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Principles of Economics 2e

2nd Edition
Steven A. Greenlaw; David Shapiro
ISBN: 9781947172364

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BuyFindarrow_forward

Principles of Economics 2e

2nd Edition
Steven A. Greenlaw; David Shapiro
ISBN: 9781947172364
Textbook Problem

What is the main reason for employing contractionary fiscal policy in a time of strong economic growth?

To determine

To state: The reasons for adopting Contractionary fiscal policy when there is strong economic growth.

Explanation

An expansionary fiscal policy of the government refers to use of government spending to increase the aggregate demand, output, employment and prices in the economy. It includes:

  1. Increase in business taxes to reduceafter tax profits.
  2. Increase in individual income taxes to decrease the disposable income and hence to increase the consumption.
  3. Reducing government purchases of final goods and services to reduce aggregate demand directly.

Consider the following diagram. Here,

AD = Aggregate Demand

AS = Aggregate Supply

P = Price level

Initially, the equilibrium output is Y0and the equilibrium price is P0. Initially, the economy is at an equilibrium where the equilibrium GDP is above the potential GDP leading to inflation (high prices)...

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