Unit 3.6 - Demand Management (Fiscal Policy)

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Fiscal policy elements that naturally mitigate fluctuations in economic activity, helping to stabilize growth.HL

automatic stabilizers

The idea that increased government borrowing raises interest rates, limiting private investment.HL

The theory of crowding out

Transfer payments provided to the unemployed to help them meet their consumption expenditure needs.HL

unemployment benefits

Circular flowHL

The continuous movement of money, goods, and services in an economy, where changes in fiscal policies, such as progressive taxes and unemployment benefits, can either withdraw or inject money, stabilizing economic activity around a trend line during different phases of the business cycle.

Keynesian economistsHL

Economists who believe in the need for active government intervention to manage economic cycles. They stress that automatic stabilizers, such as progressive taxes and unemployment benefits, are vital in mitigating the effects of recessions by supporting aggregate demand and protecting jobs.

crowding out effectHL

The phenomenon where increased government spending leads to higher interest rates, which in turn reduces private sector investment, limiting the effectiveness of fiscal policy.

economic recessionHL

A sustained fall in economic activity. Pulling the economy out of a deep one is a recognised strength of fiscal policy — though cuts to government spending that are too large can themselves push the economy into contraction or even depression.

The delay between recognizing a need for intervention and implementing it.

Administrative time lags

The delay in identifying the need for government intervention in the economy.

Recognition time lags

The delay in seeing the effects of fiscal policies after implementation.

Impact time lags

The phenomenon where increased borrowing by the government leads to higher interest rates, which in turn discourages investment by the private sector.

crowding out

Austerity

Measures taken by governments to reduce budget deficits, often involving cuts in public spending and increases in taxes, which become necessary when high public sector debts must be repaid, limiting the use of fiscal policies for economic stimulation.

loanable funds

The funds available for borrowing in the economy, where increased government borrowing can raise interest rates and crowd out private investment.

political pressures

Factors that influence government decisions on spending and taxation, often driven by the need for political gain rather than economic rationale, impacting fiscal policy effectiveness.

sustainable debt

The ability of a government to maintain budget deficits without jeopardizing its financial stability, which is crucial for effective fiscal policy implementation.

A type of tax levied directly on the income, wealth, or profits of individuals and businesses.

direct taxation

Expenditure taxes imposed on spending for goods and services in the economy.

indirect taxation

Government spending on goods and services consumed within the year.

current expenditure

Long-term items of government spending that enhance productive capacity.

capital expenditure

Tangible assets utilized to manufacture other products and services.

capital goods

The process of transforming education and training into knowledge and skills.

human capital formation

A type of fiscal strategy that is intentionally implemented by the government to affect the level of total demand in the economy.

Discretionary policy

Discretionary

A type of fiscal policy that is intentionally implemented by the government to influence aggregate demand in the economy, aiming to achieve growth and low inflation through targeted actions such as taxation and public spending.

macroeconomic aims

The government's overall economic goals: low unemployment, sustainable economic growth and low, stable inflation. Fiscal, monetary and supply-side policies are all aimed at them.

A fiscal strategy employed to decrease the level of economic activity.

contractionary fiscal policy

Job losses occurring due to falling aggregate demand during a recession.

Cyclical unemployment

The condition where a nation's exports equal its imports.

External balance

The planned revenues and expenditures of a country over a year.

The government budget

State the formula: Aggregate demand (AD)

AD = C + I + G + (X - M) Aggregate demand is the sum of consumption, investment, government spending and net exports.

State the formula: X

X = M External balance occurs when the value of exports equals the value of imports.

Budget surplus

A situation where government revenues exceed expenditures, often achieved through contractionary fiscal policy, which can help control inflation by reducing consumption, investment, and government spending, thus shifting the aggregate demand curve leftwards.

A concept that illustrates how an increase in spending or investment leads to a larger overall increase in economic demand.HL

Keynesian multiplier

The proportion of an increase in household income that is saved rather than spent on consumption or imports.HL

marginal propensity to save (MPS)

The proportion of an increase in household income that is spent on goods and services rather than saved.HL

marginal propensity to consume (MPC)

The proportion of an increase in household income that is spent on goods bought from abroad rather than on domestic output.HL

marginal propensity to import (MPM)

The proportion of each extra dollar of income earned that is taxed by the government.HL

marginal propensity to tax (MPT)

The sum of the proportions of savings, taxes, and imports from additional income.HL

Marginal propensity to withdraw (MPW)

State the formula: Keynesian multiplierHL

Keynesian multiplier = 1 ÷ (1 − MPC) Keynesian multiplier = 1 ÷ (MPS + MPT + MPM) Keynesian multiplier = 1 ÷ MPW

State the formula: MPCHL

MPC = ΔC ÷ ΔY Marginal propensity to consume: the proportion of an extra unit of income that is spent on consumption.

State the formula: MPMHL

MPM = ΔM ÷ ΔY Marginal propensity to import: the proportion of an extra unit of income spent on imports.

State the formula: MPSHL

MPS = ΔS ÷ ΔY Marginal propensity to save: the proportion of an extra unit of income that is saved.

State the formula: MPTHL

MPT = ΔT ÷ ΔY Marginal propensity to tax: the proportion of an extra unit of income paid in taxes.