question_answer

Explain the role of open market operations in correcting the problem of deflationary gap.

or

Explain using diagram, under employment equilibrium.

 

Answer:

Open market operations refers to the sale and purchase of securities by the Central Bank to commercial bank or general public. Deflationary gap refers to Aggregate Demand (AD) falling short of Aggregate Supply (AS) at full employment level. In this situation, the Central Bank buys securities in the open market and makes payments to the sellers. The money flows out of the Central Bank and ultimately reaches the commercial banks as deposits. This raises the lending capacity of the banks. People can borrow more. This will raise the level of Aggregate Demand in the economy. Therefore, due to open market operations deflationary gap will be controlled,                           Or Under Employment Equilibrium Under employment refers to a situation, when all those who are able to work at existing wage rates, are not getting jobs.    It refers to that situation in the economy where AS = AD or S =l, but without fuller utilisation of labour force. It leads to deflation in the economy.                Under Full Employment Equilibrium