Demand-Side Policies - Fiscal
Economics: Edexcel A A Level, topic 4.1.5
Functions of Fiscal Policy
Fiscal policy can have both macroeconomic and microeconomic functions.
Microeconomic functions
- Governments levy taxes so they can, among other things, provide merit goods (e.g. NHS), provide public goods (e.g. clean drinking water, infrastructure), reduce negative externalities (e.g. pollution), and reduce consumption of demerit goods (e.g. cigarettes).
Macroeconomic functions
- Governments levy taxes so they can, among other things, redistribute income and wealth by giving out transfer payments (e.g. benefits) to reduce inequality.
Government budget
- Fiscal policy depends on the government's budget.
- Budget deficit:
- When government spending exceeds government income.
- Budget surplus:
- When government spending is less than government income
Impact of Fiscal Policy
Fiscal policy can be used to influence both aggregate demand (AD) and aggregate supply (AS).
Impact of fiscal policy on AD
- A government can use fiscal policy to deliberately influence AD, and so macroeconomic objectives.
- E.g. if a government is in a recession, and a negative output gap, a government could use expansionary fiscal policy, such as cutting income tax for those on lower incomes.
- This would cause AD to rise as this group have a higher marginal propensity to consume (MPC).
- A government could also spend more money on building hospitals and schools to increase government spending (G) and so boost AD.
Impact of fiscal policy on AS
- Fiscal policy can also have a supply-side impact.
- If a government cuts corporation tax, firms will have more post-tax profits which may mean investment rises. This should boost human capital and physical capital, so increasing the productive capacity of the economy.
- If a government cuts income tax, it may attract foreign workers to come to the UK to work. This would shift LRAS to the right.
- Equally, if a government spends more on infrastructure, it could shift both AD and LRAS to the right.
Test yourself on Demand-Side Policies - Fiscal
Which of the following is an example of fiscal policy addressing a macroeconomic concern?
Which of the following is an example of fiscal policy addressing a microeconomic concern?
Which of the following types of fiscal policy would affect aggregate supply?
Which of the following fiscal policies is primarily impacting AD?
Which of the following policies would lead to this change from AD to AD1?