Final answer:
Expansionary fiscal policy involves increasing aggregate demand through increased government spending and reducing personal income and business taxes. It aims to boost economic activity during a recession and move the economy towards its potential GDP.
Step-by-step explanation:
The rules included in expansionary fiscal policy are focused on increasing the level of aggregate demand to counteract economic downturns. To achieve this, the policy may involve:
- Increasing government spending on final goods and services can also result in higher federal grants to state and local governments.
- Reductions in personal income taxes or payroll taxes to raise disposable income and boost consumption.
- Cuts in business taxes to increase after-tax profits and encourage investment spending.
Expansionary fiscal policy is typically deployed when an economy is in a recession with output below its potential GDP. By shifting the aggregate demand curve to the right, it is possible to move the economy toward a new equilibrium with output at the level of potential GDP, as suggested by the Long-Run Aggregate Supply (LRAS) curve. This is designed to reduce unemployment without causing significant inflationary pressures.