Now the equilibrium is E2, with an output level of 212 and a price level of 94. Aggregate demand to shift left. Expansionary fiscal policy will cause the: C. Short run aggregate supply to shift right. For example, investment by private firms in physical capital in the U.S. economy boomed during the late 1990s, rising from 14.1% of GDP in 1993 to 17.2% in 2000, before falling back to 15.2% by 2002. Expansionary fiscal policies either (1) increase government spending or (2) reduce taxes. The A shift shows a movement from point 3 (a recessionary gap) to point 1, long run equilibrium. Figure 3. During a recession, if a government uses an expansionary fiscal policy to increase GDP, the: A. aggregate supply curve will shift to the right. In Panel (b), the economy initially has an inflationary gap at Y1. So you would want to get to this aggregate demand curve two through your contractionary fiscal policy. 1 C) Taxes Affect Disposable Income And So Consumption. Expansionary fiscal policy occurs when the Congress acts to cut tax rates or increase government spending, shifting the aggregate demand curve to the right. shift the short-run aggregate supply curve left. Under floating ER, the ER is allowed to fluctuate in response to changing economic conditions. The intersection of aggregate demand (AD0) and aggregate supply (AS0) occurs at equilibrium E0. Note that in Fig. The extremely high level of aggregate demand will generate inflationary increases in the price level. The choice between whether to use tax or spending tools often has a political tinge. The aggregate demand/aggregate supply model is useful in judging whether expansionary or contractionary fiscal policy is appropriate. shift the aggregate demand curve right. D. All of these effects are the inverse of the factors that tend to decrease aggregate demand. 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. The former directly increases aggregate demand, the latter increases aggregate demand by raising household consumption, since household have a higher disposable income due to tax cuts. 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. b. B) no change in either price level or output, since expansionary fiscal policy is ineffective. 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. 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. 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! Therefore the government can attempt to influence the level of Real GDP produced and in turn affect government objectives: inflation, unemployment, economic growth. One more year later, aggregate supply has again shifted to the right, now to AS2, and aggregate demand shifts right as well to AD2. Sciences, Culinary Arts and Personal A cut in taxes ---, therefore shifting the aggregate demand curve to the ---Increases disposable income and consumption; right. B) shift the aggregate demand curve to the right. Expansionary policies, fiscal or monetary, are pursued when an economy is in a downtown or recession. A contractionary fiscal policy seeks to reduce aggregate demand to AD 2 and close the gap. Defense spending. Potential GDP can be passed by real GDP only in the. use expansionary fiscal policy to shift aggregate demand to the left. Price level (P) LRAS SRAS, SRAS 100 95 90 AD, AD Real GDP Y, Y uy ư c =ư O a. Figure 1. Consider first the situation in Figure 2, which is similar to the U.S. economy during the recession in 2008–2009. 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. A contractionary fiscal policy seeks to reduce aggregate demand to AD2 and close the gap. the economy is in long-run equilibrium 2.) These actions lead to an increase or decrease in aggregate demand, which is reflected in the shift of the aggregate demand (AD) curve to the right or left respectively. You can view the transcript for “Macro: Unit 3.1 — Types of Fiscal Policy” here (opens in new window). D. Short run aggregate supply to shift left. Expansionary fiscal policy although shifts IS curve to the right but Fiscal policy becomes ineffective in increasing the income level. In this case, expansionary fiscal policy using tax cuts or increases in government spending can shift aggregate demand to AD1, closer to the full-employment level of output. Expansionary Fiscal Policy. Ultimately, decisions about whether to use tax or spending mechanisms to implement macroeconomic policy is, in part, a political decision rather than a purely economic one. (The figure uses the upward-sloping AS curve associated with a Keynesian economic approach, rather than the vertical AS curve associated with a neoclassical approach, because our focus is on macroeconomic policy over the short-run business cycle rather than over the long run.) Meet Larry of Larry's Limos of Greater Ceelo. Services, Expansionary Fiscal Policy and Aggregate Demand, Working Scholars® Bringing Tuition-Free College to the Community. Contractionary fiscal policy includes . Now if you look at the right, we have the opposite scenario. The new equilibrium (E1) is at an output level of 206 and a price level of 92. C. Short run aggregate supply to shift right. After the Great Recession of 2008–2009, U.S. government spending rose from 19.6% of GDP in 2007 to 24.6% in 2009, while tax revenues declined from 18.5% of GDP in 2007 to 14.8% in 2009. The original equilibrium (E 0) represents a recession, occurring at a quantity of output (Y 0) below potential GDP.However, a shift of aggregate demand from AD 0 to AD 1, enacted through an expansionary fiscal policy, can move the economy to a new equilibrium output of E 1 at the level of potential GDP which is shown by the LRAS curve. In this situation, contractionary fiscal policy involving federal spending cuts or tax increases can help to reduce the upward pressure on the price level by shifting aggregate demand to the left, to AD1, and causing the new equilibrium E1 to be at potential GDP. Aggregate demand to shift right. Expansionary fiscal policy increases the level of aggregate demand, through either increases in government spending or reductions in taxes. An expansionary fiscal policy occurs when the government lowers taxes and/or increases spending; thus expanding output (national income). It is helpful to keep in mind that aggregate demand for an economy is divided into four components: consumption, investment, government spending, and net exports. 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, . Expansionary fiscal policy occurs when the Congress acts to cut tax rates or increase government spending, shifting the aggregate demand curve to the right. B. aggregate supply curve will shift to the left. An increase in the money supply shifts the money supply curve to the right. Now we shall look at how specific fiscal policy options work. As these occur, the government may choose to use fiscal policy to address the difference. 20.7 from IS 1 to IS 2 . Current real GDP is $100. An increase in government spending or a cut in taxes shifts the aggregate demand curve to the right. Figure 1 uses an aggregate demand/aggregate supply diagram to illustrate a healthy, growing economy. It is helpful to keep in mind that aggregate demand for an economy is divided into four components: consumption, … Most economists, even those who are concerned about a possible pattern of persistently large budget deficits, are much less concerned or even quite supportive of larger budget deficits in the short run of a few years during and immediately after a severe recession. Without a change in the money demand curve, the interest rate falls. B. Unemployment insurance. short run. Expansionary policy can do this by: Contractionary fiscal policy does the reverse: it decreases the level of aggregate demand by decreasing consumption, decreasing investments, and decreasing government spending, either through cuts in government spending or increases in taxes. Monetary Policy: Monetary policy attempts to stabilise the aggregate demand in the economy by regulating the money supply. 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