Final answer:
Sri Lankan policy makers should consider expansionary fiscal policies to increase Aggregate Demand and Economic Growth in the case of a recession, but must tailor these policies to the country’s specific economic conditions. Expansionary policies can include tax cuts and increased government spending, which, according to Keynesian economics, can shift aggregate demand to the right and stimulate economic activity toward an economy's full potential as shown in the AD/AS model.
Step-by-step explanation:
Regarding whether the policy makers of the Sri Lankan government should use expansionary fiscal policies to increase Aggregate Demand and Economic Growth, the answer is context-dependent. Expansionary fiscal policy includes methods such as reducing personal income taxes or payroll taxes to spur consumer spending, lowering business taxes to boost investment, and increasing government spending on goods and services. In a macroeconomic context, the aggregate demand/aggregate supply model illustrates how such policies can move the aggregate demand curve to the right, potentially leading to increased economic activity and growth.
For example, if Sri Lanka's economy is in a recession with aggregate demand at ADr, expansionary fiscal policies could be applied to shift aggregate demand to the right towards ADf, aiming to achieve potential GDP and full employment. This is in line with Keynesian macroeconomics, which maintains that to tackle a recession, stimulating consumption and investment through tax cuts or increasing government spending is vital. However, it is important to take into account the country's specific economic conditions such as current levels of debt, inflation, and unemployment before applying such policies.
Graphical illustration using the aggregate demand/aggregate supply (AD/AS) model would depict a rightward shift in the aggregate demand curve, from ADr to ADf, representing the policy's intended effect of boosting economic activity toward the economy's full potential.