Evaluate Fiscal policy:

Advantages
fiscal policy is defined as the sete of govenrment policies relating to its spen
ding and taxation rates. Direct and Indirect txes can be raised
or lowered to alter the amount of disposable income consumers have. An expansion
ary fiscal policy could be useful to increase AD as:
1) To encourage greater consumption, governments lower income taxes to increase
disposable income.
2) to encourage greater Investment, governments can reduce corporate taxes in or
der to make firms enjoy higher after-tax profits, useable for investment.
3) governments can increase their government spending in order to improve/ incre
ase public services and also result in the multiplier effect
Disadvantages:
1)Disincentives of Tax Cuts: Increasing Taxes to reduce AD may cause disincentiv
es to work, if this occurs there will be a fall in productivity and AS could fal
l.
However higher taxes do not necessarily reduce incentives to work if the incom
e effect dominates.
2) Side Effects on Public Spending. Reduced government spending (G) to decrease
inflationary pressure could adversely effect public services such
as public transport and education causing market failure and social inefficie
ncy.
3) Time Lags. If the government plans to increase spending this can take along t
ime to filter into the economy and it may be too late.
4) Budget Deficit Expansionary fiscal policy (cutting taxes and increasing G) wi
ll cause an increase in the budget deficit which has many adverse effects.
Higher budget deficit will require higher taxes in the future and may cause c
rowding out (see below
5) If the government uses fiscal policy its effectiveness will also depend upon
the other components of AD, for example if consumer confidence is very low,
reducing taxes may not lead to an increase in consumer spending.
6) Crowding Out caused by Increased government spending, it occurs when increase
d government spending results in decreasing the size of the private sector.
Definitions:
Indirect tax: Is a tax on expenditure (on goods and services)
Investement: Is the addition of cappital stock in a country
Unemployment equilibrium: A condition where underemployment in an economy is per
sistently above the norm and has entered an equilibrium state.
NPD's:
1) Income
2) Price of other products
3) Tastes and preferences
4) Others: (age structure, season, government spending)
Demand deficient unemployment:
this type of disequilibrium unemployment is associated with the cyclical downtur
n of an economy. As an economy moves into a period of slower growth, AD tends to
fall as consumers spend less on disposable income and services. This fall in dem
and will lead employers to lay off workers. The reduced Ad from Ad to AD1 should
result in a fall in wages. However this is not the case as wages are "sticky dow
nwards", because:
1) Paying lower wages is likely to lead to discontent and reduced motiva
tion, leading to innefficiency
2) Their might be laws like minimum wages, contracts, Trade Unions which
prevent the wages to lower.

How a decrease in consumption leads to a recession:

Recession is defined as 2 consecutive quarters of falling GDP. Fallin AD, casued
by a decrease in consumption, will lead firms to lay off workers, hence more
unemployment rises. If more people are unemployed, less consumption further occu
r. low levels of demand results in lower rates of inflation, deflation and cause
contraction.
Effect of Price Ceilings:
This is price set by the government, below the equilibrium, above which the mark
et price is not allowed to rise. It could be imposed in order to protect consume
rs
and is normally imposed on merit goods. Without the government interfereence, th
eequilibrium quantity would be at QePe. Howver, a price ceiling is imposed which
leads the price to fall to PmaxQmax. However, at this point, we have excess dema
nd (QD>QS). As a result of this the governmetn will try to shift the supply curv
e
to the right be:
1) Offer subsidies to the firm to increase production. (Opporunity cost
and increase in taxes).
2) Start to produce themselves. (Highly innefficient as not driven by pr
ofit maximization, hence AE and PE will not be achieved)
3) If the government had some previosuly stored stock, some of the produ
ct could be released and sold. (This if the good is not perishable and stock cos
ts).