Few Question-Answers Related to Fiscal Policy


Question 1

Which has a larger effect on aggregate demand: an increase in government expenditure or an equal-sized decrease in taxes? Explain your answer.

The aggregate demand gets impacted greater through the increment in the government expenditure. Aggregate demand refers to the final demand that incurs within the country regarding products and services for a particular time frame (Friedman & Heller, 1969).  It also refers to the overall products and services that are purchased within an economy at various price points. 
The aggregate refers to the effective demand and is denoted by the below given formula:
Y = C + Ip + G + (X - M)
The investments made by the government and the consumption expenditures (G), can be calculated using “G-T” which refers as the difference among the expenditures made by the government and the collected tax (Persson & Tabellini, 1994). If the expenses of the government increases or there is any kind of reductions in tax, then the increment in the Gross Domestic Product can be evident reasoning that the expenditures of the government is the major part of the overall or aggregate demand in an economy.
As per the Keynesian theory, if the employment is increased by the government using the public activities and considers the increment in the interest rates, then the investments in other areas can be compromised (Shaw, 1972). It should not be pointed towards crowding out. There is a belief among Keynesian theorists that in adverse situations, the increased expenses by the government increases the overall output (which comes as larger than original increased spending).

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Question 2

To eliminate a recessionary gap, which fiscal policy should the government pursue? Be specific.

The consideration of expansionary fiscal policy is the suggested mode for the elimination of recessionary gaps. The expansionary policies have been largely preferred by the governments whenever the economies have faced recessions. The focus in this policy has been on increasing the expenditures of the government along with reducing the taxes (Persson & Tabellini, 1994). 
The recessionary gap can be identified as the outcome of recession. This can be of the consideration that the overall or aggregate demand (GDP) is below than where it could have been in case there was complete employment. The consideration to reduce the gap will lead to the government towards increasing the expenditure which has direct impact on the overall or aggregate demand curve. The reason is that the expenditures of the government are likely to increase the demand for the goods and services. Moreover, the consideration of reduction in the taxes is generally expected to positively impact the demand curve through increased productivity of the consumers (Persson & Tabellini, 1994).
The expansionary policy impacts the demand curve and shifts it to the right. This eventually impacts the recessionary gap in a negative manner and closes the gap which in turn aid in growing and developing the economy.

Question 3

The online text discusses fiscal policy in action. Keynesian economics is a school of thought that believes fiscal policy is needed to stabilize the fluctuations in the real GDP. Classical economists such as Adam Smith believe that the economy is most efficient without government intervention. Suppose you are an advisor to a presidential candidate. Which school of thought would shape your economic plan and why? Be sure to use references to support your answer.
As stated, Keynesian consideration is that the fiscal policies is necessary to keep the economy on track and people employed. Moreover, under Keynesian economics, the government can intervene in the economy at the appropriate times to ensure that the all the components of economic cycle is running smoothly.
On the other hand, Smith’s economy suggests that the market should be left on its own and no government intervention should be there. Moreover, more entrepreneurial approaches should be boosted to improve the job opportunities and economic growth.
If both are considered, then it can be stated that if each of them is considered alone, then they have their weaknesses. Smith’s economy tumbles as unemployment becomes the major challenge. On the other hand, the Keynesian economy’s expectation is that expenditure of the government is efficient, no existent corruption, and money is spent on right activities only while collecting taxes to the amount that can support massive deficit. Such consideration cannot be attributed as realistic (London, 2016).
However, if both the aspects – Smith’s Economy and Keynes’ Economy – are brought together, then it can be suggestible to the presidential candidate. It is required that the economy runs on entrepreneurial individuals along with necessary intervention from the government wherever necessary to release any economic logjam.

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Question 4

The majority of lobbying efforts center on fiscal policy. Please discuss your opinions on lobbying regarding whether it is useful and should continue as is, it should continue but with constraints to limit how much is done, or it should be eliminated.

Lobbying consists of both the aspects, positive and negative. On one hand where the lobbying provides public (people) ways to infiltrate and influence the decisions in their favor, on the other hand it allows opportunity to unethical elements in getting their way.
The fiscal policies is required to stimulate the growth of the country on continuous (Shaw, 1972). However, it has been observed that there are various groups in the country that are left out during the fiscal development. The lobbying activities come to rescue these groups to attract the attraction of the government towards them to ensure that they are not left out in the policies that are formed. The influencing the governmental entities through the lobbyists is a legalized activity and there are nothing wrong as per the rules and regulations are concerned.
The lobbyists are necessary to influence the policies to ensure that no one is left out. However, there are issues that have come up. It has been identified that the community who can afford the highest fees of lobbyists enjoy the influences and the communities or the entities with limited capacity does not enjoy the same benefit through lobbying.
Moreover, there is no morale in the lobbying community. They act for the entities that pay them without considering the impact on the environment or any other factor of social concern. Some of the time due to negative influences the policies or the decisions are made that harm one community or business groups and harm others. Therefore, to limit such influence, it is imperative that there should be constraints on the lobbyists and their lobbying activities.
The initiation of constraints can be started through the following three steps:

  • -    Annual reports of the lobbying firms should be submitted every year to know how much is being invested behind this activity.

  • -    All the information regarding lobbying activities should be made public so that the concerned parties can have better watch on these.

  • -    The presence of lists of all the entities or the individuals involved in the lobbying activities should be on online database to bring more transparency.


  • Friedman, M., & Heller, W. W. (1969). Monetary vs. fiscal policy. New York: Norton. 

  • London, P. (2010). Understanding Adam Smith and John Maynard Keynes. [online] Huffington Post India. 

  • Persson, T., & Tabellini, G. E. (1994). Monetary and fiscal policy: Volume 1. Cambridge, MA: MIT Press. 

  • Shaw, G. K. (1972). Fiscal policy. London: Macmillan. 

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