macro 3.6 - demand management - fiscal policy

Question 1

what is fiscal policy?

Answer 1

set of government policies that pertains to government revenue and expenditure

Question 2

give the 3 categories of public spending

Answer 2

Capital expenditures: any spending that adds to the capital stock of the economy (eg upgrading a national highway, building schools or hospitals)

Current expenditures: on-going spending (eg purchases of textbooks in schools or the payment of wages to public sector employees)

Transfer payments: benefits paid to people in the economy for which no goods and services are produced in return (eg unemployment benefits, child support payments)

Question 3

give 5 sources of government revenue

Answer 3

• payment of income taxes and social security payments by households
• social security payments and corporate taxes by firms
• indirect taxes paid on expenditure on goods and services and tariffs paid on the purchase imported products
• profits or selling of nationalised businesses/industries
• renting out government-owned buildings or land

Question 4

give the uses of expansionary fiscal policy and contractionary/deflationary fiscal policy

Answer 4

expansionary- increase aggregate demand
contractionary/deflationary- reduce aggregate demand

Question 5

state the 6 aims of fiscal policy

Answer 5

• Low and stable inflation
• Low unemployment
• Promote a stable economic environment for long-term growth
• Reduce business cycle fluctuations
• Equitable distribution of income
• External balance

Question 6

describe the 3 ways in which expansionary fiscal policy may be implemented by a government

Answer 6

• greater consumption: lower income taxes to increase disposable income
• greater investment: lower corporate taxes so that firms enjoy higher after-tax profits that can be used for investment
• increase spending in order to improve or increase public services

Question 7

draw the effects of expansionary fiscal policy on a country’s economy

Answer 7

shift in aggregate demand upwards

Question 8

what is the trade-off of expansionary fiscal policy?

Answer 8

lower unemployment and higher inflation

Question 9

what is the main aim of fiscal policy?

Answer 9

to close deflationary/recessionary and inflationary gaps

Question 10

Strengths of fiscal policy

Answer 10

1. targeting of specific economic sectors
   - government can invest their funds in areas of the economy that they believe will benefit the most from the investment
   - can give tax cuts to the people that they think need them the most
2. government spending effective in deep recession as it increases AD

Question 11

constraints on fiscal policy

Answer 11

1. political pressure
   - govt spending/taxation often influenced by political rather than economic factors
   - eg deflationary fiscal policies may be needed but may be blocked by political parties who do not want to raise taxes for fears of losing votes
2. time lags
   - changing fiscal policy takes time
   - tax rates cannot be changed quickly as they will need to go through democratic processes and take time to gain approval
   - it will take time before aggregate demand shits as people have to recognise and react to the fiscal changes
3. sustainable debt
   - govt may have to run budget deficits in order to fund expansionary fiscal policies and over time this may accumulate into unsustainable national debt

Question 12

define government debt (known as federal debt in the US)

Answer 12

accumulation of all the budget deficits over the years and represents the total amount of money that a government owes to its creditors, both domestic and foreign

Question 13

how is government debt usually expressed?

Answer 13

as a percentage of GDP so shows the percentage of annual national output that the government owes

Question 14

give the main negative effect of having high levels of government debt

Answer 14

increase in debt servicing costs, which is the amount of money needed to make payments on the principal and interest on a loan in a given time period. the government will spend more of its budget on interest costs

Question 15

give the 4 main negative effects of increasing debt servicing costs

Answer 15

• may lead to crowding out of private investment.
• as interest payments increase as a percentage of government budget expenditure, this may have a damaging effect on other areas of spending. benefits and services provided by the government may need to be cut
• if the government wishes to maintain the same levels of benefits and services, this may require higher tax rates. but this may lead to falling output and incomes (deflationary)
• may decrease ability of government to respond to emergencies (eg natural disasters or military actions) - if debt is too big, they will have fewer fiscal options available.