Demand-side policies - Fiscal Policy

Question 1

Demand-side policies

Answer 1

Demand-side policies: policies that aim to manipulate aggregate demand (AD) to
achieve the macroeconomic objectives.
Fiscal policy: use of taxation, government spending and government borrowing
to influence the economy.
Monetary policy: use of interest rates and the money supply to affect AD – run
by the independent Bank of England in the UK.

Question 2

Fiscal policy: taxation

Answer 2

Direct tax: a tax on income/wealth e.g. income tax, employee NICs, corporation
tax, capital gains tax
Indirect tax: a tax on spending e.g. VAT, excise duties
Progressive tax: a tax that takes a higher proportion of income from those on
higher incomes.
Proportional tax: a tax that takes the same proportion of income whatever the
level of income.
Regressive tax: a tax that takes a lower proportion of income from those
on higher incomes.

Question 3

Public spending

Answer 3

Public spending: spending by the government to influence AD.

Current spending: government consumption G = spending on the say-
today costs of running public services e.g. wages of teachers, energy bills

for hospitals; directly affects AD.
Capital spending: government investment in the economy’s
infrastructure e.g. building hospitals & housing, new roads/railways etc

Question 4

Using demand-side fiscal policy to influence the economy

Answer 4

Increasing public spending adds to the G component of AD (same shift as
in diagram on income tax cut; if government increases its spending on

capital projects, this increases the I component of AD (and in the long-
term, if successful, could also shift AS to the right)

Question 5

Government borrowing

Answer 5

Budget deficit or fiscal deficit: is the annual amount the government
borrows to make up the gap between its income (mostly tax revenue)
and its spending. A net injections into the circular flow G>T; it is a flow
National debt (public sector net debt): a stock of the total
accumulation of budget deficits (government borrowing) that is still to
be repaid.
Balanced budget: G=T
Budget surplus: a net withdrawal from the circular flow G<T; the
government may be able to pay back some of its debt.

Question 6

Using demand-side fiscal policy to influence the economy

Answer 6

Increasing the budget deficit is a net injection into the economy; it adds
to AD; if the government borrows to invest this also adds to AD (and can
add to AS too). AD shifts right as in the diagram.
A fiscal multiplier may kick in further stimulating growth.