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To What Extet Should the Government Pay Attention to the Size of the Negative Output Gap When Deciding Whether to Increase Government Spending with a View to Increase Ad

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To what extent should the government pay attention to the size of the negative output gap when deciding whether to increase Government spending with a view to increasing Aggregate Demand?
Aggregate demand is the sum of all expenditure in the economy over a period of time. The formula for working out aggregate demand is AD=C+I+G+(X-M). Governments are always looking to increase this as it shows that the economy is producing well.

Back of sheet graph

A trade cycle diagram shows the potential and ideal output of an economy as well as the actual output produced by the economy. This can be used to see how well an economy is doing and whether they are in recovery growth or real growth. Real growth is when the productive capacity increases while recovery growth is growth that occurs as spare capacity and idle resources are brought back into production to move closer to the production possibility boundary.

Trade cycle diagram

The negative output gap is when the economy is producing less than its trend or potential output. There are many views as to what a government should do with their spending during this period. Many believe that they should reduce their spending to reduce causing any debt problems and a possible recession however a man named John Keynes said that governments should increase their spending to try and pump more money back into the economy. Keynes's theory overturned the mainstream thought of the time and brought about a greater awareness of structural inadequacies: problems such as unemployment, for example, are not viewed as a result of moral deficiencies like laziness, but rather result from imbalances in demand and whether the economy was expanding or contracting. Keynes argued that because there was no guarantee that the goods that individuals produce would be met with demand, unemployment was a natural consequence especially in the…...

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