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Fiscal Policy Topic 3 1.

Explain the concept of fiscal policy

Fiscal Policy This is the use of government expenditure and taxation to influence AD and economic activity of a country, in line with its economic objectives. Goals of Fiscal Policy 1. 2. 3. 4. Stable prices Full employment (controlling unemployment rate) Economic growth (when per capita increase real GDP) A favourable balance of payments

Instrument of Fiscal Policy 1. 2. 3. 4. Taxation (Direct and Indirect) Government expenditure Budget Combination of both taxation and govt spending

Government Expenditure 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Provision of public goods Provision of merit goods Macro-economic management to create employment and promote export Micro-economic management eg. to encourage growth of small firms Transfer payments Wages and salaries Interest on national debt Expenditure by nationalised industries Contributions to international organisation Capital expenditure

Government Revenue Comes from: 1. 2. 3. 4. 5. 6. 7. Taxes Loans and grants Sale of goods and services Interest and dividend income Surplus of nationalised industries/state corporations Income from sale of state assets Rent

Functions of government 1. 2. 3. 4. 5. To provide welfare benefits and re-distribute income Provision of security and defence Provision of infrastructure Provision of public and merit goods To manage the level of growth in the economy

Fiscal Policy as a means of Advertising A. B. C. D. Aggregate demand Unemployment Inflation Balance of payment

Fiscal Policy and Advertising CONTRADICTIONARY Goal Method Budget When Why Income Tax Income Tax Yd Yd C C AD AD NI NI EXPANSIONARY

Fiscal Policy and UC Expansionary Policy tax AD via multiplier NI AE G

Unemployment Goal Policy UE Expansionary

Fiscal Policy G T Ad (via multiplier) income tax Yd Y C UE AD Defecit budget

When? During recession Why? To increase employed

Inflation Goal Policy Fiscal policy decrease inflation contractionary increase tax Decrease govt spending When? Why? Periods of high inflation To increase employment

Fiscal policy, unfavourable Balance of Payment (defecit) Goal Policy Fiscal policy decrease balance of payments contractionary T G When? Why? AD AD

High bills To reduce the defecit

Expansionary fiscal policy

Contractionary fiscal policy

Explain the nature of the budget Taxation Revenue, Transfer Expenditure Budget Surplus and Defecit Balanced Budget

A budget is a plan of govt spending and revenue for a period of time usually 1 year. The main purpose is to announce govt plans and influence the country in the following year. Budget defecit is when in a given year the total govt expenditure exceeds its revenue from taxes and other sources. Govts tend to run budget defecits if they believe that the economy needs stimulating and the signs of this are usually high unemployment, loss of confidence and productivity. A budget defecit is usually financed by govt through: a) b) c) d) Borrowing both locally and internationally through the issue of govt securities Withdrawals from past years surpluses Grants from other govts By issuing more cash

Surplus Budget This occurs when govt intends to collect more revenue through taxes, fees and other sources that it intends to spend. The exact effects of a budget surplus depends on how govt policy makers use the fund. A surplus budget is usually done when govt believe that there is inflationary pressure in the economy, therefore an increase in taxes and govt spending will lead to a negative ripple effect. Other reasons for surpluses are: To encourage economic growth- the less the govt borrows from the public, the less the pressure on interest rate and more funds are made available in the financial market. Another reason for a surplus is to repay huge accumulated debts over the years

Where does surpluses go? 1. 2. 3. 4. Use to pay past debts Placed in reserves Invest it in foreign holdings It may be used to provide better resources

Balance Budget A balance budget is also called a neutral budget so a balance budget occurs when the govt plans to sell exactly what it intends to collect, it is usually done when the govt believe neither a stimulant nor a restraint is required in the economy. Budget Defecit A persistently large defecit can be a measure problem because of finance in the defecit. A budget defedcit has to be financed and by issuing new govt debt. The govt may have to offer higher interest rates to attract buyers. In the long run govt borrowing today means that taxes will have to increase future and this will hinder private sector. Increase in national debt In the long run, high level of govt borrowing adds to accumulated national debt, this means that govt will have to spend more interest payments to holders of the debts. There is an opportunity cost involved as these payments could have been used in more productive ways. Wasteful public spending High defecits can result in wasteful public spending as money could have been used for better purposes. Benefits of a budget defecit a) Some economists believe that govt borrowing can benefit economic growth in the long run if it is used to finance capital spending b) The budget defecit as a tool of demand management and increasing borrowing can be a stimulus for demand especially when economy is suffering from weak spending. Keynes argued that govt could use defecits in order to manage aggregate demand.