Understand the Government and Fiscal Policy
UNDERSTAND THE GOVERNMENT AND FISCAL POLICY
Keywords: Fiscal policy, taxes, government spending, equilibrium level of income, multiplier, budget, recessionary gap, inflationary gap, automatic stabilizers.
Objectives: Students should be able to understand
4.1 The sources of government revenue
4.2 The sources of government expenditure
4.3 The role played by the government in a country
4.4 Aims of fiscal policy
4.5 The government expenditure multiplier & the tax multiplier
4.6 The impact of government spending and taxes on aggregate expenditure and the equilibrium income level
4.7 How fiscal policy works
4.8 Drawbacks of fiscal policy
Ref. Book: Economics: 19th Edition by Campbell R. McConnell, Stanley L. Brue& Sean M. Flynn, McGraw-Hill Irwin, 2012 (Compiled by SP Business School), Chapter 17.
Irvin Tucker, Economics For Today’s World, South-Western College Publishing, Fifth Edition 2008, Chapter 19 and Chapter 21.
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UNDERSTAND THE GOVERNMENT AND FISCAL POLICY [pic 3]
1. Introduction
In 2-sector economy, equilibrium is attained when:
Aggregate output = Aggregate expenditure/demand
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Note that equilibrium need not occur only at full employment.
Equilibrium can occur at:
- less than full employment
→
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- more than full employment
→
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(3) full employment
What role does the government play in an economy?
Private sectors (C & I) make their decisions based on personal interest → Their combined decisions may be insufficient (which may lead to unemployment) or excessive (which may lead to inflation) → C & I cannot be counted upon to spend more when AE is too low or spend less when AE is too high → Therefore, need the government to step in to stabilize the economy at or near full employment → How does the government attain the above? →
The government can either ← or →AE, shifting it towards full employment |
Our current focus will be on fiscal policy in this chapter.
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What are the major aims of using fiscal policy?
- To maintain the economy at or close to full employment.
- To ensure a steady growth in real GDP.[pic 9]
- To ensure low inflation.
- To maintain a stable exchange rate between the dollar and foreign
currencies.
- To have a balanced current account.
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To achieve aims (1) to (5) above, the government also uses
monetary policy.
Sources of government revenue
From where does the government obtain the revenue to finance
its purchases?
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a. Main source is derived from taxes.
Examples: direct taxes (income tax, property tax) and indirect
taxes (GST).
b. Non-tax revenue – investment income, income from
sales of goods & services, repayment of government loans.
Sources of government expenditure
What are the main areas of government expenditure?
Defence and justice, social & community services, economic services
& servicing of its public debt.