Question

In: Economics

Please respond to the following in a minimum of 175 words: Compare and contrast expansionary and...

Please respond to the following in a minimum of 175 words:

Compare and contrast expansionary and contractionary fiscal policy?

Solutions

Expert Solution

Fiscal policy is the use of government spending and tax policy to influence the path of the economy over time. 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. 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, .

An expansionary fiscal policy is one that causes aggregate demand to increase. This is achieved by the government through an increase in government spending and a reduction in taxes. These two encourage consumption as they increase people's purchasing power. This can be seen graphically as a rightwards shift of the AD (aggregate demand) curve which leads to an increase in the equilibrium output of the economy and hence, an increase in GDP.
A contractionary fiscal policy is the opposite. The government decreases government spending and increases taxes. This causes consumption to fall as purchasing power declines. This can be represented as a shift to the left of the AD curve, reducing the equilibrium output of the economy and hence, reducing GDP. The government will apply each policy depending on the country's needs.


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