Question

1. During an ‘economic contraction’, why is it likely that the federal government budget will move into deficit?

2. Identify and discuss whether each of the following is: an expansionary fiscal policy; a contractionary fiscal policy; or not a fiscal policy.

i.   The personal income tax rate is lowered.

ii.   The government increases spending on defence due to a change in spending priorities.

iii.   The company income tax rate is lowered.

iv.   New South Wales builds a new tollway to expand employment and ease traffic congestion.

Answer 1

1. Economic contraction is a decline in national output as neasured by GDP. It includes drop in real oersonal income, industrial production and sales. It increases the rate of unemployment.

During these times a country is kind of going under recession . Hence the government needs to come with measures in order to bring the economy out of this situation by providing fiscal stimulus through increased spending . Hence the expenditure of the government increases whereas its revenue decreases because less taxes will be collected. Hence the deficit will increase.

2. 1) It is an expansionary fiscal policy because by lowering personal tax rates people would be left with more disposable income to spend

ii) No fiscal policy as it is just changing the priority of spending by government

iii) It is an expansionary fiscal policy because lowering corporate tax rate will lead to loss in revenue of government and corporates will be left with more income which can be used to invest in economy and increases growth in the economy.

iv) It is an expansionary fiscal policy because increased spending by government will increase employment and people will get more income to spend to consumption and investment and hence will increase growth of economy.