2.6.2 Demand-side policies

Question 1

What is fiscal policy?

Answer 1

Government led policies relating to any of these areas:
- government spending (e.g. subsides)
- taxation (revenue)
- budget balance (e.g. borrowing)

Question 2

Types of fiscal policy (taxation)

Answer 2

Direct:
- income tax
- corporation tax: tax on company profits
- National Insurance contributions: for certain state benefits
- inheritance tax: tax on transfer of money/property
- council tax: tax on property (bands)

Indirect:
- VAT: tax on spending
- capital gains tax: tax on profit earned from the sale of assets (houses/shares/bonds)
- excise duties: unit tax on sale of luxury goods (alcohol/tobacco/fuel/betting)
- stamp duty: paid when you purchase a property (rate based on value)

Taxes can be progressive, proportional or regressive.

Question 3

Progressive tax

Answer 3

When the percentage of income taken in tax rises as income rises (e.g. income tax)

Question 4

Proportional tax

Answer 4

Flat rate of tax:
When the percentage of income paid in tax is the same for each household (e.g. NICs)

Question 5

Regressive tax

Answer 5

Where the percentage of income taken in tax falls as income rises (e.g. VAT/duties)

Question 6

Why do governments impose taxes?

Answer 6

• to raise money for government spending
• to discourage the consumption of demerit goods
• to redistribute income within the economy
• to influence competitiveness
• to influence the level of AD in an economy

Question 7

Advantages of income tax

Answer 7

Advantages:
- more fair (progressive)
- can be used to improve the wealth gap
- easy to pay as it is dealt with by employers

Question 8

Disadvantages of income tax

Answer 8

Disadvantages:
- can act as a disincentive for workers to work harder to to work at all
- the tax bands and progressive system make it more complex

Question 9

Advantages of VAT

Answer 9

Advantages:
- hard for consumers to avoid
- consumers can still have a choice on what they spend their money on

Question 10

Disadvantages of VAT

Answer 10

Disadvantages:
- usually regressive
- changes in VAT can cause inflation
- increased costs of production for firms can make them less internationally competitive

Question 11

What does the Laffer curve show?

Answer 11

The optimal tax rate in an economy, represents the relationship between the tax rate and the amount of government revenue earned

Question 12

Types of government spending

Answer 12

• capital spending: investments in infrastructure that improves future productive capacity (e.g. new roads)
• current spending: day-to-day running expenses of the public sector (e.g. public sector worker salaries)
• transfer payments (e.g. pensions)

Question 13

Reasons for government spending

Answer 13

• to provide public and merit goods
• to inc. the productive capacity of the economy
• to influence the level of demand
• to incentivise the production of goods with social benefits
• to improve the wealth gap

Question 14

Fiscal/budget deficit

Answer 14

When government expenditure exceeds tax revenue

Question 15

Fiscal/budget surplus

Answer 15

When government tax revenue exceeds expenditure

Question 16

What are National Insurance Contributions?

Answer 16

Contributions paid by all employers and employees towards the cost of certain state benefits

Question 17

What is capital spending?

Answer 17

Investment on infrastructure that improves the future productive capacity/growth of an economy (e.g. new roads/buildings/weapons)

Question 18

What is current spending?

Answer 18

Day-to-day expenses of the public sector (e.g. public sector worker salaries/health services)

Question 19

What are transfer payments?

Answer 19

Money transferred to those who produced goods/services to those who do not/are not productive in the economic sense (e.g. pensions/Job Seeker’s Allowance)

Question 20

What are public goods?

Answer 20

Goods that could not be provided effectively through private businesses due to problems such as the free-rider problem, non-rivalry and non-excludability, so the govt. has to provide them so everyone has equal access (e.g. street lighting/traffic signals/road markings)

Question 21

What are merit goods?

Answer 21

Goods that would be under-consumed and under provided if left to private individuals/businesses to provide (e.g. healthcare/education)

Question 22

What is social protection?

Answer 22

Government spending on pensions and benefits (income support/disability benefits)

Question 23

Why does the government pay for social protection?

Answer 23

Due to the aging population/rising costs of production and underemployment/low-paid work

Question 24

What is debt interest?

Answer 24

Interest paid to bond holders who lend the government money when govt. expenditure exceeds govt. tax revenue, which contributes to total national debt rising

Question 25

How does capital spending benefit the economy?

Answer 25

• improves the productive capacity/potential (LRAS outwards)
• economic growth
• multiplier effects from large-scale infrastructure investments

Question 26

How does current spending benefit the economy?

Answer 26

• employment and wages(salaries) for public sector workers: inc. in living standards
• provides more essential services (healthcare): healthier population
• inc. flow of money in CFI: inc. in disposable income leading to an inc. in C (AD outwards)
• more productive workforce

Question 27

How do transfer payments benefit the economy?

Answer 27

• improved income/wealth equality
• inc. flow of money in the CFI: especially during recessions as many are out of work (AD outwards)
• reduces the impact of lost flows of money: from an aging population (large no. of retired people)

Question 28

How do public goods benefit the economy?

Answer 28

• improved social welfare/equality: equal access
• improved safety
• improved efficiency/productivity: quicker travel times (SRAS outwards)

Question 29

How do merit goods benefit the economy?

Answer 29

• healthier/skilled population
• combats the underconsumption of merit goods
• more productive workforce (LRAS outwards)