Consequences of Fiscal Policy

Fiscal Policy

• The use of government spending and revenue collection to influence the economy

Expansionary Fiscal Policy

• Used to encourage growth/output, often through increased spending or tax cuts

Government buys more goods and services

Companies that sell goods to the government earn profits, which they use to pay their workers and investors, and to hire new workers

Workers and investors have more money and spend more in shops and restaurants

In the short-term, government spending leads to more jobs and more output

Expansionary Fiscal Policy

What happens to demand?

What happens to the equilibrium price and GDP?

Contractionary Fiscal Policy

• Used to reduce economic growth/output, often through decreased spending or higher taxes

Government buys fewer goods and services

Companies that sell goods to the government have lower profits and less money available to pay workers

Workers and investors have less money to spend in shops and restaurants

Decreased demand tends to cause lower prices, forcing suppliers to cut production and possibly lay off workers

Contractionary Fiscal Policy

The growth rate of the economy slows

What happens to demand?

What happens to the equilibrium price and GDP?

Purpose of Fiscal Policy

Expansionary

• Used to prevent a recession or move the economy out of a recession

Contractionary

• Fast-growing demand can exceed supply. Producers respond by raising prices, which leads to inflation. Slowing the economy can prevent high inflation.