fiscal policy

Question 1

which two levers are manipulated by fiscal policy

Answer 1

government spending and taxes. by adjusting G & T, government can influence AD. higher spending and/or lower taxes boosts AD, while the opposite contracts it,

Question 2

government expenditure

Answer 2

capital expenditures, current expenditures, transfer payments

Question 3

capital expenditure (government expenditure)

Answer 3

these are investments in infrastructure, such as roads, bridges and schools. capital expenditures are important for long-term economic growth.

Question 4

current expenditure (government expenditure)

Answer 4

these are day-to-day expenses, such as salaries for government employees and payments for social programs. current expenditures are important for providing essential services to citizens.

Question 5

transfer payments (government expenditure)

Answer 5

these are payments made to individuals or businesses, such as social security benefits or unemployment benefits. transfer payments are not counted as part of GDP because they do not represent the production of goods or services.

Question 6

sources of government revenue

Answer 6

taxes, fees and charges & sale of assets

Question 7

taxes (government revenue source)

Answer 7

taxes are the main source of government revenue. there are two main taxes: direct taxes which are levied on individuals and businesses, and indirect taxes, which are levied on goods and services.

Question 8

fees and charges (government revenue source)

Answer 8

governments also collect fees and charges for services they provide, such as driver’s licenses and park permits

Question 9

sale of assets (government revenue source)

Answer 9

governments may sell assets, such as land or buildings, to generate revenue

Question 10

budget deficit

Answer 10

if government expenditures exceed tax revenues in any given year

Question 11

budget surplus

Answer 11

if tax revenues exceed government expenditures in any given year

Question 12

balanced budget

Answer 12

if government expenditures are equal to tax revenues

Question 13

financing a budget deficit

Answer 13

borrowing money from public or from financial institutions. when government borrows money, it issues bonds. bonds are essentially loans that the government makes to the public. the government pays interest on the bonds it issues to the public.

Question 14

short term goals of discretionary fiscal policy

Answer 14

lift an economy out of recession, decrease cyclical unemployment, control inflation, decrease trade imbalances

Question 15

discretionary fiscal policy to lift an economy out of recession

Answer 15

by increasing government spending and reducing taxes, expansionary fiscal policy stimulates AD, increase real GDP and creates jobs, pulling the economy out of a downturn.

Question 16

discretionary fiscal policy to decrease cyclical unemployment

Answer 16

as the economy grows due to expansionary fiscal policy, more jobs are created and cyclical unemployment falls

Question 17

discretionary fiscal policy to control inflation

Answer 17

fiscal policy can play a role in managing inflation, although contractionary monetary policy is usually the primary tool. contractionary fiscal policy by reducing G and/or raising T can help fight inflation

Question 18

discretionary fiscal policy to decrease trade imbalances

Answer 18

fiscal policy can be used to adjust G and T to influence imports and exports, potentially helping to manage trade imbalances

Question 19

long term impact of fiscal policy

Answer 19

promote faster growth, improve infrastructure, reduce income inequality

Question 20

fiscal policy to promote faster growth

Answer 20

prudent fiscal policy, with moderate deficits and controlled debt, fosters a stable economic environment that encourages business investment and long-term growth

Question 21

fiscal policy to improve infrastructure

Answer 21

public investments in infrastructure can boost short-term growth through increased demand and long-term growth by enhancing productive capacity

Question 22

fiscal policy to reduce income inequality

Answer 22

progressive taxation and targeted cash transfers can redistribute income and address inequality in the short-run resulting in increasing equity (fairness) in access to education and healthcare can provide long-term growth

Question 23

goals of expansionary fiscal policy

Answer 23

stimulate AD and lift the economy out of recession or deflation

Question 24

tools and impact of expansionary fiscal policy

Answer 24

increase government spending –> directly boosts AD as G is a component
decrease taxes –> raises disposable income of households and after tax profits of firms, leading to increased consumption spending due to higher disposable income & increased investment spending due to higher after tax profit incentivising firms to invest more.
the increase in real GDP generated by expansionary policy can be greater than the initial increase in G or T cuts due to the multiplier effect.
as government injects more money into the economy via increased government spending, businesses and individuals spend more, creating income for others.
this new income leads to further spending, multiplying the initial impact of the policy.

Question 25

goals of contractionary fiscal policy

Answer 25

reduce AD combat inflation and close an inflationary gap

Question 26

tools and impact of contractionary fiscal policy

Answer 26

decrease government spending –> directly reduces AD as G is a component
increase taxes –> lowers disposable income of households and after-tax profit of firms, leading to decreased consumption spending & decreased investment spending
AD curve shifts left, reducing real GDP and potentially reduced inflation
severe contraction could lead to deflation but this is rare

Question 27

Keynesian multiplier

Answer 27

pebble analogy:
initial splash (increased government spending) creates ripples (increased income and spending), amplifying the impact (multiplier effect) –> additional income and spending creates further ripples, repeating the cycle and boosting overall economic activity (real GDP) –> happens because each round of spending generates additional income which is then spent again, creating a chain reaction

Question 28

factors affecting size of multipliers

Answer 28

marginal propensity to consume (MPC) : the percentage of additional income people spend
leakages: savings, taxes, and imports that reduce the impact of spending (MPS, MPT, MPM)

Question 29

benefits of the Keynesian multiplier

Answer 29

can stimulate sluggish economy and reduce unemployment, can help combat deflationary pressures

Question 30

drawbacks of the Keynesian multiplier

Answer 30

can increase government debt if not implemented carefully, can lead to inflation if not paired with responsible monetary policy

Question 31

automatic stabiliser

Answer 31

built in features of fiscal policy that react automatically to economic fluctuations, mitigating their impact

Question 32

automatic stabilisers during recessions

Answer 32

unemployment benefits: as unemployment rises, automatic payments cushion the income loss of laid-off workers, boosting their spending and preventing a deeper downturn.
progressive taxation: as incomes fall, tax burdens automatically decrease, leaving more money in people’s pockets to spend, again supporting aggregate demand.

Question 33

automatic stabilisers during booms

Answer 33

unemployment benefits: as unemployment reduces, automatic payments reduces, preventing excess spending and AD
progressive taxation: as incomes rise, tax burdens automatically increase, siphoning off excess spending and AD thus preventing inflation form spiralling out of control

Question 34

benefits of automatic stabilisers

Answer 34

stability, efficiency, equity

Question 35

stability due to automatic stabilisers

Answer 35

automatic stabilisers act as a safety net, cushioning the impact of economic ups and downs without requiring immediate policy intervention (built-in)

Question 36

efficiency due to automatic stabilisers

Answer 36

they operate automatically, without the need for complex political negotiations, making them a quicker and more efficient response to economic changes

Question 37

equity due to automatic stabilisers

Answer 37

progressive taxation and unemployment benefits can help to reduce income inequality during both recessions and booms

Question 38

limitations of automatic stabilisers

Answer 38

limited effectiveness, effect/action lags, cost

Question 39

limited effectiveness of automatic stabilisers

Answer 39

they may not be sufficient to completely prevent deep recessions or severe inflation, hence the need for discretionary fiscal policy

Question 40

effect/action lags of automatic stabilisers

Answer 40

their effects may take time to materialise, meaning they may not be able to react instantaneously to economic changes

Question 41

cost of automatic stabilisers

Answer 41

maintaining automatic stabilisers requires ongoing government spending, which can contribute to fiscal imbalances in the long run

Question 42

crowding-out effect

Answer 42

occurs when increased government spending leads to higher interest rates, which can discourage private investment.
government borrows to finance increased G, entering the loanable funds market.
higher demand for funds raises interest rates, making borrowing more expensive for firms.
firms may reduce investment due to higher borrowing costs, negating some of the intended demand boost from G.

Question 43

criticisms of the crowding-out effect

Answer 43

monetarists argue crowding-out limits the effectiveness of fiscal policy in stimulating aggregate demand.
however, crowding-out is less likely in deep recessions where private investment is already weak.

Question 44

effectiveness of fiscal policy (advantages)

Answer 44

direct impact, multiplier effect, targeted spending, tax cuts for the poor, long-term benefits, scalability, automatic stabilisers

Question 45

direct impact of fiscal policy

Answer 45

increased government spending directly boosts AD, especially important in deep recessions when other policies are in effective (commonly used to complement MP when it is showing stubborn effect/action lags)

Question 46

multiplier effect of fiscal policy

Answer 46

increase in spending triggers a chain reaction of spending and income growth, amplifying the initial impact to close any deflationary gap or recession

Question 47

targeted spending of fiscal policy

Answer 47

can be directed to specific sectors or regions to address specific needs, inequalities & inequities while stimulating AD & real GDP