Macroeconomic Equilibrium

To restore equilibrium in an economy operating at over full employment, it is essential to address the excessive demand causing inflationary pressures. One effective method is to reduce government expenditure. Here, we explain the reasoning behind this approach:

1. Over full employment indicates that the economy is producing beyond its sustainable capacity, leading to demand-pull inflation.
2. To counteract this, the government should implement contractionary fiscal policies to reduce aggregate demand.
3. Reducing government expenditure directly lowers aggregate demand, helping to decrease inflationary pressures and bring the economy back to its potential output level.
4. This ensures resources are allocated efficiently without causing inflation, thus restoring equilibrium in the economy.

Therefore, reducing government expenditure is the appropriate action to stabilize an economy facing over full employment.