4.2.5 - Fiscal Policy And Supply-side Policies

Question 1

Define Fiscal policy

Answer 1

Involves making deliberate changes in either government spending or taxation in order to influence aggregate demand or supply and the level of economic activity

Question 2

Define the fiscal budget

Answer 2

Is financed by government spending from the collection of tax revenue

Question 3

Define a budget deficit

Answer 3

Is the annual shortfall between government spending and taxation, the annual amount the government needs to borrow

Question 4

Explain the effects of a budget deficit (4)

Answer 4

Rise in national debt - will have to borrow from the public sector

Higher debt interest repayments - have to be paid from borrowing

Increased aggregate demand- due to increased government spending

Possible increase in public sector investment- investment in infrastructure to help increase long run productive capacity

Question 5

Define a budget surplus

When is it appropriate

Answer 5

Occurs when tax revenue is greater than government spending, can allow the government to pay off public sector debt.

Is appropriate when the economy is in the growth phase of the economic cycle

Question 6

Define demand management

Answer 6

Occurs where fiscal policy is used to manipulate the level of aggregate demand

Question 7

Draw and explain expansionary fiscal policy

Answer 7

Involves increasing aggregate demand leading to an increase in government spending and reduced taxes in order to increase consumption. Will worsen the budget deficit

Question 8

Draw and explain deflationary fiscal policy

Answer 8

Involves decreasing aggregate demand, leading to a cutting government spending an increase in taxes in order to reduce consumer spending. Improves the budget deficit

Question 9

Define automatic stabilisers

Answer 9

Are expenditures, government spending, which automatically increase when the economy is going into a recession

Question 10

Define a direct tax

Answer 10

Is a tax that cannot be passed on to another person and is usyally levied on incomes

Question 11

Define a indirect tax

Answer 11

Is a tax on spending, sellers usually pass on the burden to the buyer

Question 12

Define a progressive tax

Answer 12

Occurs where those on higher incomes pay a higher proportion of their income in tax compared to those on lower incomes

Question 13

Define a regressive tax

Answer 13

Is a tax that increases in relative size and proportion on those on lower income

Question 14

Define a proportional tax

Answer 14

Is one that is paid in equal proportion by everyone

Question 15

Define income tax

Benefits and drawbacks

Answer 15

Is the main direct tax in the UK, paid on earnings from employment.

B
Progressive and seen as fair
Can be used to alleviate relative poverty

D
Is a disincentive to work
Is a complex system

Question 16

Define national insurance contributions

Answer 16

Raises finance for health and welfare expenditure, charged on income

Question 17

Define corporation tax

Benefits and drawbacks

Answer 17

Is a tax based on the profits earned by companies , 19% in the UK.

B
Based on the success of companies meaning smaller less successful firms will not be hit as hard

D
May deter foreign direct investment
Encourages tax avoidance
May discourage business investment

Question 18

Define inheritance tax

Answer 18

Is based on the value of a persons wealth when they die and it’s 40% of their net value. Peoples estate worth less than £325,000 are not subject to this tax.

Question 19

Define capital gains tax

Answer 19

Based on the profit earned from the sale of physical assets like homes and financial assets like shares and bonds

Question 20

Define Value added tax (VAT)

Benefits and drawbacks

Answer 20

Is the UK’s main indirect tax, 20% on spending on most goods and services

B
Does not affect incentive to work
Hard to avoid

D
Regressive in many cases

Question 21

Define Excise duty

Benefits and drawbacks

Answer 21

Is a unit tax paid on mainly demerit goods like alcohol, tobacco and fuel, leading to an increased price.

B
Can change patterns of expenditure
Can be used to discourage the consumption of demerit goods

D
May lead to unemployment in those industries
Can lead to black markets being created (removing possible tax)

Question 22

Define council tax

Benefits and drawbacks

Answer 22

Is based on the value of property, the higher the value the higher the charge

B
Fair as it is based on wealth and household
Raises money for local services

D
May be difficult to pay for those who are asset rich but cash poor

Question 23

Define Stamp duty

Answer 23

Is based on a percentage of the purchase price of property, paid by the purchaser and rises in bands with the value.

Question 24

Why do governments levy (impose) taxes (4)

Answer 24

Raise revenue to finance government expenditure

To change patterns of economic activity- tax can be implemented on one product to cause a shift in demand to another product

To discourage consumption and production of certain products- demerit goods

To redistribute income - progressive taxes will narrow the gap between high and low income households.

Question 25

State the principles of taxation (6)

Answer 25

Economical- should be inexpensive to collect

Equitable- should be fair and based on ability to pay

Efficient- should have few consequences

Convenient - should be easy to pay

Certain- should be able to be worked out how much each person owes

Flexible- should be able to be modified if circumstances change

Question 26

Define a hypothecated tax

What would there use be on demerit goods

Answer 26

Is a tax levied to raise money for a particular purpose

Could be used on demerit goods and activities generating negative externalities to raise money to deal with the problems that their consumption and production impose on society

Question 27

Define current spending

Impact on society?

Answer 27

Is government spending on the day to day running of it’s services, paying salaries to public sector workers.

Is likely to be more popular with voters but is likely to be inflationary

Question 28

Define capital spending

Impact on society

Answer 28

Is government spending on investment projects, such as new infrastructure

Will impact the supply side of the economy

Question 29

Should capital or current spending be used in a recession period

Answer 29

It makes sense to invest heavily in capital spending during a recession as interest rates are low and there are spare productive capacity so things can be funded for cheaper

Question 30

Define austerity

Answer 30

Austerity involves policies to reduce government spending or higher taxes in order to try and reduce government budget deficits

Question 31

Explain the arguments for and against austerity

Answer 31

For
The expansionary fiscal contraction (EFC) - Reducing government spending will mean lower tax rates in the future which gives confidence to businesses and consumers leading to an increase in investment and consumption

Budget deficits are too high and need to be reduced

Against
Liquidity trap- keynesians suggest in a liquidity trap we should increase government spending to offset the fall in private sector spending.

Aggregate demand - Government spending cuts would lead to an even bigger fall in aggregate demand

Hit’s lower income groups harder- rely more on public services and jobseekers allowance, will worsen inequality and widen the poverty gap in society.

Question 32

Explain the cyclical budget position

What occurs in a recession and boom

Answer 32

Is the part of the fiscal deficit/surplus which is caused by changes in government spending and taxation through the trade cycle.

In a recession government spending increases and taxation is lowered

In a boom government spending decreases and taxation increases

Question 33

Explain the structural budget position

What will occur if the structural deficit is large

Answer 33

Is the part of the fiscal deficit which occurs even when the economy is in a boom, will not disappear when an economy recovers.

If the structural deficit is large, 10-15% of GDP, it will cause national debt to rise very quickly. The interest rate of borrowing will add to the debt. The government will be unable to pay their debts so will either turn to organisations like the IMF to borrow money or refuse to pay it’s debts and therefore be locked out of world financial markets

Question 34

Explain the debt to GDP ratio

Answer 34

Is the metric comparing a country’s public debt, what it owes, to it’s Gross domestic product, what it produces. The ratio indicates a country’s ability to pay back it’s debts. Countries with a high ratio experience unsustainable debt and slow economic growth

Question 35

Explain the global financial crisis of 2008:

• How it happened
• effects
• fiscal policy solutions

Answer 35

Originated in the US where many relatively poor people were encouraged to take out a mortgage for property.
Many borrowers were unable to repay the loan, meaning houses were repossessed and the value of loans exceeded the value of the property, many institutions were now holding depreciating assets.

Confidence collapsed in UK banks, many of the loans it bad made were not repaid.
Financial instability and a fall in lending led to a fall in consumption and investment, GDP fell and unemployment rose.

There was a fall in taxation and increase in government spending. Welfare benefits were paid, banks that would have collapsed and led to a significant fall in AD were nationalised and quantitative easing was implemented to stimulate the economy and increase AD.
Governments were forced to turn to the IMF and in return for money were forced to cut spending, raise taxes and introduce supply side policies to stimulate the economy.
Labour tried to spend it’s way out of the recession, which created unsustainable debt and the Conservatives promised to introduce Austerity and cut government spending

Question 36

Explain fiscal policy’s impact on microeconomics

Answer 36

Fiscal policy can have a microeconomic effect where it involves intervention in individual markets.

Government spending on subsidies encourage consumption and investment of desirable products.
Indirect taxes can be used to discourage consumption and production of certain goods

These fiscal policy interventions are intended to change the pattern of economic activity

Question 37

Explain the Keynesian approach to a recession

Answer 37

Keynes said governments should intervene and use expansionary fiscal policy during a recession, increasing government spending and reducing taxation.

Is a politically popular move as people support spending on public services and benefiting from reduced taxes.

Question 38

Explain the Laffer curve

Answer 38

States that if tax rates increase above a certain level, the tax revenue will fall. This is because their would be a reduced incentive to work, if income tax was lowered, due to the possibility of post tax income being low and close to the unemployment trap. If corporation tax was increased there would be reduced investment, the UK’s competitiveness in attracting FDI would be reduced and shareholders would receive less dividends potentially reducing consumption.

Question 39

Explain the office for budget responsibility (OBR)

Answer 39

Was set up by the government to provide independent analysis of fiscal policy, in the hope it would make it harder for government’s to implement politically motivated fiscal policy

Question 40

Define Average tax rates

Answer 40

Is a measure of a household’s tax burden, how taxes affect the households ability to consume today or in the future (saving)

Question 41

Define marginal tax rates

How would a higher marginal rate affect the economy

Answer 41

Measures the degree to which taxes affect household or business economic incentives such as whether to work more, save more or change what they buy.

A higher marginal rate reduces incentives to engage in a particular activity (work) or to consume a particular item (cost of sales tax)

Question 42

Define a supply side policy

Answer 42

Are government attempts to increase productivity and increase efficiency in the economy. If successful they will cause a increase in aggregate supply and higher levels of economic growth

Question 43

Explain free market supply side policies

Answer 43

Involve policies to increase competitiveness and free market efficiency.

Question 44

Explain Interventionist supply side policies

Answer 44

Involve government intervention to overcome market failure

Question 45

Explain the benefits of supply side polcies (4)

Answer 45

Improved economic growth- will increase the sustainable rate of economic growth as increasing the productive potential of the economy will lead to a higher RGDP.

Lower unemployment- will increase incentives to work and policies to invest in infrastructure will provide employment opportunities

Lower Inflation- increased AS will lead to a lower price level. Making an economy efficient will reduce cost push inflation.

Improved trade and balance of payments- making firms more productive and competitive will increase exports

Question 46

Explain privatisation as a free market supply side policy

Answer 46

Involves selling state owned assets to the private sector, leading to increased efficiency and increased economic growth due to the increased competition.

Question 47

Explain deregulation as a free market supply side policy

Answer 47

Involves reducing barriers to entry to allow new firms to enter the market, allowing the market to become more competitive and leading to lower prices and higher quality. However some industries are not affected by competition, in a monopoly market structure.

Question 48

Explain reducing income tax as a free market supply side policy

Answer 48

Increases the incentives for people to work harder, leading to increased productivity and AS. The substitution effect occurs where workers are willing to take away from their leisure time in order to work, increasing efficiency. However lower taxes may lead to the income effect where workers are willing to add to their leisure time as they are satisfied with their wages.

Question 49

Explain reforming the labour market as a free market supply side policies

Answer 49

Involves policies that increases the economy’s flexibility, through zero hour contracts and making it easier to recruit and dismiss workers. This would create more employment opportunities, increasing efficiency and AS. However flexible markets can cause uncertainty and exploitation

Question 50

Explain reducing the power of trade unions as a free market supply side policy

Answer 50

Involves legislation to reduce the power of trade unions as a monopolist, a sole seller of labour. This would increase the efficiency in the economy, as less time is lost due to strikes and there is reduced real wage unemployment.

Question 51

Explain reducing welfare benefits as a free market supply side policy

Answer 51

Will reduce the unemployment trap, the gap between those on unemployment benefits and those on low wages, and encourage the unemployed to take jobs. This will increase efficiency and reduce the waste of labour.

Question 52

Explain encouraging immigration as a free market supply side policy

Answer 52

Allows the economy to fill skill shortages in skilled jobs, engineering and construction, and low skilled jobs, fruit picking. Will make labour markets more flexible and in economic booms will help firms keep up with growing demand. Can prevent wage inflation and help the economy to increase it’s productive potential.

Question 53

Explain increased education and training as a interventionist supply side policy

Answer 53

Will improve labour productivity and increase AS. The government may subsidise suitable education and training schemes to increase the quality and quantity of labour, increasing productivity. However this will cost and require higher taxes, will also take time to have an effect and the wrong industries may be subsidised.

Question 54

Explain improving transport and infrastructure as a interventionist supply side policy

Answer 54

Will help reduce congestion and pollution, encouraging FDI. Seen in the UK, the HS2 Cross rail linking London to other parts of the UK. Will reduce geographical immobility. However in a country, like the UK, it can be difficult to increase transport capacity.

Question 55

Explain building more affordable homes as a interventionist supply side policy

Answer 55

Reduces geographical immobility, by making it easier for workers to move and find jobs, reducing unemployment.

Question 56

Explain improved healthcare as a interventionist supply side policy

Answer 56

Improves the quality of a workforce, increasing productivity and the ability of a worker to work for longer.

Question 57

Explain the limitations of supply side policies (6)

Answer 57

Productivity growth largely depends on private enterprise- there is a limit to which the government can accelerate the growth of technological change and improvements in working practices.

Supply side policies can be counter productive- flexible labour markets will reduce costs for businesses costs for businesses but cause job insecurity and therefore a lack of productivity and motivation.

Not effective in a recession- supply side policies cannot tackle the problem of a lack of aggregate demand

Time- supply side policies take a long time to have an effect

Expensive- requires high levels of spending, leading to increased borrowing

Increased income inequality- cutting welfare benefits, abolishing minimum wage and reducing trade union power, will lead to a growing gap between high and low income earners