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1. What is fiscal policy?

The fiscal policy are policies that the government uses to influence the level of aggregate demand, the RDGP and the price level. The government uses spending and tax strategies to contract or expand the economy to stabilize the effects of inflation or recession.

1. How can it be used to get the economy out of recession?

A recession is a contraction in the business cycle where there is a significant decline in the economic activity. It is usually marked by 2 consecutive quarters of decline in the GDP and a rise in unemployment. The government can return the economy to equilibrium through expansionary fiscal policies such as increases its spending or lowering taxes or both. These should increase aggregate demand and the multiplier effect (a change in total purchases that are greater than the increase in total purchases) will increase the price level and the RGDP.

3. How can it be used to get the economy out of the situation where the economy is in an expansionary period where we exceed long run potential?

If in an expansionary period, the AD and SRAS surpass the RGDG_NRand the price level rises and it can result in an inflationary gap. The government can employee contractionary fiscal policies such as a reduction in government spending or imposing tax increases. This will shift both the AD and the SRAS left, lower the price level and return the economy to RDGP_NRor full employment.

4.Do both situations result on different impacts on inflation?Why or why not?

Yes, contractionary fiscal policies would reduce inflation whereas expansionary fiscal policies would exasperate inflation. The AD and price levels move in different directions in recessions and inflationary periods. The price level and the AD are already outpacing output during inflation so if the government were to implement increase spending or lower taxes this could result in an increase in purchases, higher price levels and higher inflation by shifting the out the demand curve even further.