Question 29

The aggregate demand curve shifts to the left.

When the government implements a contractionary fiscal policy, such as reducing spending or increasing taxes, the aggregate demand curve shifts to the left. This indicates a decrease in the overall demand for goods and services in the economy.

A) Remains unchanged

This option is incorrect because contractionary fiscal policy is specifically designed to decrease aggregate demand. Therefore, the aggregate demand curve cannot remain unchanged; it must respond to government actions by shifting.

B) Becomes horizontal

This option is incorrect as well. A horizontal aggregate demand curve would imply that price levels do not change regardless of the quantity of goods demanded, which is not the case when contractionary fiscal policy is applied. The curve would not become horizontal but instead shift to reflect lower demand.

C) Shifts to the left

This option is correct. A contractionary fiscal policy leads to reduced government spending or increased taxes, resulting in a decrease in the overall demand in the economy. This is accurately represented by a leftward shift of the aggregate demand curve.

D) Shifts to the right

This option is incorrect because a shift to the right would indicate an increase in aggregate demand, which contradicts the effects of contractionary fiscal policy. The goal of such a policy is to reduce demand rather than increase it.

Conclusion

The correct response is that the aggregate demand curve shifts to the left when contractionary fiscal policy is enacted. This is due to the reduction in government spending or increase in taxes, which decreases overall demand in the economy. All other options fail to accurately reflect the impact of contractionary fiscal measures on aggregate demand.