The Business Cycle And Policies

Question 1

demand side policies

Answer 1

mainly affect aggregate demand

Question 2

supply side policies

Answer 2

mainly affect aggregate supply

Question 3

who manages supply side policies

Answer 3

the government

Question 4

what are the types of demand side policies

Answer 4

fiscal policy and monetary policy

Question 5

Fiscal policy

Answer 5

Fiscal policy involves deliberate changes in either government spending or taxation to influence the economy.

Question 6

What do expansionary fiscal policies do?

Answer 6

Expand the economy but worsen the budget deficit, as the government is spending more (gov spending), and receiving less tax revenue

Question 7

what does contractionary fiscal policy involve

Answer 7

it occurs when the government decrease government spending and increase taxes. This contracts the circular flow of income and reduces aggregate demand

Question 8

how could expansionary fiscal policy be used on the top earners?

Answer 8

the top rate of income tax on the UK’s highest earners could be reduced from 45% down to 40%

Question 9

How can a reduction in income tax lead to the multiplier effect?

Answer 9

A lower income tax rate means that workers have a higher disposable income and therefore consume more. The increase in consumption increases aggregate demand. As consumers spend more, firms will make more sales and therefore more profit. This means that they can invest more. Because investment is a positive component of aggregate demand, AD will increase further.

As consumers spend more and firms make more profit, corporation tax and VAT revenues will increase. This means that the government can spend more and so AD will increase further. As firms expand, they will increase their derived demand for labour, so incomes will increase. This will further increase spending and income tax revenue, causing consumption and government spending to increase further. So, the overall impact on aggregate demand will be much larger.

Question 10

Why does the government need to be careful when implementing expansionary fiscal policy?

Answer 10

The immediate impact of a reduction in the income tax rate is that revenue from income tax will decrease, which will lead do a decrease in government spending and decrease aggregate demand

Question 11

in 2016 how much income tax revenue was from the richest 1%

Answer 11

27%

Question 12

higher income tax downward multiplier effect

Answer 12

A higher income tax rate means workers have a lower disposable income and therefore consume less. The decrease in consumption decreases aggregate demand. As consumers spend less, firms will make fewer sales and therefore less profit. This means that they can invest less and so AD will decrease further as investment is a positive component of AD.
As consumers spend less and firms make less profit, corporation tax and VAT revenues will decrease. This means the government can spend less and so AD will decrease further. As firms contract, they will decrease their derived demand for labour and so incomes will decrease. This will further decrease spending and income tax revenue and so consumption and government spending will further decrease. So, the overall impact on aggregate demand will be much larger.

Question 13

advantages of raising income tax

Answer 13

-decrease consumption and aggregate demand, which will help to bring the price level down and control inflation
-increase income tax revenue and help the government to balance its budget

Question 14

disadvantages of raising income tax

Answer 14

-will reduce real GDP
-increase in income tax may increase tax evasion and avoidance which could even mean that income tax revenue decreases

Question 15

benefits

Answer 15

payments made by the government to unemployed or low income workers

Question 16

advantages of increasing benefits

Answer 16

-will increase consumption, shifting AD outwards
-Will help to reduce income inequality

Question 17

disadvantages of increasing benefits

Answer 17

If benefits are too high, there is a significant disincentive for unemployed people to find a job, because they may earn more by claiming benefits. This is known as the benefits trap

Question 18

Advantages of decreasing benefits

Answer 18

-the budget deficit will improve as the government is paying out less
-Lower benefits may get the unemployed out of the benefits trap by increasing their incentive to work, reducing unemployment

Question 19

Disadvantages of decreasing benefits

Answer 19

-Poor households will have less to spend, so consumption will fall, which will decrease AD. Also, income inequality will worsen as the poor get poorer.

Question 20

infrastructure

Answer 20

items needed for businesses to operate such as roads and telecommunications networks

Question 21

crowding out

Answer 21

When government spending increases, the government demands more borrowed money, land, labour and capital. The price and interest rate increases which increases costs for firms and reduces supply

Question 22

monetary policy

Answer 22

when the central bank manipulates the base interest rate or the money supply in order to influence aggregate demand

Question 23

base interest rate

Answer 23

the interest rate offered by the central bank on savings and loans to high street banks

Question 24

MPC

Answer 24

monetary policy committee. consists of nine members and meets monthly to consider recent developments and likely future developments of aspects of UK economic performance.

Question 25

When inflation is below the target, the Bank of England is likely to…

Answer 25

decrease the base interest rate in order to increase aggregate demand. this will encourage consumers to save less and consumer more, and encourage firms to invest as it is cheaper to borrow.

Question 26

When inflation is above the target rate, the Bank of England is likely to …

Answer 26

pursue contractionary monetary policy. This involves increasing the base interest rate in order to reduce aggregate demand and reduce inflation

Question 27

Expansionary monetary policy

Answer 27

decreasing the base interest rate in order to increase aggregate demand and increase the rate of inflation

Question 28

quantitive easing

Answer 28

when the central bank buys financial assets such as bonds from high street banks. This increases the money supply for high street banks, which increases the amount of money that banks can lend. This increases the exchange rate which shifts Ad out because exports are cheaper, also increases consumption and investment

Question 29

disadvantage of quantitative easing

Answer 29

the increase in the money supply may cause an increase in the price level. High inflation could become hyperinflation

Question 30

supply side policies

Answer 30

any government policies which aim to increase the aggregate supply in the economy

Question 31

interventionist supply side policy

Answer 31

When the government increases intervention in the economy

Question 32

market based supply side policy

Answer 32

When the government decreases intervention in the economy

Question 33

recession

Answer 33

two or more consecutive quarters of negative economic growth

Question 34

recovery

Answer 34

the part of the business cycle where real GDP is increasing

Question 35

slump

Answer 35

the part of the business cycle where real GDP is decreasing

Question 36

boom

Answer 36

the part of the business cycle where real GDP is at its highest

Question 37

recession

Answer 37

when the economy experiences negative economic growth for two consecutive quarters

Question 38

positive output gap

Answer 38

when actual gdp is above potential trend gdp

Question 39

negative output gap

Answer 39

when actual gdp is below potential trend gdp

Question 40

potential trend gdp

Answer 40

the sustainable rate of gdp growth due to improvements in productive capacity