OxfordAQA International AS and A-level Economics: Fiscal policy (9640) – Revision Notes

Quick recall for fiscal policy, section 3.2.4.2 of the OxfordAQA International AS and A-level Economics specification (version 1.2, code 9640). It is International AS content. All figures are made up for illustration. Longer explanations and fuller worked examples are in the study guide. Then try the practice questions. See also the course hub and checklist, and use a free diagnostic if a topic feels shaky.

Definitions to know

Term	Meaning
Fiscal policy	Deliberate changes to government spending and taxation, to push the economy towards chosen objectives
Budget balance	Government revenue minus government spending in a year
Budget deficit	Spending exceeds revenue in the year
Budget surplus	Revenue exceeds spending in the year
National debt	The stock of past borrowing not yet repaid
Direct tax	Falls on income or wealth and is paid by the person or firm taxed
Indirect tax	Built into the price of spending and handed over by sellers
Progressive tax	The average rate climbs with income
Proportional tax	One average rate at every income
Regressive tax	The average rate drops as income climbs
Cyclical balance	The part of the balance caused by the position in the economic cycle
Structural balance	The part that would remain at potential output

Key formulas

Idea	Formula
Budget balance	Revenue - spending (negative means deficit)
Balance as % of GDP	Balance / GDP x 100
Average tax rate	Tax paid / income x 100
Marginal tax rate	Extra tax / extra income x 100
Debt ratio	Debt / GDP x 100
Closing debt	Opening debt + deficit (or - surplus)
Multiplier	1 / MPW, with MPW = MPS + MPT + MPM
Output gap	(Actual GDP - potential GDP) / potential GDP x 100
Actual balance	Structural balance + cyclical balance
Real value	Nominal value / price index x 100

Method in steps: classifying a tax

1. Work out the tax paid at each income.
2. Divide by income to get the average rate.
3. Compare the average rates: rising is progressive, equal is proportional, falling is regressive.
4. Say which measure you used. A fixed licence fee of 300 is 2% of 15,000 and 0.5% of 60,000, so it is regressive. An income tax paying 3,000 on 30,000 (10%) and 9,000 on 60,000 (15%) is progressive.

Method in steps: the fiscal effect on AD

1. Name the instrument (spending up, tax down, or the reverse).
2. Say which AD component it changes: G directly, C or I through disposable income or profit.
3. Apply the multiplier: initial change x 1/MPW.
4. State the starting position. With spare capacity, output rises; near full capacity, prices rise.
5. Evaluate: lags, size of the multiplier, confidence, debt.

Reminder: MPS = 0.05, MPT = 0.15, MPM = 0.20 gives MPW = 0.40 and a multiplier of 2.5. A rise of 20 in government spending then raises income by 50.

Method in steps: the budget and the debt

1. Balance = revenue - spending. Spending 330, revenue 300 gives -30. With GDP 1,500, that is a deficit of 2.0% of GDP.
2. Closing debt = opening debt + deficit. From 600 it becomes 630.
3. Ratios: opening ratio 600 / 1,500 = 40%. With no growth, 630 / 1,500 = 42%. If GDP grows 5% to 1,575, 630 / 1,575 = 40%.
4. Conclude: a deficit adds to the debt, but growth can stop the debt ratio rising.

Method in steps: cyclical and structural

1. Find the structural balance: the balance at potential output.
2. Cyclical balance = actual balance - structural balance.
3. Reminder: actual deficit 45, structural deficit 25, so the cyclical deficit is 20.
4. In a downturn revenue falls and benefit spending rises, so the cyclical deficit grows. In a boom it shrinks.

Evaluation checklist

Use these prompts to finish an answer on any fiscal measure.

• Size: is the change large relative to GDP, and how big is the multiplier?
• Starting point: is there a negative output gap (spare capacity) or a positive one (inflationary pressure)?
• Timing: is there a lag between spotting the problem and the effect?
• Cost: what is the opportunity cost of the spending, and what happens to the deficit and the debt?
• Conflict: does helping one objective hurt another, such as growth against equity, or unemployment against the budget?
• Judgement: which factor matters most in this case, and why?

Fiscal policy and AS in one table

Instrument	Supply-side route	Limit
Spending on training and education	Better skills; higher labour productivity	Slow; costly
Spending on infrastructure	Lower costs; better access to markets	Poor project choice
Lower tax on profits	More investment; bigger capital stock	Might not be invested
Lower income tax	Stronger reward for work	Effect on hours can be small

The aim is to shift LRAS right. The result is a higher potential output, and lower inflationary pressure at a given level of AD.

Micro functions

• Correct negative externalities with a tax on the good; correct positive externalities with a subsidy.
• Provide public goods and merit goods.
• Redistribute income: progressive taxes and benefits narrow the gap between rich and poor.
• Move resources: a tax on one product shifts demand to substitutes; spending on a sector expands it.

Reminder: tax of 1.5 per unit with 80 units sold raises 1.5 x 80 = 120. Where demand is inelastic, the tax raises more revenue and cuts quantity less.

Must-know distinctions

• Deficit (a flow in one year) and debt (a stock built up over years).
• Direct and indirect taxes, which are about how the tax is collected; progressive and regressive, which are about how the average rate changes with income.
• Cyclical (moves with the cycle) and structural (remains at potential output).
• Spending and tax cuts: government spending is injected in full in the first round, while part of a tax cut is saved.
• Expansionary (raises AD, moves towards deficit) and contractionary (cuts AD, moves towards surplus).

Quick self-test

1. Give a definition of fiscal policy.
2. A government spends 780 and collects 750. Name the result and give its size.
3. GDP is 2,600 and the deficit in question 2 happens in an economy of that size. Give the deficit as a percentage of GDP, to 1 decimal place.
4. Opening debt is 1,040. Add the deficit from question 2 to find closing debt.
5. A person earning 20,000 pays 2,000 in tax and a person earning 80,000 pays 20,000. Is the tax progressive, proportional or regressive?
6. State one example of a direct tax and one of an indirect tax.
7. Given MPS = 0.2, MPT = 0.2 and MPM = 0.1, work out the multiplier.
8. Government spending rises by 25 in the economy of question 7. Find the maximum rise in income, if there is spare capacity.
9. Potential GDP is 1,200 and actual GDP is 1,140. Find the output gap.
10. Actual deficit is 70 and structural deficit is 30. State the cyclical deficit.
11. State one way in which fiscal policy can raise AS.
12. Give one reason a fall in taxes may not raise AD by as much as expected.

Answers

1. Deliberate use of the government’s spending and tax decisions (and so its budget balance) to steer the economy.
2. Budget deficit, of 30 (750 - 780).
3. 30 / 2,600 x 100 = 1.2%.
4. 1,040 + 30 = 1,070.
5. Average rates are 10% and 25%. The rate rises with income, so it is progressive.
6. Direct: income tax or corporation tax. Indirect: a sales tax or an excise duty.
7. MPW = 0.2 + 0.2 + 0.1 = 0.5, so the multiplier is 2.
8. 25 x 2 = 50.
9. (1,140 - 1,200) / 1,200 x 100 = -5%, a negative output gap.
10. 70 - 30 = 40.
11. Spend on training, education or infrastructure to raise productivity and capacity; or cut taxes to raise investment or work incentives.
12. Households may save part of the extra income, or expect higher taxes later; or the economy may have no spare capacity so output cannot rise.

Where marks are usually lost

• Naming “tax” or “spending” without saying what happens to AD, AS or a market.
• Labelling a tax progressive because the sum paid is bigger, with no average-rate check.
• Treating the debt and the deficit as the same thing.
• Applying the multiplier when the economy is at full capacity and not noting the price effect.
• Leaving out the starting position (output gap) when judging whether a stimulus will work.
• Giving a list of evaluation points without saying which one matters most, and why.
• Leaving out units, a clear sign (deficit or surplus), or the percentage of GDP when a ratio is asked for.
• Mixing up cyclical and structural: a deficit that is mainly cyclical shrinks on its own as output recovers.
• Forgetting that the same policy can serve different objectives, which may conflict.

Official syllabus

Source: OxfordAQA, International AS and A-level Economics (9640), specification version 1.2, for International AS exams from May/June 2021 onwards and International A-level exams from May/June 2022 onwards. These notes cover section 3.2.4.2.