Economic Policies

Question 1

What is Fiscal Policy?

Answer 1

When the government controls government spending and taxes to improve the economy

Question 2

What is expansionary fiscal policy

Answer 2

when the government increases government spending and reduces taxes but worsens the budget deficit

Question 3

what is contractionary fiscal policy

Answer 3

when the government cuts government spending and increases taxes but improves the budget deficit

Question 4

What does lower income tax lead to

Answer 4

High income earners will pay less so they have more disposable income. This will lead to them spending more and thus increasing consumption which leads to an increase in AD

Question 5

What is the immediate effect of reducing taxes?

Answer 5

Decrease in tax revenue

Question 6

What is the downward multiplier effect?

Answer 6

A higher income tax rate means workers have a lower disposable income and therefore consume less. The decrease in consumption decreases aggregate demand. As consumers spend less, firms will make fewer sales and therefore less profit. This means that they can invest less and so AD will decrease further as investment is a positive component of AD.

As consumers spend less and firms make less profit, corporation tax and VAT revenues will decrease. This means the government can spend less and so AD will decrease further. As firms contract, they will decrease their derived demand for labour and so incomes will decrease. This will further decrease spending and income tax revenue and so consumption and government spending will further decrease. So, the overall impact on aggregate demand will be much larger.

Question 7

An advantage of raising income tax on high earners

Answer 7

Raising the income tax rate for high earners decreases their disposable income. This will decrease consumption and aggregate demand, which will help to bring the price level down and control inflation. Also, a higher income tax rate will increase income tax revenue and help the government to balance its budget.

Question 8

When inflation rate is below its target, what is the central bank likely to do?
(In reference to interest rates)

Answer 8

They will reduce interest rates. This will encourage consumers to save less and consume more. It will also encourage firms to invest as it is cheaper to borrow. Both of these will increase AD and inflation

Question 9

What group of people will spend more if interest rates increase?

Answer 9

Pensioners. Because they get their disposable income from the interest on savings. Thus, if interest rates increase, pensioners will have more disposable income