Answer to Question #119577 in Macroeconomics for Abiah Kalim

Question

Evaluate, using an appropriate diagram, the effectiveness of the use of fiscal policy as a method of achieving the UKs macroeconomic objective (20 marks)

Answer 1

Fiscal policy is the use of government spending and taxation to influence the economy.

Governments use expansionary and contractionary fiscal policy to influence the level of aggregate demand in the economy in an effort to achieve the economic objectives of price stability, full employment, and economic growth.

Expansionary fiscal policy is used during recession to reduce unemployment and boost economic growth.

When unemployment the government may increase spending or lower taxes, this leads to high demand for goods and services hence to meet higher demand productivity is increased leading to creation of job opportunities.

Expansionary fiscal policy

AD-aggregate demand

LRAS-long run aggregate supply

SRAS-short run aggregate supply

Increase in spending or reduced taxes leads to a shift in demand from AD1 TO AD2

Impact of expansionary fiscal policy is increased AD and leads to higher GDP.

Contractionary fiscal policy is used during times of economic booms to keep a check on inflation.

During a budget deficit, i.e. when government spending exceeds its revenue, the government may reduce spending and raises taxes to collect more revenue and as a result lower the deficit

The government uses different fiscal policy to stimulate economic growth or expansion. For example in 2009 the UK government reduced VAT tax rate to stimulate economic activity during a period of deep depression.

Contractionary fiscal policy

             

AD-aggregate demand

LRAS-long run aggregate supply

SRAS-short run aggregate supply

Reduction in spending or increased taxes leads to a shift in demand from AD1 TO AD2

Impact of contractionary fiscal policy is reduced AD and leads to lower budget deficit.