Expansionary fiscal policy occurs when the Congress acts to cut tax rates or increase government spending, shifting the aggregate demand curve to the right. A contractionary fiscal policy can shift aggregate demand down from AD0 to AD1, leading to a new equilibrium output E1, which occurs at potential GDP. The goal would be to get back to our long run equilibrium. Again, the AD–AS model does not dictate how this contractionary fiscal policy is to be carried out. Automatic stabilizers, which we learned about in the last section, are a passive type of fiscal policy, since once the system is set up, Congress need not take any further action. An alternative measure of expansionary fiscal policy that may be adopted is the reduction in taxes which through increase in disposable income of the people raises consumption demand of the people. This will increase the demand […] 1 C) Taxes Affect Disposable Income And So Consumption. Expansionary fiscal policy will. Economic studies of specific taxing and spending programs can help to inform decisions about whether taxes or spending should be changed, and in what ways. the economy is in a recessionary gap These two encourage consumption as they increase people's purchasing power. Find out how aggregate demand is calculated in macroeconomic models. The intersection of aggregate demand (AD0) and aggregate supply (AS0) is occurring below the level of potential GDP. As these occur, the government may choose to use fiscal policy to address the difference. Good work 1 / 1 pts Question 7 Which of the following would not be considered an automatic stabilizer? Expansionary fiscal policy occurs when the Congress acts to cut tax rates or increase government spending, shifting the aggregate demand curve to the right. Unemployment insurance. Expansionary policy can do this by (1) increasing consumption by raising disposable income through cuts in personal income taxes or payroll taxes; (2) increasing investments by raising after-tax profits through cuts in business taxes; and (3) increasing government purchases through increased spending by the federal government on final goods and servi… During a recession, if a government uses an expansionary fiscal policy to increase GDP, the: A. aggregate supply curve will shift to the right. If the economy is currently producing output of Y0 and the government initiates an expansionary fiscal policy adequate to close the output gap, the result is intended to be A) the vertical line at Y* will shift to the left, intersecting the AS and AD curves at Y0. Figure 1. But the AD–AS model can be used both by advocates of smaller government, who seek to reduce taxes and government spending, and by advocates of bigger government, who seek to raise taxes and government spending. Look at the figure Fiscal Policy Options. Now if you look at the right, we have the opposite scenario. Each year, the economy produces at potential GDP with only a small inflationary increase in the price level. shift the aggregate demand curve left. Expansionary fiscal policy increases the level of aggregate demand, through either increases in government spending or reductions in taxes. A Contractionary Fiscal Policy. The extremely high level of aggregate demand will generate inflationary increases in the price level. I 5. Contractionary monetary policy is enacted to halt exceptionally high inflation rates or normalize the effects of expansionary policy. An increase in expenditures shifts the aggregate demand curve to the left right. On the other hand, discretionary fiscal policy is an active fiscal policy that uses expansionary or contractionary measures to speed the economy up or slow the economy down. © copyright 2003-2020 Study.com. In Panel (b), the economy initially has an inflationary gap at Y 1. b. Watch the selected clip from this video to learn more about the ways that government can implement fiscal policies. C. Short run aggregate supply to shift right. Since the economy was originally producing below potential GDP, any inflationary increase in the price level from P0 to P1 that results should be relatively small. When the aggregate demand curve shifts to the left, the total quantity of goods and services demanded at any given price level falls. Meet Larry of Larry's Limos of Greater Ceelo. A cut in taxes ---, therefore shifting the aggregate demand curve to the ---Increases disposable income and consumption; right. Expansionary fiscal policy will cause the: C. Short run aggregate supply to shift right. In this well-functioning economy, each year aggregate supply and aggregate demand shift to the right so that the economy proceeds from equilibrium E0 to E1 to E2. Without a change in the money demand curve, the interest rate falls. use expansionary fiscal policy to shift aggregate demand to the left. Contractionary fiscal policy occurs when Congress raises tax rates or cuts government spending, shifting aggregate demand to the left. Expansionary fiscal policy can close recessionary gaps (using either decreased taxes or increased spending) and contractionary fiscal policy can close inflationary gaps (using either increased taxes or decreased spending). In Panel (b), the economy initially has an inflationary gap at Y1. Tightening the money supply discourages business expansion … 20.7 from IS 1 to IS 2 . The new equilibrium (E1) is at an output level of 206 and a price level of 92. The conflict over which policy tool to use can be frustrating to those who want to categorize economics as “liberal” or “conservative,” or who want to use economic models to argue against their political opponents. The intersection of aggregate demand (AD0) and aggregate supply (AS0) occurs at equilibrium E0. a. by increasing personal income taxes b. by increasing business taxes c. by increasing government purchases d. all of the above. What might shift aggregate demand? However, state and local governments, whose budgets were also hard hit by the recession, began cutting their spending—a policy that offset federal expansionary policy. ... CF will become negative. In Panel (b), the economy initially has an inflationary gap at Y 1. Expansionary fiscal policy occurs when the Congress acts to cut tax rates or increase government spending, shifting the aggregate demand curve to the right. The shift up of AD causes us to move along the aggregate supply (AS) curve, causing a rise in both real GDP and the price level. D) shift the short-‐‑run aggregate supply curve to the left. Shifts in the aggregate supply curve can be caused by. Despite the importance of fiscal policy, a paradox exists. The aggregate demand/aggregate supply model is useful in judging whether expansionary or contractionary fiscal policy is appropriate. Thus, it can be concluded that aggregate output and interest rates have a positive relationship with government expenses, whereas they have a negative relationship with taxes. increasing government purchases through increased spending by the federal government on final goods and services and raising federal grants to state and local governments to increase their expenditures on final goods and services. D. An expansionary monetary policy is needed to stimulate the economy. Therefore the government can attempt to influence the level of Real GDP produced and in turn affect government objectives: inflation, unemployment, economic growth. Did you have an idea for improving this content? Now we shall look at how specific fiscal policy options work. Consider first the situation in Figure 2, which is similar to the U.S. economy during the recession in 2008–2009. Sciences, Culinary Arts and Personal Which of the following would be the theoretical outcome of expansionary fiscal policy in the following aggregate demand aggregate supply model (where LRAS = long-run aggregate supply and GDP = gross domestic product)? Contractionary fiscal policy occurs when Congress raises tax rates or cuts government spending, shifting aggregate demand to the left. Fiscal policy can also be used to slow down an overheating economy. Should the government use tax cuts or spending increases, or a mix of the two, to carry out expansionary fiscal policy? increasing consumption by raising disposable income through cuts in personal income taxes or payroll taxes; increasing investments by raising after-tax profits through cuts in business taxes; and. the economy is in long-run equilibrium 2.) In the real world, however, aggregate demand and aggregate supply do not always move neatly together, especially over short periods of time. Aggregate demand may fail to grow as fast as aggregate supply, or it may even decline causing a recession. The shifts labeled A and B show expansionary fiscal policy in action. Loss of business confidence. Earn Transferable Credit & Get your Degree, Get access to this video and our entire Q&A library. An expansionary fiscal policy will expand the economy's growth. An expansionary fiscal policy seeks to shift aggregate demand to AD 2 in order to close the gap. Expansionary fiscal policy will A) shift the aggregate demand curve to the left. C. aggregate demand curve will shift to the left. An expansionary monetary policy will reduce interest rates and stimulate investment and consumption spending, causing the original aggregate demand curve (AD 0) to shift right to AD 1, so that the new equilibrium (Ep) occurs at the potential GDP level of 700. As a general statement, conservatives and Republicans prefer to see expansionary fiscal policy carried out by tax cuts, while liberals and Democrats prefer that expansionary fiscal policy be implemented through spending increases. This makes the LM curve to shift to the rightward direction. Question 6 1 / 1 pts In an aggregate demand and aggregate supply graph, an expansionary fiscal policy can be illustrated by a: Leftward shift in the aggregate demand curve Correct! B). Expansionary fiscal policy includes ---Increasing government expenditures and decreasing taxes. This can be thought of as the economy contracting. I D) All Of The Above. You can view the transcript for “Macro: Unit 3.1 — Types of Fiscal Policy” here (opens in new window). All rights reserved. B. Figure 3. Normalize the effects of expansionary policy if the aggregate demand curve to the left.! Figure 2, which is above potential, as shown in Figure 2, which similar. 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Or recession an expansionary fiscal policy seeks to reduce aggregate demand as aggregate supply or. Model is useful in judging whether expansionary or contractionary fiscal policy can also be to...

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