Fiscal Policy Based on Aggregate Demand
This Demonstration shows whether contractionary or expansionary fiscal policy is necessary, based on where an arbitrary aggregate demand curve is in relation to a corresponding short run aggregate supply curve. The current employment and full employment lines are also shown relative to the aggregate demand (AD) and short run aggregate supply (SRAS) curves. Based on the AP Macroeconomics curriculum, it is assumed that the SRAS curve exhibits exponential growth past the level of full employment. This simple model demonstrates the relation of AD to SRAS and the effects of fiscal policy on employment and output.
This is a basic model using ideas in the AP Macroeconomics curriculum and as such should not be construed as covering a full realization of all possible economic states. For instance, the policy described here is solely fiscal, where it is assumed that monetary policy must be held constant over this period of changing AD. The counterpoint to a demand-based fiscal policy is a supply-based policy of subsidies for businesses and decreasing corporate taxes. The real world is where these factors are all correlated, and if AD increases beyond full employment while monetary policy is held constant, then inflation of prices will occur, as well as expansion of the national output.
While it would be optimal for the vast majority of the citizens if the government and the Federal Reserve acted so as to use fiscal policy to target full employment, the reality is that the last time any such expansionary fiscal policy was tried in the USA was in 2009, but its effects were limited by a long period of austerity policies and reduced government spending. Expansionary fiscal policy is otherwise called Keynesian spending; contractionary policy is called fiscal austerity and is the reduction of government spending, usually by cutting social services.
This was a project for Advanced Topics in Mathematics II, 2016–2017, Torrey Pines High School, San Diego, CA.