Answer to Question #165659 in Macroeconomics for varshini

Question

 In explain how is fiscal policy could be effective in promote economic growth/ in restore from economic recession. o You may discuss about: the components in fiscal policy. (G & T) o How are the components able to increase aggregate demand. o Provide real world example/s in your explanation. o Elaboration is subject to student’s creativity and depth of study on the topic.

Answer 1

Fiscal policy

Fiscal policy refers to when a government of a certain country uses it's expenditure and taxation to influence the economy.

The government can increase the quantity of demand by cutting taxes and increasing government expenditure. Lower income tax will increase the income available for saving and investment and encourage consumers to spend. Higher government spending will create more jobs and ensure that citizens have more income to spend thus raising the quantity demanded.

The following are the three main tools that the government administers to the economy to help it influence the economy.

(i) Government spending

Government spending includes the purchase of goods and services - for example, new vehicles for government employees and police. Government spending is a fiscal policy tool because it can raise or lower real gross domestic product. By changing government spending, the government can influence the economic growth of a country. This spending affects businesses that sell goods and services to the government. Consumers then go on to spend the income they earn from those businesses, stimulating real gross domestic product even more. For example, when CMC Holdings receives a large order for more government vehicles, their sales increase, and they hire more employees who earn a salary from the company. They then spend this money on goods and services. The effect of an increase in government spending now leads to increase in output translating to economic growth.

(ii) Taxation

Taxes are an important fiscal policy tool because changes in taxation affect the average consumer's income. These changes in consumption lead to changes in real gross domestic product. By reducing or increasing taxes, the government can influence economic growth. Taxes can be changed in several ways including raising or lowering, eliminating or modifying the marginal tax rates. For example, lowering pay as you earn(P.A.Y.E) for government workers will raise their incomes and they are able to spend more on purchasing goods and services. This will greatly impact on production thus stimulating economic output.

(iii) Transfer funds

They include monthly payment to elderly and refugees, students grants among others. These funds benefit many consumers. Transfer funds are an important fiscal policy tool because changes in transfer funds lead to changes in consumer income, and when consumers spend more of their income, it influences economic output of that state. For example transfer payments for the elderly will raise consumers income, who will result in spending more on goods and services. This increases output to meet high demand.