Chapter 17

Question 1

Define fiscal policy

Answer 1

FISCAL POLICY is discretionary/ active. It refers to the change in government spending or
tax collections or both by the government to promote full-employment, price stability and
economic growth. involves decisions about government spending and taxation.
ˆ There are two types of fiscal policy:

Question 2

What are the 2 types of fiscal policy and shortly mention what each does.

Answer 2

– Expansionary fiscal policy (↑ gvt expenditure and/or ↓ taxation).
– Contractionary fiscal policy (↓ gvt expenditure and/or ↑ taxation).

Question 3

What causes an expansionary fiscal policy and what does it result in ?

Answer 3

(1)Increase in government spending
(2) Decrease in taxes
An expansionary fiscal policy results in an increase in aggregate demand to push the economy** out of a recession or away from high levels of unemployment.**
*budget deficit increases
*budget surplus decreases
*inflation increases
*GDP increases
*unemployment decreases

Question 4

What causes an contractionary fiscal policy and what does it result in ?

Answer 4

(1) Decrease in government spending
(2)Increase in taxes
A contractionary fiscal policy results in a decrease in aggregate demand to decrease inflation.
*budget deficit decreases
*budget surplus increases
*inflation decreases
*GDP decreases
*unemployment increases

Question 5

When demand-pull inflation occurs, what kind of fiscal policy may help control it?

Answer 5

Contractionary

Question 6

When the economy faces demand-pull inflation, fiscal policy should move toward a…..

Answer 6

gov budget surplus

Question 7

what is a budget deficit and suprlus?

Answer 7

• BUDGET DEFICIT = expenditures > revenues
• BUDGET SURPLUS = expenditures < revenues
• budget deficit; The amount by which the expenditures of the government exceed its revenues in any year.

Question 8

If the economy starts out with a balanced government budget, a subsequent expansionary fiscal policy will create a __.

Answer 8

budget deficit

Question 9

illustrate graphically what will happen to the AS and AD curves given an expansionary fiscal policy

Answer 9

see graph 17.1 in textbook

Question 10

illustrate graphically what will happen to the AS and AD curves given a contractionary fiscal policy

Answer 10

see graph 17.2

Question 11

what tools will be used to positively stimulate the economy?

Answer 11

• Tax reductions
• Increases in government spending

Question 12

What are some objectives of fiscal policy

Answer 12

• Full employment
• Price stability
• Accelerating the rate of economic development
• Optimum allocation of resources
• Equitable distribution of income and wealth
• Economic stability
• Capital formation and growth
• Encouraging investment

Question 13

what tools will be used to negatively stimulate the economy?

Answer 13

• Tax increases
• dereases in government spending

Question 14

Why is it that government purchases of R5 billion to stimulate the economy, can end up adding R20 billion to aggregate demand?

Answer 14

This happens because the multiplier process magnifies the initial change in spending into successive rounds of new consumption spending

Question 15

In an economy where the marginal propensity to consume (MPC) is 0.8, if the government increases its purchases (G) by R100 billion, then equilibrium output (Y) will increase by __.

Answer 15

R500 billion

Reason: ΔY = 1/(1−MPC) * ΔG
ΔY = 1/(1−0.8) * 100
ΔY =500

Question 16

Regarding expansionary fiscal policy, why are the tax reductions slightly larger than the increases in gov spending to achieve the same rightward shift?

Answer 16

Tax reductions increases savings rather than consumption

Question 17

What are the problems that fiscal policy faces and shortly describe each

Answer 17

Problems of timing:
* Recognition lag: is the time difference between the start of recession or inflation and the awareness that it is happening
* Administrative lag is the time difference between recognising the need for fiscal action and taking action
* Operational lag is the time difference between taking = action and seeing results

Political considerations
Political business cycles the tendency of the government
to reduce taxes and increase government spending before elections and then raising taxes and decreasing government spending afterwards

Future policy reversals
The fiscal policy may lose some its strength if it fails to achieve its intended objective. If taxpayers believe that tax reductions are temporary, they may not increase spending and aggregate demand won’t increase.

Crowding-out effect
is the rise in interest rates and a resulting decrease in planned investment caused by the government’s increased borrowing to finance budget deficits and refinance debt. It lowers the future production capacity of the economy

Offsetting provincial and local (municipal) finance
Provincial and local governments are pro-cyclical which means that they worsen rather than correct recession or
inflation.

Question 18

Graphically illustrate the crowding out effect and expain the grapth

Answer 18

See figure 17.3
* If the investment demand curve (ID1) is fixed, the increase in the interest rate from 6% to 10% caused by financing a large public debt will move the economy from a to b and crowd out $10 billion of private investment
* This causes a decrease the size of the capital stock inherited by future generations.
* However, if the public goods enabled by the debt improve the investment prospects of businesses, the private investment demand curve will shift rightward, as from ID1 to ID2
* That shift may offset the crowding-out effect wholly or in part. In this case,
* it moves the economy from a to c.

Question 19

Define public debt

Answer 19

• Public debt is the total amount borrowed by the government owed to the owners of government
  securities
• It’s the total accumulation of all prior deficits minus surpluses through time.
• Also called government debt, national debt or sovereign debt.

Question 20

How is public debt accumulated

Answer 20

Public debt is accumulated over time when a
government spends more money than it collects in revenue, usually through taxes. To
cover this gap, the government borrows money.

Question 21

What are some problems involving public debt? Describe each shortly. (need to finish this card)

Answer 21

• Interest charges
• Bankruptcy concerns
• Foreign owned debt

Question 22

Define tax burden

Answer 22

Tax burden is the true economic weight of a tax (the total cost of taxes
imposed on society).

Question 23

What are the 2 main principles to taxation

Answer 23

• Benefits recieved principle
• Ability to pay principle

Question 24

What is the benefits-received principle of taxation?

Answer 24

• The idea that those who receive the benefits of goods and services provided by government should pay the taxes required to finance them.
• Households and businesses should purchase the goods and services of government as they buy other commodities

Question 25

What is the ability-to-pay principle of taxation?

Answer 25

The idea that those who have greater income (or wealth) should pay a greater proportion of it as taxes than those who have less income (or wealth).

Question 26

What tax systems are there and shortly describe each

Answer 26

* **PROGRESSIVE** tax is progressive if its average rate increases as income increases e.g. personal income tax * **REGRESSIVE** tax is regressive if its average rate decreases as income increases e.g. value-added tax * **PROPORTIONAL** tax is proportional if its average rate remains the same regardless of the size of income e.g. company tax

Question 27

Define tax incidence

Answer 27

ˆ Tax incidence refers to who actually bears the burden of taxation. the person or group that ends up paying a tax.

Question 28

what determines tax incidence?

Answer 28

relative price elasticity of supply and demand

Question 29

* When supply is more elastic than demand, .............. bear most of the tax burden. * When demand is more elastic than supply, ........ bear most of the cost of the tax.

Answer 29

* buyers * producers

Question 30

Tax revenue is larger when ......

Answer 30

Tax revenue is larger the more inelastic the demand and supply are

Question 31

Graphically illustrate tax incidence and elastic vs inelastic supply

Answer 31

See figure 17.6

Question 32

Graphically illustrate tax incidence and elastic vs inelastic demand

Answer 32

See figure 17.5

Question 33

Graphically illustrate the impact of an excise tax of R2 per unit on supply and demand.

Answer 33

See figure 17. 4

Question 34

What must we calculate in order to determine whether a particular tax is progressive, regressive or proportional?

Answer 34

tax incidence

Question 35

What types of South african taxes are there? shortly describe each and mention the incidence and impact.

Answer 35

**Personal income tax** * a tax levied on the taxable income of individuals, households and * unincorporated firms * incidence is on the individual * there is little chance for shifting it * for every rand paid as tax, individuals have one less rand in their pockets **Corporate income tax** * a tax levied on the income or capital of corporations or legal entities * incidence falls on the company’s stockholders (owners) via lower dividends or smaller amounts of retained corporate earnings lower wage growth for workers in the long run * reduction in return on investment which may slow capital accumulation **Value added and exercise taxes** * a tax levied on taxable supplies of goods * both taxes often shifted partly/largely to consumers via higher prices * VAT covers wider range of products. Excise taxes fall on a select list of goods. **Specific excise taxes** * a tax levied on the manufacture, sale or use of certain types of goods and product * Consumers and producers share the burden of the tax in some proportion

Question 36

Define efficiency loss of taxes

Answer 36

The loss of net benefits to society because a tax reduces the production and consumption of a taxed good below the level of allocative efficiency. Also called the deadweight loss of the tax.

Question 37

Graphically illustrate efficiency loss of taxes

Answer 37

See figure 17.7

Question 38

What other tax goals are as important or even more important thatn minimizing efficiency loss from taxes/

Answer 38

* Redustrubtive goals * reducing negative externalities