The government can use <u>an expansionary fiscal policy </u> in the form of <u>an increase in government spending </u> to increase the level of aggregate demand in the economy.
<h3>How does Government Spending Affect the Economy ?</h3>
There is a high possibility that the rise in taxes will negate the impact of rising government spending which would leave Aggregate Demand (AD) unchanged. However, it is possible that increased spending and rise in tax could lead to an increase in GDP.
In a recession, consumers may reduce spending leading to an increase in private sector saving. Therefore a rise in taxes may not reduce spending as much as usual.
The increased government spending may create a multiplier effect. If the government spending causes the unemployed to gain jobs then they will have more income to spend leading to a further increase in aggregate demand. In these situations of spare capacity in the economy, the government spending may cause a bigger final increase in GDP than the initial injection.
However, if the economy is at full capacity, the increase in government spending would tend to crowd out the private sector leading to no net increase in Aggregate demand from switching from private sector spending to government sector spending.
<h3>Which type of policy does the governments adopt to increase the aggregate demand in the economy?</h3>
Expansionary fiscal policy increases the level of aggregate demand, either through increases in government spending or through reductions in taxes. Expansionary fiscal policy is most appropriate when an economy is in recession and producing below its potential GDP.
Therefore, we can conclude that the correct option is C.
Your question is incomplete, but most probably your full question was:
The government can use _____________ in the form of ____________________ to increase the level of aggregate demand in the economy.
A. a contractionary fiscal policy; a reduction in taxes
B. an expansionary fiscal policy; an increase in corporate taxes
C. an expansionary fiscal policy; an increase in government spending
D. a contractionary fiscal policy; an increase in taxes
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