IGCSEEconomicsCambridge (CIE)Revision Notes4. Government & the Macroeconomy4.2 Fiscal PolicyFiscal Policy Measures

Syllabus Edition

First teaching 2025

First exams 2027

Fiscal Policy Measures (Cambridge (CIE) IGCSE Economics): Revision Note

Exam code: 0455 & 0987

Steve Vorster

Written by: Steve Vorster

Reviewed by: Lisa Eades

Updated on

Understanding fiscal policy

  • Fiscal policy involves the use of government spending and taxation (revenue) to influence total (aggregate) demand in the economy 

  • Fiscal policy is usually presented annually by the government through the Government Budget

    • Fiscal policy can be expansionary in order to generate further economic growth

    • Fiscal policy can be contractionary in order to slow down economic growth or reduce inflation

Fiscal policy measures

  • When using fiscal policy, the government can change two main elements:

Changes in taxes

  • Reducing taxes increases consumers’ disposable income and may encourage higher spending

  • Increasing taxes reduces disposable income, lowering spending and potentially slowing inflation

Changes in government spending

  • Increasing spending boosts demand for goods and services, creating jobs and encouraging growth

  • Decreasing spending reduces total (aggregate) demand, which can slow inflation but may lead to higher unemployment

The effects of fiscal policy on macroeconomic aims

  • To understand the effects of fiscal policy on an economy, it is useful to know how total demand (gross domestic product) is calculated

  • Total (aggregate) demand = household consumption (C) + firms' investment (I) + government spending (G) + exports (X) - imports (M)

AD space equals space straight C space plus space straight I space plus space straight G space plus space left parenthesis straight X space minus space straight M right parenthesis

  • From this, it is logical that changes to fiscal policy can influence any of these components – and often several of them at once

Expansionary fiscal policy

  • Lower taxes and/or higher government spending

    • Increases total (aggregate) demand in the economy, encouraging higher output and employment

    • Useful during a recession to boost economic growth and reduce unemployment

  • May risk higher inflation if total (aggregate) demand grows too quickly

  • Can be directed towards sustainable growth by funding renewable energy, public transport, and green infrastructure

Contractionary fiscal policy

  • Higher taxes and/or lower government spending

    • Reduces demand in the economy, helping to control inflation

    • Useful when the economy is overheating or inflation is high

  • May slow growth and increase unemployment if used for too long

  • Can support environmental sustainability by reducing subsidies for polluting industries and increasing taxes on harmful activities (e.g. carbon taxes)

Macroeconomic aim

How fiscal policy can help achieve it

Economic growth

  • Increase government spending on projects and cut taxes to encourage spending and investment

Lower inflation

  • Raise taxes or reduce spending to lower total demand and reduce price pressures

Lower unemployment

  • Fund job creation schemes and infrastructure projects, lower taxes to stimulate hiring

Healthy balance of payments

  • Tax imports (tariffs) to reduce demand for foreign goods and support domestic industries

Fairer income distribution

  • Use progressive taxes and targeted government spending to reduce inequality

Sustainability

  • Fund renewable energy, protect natural resources and use environmental taxes to encourage greener behaviour

Examiner Tips and Tricks

When discussing sustainability in fiscal policy, focus on long-term benefits. For example: “Government investment in renewable energy creates jobs now while reducing future environmental costs"

Examples of fiscal policy

Contractionary fiscal policy

Example 1

The government increases income tax levels

Effect on the economy

  • Consumers pay more tax → discretionary income reduces → consumption reduces → total demand reduces

Impact on macroeconomic aims

  • Economic growth slows down

  • Inflation eases

  • Unemployment may increase as output is falling and fewer workers are required

  • Current Account Improves (with less income, imports may fall)

Example 2

The government freezes/reduces public sector workers pay

Effect on the economy

  • Wages stagnate or reduce → Consumer confidence falls → consumption decreases → total demand decreases

Impact on macroeconomic aims

  • Economic growth slows down

  • Inflation eases

  • Unemployment may increase as output is falling

  • Current Account improves (with less income, imports may fall)

Example 3

The government cuts public spending in its budget

Effect on the economy

  • Less demand for goods/services → less income for firms → output and profits decrease → total demand decreases

Impact on macroeconomic aims

  • Economic growth slows down

  • Inflation eases

  • Unemployment may increase as output is falling

  • Current Account improves (with less income, imports may fall)

  • Less corporation tax available for redistribution

  • Sustainability may worsen due to lower green subsidies being available

Expansionary fiscal policy

Example 1

The government decreases corporation tax

Effect on the economy

  • Firms' net profits increase → investment by firms increases → total demand increases

Impact on macroeconomic aims

  • Economic growth increases

  • Inflation rises

  • Unemployment may decrease as output is rising, which requires more workers

  • Current Account – Unsure – Exports may rise due to new investments in the economy, but imports may rise due to higher income generated by the investment

Example 2

The government increases unemployment benefits

Effect on the economy

  • Household income increases → consumption increases → total demand increases

Impact on macroeconomic aims

  • Economic growth increases

  • Inflation rises

  • Unemployment may decrease as output is rising, which requires more workers (although increased unemployment benefits may discourage some people from entering the labour market)

  • The Current Account is unlikely to change, as this policy helps the poorest and imports are unlikely to increase

  • Redistribution of income has increased and there is more equity in society

Unlock more, it's free!

Join the 100,000+ Students that ❤️ Save My Exams

the (exam) results speak for themselves:

    Test yourselfFlashcards
    Previous:TaxationNext:Monetary Policy Measures
    Author
    Reviewer
    Steve Vorster

    Author: Steve Vorster

    Expertise: Economics & Business Subject Lead

    Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.

    Lisa Eades

    Reviewer: Lisa Eades

    Expertise: Business Content Creator

    Lisa has taught A Level, GCSE, BTEC and IBDP Business for over 20 years and is a senior Examiner for Edexcel. Lisa has been a successful Head of Department in Kent and has offered private Business tuition to students across the UK. Lisa loves to create imaginative and accessible resources which engage learners and build their passion for the subject.