CHAPTER 29 FISCAL POLICY
The motive of the fiscal policy is to achieve (i) Full employment (ii) Price stability (iii) Long-term economic
Deficit: Adds to the government debt Debt: Amount borrowed to finance deficit
Demand-Side effects of Tax Supply Side effects of Tax Tax Cut
Tax increases; Tax increases; Increase the supply of labour
Agg Dmnd decreases Higher-income taxes decreases Increase full-employment (quantity
Disposable income decreases the motivation(incentive) to work. of labour)
-Supply of labour decreases.(Small
labour) Increases Potential GDP
-decreases potential GDP
Tax on income & Incentive to Save: tax on interest weakens the incentive to save & lend; decreases supply of
loanable funds. Savings and investment also decrease; the real GDP also goes down.
Laffer Curve: Relationship between the tax rate(X-axis) and the amount of tax revenue(Y-axis).
Fiscal policy is used as a tool to stabilize the business cycle by changing the aggregate demand by either
(i) Discretionary (ii) Automatic
Discretionary Automatic (in other words one action leads to
-action initiated by an act of Parliament -action initiated by state of the economy
-Change in a spending program or a tax law -Examples: An increase in unemployment stops and
E.g A cut in income tax rates increase in the payments to the unemployed.
Inc in defence spending -A fall in income induces a decreased tax revenue.
FISCAL POLICY MULTIPLIERS
1. Government Expenditure Multiplier
-change in govt. expenditure on goods and services
-Product of Aggregate demands, so as govt. expenditure changes, aggregate demand changes.
- if government increases govt. expenditures it can stimulate the economy
refer to calculation in slides
---Government Expenditure Multiplier =Change in Equilibrium/ Change in Government Expenditures--
-AE curve rises upward by the change in govt. Shifts curve AE0 to AE1. See graph slide 27. 2. Autonomous Tax Multiplier
-Change in autonomous taxes on aggregate expenditures and real GDP
-Decrease in taxes increases disposable income which increases consumption expenditure.
Autonomous Taxes that are levied (imposed) independently of the level of income. Meaning
these taxes you will have to pay either you have or you don’t have income.
(a) Property Tax (depends on the value of the property
(b) User Fees for government services
(c) The GST
Induced Taxes: Taxes that vary with real GDP and income are called induced t