Explanation of Contractionary Fiscal Policy
1. Decrease the Government expenditure (G) component of AD by building less infrastructure such as roads or expansion of the railway lines
2. Decrease the Consumption expenditure (C) component of AD by giving less transfer payments such as cash vouchers to households. With lesser disposable income and purchasing power, consumers will likely reduce their demand for consumer goods and services
3. Decrease the Consumer expenditure (C) and Investment expenditure (I) components of AD by raising direct taxes (T). Higher income tax means that households will have lesser disposable income. With the fall in purchasing power, households are less likely to spend on consumer goods/services to satisfy their wants. Higher corporate tax (which lowers expected after-tax profit) will reduce the post-tax expected rate of returns on investment for firms. With lower returns on investment, firms (being profit-motivated) will likely lower their investment expenditure
