Demand Management: Fiscal Policy

Question 1

What is Fiscal Policy?

Answer 1

The use of government spending and taxation to influence aggregate demand in the economy.

Question 2

What is the Keynesian Multiplier?

Answer 2

A process where an initial injection into the economy leads to a larger increase in national income due to repeated spending cycles.

Question 3

Formula for the Keynesian Multiplier

Answer 3

Multiplier = 1 / (1 - MPC)

Question 4

What is a budget deficit?

Answer 4

When government expenditure is greater than revenue.

Question 5

Name the 3 types of government expenditure and what.

Answer 5

Current – Daily operations (e.g. salaries)
Capital – Infrastructure investment (e.g. roads)
Transfer payments – Welfare payments (e.g. unemployment benefits)

Question 6

What is crowding out in fiscal policy?

Answer 6

When increased government borrowing raises interest rates, reducing private investment.

Question 7

What are automatic stabilisers?

Answer 7

Fiscal changes that occur automatically with the economic cycle.

Question 8

Examples of automatic stabilisers.

Answer 8

Tax revenue and welfare payments.

Question 9

Strengths of fiscal policy

Answer 9

Can target specific sectors.
Promotes equity.
Stimulates demand in deep recessions.
Can increase LRAS via capital spending.

Question 10

Weaknesses of fiscal policy

Answer 10

Time lags
Political constraints
Crowding out
Risk of high public debt