Cambridge O Level Economics: Fiscal policy measures and their effects (2281) – Revision Notes

These revision notes are for Cambridge O Level Economics 2281, syllabus for examination in 2026, statements 4.3.7 to 4.3.9 (definition of fiscal policy, fiscal policy measures including budget deficit and surplus calculations, and effects on the government’s macroeconomic aims). Full explanations are in the study guide, and exam-style questions are in the practice set.

Related pages: the course hub, the printable checklist, the mixed economic system and government intervention and the diagnostics. Every figure here is invented.

Definitions

Term	Meaning
Fiscal policy	The government altering its spending and its taxes to steer the economy towards its aims
Budget surplus	Government revenue is greater than government spending
Budget deficit	Government spending is greater than government revenue
Balanced budget	Revenue equals spending
Expansionary fiscal policy	More government spending or lower taxes, so that the economy’s spending rises
Contractionary fiscal policy	Less government spending or higher taxes, so that the economy’s spending falls

The five aims (4.2.1) are growth, jobs, price stability, a steady balance of payments and redistribution.

Calculations

Task	Method
Budget balance	Total revenue − total spending. Positive means surplus, negative means deficit
Deficit as % of GDP	Deficit ÷ GDP × 100
Revenue from a tax	Rate × tax base
Change in revenue from a rate change	(New rate − old rate) × base, if the base is unchanged
Effect of a package	Add the revenue changes, add the spending changes, then recalculate the balance
Growth rate	(New output − old output) ÷ old output × 100
Unemployment rate	Unemployed ÷ labour force × 100

Method in steps: budget balance

1. Add every revenue line to get total revenue.
2. Add every spending line to get total spending.
3. Subtract spending from revenue.
4. Give the sign and the word, for example “deficit of 40”.

Worked reminder

Country D (illustrative): revenue 640, spending 700. Balance = 640 − 700 = −60, a deficit of 60. The government raises a sales tax rate from 5% to 8% on a base of 1,000 and cuts spending by 10. Extra revenue = 3% × 1,000 = 30. New revenue 670, new spending 690. New balance = −20, so the deficit falls from 60 to 20.

The measures at a glance

Measure	Type	Budget moves towards
Lower income tax or company tax	Expansionary	Deficit
Higher income tax or sales tax	Contractionary	Surplus
More spending on health, education, roads, welfare	Expansionary	Deficit
Cuts in spending or subsidies	Contractionary	Surplus

A deficit is met by borrowing, which builds up debt. A surplus can pay off debt or be kept in reserve. Falling revenue and rising welfare costs in a recession can widen a deficit without a new decision: fiscal policy is the deliberate change.

Effects on the aims: chains to learn

Aim	Expansionary chain	Contractionary chain
Growth	More spending or investment, so firms sell and produce more, so output rises	Less spending, so slower growth
Unemployment	Public projects hire directly, workers spend wages, so firms hire more	Less demand, so firms cut jobs
Stable prices	Risk of rising prices if firms cannot produce more	Less spending, so inflation slows
Balance of payments	Higher incomes, so more imports, so current account worsens	Lower incomes, so fewer imports, so the position improves
Redistribution	Welfare, health and education spending for low earners	Progressive tax takes a larger share from high earners

Aggregate demand and aggregate supply are not required for this topic. Use chains instead.

Second worked reminder: a package that flips the balance

Country F (illustrative) has revenue of 500 and spending of 470, a surplus of 30. It raises spending by 55 and lowers income tax revenue by 15. New spending = 525. New revenue = 485. New balance = 485 − 525 = −40, a deficit. The swing is 70, which equals 55 + 15.

Third worked reminder: tax paid under a progressive system

Rule (illustrative): no tax on the first 10,000, then 20% on income above that. A person earning 30,000 pays 20% × (30,000 − 10,000) = 4,000, an average rate of 4,000 ÷ 30,000 = 13.3%. A person earning 8,000 pays nothing. Richer people pay a larger share of their income, so the system is progressive and helps redistribute income.

How to write a chain answer

1. Name the measure and its direction (for example, a cut in income tax).
2. Say who changes behaviour: households, firms or workers.
3. Say what they do: spend more, invest more, hire more or import more.
4. Link to the named aim: more output, fewer unemployed, faster price rises.
5. Add a limit or a cost for the evaluation mark: savings, lags, borrowing or a conflict with another aim.

Weak: “Lower tax helps growth.” Better: “A cut in income tax raises take-home pay, so households spend more, firms sell more and produce more, and output grows. This depends on households spending the extra income rather than saving it.”

Limits to remember for each aim

Aim	A reason the policy may not work well
Growth	Households save the tax cut; projects take years; borrowing has to be repaid
Unemployment	Structural unemployment needs training and the right skills, not just more spending
Stable prices	Higher sales taxes raise prices directly; spending cuts can raise unemployment
Balance of payments	Extra income leaks into imports; subsidies cost the budget
Redistribution	High taxes may reduce the incentive to work; benefits cost money

Must-know distinctions

• Fiscal vs monetary: fiscal uses taxes and spending. Monetary uses interest rates, the money supply and exchange rates.
• Deficit vs debt: a deficit is one year’s shortfall. The national debt is everything owed after years of borrowing.
• Inflation falling vs prices falling: a lower inflation rate still means prices rise, but more slowly.
• Effect on incomes vs effect on prices: a tax rise lowers incomes, but a sales tax also raises prices.
• Cyclical change vs policy change: only deliberate changes are fiscal policy.

Evaluation checklist

Ask each time: how big is the change? Is there a time lag? Is there spare capacity in the economy? Will people save a tax cut or spend it? Is spending on imports high? Who pays, through borrowing and future tax? Does helping one aim damage another (for example, jobs versus prices)?

Quick self-test

1. Define the term fiscal policy.
2. Country E has revenue of 1,250 and spending of 1,180. State the balance and say if it is a surplus or deficit.
3. Revenue is 900 and spending is 960. Calculate the deficit as a percentage of GDP of 4,800.
4. A sales tax rises from 6% to 9% on a base of 2,000. Calculate the extra revenue.
5. State two expansionary fiscal measures.
6. A government cuts income tax from 20% to 18% on taxable income of 3,000. Calculate the arithmetic fall in revenue.
7. Why can a fall in the inflation rate still mean prices are rising?
8. Output rises from 2,400 to 2,508. Calculate the growth rate.
9. Explain one way expansionary fiscal policy can worsen the balance of payments.
10. State one reason why a tax cut may reduce revenue by less than the arithmetic suggests.

Answers

1. Deliberate changes to government spending and taxes to steer the economy towards macroeconomic aims.
2. 1,250 − 1,180 = +70, a surplus of 70.
3. Deficit = 960 − 900 = 60. 60 ÷ 4,800 × 100 = 1.25% of GDP.
4. 3% × 2,000 = 60.
5. Any two of: cutting income tax, cutting company tax, raising spending on schools, building roads, raising welfare payments.
6. Old revenue = 20% × 3,000 = 600. New = 18% × 3,000 = 540. Fall = 60.
7. The rate measures how fast prices rise. A rate of 2% down from 5% means prices still increase, only more slowly.
8. (2,508 − 2,400) ÷ 2,400 × 100 = 4.5%.
9. Higher incomes lead to more spending on imports, so import spending rises faster than exports and the current account moves towards deficit.
10. Higher take-home pay leads to more spending and higher incomes, which widens the tax base, so the full arithmetic loss does not happen.

Where marks are usually lost

• Giving a balance as a bare number with no “deficit” or “surplus”.
• Subtracting the wrong way round, so a deficit appears as a surplus.
• Changing the tax rate in a sum but forgetting to apply it to the tax base.
• Stating that spending or tax changes “help the economy” with no chain to a named aim.
• Using interest rates or the money supply in a fiscal answer.
• Treating every aim as improved by the same measure, with no mention of a conflict.
• Calling the deficit the national debt.
• Writing “it depends” without saying on what.

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.