2.5 Fiscal policy and supply side policies

Question 1

Fiscal policy

Answer 1

the use of taxation and government spending to achieve policy objectives

Question 2

direct tax

Answer 2

a tax which cannot be shifted by the person legally liable to pay the tax onto someone else. They are normally levied on income and wealth.

Question 3

Income tax

Answer 3

a direct tax levied on personal income

Question 4

Income tax threshold

Answer 4

the level of income above which people pay income tax

Question 5

Indirect tax

Answer 5

a tax which can be shifted by the person legally liable to pat the tax onto someone else, for example through raising the price of a good being sold by the taxpayer. They are normally levied on spending

Question 6

Progressive tax

Answer 6

a tax when, as income rises, a greater proportion of income is paid in taxation

Question 7

proportional tax

Answer 7

a tax when, as income rises, an equal proportion of income is paid in taxation

Question 8

regressive tax

Answer 8

a tax when, as income rises, a smaller proportion of income is paid in taxation

Question 9

wage elasticity of supply of labour

Answer 9

proportionate change in supply of labour following a change in the wage rate

Question 10

laffer curve

Answer 10

• a curve which shows the levels of tax revenue relative to the income tax rate
• if tax cuts cause incomes to rise (due to incentives) proportionally more than the tax rate has fallen, tax revenues will increase
• if tax increases cause income to fall proportionally more than the tax rate has risen, then tax revenues will decrease

Question 11

Describe the shape of an individual workers labour supply curve

Answer 11

• workers face an opportunity cost - labour vs. leisure
• an individual has a backward bending supply curve
• at a certain point hourly wage rate will be large enough to cause people to want more leisure hours, since leisure time is a normal good

Question 12

Why collect taxes? (4)

Answer 12

• to pay for government expenditure
• to correct market failures such as externalities
• to manage the level of spending in the economy
• to redistribute income

Question 13

policy instrument

Answer 13

a tool or set of tools used to try and achieve a policy objective

Question 14

Balanced budget

Answer 14

occurs when government spending equals government revenue (G=T)

Question 15

budget deficit

Answer 15

occurs when government spending exceeds government revenue (G>T)

Question 16

budget surplus

Answer 16

occurs when government revenue exceeds government spending (G<T)

Question 17

public sector borrowing

Answer 17

borrowing by the government and other parts of the public sector to finance a budget deficit

Question 18

national debt

Answer 18

the amount of accumulated debt, resulting from past government borrowing, that is owed by the UK government

Question 19

multiplier

Answer 19

the relationship between an initial change in aggregate demand and the resulting usually larger change in national income

Question 20

cyclical unemployment

Answer 20

those unemployed because there is a lack of economic activity in the economy and their labour is not demanded due to the existence of sticky wages (e.g. during a recession)

Question 21

contractionary policies

Answer 21

policies aimed at reducing aggregate demand

Question 22

expansionary policies

Answer 22

policies aimed at increasing aggregate demand

Question 23

Describe expansionary fiscal policy

Answer 23

• budget deficit (G>T)
• lower taxes increases disposable incomes, C↑, AD↑
• increased government spending on services in the economy creates new jobs

Question 24

How can fiscal policy be used to influence AS?

Answer 24

• The government could reduce income and corporation tax to encourage spending and investment.
• The government could subsidise training or spend more on education. This lowers costs for firms, since they will have to train fewer workers. Spending more on healthcare helps improve the quality of the labour force, and contributes towards higher productivity.
• Governments could spend more on infrastructure, such as improving roads and schools.

Question 25

supply-side economics

Answer 25

a branch of free-market economics which argues that government policy should be used to improve the competitiveness and efficiency of markets with an aim to increase the productive potential of an economy

Question 26

supply side policies

Answer 26

the use of policy instruments to create more competitive and efficient markets with an aim to increase the productive potential of an economy

Question 27

interventionist supply-side policies

Answer 27

the regulation or replacement of free markets with an aim to promote competition and efficiency aiming to increase the productive potential of an economy

Question 28

non-interventionist supply-side policies

Answer 28

the freeing-up of markets, promotion of competition, promotion of efficiency, and a reduction in the economic role of the government with an aim to increase the productive potential of an economy

Question 29

privatisation

Answer 29

the transfer of publicly owned assets to the private sector

Question 30

marketisation

Answer 30

the provision of goods and services shifting from the non-market sector to the market sector

Question 31

deregulation

Answer 31

the removal of rules which restrict economic action

Question 32

contractualisation

Answer 32

services that are provided by the government being contracted to private sector bidders

Question 33

supply-side improvement

Answer 33

reforms undertaken by the private sector to reduce costs to enable firms to become more productively efficient and competitive

Question 34

aims of supply side policies (5)

Answer 34

• increase incentives
• promote competition
• reform the labour market
• improve skills and quality of the labour force
• improve infrastructure

Question 35

Strengths of supply-side policies (1)

Answer 35

• Supply-side policies are the only policies which can deal with structural unemployment, because the labour market can be directly improved with education and training.

Question 36

Weaknesses of supply side policies (3)

Answer 36

• Demand-side policies are better at dealing with cyclical unemployment, since they can reduce the size of a negative output gap and shift the AD curve to the right.
• There are significant time lags associated with supply-side policies.
• Market-based supply-side policies, such as reducing the rate of tax, could lead to a more unequal distribution of wealth.

Question 37

Office for budget responsibility

Answer 37

an advisory public body that provides independent economic forecasts and analysis of the public finances as background to perpetration of the UK budget

Question 38

Duties of the Office of Budget Responsibility (4)

Answer 38

• forecasts of the economy and public finances
• evaluation of the government’s performances against its fiscal targets
• scrutiny of the government’s policy costings
• assess the long-term sustainability of the public finances

Question 39

Canons (or principles) of taxation

Answer 39

criteria used for judging if a tax is good or not

Question 40

What are the six canons of taxation?

Answer 40

• economy - a tax must be cheap relative to the revenue it yields
• convenience - a tax must be convenient for taxpayers to pay
• certainty - taxpayers must be reasonably certain of the amount they will be expected to pay
• equity - a tax must be fair
• efficiency - a tax must achieve its desired objectives with minimum intended consequences
• flexibility - a tax must be easy to change to meet new circumstances

Question 41

Economic cycle

Answer 41

regular fluctuations in the level of economic activity around the productive potential of the economy. In the cycle the economy moves from troughs, when it is operating below its productive capacity, to booms when it is operating above its productive capacity

Question 42

Automatic stabilisers

Answer 42

features of modern government budgets, particularly income taxes and welfare spending, that act to dampen fluctuations in real GDP and reduce the size of output gaps

Question 43

Cyclical budget deficit

Answer 43

the part of the budget deficit which rises in the downswing of the economic cycle and falls in the upswing of the cycle

Question 44

Structural budget deficit

Answer 44

the part of the budget deficit which is not affected by the economic cycle but results from structural change affecting the government’s finances

Question 45

Examples of microeconomic supply-side policies - industrial policy measures (5)

Answer 45

• privatisation
• marketisation
• deregulation
• internal markets
• subsidising spending on research and development

Question 46

Examples of microeconomic supply-side policies - labour market measures (6)

Answer 46

• lower rates of income tax
• reducing state welfare benefits relative to average earnings
• changing employment law to reduce the power of trade unions
• repealing legislation which limits employers’ freedom to employ
• more flexible pension agreements
• improving the training of labour

Question 47

Examples of microeconomic supply-side policies - financial and capital market measures (4)

Answer 47

• deregulating financial markets
• encouraging saving
• promoting entrepreneurship
• reducing public spending and public-sector borrowing

Question 48

Financial crowding out

Answer 48

when governments borrow money to finance a deficit, and in doing so increase the interest rate for consumers and firms, reducing their availability of credit

Question 49

Current government expenditure

Answer 49

Current spending is short term and has to be renewed. For example, it could be on drugs for the health service

Question 50

Capital government expenditure

Answer 50

spending on physical assets like roads, bridges, hospital buildings and equipment. Capital spending is long term as it does not have to be renewed.