(i) "With an objective to reduce inflation, government may reduce public Expenditure." Discuss the rationale behind such a step which may be taken by the Government. (ii) Define Effective Demand Principle. (i) State the meaning of 'unintended accumulation of inventories'. (ii) "In an economy, Aggregate Demand (AD) is more than Aggregate Supply (AS)." Elaborate the possible impacts of the same, on the level of output, income and employment.

Question

Accepted Answer

(i) **Rationale for reducing public expenditure to control inflation:**
- Government expenditure is a component of aggregate demand (AD = C + I + G + NX)
- Reducing government spending directly reduces aggregate demand
- Lower aggregate demand reduces pressure on prices, controlling inflation
- It also helps in fiscal consolidation and reducing fiscal deficit

(ii) **Effective Demand Principle:** According to Keynes, the level of employment and output in an economy is determined by effective demand, which is the aggregate demand that is backed by purchasing power. When effective demand is deficient, the economy operates below full employment, leading to unemployment. The principle states that entrepreneurs produce goods only when they expect to sell them at a profit, so actual output depends on expected demand.