Fiscal Policy

Question 1

explain how fiscal policy can affect the levels of income within the economy.

Answer 1

• the government can set a range of tax levels.
• by increasing the rate of tax, it effectively lowers aggregate demand: individuals have less disposable income and firms will have less profit
• taxation can impact unemployment, economic growth and inflation

Question 2

explain how fiscal policy can affect the levels of expenditure within the economy.

Answer 2

• the government can use the income from taxation for spending purposes: education, healthcare and defences
• by increasing the expenditure, government can increase aggregate demand in the economy, and vice versa
• when income is below expenditure, the government will have to borrow: increase in debt and therefore higher interest payments

Question 3

explain how fiscal policy can be used to achieve government objectives: maintaining full unemployment

Answer 3

• if there is a lower taxation, there is a greater incentive for individuals to work
• in effect, the real wage rate will increase
• firms will see an increase in profits if corporation tax falls
• this can be reinvested to create jobs
• by increasing expenditure, government create an increase in aggregate demand
• this leads to more people working as firms demand more workers

Question 4

explain how fiscal policy can be used to achieve government objectives: ensuring price stability

Answer 4

• increased taxation reduces aggregate demand
• this leads to a fall in demand pull inflation rates
• it will also impact on the costs of a firm
• higher taxes increases costs
• this will impact supply as cost push inflation will occur
• by raising or lowering taxation, the government can help the economy to meet its inflation target.

Question 5

explain how fiscal policy can be used to achieve government objectives: achieving economic growth

Answer 5

• reducing taxation gives firms a greater incentive to produce
• it reduces the costs of firms
• this leads to an increase in the supply of goods and services
• an increase in spending leads to higher aggregate demand
• this leads to increased output
• as a result GDP will increase

Question 6

state what is meant by a balanced budget

Answer 6

when government revenue is equal to or greater than government expenditure

Question 7

explain the consequences of operating a budget deficit.

Answer 7

• the government will have to borrow the difference between income and expenditure
• this will increase national debt, meaning interest will have to be paid on the borrowing
• if government expenditure is targeted, say on education or infrastructure, it can help increase the supply of goods and services, increasing economic growth

Question 8

explain the consequences of operating a budget surplus.

Answer 8

• running a budget surplus means that a government will be able to pay off the national debt
• this helps reduce interest payments as the gov no longer have to pay for as much debt
• however, to find a surplus, the government is likely to raise taxation or lower expenditure.