According to Keynesian theory, during recession, what should the government ideally do?
Show answer & explanation
Correct answer: B
Explanation
The correct answer is Option 2: Increasing spending and cut taxes
Detailed Analysis & SolutionJohn Maynard Keynes, the father of modern macroeconomics, proposed that during a recession, the primary problem is a lack of aggregate demand. When people stop spending, businesses lose revenue, lead to layoffs, and the economy spirals downward.
To break this cycle, Keynes advocated for Expansionary Fiscal Policy:
Increase Government Spending: The government should spend money on public works (roads, bridges, schools). This directly creates jobs and puts money into the pockets of workers, who then spend it on goods and services.
Cut Taxes: Reducing taxes gives consumers more disposable income and businesses more profit to reinvest, further boosting demand.
Deficit Financing: Keynes argued that it is acceptable for a government to run a budget deficit during a recession to "prime the pump" of the economy.
Potential Competition QuestionsQ1. Which of the following is known as "Priming the Pump" in economics?
Answer: Infusing government spending to stimulate demand
Q2. According to Keynesian economics, the "Liquidity Trap" is a situation where:
Answer: Interest rates are so low that monetary policy becomes ineffective.