3.6 Demand Management: Fiscal Policy (DP IB Economics: HL): Flashcards
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Define fiscal policy.
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Define fiscal policy.
Fiscal policy involves the use of government spending and taxation to influence aggregate demand in the economy.
What is a budget deficit?
A budget deficit occurs when government revenue is less than government expenditure, and must be financed through public sector borrowing.
Define direct tax.
A direct tax is a tax imposed on income and profits that is paid directly to the government by an individual or firm.
Fiscal policy involves the use of government spending and to influence aggregate demand.
Fiscal policy involves the use of government spending and taxation to influence aggregate demand.
True or False?
Transfer payments contribute directly to aggregate demand.
False.
Transfer payments involve no exchange of goods or services, so income is only moved between groups and does not add to aggregate demand.
Define indirect tax.
An indirect tax is a tax imposed on spending, for which the supplier is responsible for sending the payment to the government.
What are the three categories of government expenditure?
The three categories are current expenditure, capital expenditure and transfer payments.
True or False?
A balanced budget means government revenue equals government expenditure.
True.
A balanced budget occurs when government revenue is exactly equal to government expenditure.
Define expansionary fiscal policy.
Expansionary fiscal policy involves reducing taxes or increasing government spending in order to increase aggregate demand.
Aggregate demand equals consumption, investment, government spending, plus exports minus .
Aggregate demand equals consumption, investment, government spending, plus exports minus imports.
Which two tools can a government use for contractionary fiscal policy?
Contractionary fiscal policy uses increasing taxes or decreasing government spending to reduce aggregate demand.
How can fiscal policy help achieve greater equity?
Fiscal policy can redistribute income through taxation so as to ensure more equity in society.
Define the multiplier.
The multiplier is the ratio of the change in real income to the injection that created the change.
What key idea underpins the multiplier process?
The multiplier process is based on the idea that one individual's spending is another individual's income.
Define marginal propensity to consume (MPC).
The marginal propensity to consume (MPC) is the proportion of additional income that is spent on consumption.
The higher the leakages in an economy, the the value of the multiplier.
The higher the leakages in an economy, the smaller the value of the multiplier.
Define marginal propensity to save (MPS).
The marginal propensity to save (MPS) is the proportion of additional income that is saved.
True or False?
A higher marginal propensity to save gives a larger multiplier.
False.
A higher marginal propensity to save means greater withdrawals, which gives a smaller multiplier.
How is the multiplier calculated using the withdrawals approach?
Using withdrawals, the multiplier equals 1 ÷ (MPS + MPT + MPM).
What happens to the multiplier if the marginal propensity to consume rises?
If the marginal propensity to consume rises, the value of the multiplier increases.
Marginal propensities show how each additional of income is allocated to consumption, saving, tax or imports.
Marginal propensities show how each additional dollar ($) of income is allocated to consumption, saving, tax or imports.
True or False?
The multiplier can only increase national income, never reduce it.
False.
The multiplier can also work in reverse, producing a downward multiplier effect when injections are reduced.
Calculate the multiplier when the marginal propensity to consume is 0.6.
Using 1 ÷ (1 − MPC), the multiplier is 1 ÷ (1 − 0.6) = 2.5.
What happens to the multiplier if interest rates increase?
If interest rates increase, saving rises and consumption falls, so the multiplier reduces.
Define marginal propensity to tax (MPT).
The marginal propensity to tax (MPT) is the proportion of additional income that is paid in tax.
Define automatic stabilisers.
Automatic stabilisers are automatic fiscal changes that occur as an economy moves through the stages of the business cycle.
How do automatic stabilisers behave during a recession?
In a recession, tax revenue automatically falls and unemployment benefits rise, keeping real GDP higher than it would otherwise be.
Define crowding out.
Crowding out is where expansionary fiscal policy, particularly government spending, leads to a reduction in private sector spending or investment.
Why does crowding out push up interest rates?
Government borrowing competes for the limited savings available, which raises the real interest rate.
A strength of fiscal policy is that government spending can be at specific industries.
A strength of fiscal policy is that government spending can be targeted at specific industries.
True or False?
Fiscal policy can usually be implemented more quickly than monetary policy.
False.
Fiscal policy takes longer to plan and implement; budgets are usually annual, whereas monetary policy can be adjusted 4–8 times a year.
Give one strength of fiscal policy relating to income.
Fiscal policy can redistribute income through taxation.
Define time lags as a weakness of fiscal policy.
Time lags are delays that make it difficult to predict exactly when a fiscal policy's desired effect on the economy will occur.
How can fiscal policy reduce negative externalities?
Fiscal policy can reduce negative externalities through taxation.
Increased government spending can create budget deficits that are added to the national .
Increased government spending can create budget deficits that are added to the national debt.
What is meant by a conflict between objectives as a weakness of fiscal policy?
Pursuing one aim can undermine another, for example cutting taxes to boost growth may cause inflation.
True or False?
In a boom, automatic stabilisers have a disinflationary effect.
True.
In a boom, higher tax revenue and lower benefit payments reduce real GDP below what it would otherwise be, which is disinflationary.
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