Fiscal Policy

Question 1

What are injections into the circular flow of income?

Answer 1

Government spending, investment and exports.

Question 2

What is the multiplier effect?

Answer 2

An increase in an injection adds directly to AD and triggers multiple rounds of repeat spending such that the final increase in GDP is much larger than the initial injection.

Question 3

What does the MPC represent?

Answer 3

How much of extra income is spent.

Question 4

What happens to the MPC when taxes are lower?

Answer 4

It will increase which means that the value of the multiplier will increase.

Question 5

Why does a reduction in taxes lead to the size of the multiplier increasing?

Answer 5

Withdrawing less money at each round of repeat spending i.e. smaller MPW thus leaving more disposable income for further rounds of spending.

Question 6

What is an evaluation point about expansionary fiscal policy in terms of loanable funds?

Answer 6

There is a fixed amount of loanable funds in the economy so if there is an increased demand for these funds then the prices of these funds will increase i.e. the interest rate will rise, this higher interest rate on borrowed money disadvantages private sector spending so AD shifts leftwards again so the overall rightward shift is diminished.

Question 7

What is an expansionary fiscal policy?

Answer 7

An increase in government spending and a reduction in taxes.

Question 8

What are policy instruments?

Answer 8

A set of measures designed to help the government achieve its policy objectives.

Question 9

What is fiscal policy?

Answer 9

The use of government spending and taxation in order to influence AD.

Question 10

What is the budget?

Answer 10

An estimate of government spending and revenue for the coming year.

Question 11

What is a budget deficit?

Answer 11

When government spending is higher than the revenues received from taxes.

Question 12

What is a budget surplus?

Answer 12

When government spending is lower than the revenues received from taxes.

Question 13

What is a budget surplus?

Answer 13

When government spending is lower than the revenues received from taxes.

Question 14

What is public sector borrowing?

Answer 14

What the government borrows in one year when it is running a budget deficit.

Question 15

What is national debt?

Answer 15

The accumulation of all previous public sector borrowings that have not yet been repaid.

Question 16

Why would an expansionary fiscal policy worsen the budget deficit?

Answer 16

The government would need to borrow more.

Question 17

How would a reduction in income tax lead to AD shifting right?

Answer 17

It leaves people with higher amounts of disposable income therefore there is higher consumption.

Question 18

How would a reduction in income tax lead to AD shifting right?

Answer 18

It leaves people with higher amounts of disposable income therefore there is higher consumption.

Question 19

How would a reduction in corporation tax lead to AD shifting right?

Answer 19

It means there is a higher retained profit therefore there is more investment.

Question 20

What is direct tax?

Answer 20

Tax on earnings.

Question 21

What an indirect tax?

Answer 21

A tax on goods and services.

Question 22

What is an example of an indirect tax?

Answer 22

VAT

Question 23

Why might an expansionary fiscal policy reduce the budget deficit?

Answer 23

In the long term, AD shift right which means there is more employment therefore the government can get more income tax.

Question 24

How might an expansionary fiscal policy lead to reducing the budget deficit in terms of tax evasion?

Answer 24

Fewer people look to avoid/evade the tax.

Question 25

How might an expansionary fiscal policy lead to reducing the budget deficit in terms of tax evasion?

Answer 25

Fewer people look to avoid/evade the tax.

Question 26

How is the elasticity of the AS curve an evaluation point for fiscal policy?

Answer 26

They need to consider the size of the output gap otherwise they run the risk of undermining the price stability objective.

Question 27

How are time lags an evaluation point for fiscal policy?

Answer 27

Recognition lag: the government took time to realise there was a problem or impending recession which isn’t easy as macroeconomic data isn’t always correct, decision lag: to took time for the government to decide what to do and action lag: even when decisions have been made governments would then have to put their fiscal policy into practice, furthermore, changes in fiscal policy can only occur once a year in the annual budget. By the time FP transmits into AD, the threat may have gone.

Question 28

How is what happens in the future an evaluation point for fiscal policy?

Answer 28

A budget deficit can only happen if government borrows from the debt markets which adds to the UK’s national debt, in the long-run however, this money has to be paid back with interest hence we may see a future rise in taxation and cuts in public sector spending to fund the repayments.

Question 29

How is what happens in the future an evaluation point for fiscal policy?

Answer 29

A budget deficit can only happen if government borrows from the debt markets which adds to the UK’s national debt, in the long-run however, this money has to be paid back with interest hence we may see a future rise in taxation and cuts in public sector spending to fund the repayments. This would shift AD in again.

Question 30

Why might a contractionary FP be inflationary?

Answer 30

AS shifts to the left due to less investment in research and development therefore the productive capacity of the economy reduces and firms may leave the UK. Furthermore there is a lower incentive to work due to the higher rates of income tax so the quantity of the factors of production decreases.