Fiscal Policy Flashcards
Role of the Government Nationally/ Locally
It owns industries such as schools and hospitals, produces goods,
provides regulations and laws and collects taxes.
- Why does the government produce goods:
- Essential goods
- Goods which would be underproduced by the private sector
- Goods which have strategic importance
Role of the government internationally?
- Place restrictions on imports and exports
- Choose whether to promote free international trade
- Create policies towards multinational companies
- Join trade blocks
Main aims of the Government?
Economic growth
Low unemployment
Price stability
Balance of payments stability
Redistribution of income
Economic growth Definition
Economic growth is an increase in the output of an economy.
• In the long run it is also an increase in the productive potential.
Actual economic growth definition
Actual economic growth: increase in output of the economy
Potential economic growth definition
Potential economic growth: increase in the economy’s productive capacity
How can economic growth be analyzed?
Economic growth can also be analyzed using Aggregate Demand and Aggregate Supply
What is AD?
AD is the total demand for a country’s products. (Consumer expenditure + Investment + Government Spending + Net Exports)
What is AS?
AS the number of goods and services that domestic firms are willing and able to sell.
What is economic growth (the aim)?
Governments aim for economic growth because increasing the output of goods and services can raise peoples’ living standards.
• It can also help achieve some of the other aims like unemployment and stable prices.
What is low unemployment?
Full employment: All people who are willing and able to work at the current wage rate are able to find work.
• This does not include people who are economically inactive and so are not apart of the labor force.
Why aim for full employment?
• Unemployment is a waste of resources and also leads to disadvantages for the unemployed. Further, the government will have to spend tax revenue supporting these people.
What is price stability?
Achieving this aim means the price level in the economy is not changing significantly over time.
- Price stability allows firms, workers, and households to plan better for the future.
- The goal for most governments is not a 0% change in price. Some governments will have a target inflation rate (2% for example).
What is balance of payments stability?
- Balance of Payments: the record of a country’s economic transactions with other countries.
- Countries want the revenue from selling exports to equal the value of their imports.
What is redistribution of income?
- Moving income from the rich to the poor.
- Governments redistribute by taxing the rich more than the poor and then spending on benefits for the poor such as housing benefits.
- Without government intervention inequality between the rich and poor can grow very large.
What is a budget?
The government will set out its spending plan
in a budget. This will show the relationship
between government spending and government revenue.
What is a budget surplus?
Budget Surplus: Revenue is higher than
spending
What is a budget deficit?
Budget Deficit: Spending is higher than
revenue
Reasons for government spending? (4)
Influence economic activity
Reduce market failure
Promote equity
Pay interest on the national debt
What is the outcome of government spending?
Government spending will increase aggregate demand in the country.
Why tax? (4)
To raise revenue.
To redistribute income.
To discourage demerit goods.
To raise the costs of firms.
Direct vs Indirect taxes
Direct taxes are taxes on a person or firm’s income and wealth.
• Indirect taxes are taxes on spending.
Progressive, Proportional or Regressive taxes
- Progressive taxes take a larger percentage of income from the rich.
- Proportional taxes takes the same percentage from everyone.
- Regressive taxes take a larger percentage of income from the poor.
Types of taxes?
Income tax
Corporation tax
Capital gains tax
Inheritance tax
Sales tax
Customs duties/Tariffs
What makes a good tax?
Equity
Certainty
Convenience
Flexibility
Economic
Efficiency
Tax burden: Direct vs Indirect
A direct tax results in the entire burden being on the person or firm targeted by the tax.
• An indirect tax may result in a firm passing on some of the burdens to its consumers.
Impacts of Taxes
- When PED = PES the burden of the tax will be equal between the consumer and producer
- When PED is greater than PES the burden of tax will be greater for the producer
- When PED is less than PES the burden of the tax will be greater for the consumer
Impact of Direct taxes?
If taxes on earnings is set too high, may discourage effort or enterprise.
If taxes on income from savings are set high, it will
discourage saving.
Offer the benefit of being able to redistribute income and are a good source of tax revenue in developed economies.
Impact of Indirect taxes
Increasing indirect taxes will raise prices.
May be less of discouragement to effort and
enterprise.
Can be used selectively on certain goods.
People have more of a choice.
Work better in less developed countries where
more people work in less regulated jobs.’
Expansionary Fiscal Policy
If a government wants to raise aggregate demand in order to increase economic growth or employment it should increase spending or lower taxes.
Contractionary Fiscal Policy
Cuts in government spending or rises in taxation will reduce aggregate demand.
