Final Answer:
Expansionary fiscal policy involves an increase in government spending or a reduction in taxes with the aim of boosting aggregate output (Y).
Step-by-step explanation:
Expansionary fiscal policy is a macroeconomic strategy employed by governments to stimulate economic activity, particularly during periods of downturn. The core idea is to increase aggregate demand in the economy, which is represented by the variable Y. Aggregate demand is the total quantity of goods and services demanded by consumers, businesses, government, and foreigners.
By either increasing government spending or cutting taxes, the government injects more money into the economy, leading to higher consumer spending and business investments. This, in turn, results in an increase in aggregate output (Y).
Mathematically, the relationship between government spending (G), taxes (T), and aggregate output (Y) is expressed through the Keynesian expenditure model: Y = C + I + G + (X - M), where C is consumption, I is investment, G is government spending, X is exports, and M is imports. An increase in G or a decrease in T directly contributes to the Y component of the equation, fostering economic growth. This policy is particularly effective in times of economic recession when private sector spending is insufficient to drive overall demand.
However, it's essential to consider potential downsides, such as the risk of inflation or the accumulation of government debt. Striking the right balance and timing is crucial for successful implementation. Overall, expansionary fiscal policy plays a vital role in stabilizing and promoting economic growth by actively managing the overall demand in the economy.