5.1 Fiscal Policy

Question 1

Definition of fiscal policy

Answer 1

The use of government spending (G) and taxation (T) to influence the economic activity or to solve macroeconomic problems such as balance of payments disequilibrium or inflation

Question 2

Expansionary fiscal policy
( government spending > tax rate)

Answer 2

To increase aggregate demand
Increase employment and and output
Inflation
Lowering tax rate increase household disposable income( increase consumption)
Drawbacks
- increase national debt
-

Question 3

Contractionary fiscal policy
( government spending < taxation )

Answer 3

Decreased aggregate demand
Deflation
Higher tax revenue

Drawbacks:
Unemployment

Question 4

Strengths of fiscal policy

Answer 4

A) Ability to target sectors of the economy
B) direct impact of government spending on
AD
C) ability to affect potential output

Question 5

Weakness of fiscal policy

Answer 5

A)Problems of time lags
B) Political constraints (politically unpopular)
C) crowding out effect
- economic theory that argues that rising public sector spending drives down or even eliminates private sector spending
D) in a recession, tax cuts may not be effective in increasing aggregate demand