Demand-side policies – fiscal policy

Question 1

What are demand side policies?

Answer 1

policies that aim to manipulate aggregate demand (AD) to
achieve the macroeconomic objectives.

Question 2

What are fiscal policies?

Answer 2

use of taxation, government spending and government borrowing
to influence the economy.

Question 3

What are monetary policies?

Answer 3

use of interest rates and the money supply to affect AD – run by the independent Bank of England in the UK.

Question 4

What is direct tax?

Answer 4

tax on income/wealth e.g. income tax, employee NICs, corporation tax, capital gains tax

Question 5

What is an indirect tax?

Answer 5

a tax on spending e.g. VAT, excise duties

Question 6

What is a progressive tax?

Answer 6

a tax that takes a higher proportion of income from those on
higher incomes.

Question 7

What is a proportional tax?

Answer 7

a tax that takes the same proportion of income whatever the level of income.

Question 8

What is a regressive tax?

Answer 8

a tax that takes a lower proportion of income from those on higher incomes

Question 9

Explain, with a diagram, how governments can use demand side fiscal policy (i.e cutting income tax) to influence the economy

Answer 9

Initial equilibrium at Y1 and PL1.
Government cuts income tax, stimulating a
rise in consumer spending which shifts AD
from AD1 to AD2, ceteris paribus.
Real GDP increases from Y1 to Y2. Short
run economic growth, helps to close the
negative output gap, drawing unemployed
resources into use, but there may be some
demand-pull inflation (PL1 to PL2).
A fiscal multiplier effect could further
stimulate AD growth and real GDP may
increase further.

Question 10

What is public spending?

Answer 10

spending by the government to influence AD

Question 11

What is current spending?

Answer 11

government spending G = spending on the day to day costs of running public services e.g. wages of teachers, energy bills for hospitals; directly affects AD.

Question 12

What is capital spending?

Answer 12

government investment in the economy’s
infrastructure e.g. building hospitals & housing, new roads/railways etc

Question 13

How can increasing public spending add to G component of AD?

Answer 13

Increasing public spending adds to the G component of AD (same shift as
in diagram on income tax cut; if government increases its spending on
capital projects, this increases the I component of AD (and in the longterm,
if successful, could also shift AS to the right)

Question 14

What is budget deficit?

Answer 14

is the annual amount the government
borrows to make up the gap between its income (mostly tax revenue)
and its spending. A net injections into the circular flow G>T; it is a flow

Question 15

What is national debt (public sector net debt)?

Answer 15

a stock of the total
accumulation of budget deficits (government borrowing) that is still to
be repaid.

Question 16

How can increasing the budget deficit influence the economy?

Answer 16

Increasing the budget deficit is a net injection into the economy; it adds
to AD; if the government borrows to invest this also adds to AD (and can
add to AS too). AD shifts right as in the diagram.
A fiscal multiplier may kick in further stimulating growth