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Contractionary Fiscal Policy

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3a. After the shock the economy will face an inflationary gap. A contractionary fiscal policy would help to move the economy back to potential output. The policy would shift the aggregate demand curve back to the left after the increased consumer spending moved the curve to the right.
3b. After the shock the economy will face a recessionary gap. An expansionary fiscal policy would help to move the economy back to potential output. The policy would shift the aggregate demand curve back to the right after the decreased investment spending moved the curve to the left.
3c. After the shock the economy will face an inflationary gap. A contractionary fiscal policy would help to move the economy back to potential output. The policy would shift the aggregate demand curve back to the left after the increased government spending moved the curve to the right. …show more content…

After the shock the economy will face a recessionary gap. An expansionary fiscal policy would help to move the economy back to potential output. The policy would shift the aggregate demand curve back to the right after the decreased investment spending moved the curve to the left.

4a. The appropriate fiscal policy response to this situation if the primary concern of the government was to maintain economic growth would be an expansionary fiscal policy. As a result AD1 would shift to the right and the equilibrium point would move to the right, so that it was on the LRAS line again but higher up on that line.
4b.The appropriate fiscal policy response to this situation if the primary concern of the government was to maintain price stability would be a contractionary fiscal policy. As a result AD1 would shift to the left and the equilibrium point would move to the left, so that it was even with P1.
4c. An expansionary fiscal policy would be increase the price level, but would worsen inflation. A contractionary fiscal policy would decrease the price level but as a result it would increase the recessionary

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