How does fiscal policy directly affect aggregate demand?

Fiscal policy directly affects aggregate demand primarily through adjustments in government spending and taxes. When the government increases its spending, it injects additional money into the economy, which can stimulate overall demand for goods and services. This increase in spending can lead to more jobs, higher consumer income, and increased consumption, all of which contribute to higher aggregate demand.

Similarly, changes in taxation can also have a significant impact on aggregate demand. For instance, when taxes are lowered, consumers have more disposable income, which can lead to increased consumption. Conversely, an increase in taxes can reduce disposable income and lead to lower aggregate demand.

By using fiscal policy tools such as government spending and taxation, policymakers can influence economic activity directly, making this approach a core component of how aggregate demand is shaped.