Revision NotesExam QuestionsFlashcardsPast Papers
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

Last updated

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