How can fiscal policy be used to control and regulate economic activity
...fiscal policy, the government will increase its expenditures. Such as expenditure on good and services, transfer payments and debt interest. Most of the countries’ government will spend largely in goods and services. This includes defence, nation health services, computers for schools, construction of new roads and urban regeneration. So that, it can raises up the level of equilibrium income to the level of potential income. It can see the effect in below: E’ Y = National Income E E = Government Expenditure Y Y’ The graph shows the increase in government expenditure from E to E’, the National Income then raise from Y to Y’. As a result a new equilibrium income level has increased and it can benefit to the economy. Moreover, transfer payments which are payments to individuals, businesses, other levels of government and the rest of the world and debt interest is the interest on the government debt minus interest received by the government on its own investment. Both transfer payments and debt interest can have this effect too. Besides increase government expenditure, government can also reduce its taxes. There are two major tax incomes, one is Direct tax and the other is indirect tax. The decrease in these two taxes can raise the real GDP (National Income) and level of potential income of each person. For contractionary fiscal policy, it is a decrease in government expenditures or an increase in tax revenues. This is opposite to expansionary fiscal policy. To use these two kinds of policies, the government should consider the situation of the economy. If there is a economic boom, the government should use contractionary fiscal policy to stabilize the economy by increase the tax revenues and reduce the expenditure. While there is an economic downturn, the government should use expansionary fiscal policy since the aggregate demand is low and unemployment is high, government have to do something to support the economy and increase the real GDP. However, there is one important thing to consider in real world, that is multiplier. Taxes multiplier is the amount by which a change in tax is multiplied to determine the charge in equilibrium expenditure that it generates. Also, government purchases multiplier is the amount by which a change in government purchases of goods and services is multiplied to determine the change in equilibrium expenditure that it generates. These multipliers mean “ the amount you spend = the amount you generate”. The government should consider the multipliers before it takes actions. Sometimes, the government purchase multiplier maybe too small, so the government spends more but only generates little to the economy. Therefore the government may consider other methods, it maybe reduce tax revenues. Automatic stabilizers are mechanisms that operate without the need for explicit action by the government. There are several important stabilizers in an economy. First is proportional and progressive tax system. During periods of low economic activity the government’s revenue from a proportional or progressive tax system will also be lower. It increases real income of people at economy downturn. While during economy boom, the progressive tax system can stabilizes the economy since the level of real income of people was high. The more income earned, the more he or she will pay for the tax. Thus it can reduce the inflation rate effectively. But according to economic assumption, a person will make profit maximization. Second are welfare schemes and subsidies, welfare schemes include unemployment benefits, public assistance allowances and industrial supporting schemes. The subsidies include a discount rate of borrowing money from government of small firm or a small fix amount of subsidies for them. In this case, if the government is now increases its expenditure, the firms may have more benefits. So, they will spend more on investment or develop their product. However, it is not effective as the firms may feel the future is unexpected and keep their money in pockets rather than spending them. It is very common phenomenon, as people do not want to face risks. Fiscal Policy over the Busines...