Aggregate Demand Policies

Question 1

What is budgetary policy?

Answer 1

Government strategy involving changes to the level and composition of revenue and spending to influence aggregate demand (AD).

Question 2

What are the components of government revenue (receipts)?

Answer 2

Direct taxes (e.g. income tax, company tax)

Indirect taxes (e.g. GST, excise duties)

Non-tax revenue (e.g. profits from government businesses)

Question 3

What are the components of government outlays (spending)?

Answer 3

G1 (Government Consumption) – e.g. wages, defence

G2 (Government Investment) – e.g. infrastructure

Government Transfer payments – e.g. welfare

Question 4

Define the three possible budget outcomes.

Answer 4

Surplus: Receipts increase relative to Outlays

Deficit: Receipts decrease relative to Outlays

Balanced: Receipts = Outlays

Question 5

What is direct taxation?

Answer 5

Tax levied directly on income or profits of individuals and businesses. Makes up ~70% of total federal revenue.

Question 6

Name seven examples of direct taxes.

Answer 6

Personal income tax
Capital gains tax
Medicare levy
Company tax
Fringe Benefits Tax
Petroleum Rent Tax
Super Fund Tax

Question 7

What is the PAYG income tax system and how does it affect equity? -Direct taxation

Answer 7

Tax on income deducted regularly from wages. It is progressive, helping to narrow income inequality.

Question 8

What is indirect taxation?

Answer 8

Tax levied on goods/services at point of sale, paid by consumers. Accounts for ~22% of revenue.

Question 9

Name three examples of indirect taxes.

Answer 9

GST
Excise duties
Customs tariffs

Question 10

What is the GST and why is it considered regressive?- indirect taxation

Answer 10

A 10% broad-based tax on most goods/services. It takes a higher % of income from low-income earners.

Question 11

What are the three main tax structures and how do they affect equity?

Answer 11

Progressive
Definition: Tax rate rises as income rises.
Example: Personal income tax
Effect on Equity: Narrows income inequality

Regressive
Definition: Tax burden falls more heavily on lower-income earners as a % of income.
Example: GST, excise
Effect on Equity: Increases income inequality

Proportional
Definition: Tax rate stays constant regardless of income.
Example: Company tax (25% or 30%)
Effect on Equity: Neutral income distribution

Question 12

How does the revenue mix influence the economy?

Answer 12

Affects:
* AD & economic activity
* Inflation
* Employment
* Income distribution
* Resource allocation
* External stability
* Living standards

Question 13

What are budget expenses (outlays)?

Answer 13

Budget expenses (or outlays) refer to how the government uses revenue to provide goods, services, and income to households and businesses.

Influence aggregate demand (AD) by affecting C (consumption), I (investment), and G (government spending).

Question 14

What is government debt (public debt)?

Answer 14

Government debt (also called public debt) is the total amount of money the government owes.

Question 15

What is a budget deficit?

Answer 15

A budget deficit happens when the government’s spending is greater than its revenue in a single year.

*It means the government is not collecting enough taxes to pay for all its programs and services.
*To cover the gap, the government must borrow money, which adds to public debt.

Question 16

Simple analogy: Deficit vs. Debt?

Answer 16

Deficit = Spending more than you earn this year

Debt = Total amount owed from all past years

Question 17

What are three major functions of government spending?

Answer 17

Social security & welfare (~36%)
-Transfer payments for aged, unemployed, carers, students, disabled, etc.

Health (~15%)
-Spending on public hospitals, Medicare, pharmaceuticals, and medical infrastructure.

Education (~7%)
-Schools, universities, TAFE, salaries, and building programs.

Question 18

What is government current spending (G1)?

Answer 18

Day-to-day running costs: wages, materials, services.

Examples: Teacher salaries, hospital supplies.

Question 19

What is government capital spending (G2)?

Answer 19

Spending on long-term infrastructure and investment projects.

Examples: Building roads, NBN, new schools or hospitals.

Question 20

What is the budget outcome?

Answer 20

Budget outcome = Total government receipts − Total government outlays

Question 21

What are the three possible budget outcomes?

Answer 21

Balanced budget: Receipts = Outlays → neutral AD

Budget deficit: Receipts < Outlays → expansionary

Budget surplus: Receipts > Outlays → contractionary

Question 22

How can a budget deficit be financed?

Answer 22

Borrowing from overseas (bonds to foreign investors)

Borrowing locally (RBA or private investors)

Question 23

What are the risks of overseas borrowing to finance a deficit?

Answer 23

Increases net foreign debt

May weaken credit rating and external stability

Question 24

What are the problems with ongoing budget deficits?

Answer 24

Higher public debt

Interest repayments → opportunity cost

Less fiscal flexibility

Burden on future generations

Question 25

How can a budget surplus be used?

Answer 25

Repay debt Save in the RBA Invest in Future Fund or other special purpose funds

Question 26

What are the benefits of a budget surplus?

Answer 26

Offsets deficits without borrowing Builds crisis resilience Supports AAA credit rating Boosts investor confidence

Question 27

Headline vs. Underlying Budget Outcome?

Answer 27

Headline: Total cash received by the government minus total cash paid out Underlying: Adjusted measure that removes temporary or volatile items (e.g. asset sales, investments in Future Fund) Key difference: The headline cash outcome includes one-off or volatile items like asset sales, while the underlying cash outcome excludes them, making it the preferred measure for assessing the government’s fiscal stance.

Question 28

Why express the budget outcome as a % of GDP?

Answer 28

To show the budget's size relative to the economy. A larger % = greater macroeconomic impact.

Question 29

List 3 factors that influence final budget outcomes

Answer 29

GDP growth Unemployment rate Commodity prices

Question 30

What is relationship Between Budget Outcome and Government Debt

Answer 30

How Deficits Affect Debt *Deficits require borro32wing, usually via government bonds. *E.g. 2008–2022: 14 consecutive deficits added $612b+ to public debt. Surpluses Can Reduce Debt *Funds from surpluses can be used to repay debt or build savings (e.g. Future Fund). *Fiscal consolidation slows debt growth and improves long-term sustainability.

Question 31

Structural vs. Cyclical Deficit?

Answer 31

Structural: Result of deliberate policy Cyclical: Caused by economic downturns; should self-correct as economy recovers

Question 32

List 2 risks of high public debt.

Answer 32

Loss of AAA credit rating Reduced living standards from higher future taxes or lower spending

Question 33

What is the stance of budgetary policy?

Answer 33

It refers to whether the budget is expansionary, contractionary, or neutral in its effect on aggregate demand (AD).

Question 34

What is an expansionary budget stance?

Answer 34

Increases AD by injecting money into the economy (e.g. higher spending, lower taxes). Usually involves a budget deficit or smaller surplus.

Question 35

What is a contractionary budget stance?

Answer 35

Decreases AD by withdrawing money from the economy. Typically involves a budget surplus or smaller deficit.

Question 36

What is a neutral budget stance?

Answer 36

Has minimal effect on AD. Occurs when the budget is balanced (receipts ≈ outlays).

Question 37

How do you determine the stance of budgetary policy?

Answer 37

Look at budget outcome: oDeficit: More spending than revenue – injects money into the economy → expansionary. oSurplus: More revenue than spending – withdraws money from the economy → contractionary. Compare changes over time (especially as a % of GDP). Growing deficit → more expansionary Growing surplus → more contractionary

Question 38

When is an expansionary stance typically used?

Answer 38

During economic downturns, to reduce unemployment and stimulate growth.

Question 39

When is a contractionary stance typically used?

Answer 39

During economic booms, to reduce inflationary pressures.

Question 40

What are Automatic Stabilisers (Cyclical)?

Answer 40

Changes in tax revenues and welfare outlays that occur automatically in response to changes in economic activity. ~They are Built-in responses to economic changes that operate without new government decisions.

Question 41

How do Automatic Stabilisers work during a contraction?

Answer 41

Unemployment benefits (Jobseeker): 1. The government collects less money in taxes because: 2. People earn less income → they pay less income tax 3. Businesses make less profit → they pay less company tax 4. People spend less → less GST and excise tax is collected 5. The government spends more money on welfare payments like JobSeeker, because more people are unemployed or need financial help. The budget moves towards a deficit adopting an expansionary stance → increases AD → stabilises economy.

Question 42

What are two advantages of Automatic Stabilisers?

Answer 42

oThey operate automatically as economic conditions change, without the need for new legislation or delays, helping to quickly stabilise aggregate demand (AD). oBecause they do not require active decision-making, they avoid political delays or debate and can self-correct over the business cycle, helping to avoid persistent deficits or surpluses.

Question 43

What are two disadvantages of Automatic Stabilisers?

Answer 43

oIn deep or prolonged recessions, automatic stabilisers may not provide a strong enough boost to AD on their own, requiring discretionary intervention. oTheir effectiveness is tied to the design of the tax and welfare systems; if these systems are poorly structured, stabilisers may not adequately smooth fluctuations.

Question 44

What are Discretionary Stabilisers (Structural)?

Answer 44

Deliberate changes in tax rates or spending levels by the government.

Question 45

How do Discretionary Stabilisers work during a contraction?

Answer 45

Stage 3 tax cuts: 1. Normally, when you earn money, a part of it goes to the government as income tax. 2. If the government lowers the tax rate, you get to keep more of your pay. In result: You have more disposable income (money you can spend or save). 3. People spend more (↑ consumption) With more money in your pocket, you're more likely to buy goods and services. 4. This increases consumption, which is a key part of Aggregate Demand (AD). 5. Businesses pay less company tax Companies also pay tax on their profits. 6. If the government cuts this tax, businesses keep more of their profits. In result: They might spend more on investment, like buying new equipment or expanding their business

Question 46

What are two advantages of Discretionary Stabilisers?

Answer 46

oGovernments can tailor spending or tax changes to specific economic conditions, sectors, or groups, potentially enhancing the effectiveness of the response. oIn periods of sharp downturn or overheating, discretionary measures can provide a larger and more immediate shift in AD than automatic stabilisers alone.

Question 47

What are two disadvantages of Discretionary Stabilisers?

Answer 47

oExpansionary measures may be politically difficult to reverse, risking structural deficits and rising government debt if not withdrawn once the economy recovers. oPolicy formulation, approval, and implementation can take time, reducing effectiveness and potentially causing the stimulus to arrive too late.

Question 48

What are the similarities between automatic and discretionary stabilisers?

Answer 48

o Automatic and discretionary stabilisers are designed to operate countercyclically, helping to reduce the severity of economic booms and recessions by influencing the level of AD. o They assist in promoting low inflation, strong and sustainable economic growth, and full employment, which supports improved living standards.

Question 49

What are the differences between automatic and discretionary stabilisers?

Answer 49

*Automatic stabilisers operate without the need for new government action — they respond immediately to changes in the level of economic activity. *Discretionary stabilisers require deliberate policy decisions (e.g. a new tax cut or spending program), which involve time lags in implementation. *Automatic stabilisers tend to self-correct and do not usually result in structural deficits, as deficits during downturns are expected to be offset by surpluses during booms. *Discretionary stabilisers, if not reversed after a recovery, can cause persistent structural deficits, increasing public debt over time.

Question 50

Explain how automatic and discretionary stabilisers can influence the budget outcome and government debt levels.

Answer 50

*Automatic stabilisers: Influence budget outcome (deficit/surplus) without changing long-term debt, assuming surpluses follow deficits. *Discretionary stabilisers: Can lead to permanent structural deficits if not reversed → increase public debt.

Question 51

What are 2 advantages of using budgetary policy affect AD and influence the achievement of domestic macroeconomic goals and living standards

Answer 51

1.Automatic Stabilisers Operate Quickly Automatic stabilisers, such as progressive income taxes and welfare payments, respond immediately to changes in economic activity. In a downturn, lower tax revenue and higher welfare spending naturally make the budget more expansionary, supporting aggregate demand. This helps to stabilise the business cycle, protect jobs and incomes, and enhance living standards without the need for new policy decisions. 2. Targeted Spending to Address Specific Weaknesses Budgetary policy allows the government to precisely target areas of economic weakness through changes in spending and taxation. For example, increased funding to sectors like health, education, or infrastructure can create jobs, reduce inequality, and promote equity. This improves material living standards, supports strong and sustainable economic growth, and can assist in achieving full employment.

Question 52

What are 2 disadvantages of using budgetary policy affect AD and influence the achievement of domestic macroeconomic goals and living standards

Answer 52

1. Discretionary Measures Have Long Time Lags Discretionary budgetary policies often face delays due to planning, approval, and implementation stages. For example, infrastructure projects may take years to complete, meaning their impact on aggregate demand might arrive too late to address a recession. This limits the budget’s ability to respond quickly to economic shocks, reducing its effectiveness in stabilising the business cycle, supporting employment, and improving living standards in the short term. 2. Risk of Structural Deficits and Long-Term Debt Ongoing use of expansionary budgets without reversal can lead to structural budget deficits and rising public debt. For instance, continuing tax cuts or high spending after recovery can strain government finances. This may require future tax increases or service cuts, reducing material living standards and weakening the government’s ability to respond to future downturns, compromising the achievement of long-term macroeconomic goals.