Fiscal Policy and Aggregate Demand

Fiscal policy is the use of government spending and taxation to influence aggregate demand (AD). It is one of the most tested ideas on the AP Macroeconomics exam because it connects a policy action to output, the price level and unemployment in a single chain.

The reasoning chain

Expansionary fiscal policy means higher government spending or lower taxes.

1. Higher spending or lower taxes raises AD.
2. AD shifts right along the short-run aggregate supply curve.
3. Real GDP rises, unemployment falls, and the price level rises.

Contractionary policy runs the chain in reverse: AD shifts left, output and the price level fall.

Worked point

Suppose the economy is in a recession below full employment. An increase in government spending shifts AD to the right. On your graph, draw AD1 to AD2, show real output rising toward the full employment line, and label the higher price level.

The FRQ approach

A written answer plus a wrong graph loses points, and the reverse is also true. Draw the AD and AS axes, shift the correct curve in the correct direction, and state what happens to output, the price level and unemployment. That labelled chain is what earns the marks.