demand side policies Flashcards
what are demand side policies
involve the government manipulating AD in order to achieve macroeconomic objectives.
what is fiscal policy
is the government manipulation of tax rates, government spending and government borrowing to influence AD and the performance of the economy.
what is contractionary fiscal policy?
A contractionary fiscal position is when tax rates are increased and/or government spending is reduced. This decreases AD and reduces the rate of inflation
what is expansionary fiscal policy?
An expansionary fiscal position is when tax rates are decreased and/or government spending is increased. This increases AD and increases the rate of inflation
what is a budget deficit?
When the economy is growing slowly, the government can run an expansionary fiscal policy to boost AD: The government can reduce taxes and increase government spending to pump spending power into the economy.
change in income tax effect?
Income Tax: A reduction in income tax increases disposable income, which leads to a rise in consumption and hence AD
change in corporation tax effect?
A reduction in corporation tax increases firms’ retained profits, which leads to a rise in investment and hence AD.
change in gov. spending effect?
Government Spending: Increasing government spending increases AD directly because G is a component of AD).
multiplier is what?
Multiplier: Government spending creates more jobs (e.g. for builders). The incomes earned by these workers will be re-‐spent in the economy, creating new incomes-‐ the multiplier effect.
overall effect of gov. spending and multiplier?
Therefore, AD increases and the AD curve shifts to the right. If the economy is below full capacity, there is a rise in price and output. If the economy is at full capacity, there is a rise in price only.
However, the government need to limit the extent of the deficit to prevent inflation reaching too high a point.
whats an example of multiplier in action?
For example, if the government builds a new hospital and does not pay for it all through current taxation, but instead borrows to finance the scheme, there will be an increase in AD. When the government pays for the workers and building materials for the hospital, the incomes will be re-‐spent in the economy-‐ the multiplier effect.
Evaluation: How effective is Fiscal Policy? 1 (AD)
Magnitude (size of change in G and T)
Time Lag (in UK fiscal policy can only be implemented in annual budget, so there is time lag.
Implementation Lag (can only be implemented at start of fiscal year, effect delayed further)
Multiplier (The magnitude of the effect depends on the size of the multiplier. The larger the MPS, the smaller the multiplier, and hence the smaller the effect on AD.)
Evaluation: How effective is Fiscal Policy? 2 (AD)
Response of workers (When the government sets out to expand its spending, people try to cash in on this by increasing their pay demands, so the effect will be increased wages and costs rather than expanded output.)
Effect on Private Sector (Government spending reduces the scope for private firms to supply the same service. For example, if the government built a hospital, there is less scope for a private hospital in the area to provide the same service.)
Evaluation: How effective is Fiscal Policy? 3 (AD)
Inflationary or Deflationary Effects (A fiscal deficit aimed at boosting the economy can cause high inflation rates if it is not managed well.
A fiscal surplus aimed at reducing inflation can cause higher unemployment if it is not managed well.)
Spare Capacity (If the economy is at maximum efficiency (at the point where the LRAS curve is vertical), a change in AD will have no effect on output and will only affect the price. Therefore the effect of the fiscal intervention is only inflationary for a budget deficit or deflationary for a budget surplus. Hence, the elasticity of the AS curve at where the AD curve shifts determines the effect of the fiscal position)
Evaluation: How effective is Fiscal Policy? 4 (AD)
Effect on BOP (If AD increases, income increases, which leads to an increase in imports. But there is no immediate reason for exports to change, so in the short run there is likely to be an increase in the current account deficit.
Out-dated information (t takes a long time to collect data about economic performance, so once the government have information with which to decide their Fiscal position, the information will be out of date-‐ the economy will have changed.)
Economic Growth (The shift in AD leads to actual growth, but does not lead to potential growth-‐ this would require the AS curve to shift to the right (see below)
