Final answer:
Fiscal policy, including increased government spending and tax cuts, is used to address a recessionary gap by shifting the aggregate demand upward in the AD-AS model, moving the economy towards potential GDP.
Step-by-step explanation:
The question pertains to the analysis of fiscal policy actions using the aggregate demand and supply (AD-AS) model within the context of macroeconomics. When an economy is experiencing a recessionary gap, it implies that the actual output is less than potential GDP, representing underutilized resources, including labor. Fiscal policymakers can utilize tools such as increases in government discretionary spending and decreases in personal income taxes to stimulate economic activity.
Represented graphically, an increase in government spending or a decrease in taxes would shift the aggregate expenditure function upwards in the AD-AS model. This shift, depicted as AEo to AE₁, results in a new equilibrium (E₁) at the level of potential GDP. Specifically, these actions serve to increase aggregate demand, reducing the recessionary gap and helping to bring output and employment back to their potential levels.
If we consider a scenario where policymakers enact tax cuts, this can be shown in the AD-AS diagram as well. Tax cuts increase consumers’ disposable income, which increases their consumption, thereby increasing aggregate demand. This shift in the aggregate demand curve can be a tool to lead the economy out of a recession, as claimed by some policymakers.