Answer to Question #134445 in Economics of Enterprise for Mivasha

Question

Explain how fiscal policy can be implemented if an economy is in the downswing of a business cycle

Answer 1

The down swing of a business cycle is characterized with falling output. Therefore, expansionary fiscal policies are required to stimulate demand, investment, and hence gross domestic product. There are two instruments in fiscal policy: taxation and government expenditure. The government can reduce taxation, both direct and indirect taxes, and increase its spending in the economy as an expansionary fiscal policy to deal with falling output: downswing.

Reducing taxation increases consumer disposable income thereby stimulating demand. Lower corporate taxes also motivate firms to expand output. Eventually, with a decrease in taxation, aggregate demand increases due to an increase in consumption and investment spending in the economy. The downswing will then turn into an upswing.

The increase in government spending in the economy increases aggregate demand since government spending is a component of aggregate demand. Government spend on both consumables and investment goods. The end result is an increase in gross domestic product and an elimination of the recessionary gap: upswing.