Final answer:
Fiscal policy is the government's use of taxation and spending to influence the economy, aimed at managing aggregate demand. Expansionary fiscal policy increases demand by increasing spending or cutting taxes, while contractionary policy reduces demand by reducing spending or hiking taxes. Over time, growth in resources shifts the aggregate supply curve to the right, increasing output.
Step-by-step explanation:
Fiscal policy refers to the government's approach to influencing the economy through changes in government spending and tax policy. These changes are aimed at managing aggregate demand to ensure that the economy grows at a steady rate, without excessive inflation or recession. The manipulation of taxation and spending is the direct way in which fiscal policy influences aggregate demand. For instance, during a recession, the government may employ expansionary fiscal policy, which involves either increasing government spending or decreasing taxes to stimulate aggregate demand. Conversely, in times of inflation, the government might use contractionary fiscal policy, which entails decreasing government spending or increasing taxes to reduce aggregate demand.
Graphically, we can observe that changes in fiscal policy shift the aggregate demand curve. When government spending is increased, or taxes are decreased (expansionary fiscal policy), it encourages more money to circulate in the economy, which shifts the aggregate demand curve outward. When government spending is reduced, or taxes are increased (contractionary fiscal policy), it can slow down the economy and shift the aggregate demand curve inward. Additionally, over time, as the population grows and businesses continue to advance in terms of technology and capital, these changes naturally lead to shifts in the aggregate supply curves. Typically, this is seen as a shift to the right, indicating an increase in the economy's output capacity.