Question

What are the options available under fiscal policy if we are in an expansionary gap? Which is more effective? Why?

Answer 1

If the economy is in expansionary gap then the aggregate demand is more than the potential output. To control the output and price rise in the market, the government will have to increase the taxes and reduce the government purchases in the market.

Reduction in the government purchases will be more effective because government purchases is part of the aggregate demand and fall in purchases will shift the AD curve to the left and bring the ecoomy back to the equilibrium.