Cambridge O Level Economics: Fiscal policy measures and their effects (2281) – Practice Questions

These are original questions written for Marlbridge, for revision and practice on this content. They are not reproduced past-paper questions, and they do not replicate the exam’s exact structure, question count or mark tariffs – examination boards hold copyright in their own papers. Use these alongside the official past papers from your board or school.

These questions are for Cambridge O Level Economics 2281, syllabus for examination in 2026, statements 4.3.7 to 4.3.9 on fiscal policy: the definition, measures including budget deficit and surplus calculations, and effects on macroeconomic aims. Every country and figure is invented. Read the study guide first and keep the revision notes beside you. See also the course hub and the printable checklist.

Questions

1. Define the term fiscal policy. [2]

2. Country P’s government budget for one year is shown (invented figures, million units).

Revenue		Spending
Income tax	640	Health	400
Sales tax	480	Education	380
Company tax	210	Welfare	360
Other	90	Transport	250
		Defence	150
		Other	110

(a) Calculate total government spending. [2] (b) Calculate the budget balance and say which of the two it is. [2] (c) State one way the government could finance the balance. [1]

3. State whether each measure is expansionary or contractionary, and explain its effect on the budget balance.

(a) A cut in the rate of income tax. [2] (b) A cut in spending on public building projects. [2]

4. Country R raises its sales tax rate from 8% to 11%. Taxable spending is 2,400 million units.

(a) Calculate the extra revenue if taxable spending does not change. [3] (b) Explain why the extra revenue might be lower than your answer to (a). [2]

5. Country S has revenue of 900 and spending of 855 (million units). It then raises spending by 70 with revenue unchanged. GDP is 2,500.

(a) Calculate the new budget balance. [2] (b) Calculate the balance as a percentage of GDP. [2]

6. Explain how higher government spending on training programmes might reduce unemployment. [4]

7. Explain how contractionary fiscal policy might reduce inflation, and state one cost of using it. [5]

8. Country T has a deficit on the current account of its balance of payments. Explain how fiscal policy might reduce it, and explain why the policy might not work. [6]

9. Country U charges no tax on the first 10,000 units of income and 20% on income above 10,000. Three workers earn 8,000, 30,000 and 50,000.

(a) Calculate the average tax rate for each worker. [3] (b) Explain how the government could use its spending to help redistribute income. [3]

10. Country V has unemployment of 12%, very slow growth and a deficit of 120 million units (3% of GDP of 4,000). The government plans to spend 80 more on rural roads and to cut company tax, reducing revenue by 20.

(a) Calculate the new deficit, and as a percentage of GDP. [2] (b) Evaluate whether the plan is likely to help Country V. [6]

11. Country W has revenue of 1,100 and spending of 1,260 (million units) and high inflation. The government raises its sales tax rate from 12% to 15% (taxable spending 2,000) and cuts spending by 50.

(a) Calculate the new budget balance, assuming taxable spending is unchanged. [3] (b) Discuss whether this package is a good way to meet the government’s macroeconomic aims. [7]

Answers

1. Deliberate changes by the government to its spending [1] and to its taxes [1], made to steer the economy towards its macroeconomic aims. [2] Examiner insight: A definition naming only spending or only taxes, or bringing in interest rates, may miss what the question is looking for.

2. (a) 400 + 380 + 360 + 250 + 150 + 110 [1] = 1,650 million units [1] (b) Revenue = 640 + 480 + 210 + 90 = 1,420 [1]. Balance = 1,420 − 1,650 = −230, a deficit of 230 million units [1] (c) Borrowing (for example selling government bonds), which builds up the national debt [1] Examiner insight: Give the word as well as the number. A bare minus sign may not show that you know what a deficit is.

3. (a) Expansionary [1]. Less tax is collected, so revenue falls and the balance moves towards deficit [1] (b) Contractionary [1]. Spending falls, so the balance moves towards surplus [1] Examiner insight: Both the label and the budget effect are asked for, so a one-word answer is unlikely to gain full credit.

4. (a) Old tax = 8% × 2,400 = 192 [1]. New tax = 11% × 2,400 = 264 [1]. Extra revenue = 72 million units [1] (b) Higher prices may lead people to buy less, so taxable spending falls [1]. The tax is then charged on a smaller base. For example, if the base fell 5% to 2,280, the extra revenue would be about 58.8 [1] Examiner insight: Part (b) rewards the idea that the base can change. Saying only that “people may avoid tax” is a weaker explanation.

5. (a) New spending = 855 + 70 = 925 [1]. Balance = 900 − 925 = −25, a deficit of 25 million units [1] (b) 25 ÷ 2,500 × 100 [1] = 1.0% of GDP [1] Examiner insight: The starting position was a surplus of 45. Check the sign at the end of the working to see that a surplus has become a deficit.

6. Training raises the skills of unemployed workers [1]. Their skills then match the jobs that firms need to fill [1]. Firms can fill vacancies more easily, so more of the unemployed find work [1]. This works best for structural unemployment, but it takes time and costs the government money [1] [4] Examiner insight: A chain with each link stated tends to earn more than a list of effects. Finish by connecting back to unemployment.

7. Higher taxes or lower spending reduce households’ spending power [1]. Firms sell less, so there is less pressure to raise prices [1]. The rate of inflation slows (prices still rise, but more slowly) [1]. Cost: firms may cut output [1], so unemployment may rise [1] [5] Examiner insight: “Prices fall” is a common slip. Inflation slowing means prices rise more slowly.

8. Contractionary policy lowers incomes [1], so households buy fewer imports and the deficit narrows [1]. Subsidies or tax relief for exporters cut their costs and help them sell abroad [1]. It might not work because cutting spending raises unemployment and conflicts with another aim [1]; exporters may still struggle if overseas demand is weak [1]; subsidies cost money, widening the budget deficit [1] [6] Examiner insight: Part of the credit is for the reasons it may fail. Make these specific to the balance of payments rather than saying “it depends”.

9. (a) Worker 1: tax = 0 so 0% [1]. Worker 2: 20% × (30,000 − 10,000) = 4,000, so 4,000 ÷ 30,000 = 13.3% [1]. Worker 3: 20% × 40,000 = 8,000, so 8,000 ÷ 50,000 = 16% [1] (b) Spend on welfare payments to low-income households [1], on health and education available to all or aimed at poorer areas [1], which raises their living standards relative to richer households [1] [6] Examiner insight: Show the working for each average rate. Point out that richer workers pay a higher share, which is what makes the tax progressive.

10. (a) New deficit = 120 + 80 + 20 = 220 million units [1]. 220 ÷ 4,000 × 100 = 5.5% of GDP [1] (b) For: road building creates jobs directly and those workers spend wages [1]. Company tax cuts may encourage firms to invest and hire [1]. With 12% unemployment and slow growth there is spare capacity, so inflation risk is small [1]. Against: the deficit rises from 3% to 5.5% of GDP, so more borrowing and future debt costs [1]. Effects take time to appear and firms may save the tax cut [1]. Judgement: the plan is likely to help if the roads are well chosen and the borrowing is manageable, because unemployment is the bigger problem [1] [8] Examiner insight: Evaluation is helped by using the figures given, such as the rise in the deficit to 5.5% of GDP, and by ending with a reasoned judgement.

11. (a) Extra sales tax = 3% × 2,000 = 60 [1]. New revenue = 1,160 and new spending = 1,210 [1]. Balance = −50, a deficit of 50 million units [1] (b) Higher sales tax and lower spending reduce spending power [1], which should slow inflation [1]. The deficit falls from 160 to 50, so less borrowing [1]. However, a sales tax raises prices directly, so inflation may rise at first [1]. Spending cuts could increase unemployment, a conflict between aims [1]. Poorer households spend more of their income on goods, so a sales tax can widen inequality [1]. Judgement: it is a reasonable package if the cuts avoid vital services and the government watches jobs [1] [10] Examiner insight: The strongest answers discuss at least two aims (here prices, jobs and the deficit) and show how they conflict, rather than treating each in isolation.

Where marks are usually lost

• Writing a balance with no word “deficit” or “surplus”.
• Subtracting spending from revenue the wrong way round.
• Calculating a tax change on the wrong base, or not applying the new rate to the whole base.
• Saying a tax cut always reduces revenue by the full amount.
• Saying inflation “falls” when prices are still rising.
• Using interest rates or the money supply in a fiscal question.
• Listing effects without a chain to the named aim.
• Evaluation that ignores the figures in the question and ends without a judgement.

Next steps

• Re-read the revision notes and then the study guide.
• Check what is covered on the course hub and the printable checklist.
• Take one of the free 10-minute diagnostics.
• Book a free trial class.

Official syllabus

Cambridge O Level Economics 2281, syllabus for examination in 2026 (version 2), published by Cambridge University Press and Assessment (Cambridge International Education), section 4.3 Fiscal policy, statements 4.3.7 to 4.3.9.