Fiscal policy and supply-side policies

Question 1

What is fiscal policy?

Answer 1

Changes to government spending and and Taxation in order to influence AD

Question 2

What are the macroeconomic and microeconomic functions of fiscal policy?

Answer 2

-Macroeconomic: Stabilizing economic growth, controlling inflation, and reducing unemployment

-Microeconomic: Allocating resources and redistributing income to achieve equity.

Question 3

How can fiscal policy influence aggregate demand (AD)?

Answer 3

Expansionary fiscal policy: Increases AD by raising government spending and/or cutting taxes

Contractionary fiscal policy: Reduces AD by decreasing government spending and/or raising taxes

Question 4

How can fiscal policy influence aggregate supply (AS)?

Answer 4

Investing in infrastructure, education, and healthcare improves productivity

Offering tax incentives for businesses to encourage investment and innovation

Question 5

How do government spending and taxation affect the pattern of economic activity?

Answer 5

Spending: Targets specific sectors (e.g., defence, healthcare) to stimulate growth

Taxation: Alters incentives, such as encouraging work or discouraging harmful consumption (e.g., carbon taxes)

Question 6

What are the types of public expenditure?

Answer 6

Current Expenditure: Day-to-day spending (e.g., wages for public workers)

Capital Expenditure: Long-term investments (e.g., infrastructure)

Transfer Payments: Payments without direct goods/services (e.g., welfare benefits)

Question 7

Why do governments levy taxes?

Answer 7

-To raise revenue for public services.
-To redistribute income and reduce inequality.
-To correct market failures (e.g., taxing pollution).
-To stabilize the economy (e.g., counter inflation).

Question 8

What is the difference between direct and indirect taxes?

Answer 8

Direct Taxes: Levied on income or wealth (e.g., income tax, corporation tax)

Indirect Taxes: Levied on goods and services (e.g., VAT, excise duty)

Question 9

What are progressive, proportional, and regressive taxes?

Answer 9

-Progressive Tax: Higher-income earners pay a larger percentage (e.g., income tax in the UK)

-Proportional Tax: Same percentage paid by all (e.g., flat tax)

-Regressive Tax: Lower-income earners pay a larger percentage of their income (e.g., VAT)

Question 10

What are the principles of taxation?

Answer 10

-Equitable: Fairly distributed based on ability to pay.
-Efficient: Minimal distortion to economic activity.
-Convenient: Easy to pay and collect.
-Certain: Clear about how much and when to pay.

Question 11

What is the budget balance, and how is it related to the national debt?

Answer 11

Budget Balance: The difference between government revenue and expenditure

Deficit: Spending > Revenue (adds to national debt)
Surplus: Revenue > Spending (reduces national debt)

National Debt: Accumulated past budget deficits

Question 12

What are cyclical and structural budget deficits?

Answer 12

Cyclical Deficit: Occurs due to economic downturns (temporary)

Structural Deficit: Exists regardless of the economic cycle (persistent)

Question 13

What are the consequences of budget deficits and surpluses?

Answer 13

Deficits:
-Can stimulate growth but increase national debt.
-May lead to higher borrowing costs or inflation.

Surpluses:
-Reduce debt but may slow growth if spending is cut too much.

Question 14

Why is the size of the national debt significant?

Answer 14

High debt can lead to:
-Higher interest payments, reducing funds for other spending
-Reduced investor confidence and borrowing ability
-Long-term crowding out of private investment

Question 15

What is the role of the Office for Budget Responsibility (OBR)?

Answer 15

-Provides independent analysis of UK public finances
-Assesses the sustainability of government fiscal policy
-Produces economic forecasts

Question 16

What is expansionary fiscal policy?

Answer 16

-Increases government spending and/or cuts taxes to boost AD and
reduce unemployment

-Risks: May lead to inflation or increase the budget deficit

Question 17

What is contractionary fiscal policy?

Answer 17

-Decreases government spending and/or raises taxes to reduce AD
and control inflation

-Risks: May slow growth and increase unemployment.

Question 18

What are automatic stabilizers?

Answer 18

Automatic stabilizers are fiscal mechanisms that help smooth economic fluctuations without requiring deliberate government action. They operate automatically based on changes in the economy.

Question 19

How do automatic stabilizers work during a recession?

Answer 19

-Increased Welfare Spending: As unemployment rises, more people
claim benefits (e.g., jobseeker’s allowance), boosting aggregate
demand (AD)

-Reduced Tax Revenue: Lower incomes mean people pay less
income tax and VAT, reducing the tax burden on households

Question 20

How do automatic stabilizers work during an economic boom?

Answer 20

-Reduced Welfare Spending: Fewer people need benefits as employment rises, helping to reduce government spending

-Increased Tax Revenue: Higher incomes mean more tax is collected, cooling excessive demand and reducing inflationary pressure

Question 21

Why are automatic stabilizers important?

Answer 21

-They provide stability by reducing the amplitude of economic cycles
-They operate immediately, without requiring legislative action
-They help prevent recessions from worsening and reduce risks of
overheating during booms

Question 22

What are examples of automatic stabilizers?

Answer 22

-Progressive Income Tax: Higher earners pay a larger proportion of income in tax, dampening demand during booms

-Welfare Benefits: Payments such as unemployment benefits increase in downturns to support incomes and spending

Question 23

What are the limitations of automatic stabilizers?

Answer 23

-They may not be strong enough to fully counteract severe recessions
-In economies with low levels of taxation or welfare spending, their impact is limited
-They can worsen the budget deficit during downturns.

Question 24

What is the evaluation when thinking about fiscal policy?

Answer 24

-Size of the output gap
-Size of the multiplier
-Consumer/Business confidence
-State of gov finances
-LR returns to the gov
-Laffer curve ideas
-Role of automatic stabilisers