

Y = C + I

But households don't spend all their income. They save. So $C = Y - S$ . Substituting:

Y = (Y - S) + I

Which simplifies to:

S = I

Important

In equilibrium, planned savings must equal planned investment. This is the Keynesian cross condition. If people save more than firms invest, total spending falls short of output — inventories pile up, firms cut production, and income falls until savings and investment match again.

The 45° Line Diagram (Describe It)

Draw a graph with Aggregate Demand (AD) on the vertical axis and National Income (Y) on the horizontal axis.

Draw a 45° line from the origin. Every point on this line represents $AD = Y$ — the equilibrium condition.
Draw the AD curve (which is $C + I + G + (X-M)$ ). It slopes upward because as income rises, consumption rises.
Where the AD curve crosses the 45° line — that's the equilibrium point. …

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Both statements are false. During a deflationary gap the central bank should lower (not raise) the repo rate, and buying government securities in the open market is an Open Market Operation carried out by the central bank — not by the government. The correct option is (D).

Let's first get the economic context clear. A deflationary gap — also called a recessionary gap — occurs when the economy's actual output is below its potential output, meaning aggregate demand is too low. Unemployment rises, prices may fall or grow very slowly, and the economy is stuck in a low-activity rut. The textbook remedy is to expand aggregate demand, not contract it.

Now examine Statement 1: "During deflationary gap, the Central Bank of a country may increase the repo rate." The repo rate is the rate at which the central bank lends short-term funds to commercial banks. Raising it makes borrowing costlier for banks, who pass on higher interest rates to businesses and households — discouraging borrowing and spending. That is a contractionary monetary policy move, the opposite of what a deflationary gap requires. During a deflationary gap the central bank would reduce the repo rate to make credit cheaper and stimulate spending. So Statement 1 is false. …

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