Fiscal Policy and Resource Allocation

Questions and Answers

Which of the following is NOT an objective of fiscal policy?

Stability

Economic Growth

Maximizing government revenue (correct)

Equity in income distribution

What is one of the main roles of fiscal policy during economic recession?

To reduce government spending

To eliminate public goods

To increase interest rates immediately

To stimulate aggregate demand (correct)

How does fiscal policy primarily influence economic growth?

By adjusting government budgets (correct)

By controlling the supply of money

By imposing trade tariffs

By deregulating financial markets

Which statement correctly reflects the Keynesian view on fiscal policy?

Governments should actively manage demand to revive the economy. Signup and view all the answers

Which challenge is commonly associated with implementing fiscal policy?

Timing of fiscal measures Signup and view all the answers

What does the term 'overheating' refer to in the context of fiscal policy?

Excessive economic growth leading to inflation Signup and view all the answers

In the classical view, what is emphasized regarding government budget policy?

Balanced budgets and laissez-faire principles Signup and view all the answers

What is a crucial function of fiscal policy during business cycles?

It aims to stabilize economic fluctuations. Signup and view all the answers

What is the primary reason fiscal deficit is considered harmful?

It raises interest rates, crowding out private investment. Signup and view all the answers

How does high fiscal deficit contribute to inflation?

It increases demand ahead of supply, creating inflationary pressure. Signup and view all the answers

Which of the following best captures the relationship between fiscal deficit and public debt?

Fiscal deficit accumulates public debt over time. Signup and view all the answers

Which indicator is NOT considered a macroeconomic indicator of fiscal deficit?

Unemployment rate. Signup and view all the answers

What is the outcome of a monetized fiscal deficit on the money supply?

It increases the money supply. Signup and view all the answers

Which of the following is an objective of fiscal policy?

To manage public debt. Signup and view all the answers

Which of the following challenges is associated with fiscal policy?

Effectively managing inflation rates. Signup and view all the answers

How does fiscal policy typically respond to business cycles?

By increasing government spending during booms. Signup and view all the answers

What is one of the primary objectives of fiscal policy?

Achieve equitable income distribution Signup and view all the answers

Which component is NOT included in the GDP equation?

Government Loans Signup and view all the answers

How does increasing government expenditure during a recession directly affect the economy?

It stimulates aggregate demand. Signup and view all the answers

Which of the following describes a risk of using fiscal policy to address an overheated economy?

Creation of asset price bubbles Signup and view all the answers

Which of the following is a target variable associated with government borrowing?

Real GDP Signup and view all the answers

What should be done according to fiscal policy when an economy is at risk of recession?

Run a budget deficit Signup and view all the answers

Which of the following functions is NOT a direct function of fiscal policy?

Regulating the stock market Signup and view all the answers

According to fiscal policy principles, which action would be most appropriate to combat inflation?

Increase taxes Signup and view all the answers

Study Notes

Understanding Fiscal Policy

Fiscal Policy (FP) involves government budget implementation affecting income (receipts) and expenditure, aimed at influencing macroeconomic variables.
Fiscal Policy equation: GDP = C + I + G + NX; GNI includes net receipts (NR): GNI = C + I + G + NX + NR.

Function of Fiscal Policy

Policy Variables include taxation, government expenditure, subsidies, and government borrowing/deficits.
Target Variables impacted: real GDP, employment, consumption, savings, investment, equitable income distribution, exports, housing, and specific goals.

Fiscal Policy and Business Cycles

In a recession, measures include increasing government expenditure, reducing taxes, and running a budget deficit.
Risks during recession management: potential inflation, asset price bubbles, and currency depreciation.
For an overheated economy, policies involve reducing government expenditure, increasing taxes, and running a surplus budget, with risks of recession.

Historical Perspectives on Government Budget

Classical view emphasizes laissez-faire, balanced budgets, and public goods, recognizing market failures during the Great Depression (1929-33).
Keynesian view argues for active government intervention to balance aggregate demand (AD) post-Great Depression, highlighting failures of consumption (C) and investment (I) in economic recovery.

Objectives of Fiscal Policy

Aims include promoting economic growth, stability throughout recession and overheating phases, and equitable income distribution.

Trends in Fiscal Deficits

Fiscal Deficit = Government Borrowings.
Revenue Deficit = Revenue Expenditure – Revenue Receipts.
Effective Revenue Deficit = Revenue Deficit - grants aiding capital asset creation.
Primary Deficit = Fiscal Deficit – Interest Payments.

Risks of High Fiscal Deficit

Impact on Interest Rates: High borrowing raises demand for funds, leading to increased interest rates, which may crowd out private investment.
Impact on Inflation: High deficits can build inflationary pressure through excess demand and increased money supply.
Impact on Public Debt: Accumulation of fiscal deficit results in rising public debt, critical indicators as % of GDP.

Key Indicators

Public Debt as a % of GDP and Fiscal Deficit as a % of GDP are vital macroeconomic indicators.
Tax GDP ratio estimated at 82% in 2023.

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Description

This quiz explores the role of fiscal policy in economic resource allocation and its impact on aggregate demand. It examines the equations for GDP and GNI, highlighting the importance of government budgeting. Test your understanding of how these components interact in the economy.