1
FISCAL POLICY
Budget: a financial statement showing the forecasted government revenue and
expenditure in the coming fiscal year.
Reasons governments spend:
1. Providing Public and Merit Goods
he private sector is driven by profit. This leads to two specific problems:
T
Public Goods: These are "non-excludable" and "non-rivalrous" (e.g., streetlights). Since
businesses can't easily charge people for using them, they won't provide them at all.
The government must step in to provide these.
erit Goods: These are goods that are better for people than they realize (e.g.,
M
healthcare and education). The private sector would provide them, but only at a high
price, meaning many people wouldn't be able to afford them.
2. Supply-Side Improvements
he government spends money to increase the productive capacity of the economy. By
T
investing in education and vocational training, the workforce becomes more skilled and
efficient.
he Result: An increase in Labour Productivity, which shifts the Long-Run Aggregate
T
Supply (LRAS) curve to the right, leading to long-term economic growth.
3. Reducing Negative Externalities
egative externalities are "spillover effects" on third parties, like pollution from a factory.
N
The government spends money on monitoring, regulation, and enforcement (like
environmental inspectors) to ensure firms
reduce their harmful impact on society.
4. Subsidies
subsidy is a financial grant given to a firm to lower their costs of production.
A
Governments do this for:
Essential Industries: Such as agriculture, to ensure food security.
Struggling Industries: To prevent mass unemployment if a major employer is failing.
, 2
Lowering Prices: To make essential goods cheaper for consumers.
5. Redistribution of Income
eft alone, a market economy can lead to a wide gap between the rich and the poor.
L
The government spends on Transfer Payments (welfare benefits like unemployment or
disability checks).
his money is usually funded through progressive taxation (where the rich pay a higher
T
percentage). This helps reduce poverty and ensures a basic standard of living for
everyone.
6. Economic Growth (Fiscal Policy)
hen the economy is in a recession (low growth, high unemployment), the government
W
can deliberately increase its spending to "inject" money into the circular flow of income.
his increases Aggregate Demand (AD), which encourages firms to produce more and
T
hire more workers, effectively "kick-starting" the economy
The effect of government spending
1.The Growth vs. Inflation Trade-off
hen the government spends more, it increases Aggregate Demand (AD).
W
The Good: Firms see higher demand, produce more, and the economy grows (GDP increases).
The Risk: If the economy is already near full capacity, firms cannot produce more goods quickly enough.
Instead of output going up, they simply raise prices to manage the demand. This results in Demand-Pull
Inflation.
2. The Long-Run Supply-Side Benefit
pending isn't just about the "now." When the government builds a new highway or a high-speed rail link
S
(Infrastructure):
It reduces transport costs for businesses.
It allows workers to move more easily to where jobs are.
This increases the Productive Capacity of the nation, shifting the LRAS (Long-Run Aggregate Supply) to
the right, which creates growth without causing inflation.
3. Living Standards and Equity
By spending on welfare (unemployment benefits, 7pensions), the government creates a "safety net."
This ensures that even those without jobs can consume basic goods.
FISCAL POLICY
Budget: a financial statement showing the forecasted government revenue and
expenditure in the coming fiscal year.
Reasons governments spend:
1. Providing Public and Merit Goods
he private sector is driven by profit. This leads to two specific problems:
T
Public Goods: These are "non-excludable" and "non-rivalrous" (e.g., streetlights). Since
businesses can't easily charge people for using them, they won't provide them at all.
The government must step in to provide these.
erit Goods: These are goods that are better for people than they realize (e.g.,
M
healthcare and education). The private sector would provide them, but only at a high
price, meaning many people wouldn't be able to afford them.
2. Supply-Side Improvements
he government spends money to increase the productive capacity of the economy. By
T
investing in education and vocational training, the workforce becomes more skilled and
efficient.
he Result: An increase in Labour Productivity, which shifts the Long-Run Aggregate
T
Supply (LRAS) curve to the right, leading to long-term economic growth.
3. Reducing Negative Externalities
egative externalities are "spillover effects" on third parties, like pollution from a factory.
N
The government spends money on monitoring, regulation, and enforcement (like
environmental inspectors) to ensure firms
reduce their harmful impact on society.
4. Subsidies
subsidy is a financial grant given to a firm to lower their costs of production.
A
Governments do this for:
Essential Industries: Such as agriculture, to ensure food security.
Struggling Industries: To prevent mass unemployment if a major employer is failing.
, 2
Lowering Prices: To make essential goods cheaper for consumers.
5. Redistribution of Income
eft alone, a market economy can lead to a wide gap between the rich and the poor.
L
The government spends on Transfer Payments (welfare benefits like unemployment or
disability checks).
his money is usually funded through progressive taxation (where the rich pay a higher
T
percentage). This helps reduce poverty and ensures a basic standard of living for
everyone.
6. Economic Growth (Fiscal Policy)
hen the economy is in a recession (low growth, high unemployment), the government
W
can deliberately increase its spending to "inject" money into the circular flow of income.
his increases Aggregate Demand (AD), which encourages firms to produce more and
T
hire more workers, effectively "kick-starting" the economy
The effect of government spending
1.The Growth vs. Inflation Trade-off
hen the government spends more, it increases Aggregate Demand (AD).
W
The Good: Firms see higher demand, produce more, and the economy grows (GDP increases).
The Risk: If the economy is already near full capacity, firms cannot produce more goods quickly enough.
Instead of output going up, they simply raise prices to manage the demand. This results in Demand-Pull
Inflation.
2. The Long-Run Supply-Side Benefit
pending isn't just about the "now." When the government builds a new highway or a high-speed rail link
S
(Infrastructure):
It reduces transport costs for businesses.
It allows workers to move more easily to where jobs are.
This increases the Productive Capacity of the nation, shifting the LRAS (Long-Run Aggregate Supply) to
the right, which creates growth without causing inflation.
3. Living Standards and Equity
By spending on welfare (unemployment benefits, 7pensions), the government creates a "safety net."
This ensures that even those without jobs can consume basic goods.
