![]() The economy deflates as the price level decreases from P to P1. ![]() The balance of payments deteriorates as imports increase.Ĭontractionary/Deflationary fiscal policy: decrease in government spending and increase in taxation to reduce inflation. Unemployment would decrease if more labour is needed to produce extra output, as the economy grows. The economy reflates as the price level increases from P to P1. Profits of firms increase and investment, as well as capital and current spending. Investment provides jobs which increases income and consumption. Increase in government spending on investment: increases AD due to the multiplier effect. As C and I are components of AD, AD increases.Ī decrease in corporation tax: increases the proportion of retained profits, increasing investment and AD.Ī decrease in indirect tax like sales tax (VAT): increases the purchasing power of consumers and real income, so AD increases. Accelerator effect shows investment relies on consumption, more consumption induces more investment. fiscal stimulus which would involve spending on infrastructure.Įxpansionary/Reflationary fiscal policy: increase in government spending and reduction in taxation.ĪD will initially increase and the effect will increase further due to the multiplied effect.Ī decrease in income tax: disposable income (Y) increases and because of the consumption function C = a + bY, consumption increases. However, an increase in taxation, as a factor of aggregate demand, shifts AD inwards.ĭiscretionary fiscal changes: deliberate changes in direct and indirect taxation and government spending, e.g. National debt: the sum of all past debt/borrowing and interest on the debt.Ī budget deficit increases the national debt and surplus reduces it.Īn increase in government spending, as a component of aggregate demand, shifts AD outwards. Transfer payments: benefits paid for which no goods and services are received in return, such as unemployment benefits and pensions.īudget surplus: if government revenues exceed total expenditures.īudget deficit: if total expenditures exceed government revenue.īalanced budget: if total expenditures and government revenue are equal. Sources of government revenue: primarily from taxes (direct and indirect), as well as from the sale of goods and services, profits from state owned enterprises, sale of state owned enterprises and rent from government owned buildings and land.Ĭurrent spending: day-to-day expenditure on wages, books for schools, drugs for the health sector.Ĭapital spending: adding to the capital stock of the economy, e.g. Fiscal policy: the use of government spending and taxation to influence the level of economic activity.
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