Fiscal and Supply Side Policies

Question 1

What is Fiscal Policy?

Answer 1

The manipulation of government spending, taxation and borrowing to influence the level of economic activity.

Question 2

What are the 3 objectives of Fiscal policy?

Answer 2

Keep inflation at 2%.
Stimulate economic growth and employment during recession.
Maintain a stable economic cycle, minimising boom and bust.

Question 3

What microeconomic targets can fiscal policy have?

Answer 3

Improving education, health and the redistribution of income.
(Fiscal policy also can have supply side effects.)

Question 4

In what scenario is fiscal policy expansionary?

Answer 4

When the government is trying to positively stimulate economically.

Question 5

What are the methods of expansionary fiscal policy?

Answer 5

Cutting taxes, raising government spending, increasing the budget deficit.

Question 6

When is fiscal policy called contractionary?

Answer 6

If the government is trying to constrain AD, reduce debt or control inflation

Question 7

What are the methods of contractionary fiscal policy?

Answer 7

Increasing taxes, cutting government spending, cutting the budget deficit.

Question 8

Expansionary fiscal policy graph - AD analysis

Answer 8

1 - assume the government plan to stimulate economic growth.
2 - may decide to cut taxation, boosting AD to AD1 as consumption rises.
3 - this will increase RNO from Y to Y1
4 - will create employment.
5 - come at the expense of an increase in price level to p1 (hamper inflation target)
6 - if consumption is spent on imports, the balance of payments on current account will worsen.

Question 9

Expansionary fiscal policy - AS analysis

Answer 9

1- assume the government want to stimulate the supply side of the economy
2 - cut corporation tax to boost firms profits which will be reinvested into capital projects.
3 - LRAS will shift to the right to LRAS1.
4 - Productive capacity increased to FE1 and price level fell from P to P1, softening inflationary pressure.
5 - If AD remains unchanged, spare capacity increased in size from Y-FE to Y1-FE1 (a waste of economic resources).

Question 10

Contractionary fiscal policy - AD analysis

Answer 10

1 - Assume the government would like use fiscal policy to maintain its inflationary target of 2% because the economy is having capacity constraints.
2 - may increase taxation, cutting AD to AD 1 as consumption falls.
3 - reduces inflationary pressure, price level falls from P to P1.
4 - benefit of improving the balance of payments on current account as less income is spent on imports.
5 - come at the expense of a reduction in RNO from Y to Y1, damaging economic growth.
6 - falling consumption & lower AD is likely to increase cyclical unemployment.

Question 11

What is Public expenditure?

Answer 11

Entails government spending to pay for the needs of society such as health, education, infrastructure.

Question 12

What is current expenditure?

Answer 12

Short term spending on a day to day running of the country (wages & consumables).

Question 13

What is capital expenditure?

Answer 13

Long term spending on assets (hospitals, schools, infrastructure).

Question 14

What are transfer payments?

Answer 14

They are a redistribution of income where no good or service is provided in return (balance payments).

Question 15

What is the public sector net cash requirement?

Answer 15

The finance required to pay for a budget deficit - difference between expenditure and income.

Question 16

What impact will left and right leaning governments have on public expenditure?

Answer 16

Left leaning - increase public spending to look after the needs of society.
Right leaning - reduce public spending and believe that markets should be left to fend for themselves.

Question 17

What is direct tax?

Answer 17

Imposed on the income of individuals/businesses directly to the government.
- income tax
- corporation tax
- inheritance tax
- national insurance contributions

Question 18

What is indirect tax?

Answer 18

Imposed on goods and services.
VAT, Excise duty, Customs duty.

Question 19

What is progressive and regressive tax?

Answer 19

Increase the proportion of tax as workers earn more, a regressive tax is vice versa. Proportional tax means all workers will pay the same percentage of their income as tax.

(Tax friendly environment to attract foreign businesses and stop domestic business from leaving).

Question 20

What is budget deficit?

Answer 20

When a government receives less income through tax receipts and other government revenue than it spends.

Govt spending > Govt revenue

Question 21

What is budget surplus?

Answer 21

When a government receives more income through tax receipts and other government revenue that it has to pay out in its spending alone.

Question 22

What is the national debt ?

Answer 22

The total amount of money owed by the government.

Question 23

What is a balance government budget?

Answer 23

Where government revenue is equal to government expenditure.

Question 24

Who outlines the future spending of the government ?

Answer 24

The chancellor of Exchequer in march each year.

Question 25

How does fiscal policy improve economic growth?

Answer 25

• expansionary policy works as a short run stimulus to economic growth.
• fiscal stimulus through tax cuts and increased government spending help lift a country out of recession.
• keneysian economics favour this approach and consider increasing the budget deficit in the short run to put the economy back on target.

Question 26

How does fiscal policy improve unemployment?

Answer 26

• Higher government spending leads to higher levels of employment if there are good policies to support training programmes and back to work schemes.
• Fiscal policy improving employment statistics is a vital part of economic policy.

Question 27

How does fiscal policy improve inflation?

Answer 27

• In theory, expansionary policy will boost AD and create inflationary pressure (contractionary policy is the opposite).
• It’s difficult to reach the target inflation using broad instruments (taxation and government spending)
• inflation sources are varied and come from many sources fiscal policy can’t control.

Question 28

How does fiscal policy improve the balance of payments on current account?

Answer 28

• The UK has a high propensity to import, so expansionary policy tends to limit out ability to achieve the target.
• the government can employ expenditure switching policies (taxing foreign imports to make domestic goods more attractive)

Question 29

What are the built in trade offs of fiscal policy?

Answer 29

Expansionary policy - > higher output + lower unemployment
- at the expense of high inflation

Tight fiscal policy control inflation
- but many increase unemployment and damage GDP

Question 30

Is fiscal policy effective?

Answer 30

• the size of the change in government spending or taxation will vary its impact.
• the efficiency and timing of changes will also influence policy effectiveness.
• the multiplier size will influence the size of changes in AD.
• how close to full employment the economy is effects the effectiveness of fiscal policy.
• the time it takes for full effect of tax cuts or spending increases to have the desired effect.

Question 31

what is supply-side policy?

Answer 31

policies that intend to improve the long run productive potentital of the economy.
if its succesful, a supply side policy will shift the production possibilty frontier to the right.

Question 32

what is deregulation (one of 9 Supply side policy options)?

Answer 32

opening markets to freer competition and removing barriers to entry should help to drive productivity gains and boost supply.

Question 33

what is privatisation (one of 9 Supply side policy options)?

Answer 33

The minimisation of state contol which can be inefficient.
Many governments (mainy conservative) have pursued this to privatise key areas of the economy to drive efficency.

Question 34

what is cutting income tax (one of 9 Supply side policy options)?

Answer 34

creates incentives to work and expand the labour force.
It may influence the economically inactive to enter the labour force and boost output.

Question 35

what is cutting corporation tax (one of 9 Supply side policy options)?

Answer 35

increases the profit motive of firms which can be re-invested in captial

Question 36

what is modification of welfare payments ( one of 9 Supply side policy options)?

Answer 36

when the gap between benefits and wages widens to boost work incentives.

Question 37

what is the reformation of Trade uninons (one of 9 Supply side policy options)?

Answer 37

A reduction in trade union power and influence may give rise to lower wage rises (feeding through to lower inflation) and more labour market flexibiliity.

Question 38

what is training and education (one of 9 Supply side policy options)?

Answer 38

improves productivity, mobility and flexibility of the workforce.

Question 39

what is investment grants (one of 9 Supply side policy options)?

Answer 39

offering incentives to invest in captial.

Question 40

what is regional/industrial policy (one of 9 Supply side policy options)?

Answer 40

It provides incentives for firms to set up in depressed regions.

Question 41

what is human capital?

Answer 41

the knowledge, experience and skill possed by an indivdual viewed in terms of value to their country or organisation.

Improving human capital could be seen as a merit good that benfits society in the long run, leading to economic growth.

Question 42

how does supply side policy improve human captial?

Answer 42

• the government invest in education and training to improve the skills and qualifications of the workforce.
• tax incentives are given to get people back to work
• A better educated workforce will help increase the productive capacity of the economy leading to growth, greater employment and higher living

Question 43

how does supply side policy effect inequality?

Answer 43

• extreme income inequality is generally unacceptable, we should be able to acess fair wages
• studies suggest that increasing income equality will lead to high level of economic growth and a better living standard.

Question 44

how do the government adopt the findings of the National infrastructure assesment (NIA)?

Answer 44

through the national infrastructure structure (NIS)?

Question 45

How can supply side improvements occur independently of the government?

Answer 45

• if there is confidence in the economy, businesses may expand their production of goods and services, investing in new and efficent capital processes.

-firms may believe the economy is likely to grow in the future, so invest now to meet demand.

• competition may be so intense among leading firms that innovation is driven be a desire to gain market share

Question 46

EXPANSIONARY SUPPLY SIDE POLICY analysis

Answer 46

1 - if the economy is running against capacity constraints, the government may implement supply side policy
2 - investment (training and education) should boost LRAS TO LRAS 1
3 - positive effect on inflation as the price level moves from P to P1
4 - economic growth is enhanced to Y1 creating employment. Productive potential increases to FE.
5 - a highly skilled workforce may improve the competitiveness of UK exports in quality and quantity which may improve the balance of payments on the current account (if ceterus paribus)

Question 47

IS supply side policy effective?

Answer 47

TIME LAGS - policies have time lags in terms of effectiveness, traning and education may take years to feel its full effects.
COST - may be expensive to implement (HS2 costs 42bn)
POLICIES OF COMPETING NATIONS - competitiors (USA, china, germany) will also implement supply side policies , if more effective than the UK’s then anticipated gains in INT trade may not occur.
LIKELIHOOD OF GOVERNMENT FALIURE - cases of poorly administered government supply side policies that have the desired outcome.