- Explain how factors including the progressive tax system and unemployment benefits, which are influenced by the level of economic activity and national income, automatically help stabilize short-term fluctuations.
- Explain that fiscal policy can be used to promote long-term economic growth (increases in potential output) indirectly by creating an economic environment that is favourable to private investment, and directly through government spending on physical capital goods and human capital formation, as well as provision of incentives for firms to invest.
- Evaluate the effectiveness of fiscal policy through consideration of factors including the ability to target sectors of the economy, the direct impact on aggregate demand, the effectiveness of promoting economic activity in a recession, time lags, political constraints, crowding out, and the inability to deal with supply-side causes of instability.
Tasks:
- Based on the video and the information in your packet, use examples to explain how progressive taxes and unemployment benefits automatically help stabilize the economy (link to business cycle…. i.e. flattens out the peaks and troughs)
- Key question - what are the potential supply side effects of expansionary fiscal policy? Consider the direct effects of lower business taxes, government spending on education/training, and government spending on development of infrastructure (capital expenditure); and also the indirect effects of government providing a stable macroeconomic environment in order for consumers/firms to be able to plan and carry out economic activities
- Lastly, you need to consider the strengths and weaknesses of using fiscal policy. Look at the information in the packet and use this to complete summary chart on the back page. Under strengths consider the ability to target sectors of the economy, the direct impact on aggregate demand plus potential supply-side effects above, and the effectiveness of promoting economic activity in a recession. Under weaknesses consider time lags, political constraints, and crowding out (include a diagram to help explain crowding out). Note also that fiscal policy does that deal with supply side causes of instability, e.g some form of unemployment require supply-side solutions (more on that in Unemployment topic) and inflation may be caused by supply-side shocks rather than increasing demand (more of that in Inflation topic)
- Bonus question: Why does an increase in government spending have more of an impact on AD than a reduction in taxes?
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