If the government adopts contractionary fiscal policy, it:
Show answer & explanation
Correct answer: A
Explanation
Correct Answer:
Reduces public expenditure or increases taxes
Explanation:
A contractionary fiscal policy is a macroeconomic tool used by a government to cool down an overheating economy or control high inflation. To decrease aggregate demand and reduce the amount of money circulating in the market, the government either reduces its public expenditure (spending less on infrastructure, public services, etc.) or increases taxes (leaving consumers and businesses with less disposable income).
Key Points:
Primary Objective: The main goal of contractionary fiscal policy is to control inflation and stabilize economic growth when an economy is growing too rapidly.
Opposite Policy: It is the exact opposite of expansionary fiscal policy, which involves increasing government spending and cutting taxes to stimulate a sluggish economy.
Impact on Demand: By cutting spending and raising taxes, the overall aggregate demand in the economy shifts downward, easing price pressures.
Important Questions and Answers:
Question: What is the primary purpose of implementing a contractionary fiscal policy?
Answer: To control inflation and cool down an overheating economy.
Question: What happens to disposable income when taxes are increased under a contractionary policy?
Answer: Disposable income decreases, which leads to lower consumer spending and business investment.