ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -A contractionary fiscal policy can shift aggregate demand down from AD0 to AD1, leading to a new equilibrium output E1, which occurs at potential GDP.

Detailed explanation-2: -Contractionary fiscal policy decreases the level of aggregate demand, either through cuts in government spending or increases in taxes. Contractionary fiscal policy is most appropriate when an economy is producing above its potential GDP.

Detailed explanation-3: -Fiscal policy that increases aggregate demand directly through an increase in government spending is typically called expansionary or “loose.” By contrast, fiscal policy is often considered contractionary or “tight” if it reduces demand via lower spending.

Detailed explanation-4: -Contractionary monetary policy is enacted to halt exceptionally high inflation rates or normalize the effects of expansionary policy. Tightening the money supply discourages business expansion and consumer spending and negatively impacts exporters, which can reduce aggregate demand.

Detailed explanation-5: -To enact contractionary fiscal policy, the government may decrease spending, increase taxes, and enact a combination of decreased spending and increased taxation.