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CH9: Fiscal Tools, It is the discretionary management of govt. spending…

- - - - To finance the provision of goods and services which are not efficiently provided by the market. E.g education, healthcare
    - - Reduce inflation / for economic growth
      - Protect domestic industries through tariffs
      - Change pattern of dd through indirect tax and therefore rss allocation (curbing ext. for optimal rss allocation
    - - Reduce income inequality through progressive income taxes (tax brackets) where the rich pay a greater proportion of their incomes in taxes than the poor
      - To check on consumption of commodities regarded socially undesirable e.g cigarettes and alcohol
  - - - Taxes on income and wealth
    - - Taxes on expenditure or production of goods and services
  - - - Income effect
        
        Raising tax reduce disposable income, people have to work more in order to maintain their consumption of goods and services. They reduce their leisure time and work longer hrs. Encouraging people to work more
      - Substitution effect
        
        Raising tax reduce disposable income, thus an hour taken in leisure from work now involves a smaller sacrifice in consumption. This causes people to substitute leisure for work. Encouraging people to work less
    - - Disincentives firms to invest due to higher taxes as the profits obtained from taking the same risks are reduced
    - - High progressive income tax may deter entry to lucrative professions. May affect other FOPs, or supply of final goods and services
    - - Heavy progressive direct taxes may reduce willingness and ability to save. This can reduce funds available for investments
    - - A corporate tax cut may lead to firms incentivised to invest as after-tax profitability increased and expected ROR increase.
        Tax cuts may lead to govt. deficit, which could leda to govt borrowing from banks to finance other expenditures, leading to a higher interest rate and in turn reduce investment (crowding-out effect)
    - - Tax increment can lead to a decrease in inflation as disposable income decreases, C decreases, AD decreases. OR I decrease, AD decrease. Firms need not bid up prices of FOP in light of excess capacity. GPL falls when AD falls
- - - - Incurred on a daily basis E.g wage cost of civil servants and expenses on social services (education, health and social welfare)
    - - Purpose of economic and social dev. E.g. Expenditure on building of expressways, schools, flood alleviation schemes
  - - - Through grants and subsidies to affect pattern of production
    - - Expenditure on infrastructure, such as buildings and skills training of workers improve productive capacity and increases the LRAS. Leads to potential economic growth.
    - - govt. expenditure increases G, thus increasing AD and thus increases level of employment, output via multiplier effect.
        During inflation G is decreased to decrease AD to lead to a decrease in GPL to lessen effect of inflation
    - - Expenditure on health, educational services, social welfare and old age pensions. Works tgt with progressive tax system. Reduces income inequality
- - - - When tax increase, e.g income tax, C decreases. Together with a fall in G, AD decreases and leads to a more than proportionate decrease in RNY due to reverse multiplier effect
    - - AD falls, RNY falls UNNT increases
    - - AD falls GPL falls. Reduces demand-pull inflation. This increases the qty dd of X, assuming PEDx >1, TRx increases which can mitigate fall in G and C, cp
  - - - Given a budget surplus, this will go into the economy's reserves which can be used to manage external volatility and deal with unexpected economic recession.
    - - With capital outflow, there is an increase in supply of domestic country's currency in FOREX and leads to a depreciation of exchange rate. Leads to X being cheaper in foreign currency, thus qty dd for exports increase. M is more expensive and thus qty dd for imports decrease. (X-M) increases assuming Marshall-Lerner condition holds |PEDx+PEDm|>1