4.3 fiscal policy

Question 1

What is fiscal policy

Answer 1

Fiscal policy is a government policy which adjusts government spending and taxation to influence the economy.

Question 2

What are the 2 types of fiscal policy

Answer 2

Expansionary
Contractionary

Question 3

What is expansionary fiscal policy

when to use (2 instances)

aka

Answer 3

Involves reducing taxes and increasing govt. spending to boost demand, so employment and output rises.

when to use: During an economic recession - demand and output is falling, high unemployment
or
when there is a large budget surplus

aka: reflationary

Question 4

What is contractionary fiscal policy

when to use (2 instances)

aka

Answer 4

Involves increasing taxes and reducing govt. spending to reduce demand.

When to use: times of high inflation
When there is a budget deficit

aka: deflationary

Question 5

Analyse expansionary fiscal policy

a risk

Answer 5

Cutting taxes on profits - incentivize firms to increase output and invest in new productive capacity.

cutting taxes on personal incomes - encourage people to participate in productive activity. Motivate employees to increase their output

Output and employment rises

risk:
people may chose to spend money on imported goods or save more. defeats the purpose

Question 6

list the problems with fiscal policy

Answer 6

cumbersome to use
Crowds out private spending
Can reduce incentives to work and enterprise
Expansionary fp causes expectations of inflation

Question 7

Why are fps cumbersome to use

Answer 7

Difficult for the govt to know when and by how much to change public spending and taxes exactly. Sometimes they may cut taxes too much, which leads to aggregate demand increasing at a faster rate than aggregate supply which leads to high inflation

vice versa if taxes are increased too much then unemployment could rise aggregate demand would fall. and businesses need to cut down cost of production

Question 8

What is crowding out
how is it related to fps

Answer 8

The more govts borrow from pvt sector to fund expansionary policies the less the pvt sector has to spend on itself.

Question 9

Why can fps reduce incentives to work and enterprise

Answer 9

High taxes = reduced work effort
Reduces labour productivity, total output and profits.

If producitivity falls, cost of production for firms would rise. could lead to unemployment

Question 10

Why do fps create expectations of inflation

Answer 10

When expansionary fp is used then people and business may predict inflation to be coming. workers could demand higher wages which in turn would speed up inflation (cost push inflation)

Rising wages would also lead to higher cost of production which could lead to unemployment.