Question

Use the aggregate expenditures model to show how government fiscal policy could eliminate either a recessionary expenditure gap or an inflationary expenditure gap. Explain how equal size increases in G and T could eliminate a recessionary gap and how equal-size decreases in G and T could eliminate an inflationary gap.

Answer 1

Explanation:

Since government spending is one of the components of aggregate demand, an increase in government spending will shift the demand curve to the right. A reduction in taxes will leave more disposable income and cause consumption and savings to increase, also shifting the aggregate demand curve to the right.