Chapter 13, Problem 13.1LO

To determine

The effects of discretionary fiscal policy as per Keynesian model.

Explanation of Solution

When the government uses its discretionary fiscal policy, it uses its tool of government spending and government taxation to maintain the equilibrium level of GDP.

Consider a case, where government uses expansionary fiscal policy to increase the real GDP. The government will increase government expenditure or reduces taxes or use a combination of both. The use of expansionary fiscal policy by government shifts the IS curve to the right from IS to IS’. Note that, the LM curve is horizontal because we are dealing with Keynesian macroeconomic model. When government increases spending or reduces taxes, it increases the disposable income and consumption expenditure rises. This further leads to an increase in demand for goods and services. So, the firm will produce more to meet the increased aggregate demand. As a result, output rises from Y to Y’.

Economics Concept Introduction

Introduction:

Discretionary Fiscal Policy: It is a tool used by the government to achieve equilibrium level of GDP during different economic situations. The policy mainly focuses on government spending and its taxation tools.