Fiscal Policy

Meaning of Fiscal Policy: 

Fiscal Policy may be defined as that part of governmental economic policy which deals with taxation, expenditure, borrowing and the management of public debt in an economy. It is an indispensable instrument of modern public finance. The importance of fiscal policy has greatly increased in modern times, both in the developed as well as the underdeveloped countries of the world. In developed countries, fiscal policy is being increasing used as an instrument to achieve full employment and economic stability. In underdeveloped countries, on the contrary, fiscal policy is more and more being used as a means to step up the rate of economic growth. Fiscal policy primarily concerns itself with the flow of funds in the economy. Taxation diverts the funds from the private sector to the governmental sector. Public expenditure on the contrary, diverts funds from the governmental sector back to the economy. Public borrowing, like taxation also diverts funds from the private sector to the governmental sector, but the two diversions influence the private sector in different ways. Management of public debt includes functions, such as, floating of governmental loans, payment of interest thereon and retirement of matured debts. Fiscal policy, thus, exerts a very powerful influence on the working of the national economy. It directly affects the volume of output, income and employment in the economy. The greater the percentage of national income and expenditure represented by the governmental budget, the greater would be the influence of fiscal policy on aggregate economic activity.

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Module 01: Question Bank

Two Marks Questions:

1. Define macroeconomics. 
2. Give any four concepts of macroeconomics. 
3. State any two importance of Macroeconomics. 
4. What is unemployment? 
5. What is an economic policy? 
6. Name any four economic problems in an economy. 
7. Define National Income. 
8. Define economic growth. 
9. Define economic planning. 
10. What is business cycle? 
11. Define stagflation. 
12. Mention the two functions of investment. 
13. Mention any four central issues of Macro economics. 
14. What is Fallacy of composition? 
15. State any four limitations of macro economics. 
16. What is an exchange rate? 
17. What is surplus balance of payments? 
18. What is deficit balance of payments? 
19. State the types of Macro economics. 
20. What is macro statics? 
21. What is Macro dynamics? 
22. What is comparative macro statics? 
23. Mention any two concepts of National Income. 
24. What is NNP? 
25. What is depreciation? 
26. What is Personal Income? 
27. What is disposable personal income? 
28. What is Per capita income? 
29. State the methods of measuring National Income. 
30. State any two difficulties in the estimation of National Income. 
31. State any two importance of National Income analysis. 

Five Marks Questions:

1. Define Macroeconomics and discuss its nature. 
2. Describe the importance of Macro economics. 
3. Discuss any four central issues of macro economics. 
4. Describe the subject matter of macro economics. 
5. Describe any four limitations of macro economics. 
6. Describe macro statics. 
7. Describe macro dynamics. 
8. Describe comparative macro statics. 
9. Discuss Macro statics v/s Macro dynamics. 
10. Describe any four concepts of National Income. 
11. Describe any two methods of calculating the National Income. 
12. Describe the difficulties in measuring the national income. 
13. Describe the importance of national income analysis. 

Ten Marks Questions:

1. Describe the central issues of macro economics. 
2. Describe the limitations of macro economics. 
3. Describe the types of macro economics. 
4. Describe the concepts of National Income. 
5. Describe the methods of measurement of the National Income.

Business Cycles

An important feature of the working of a capitalist economy is the existence of alternating periods of prosperity and depression generally referred to as a ‘business cycle’ or ‘trade cycle’. In a business cycles there are wave like fluctuations in aggregate employment income, output and price-level. The term business cycle has been defined in various ways by different economists. 

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Phases of the Business Cycle

1. Recovery: 

We start from a situation when depression has lasted for some time and revival phase or the lower-turning points starts. The ‘originating force’ or ‘starters’ may be exogenous or endogenous forces. Suppose the semi-durable goods wear out which necessitates their replacement in the economy, it leads to increased demand investment and employment increase. Industry begins to revive. Revival also starts in related capital goods industries.

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Methods of Measuring National Income

In preparing the national income estimate it is necessary to add the values of all final goods and services produced and exchanged during a year. Thus what ever is produced is either used for consumption or saving. There are three methods of estimating national income. They are: 

• The census of products method 

• The census of income method 

• The expenditure method 

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Concepts of National Income

There are a number of concepts pertaining to national income. They are: 

• 1. Gross National Income (GNP) 

• 2. Net National Income (NNP) 

• 3. Gross Domestic Product (GDP) 

• 4. Personal Income 

• 5. Disposable Personal Income 

• 6. Per Capita Income 

1. Gross National Income: 

GNP is the total measure of the flow of goods and services at market value resulting from current production during a year in a country, including net income from abroad, GNP includes four types of final goods and services: (1) Consumer’s goods and services to satisfy the immediate wants of the people. (2) Gross Private Domestic Investment in capital goods consisting of fixed capital formation, residential construction and inventories of finished and unfinished goods.(3) goods and services produced by the government and (4) net exports of goods and services that is, the difference between value of exports and imports of goods and services, known as net income from abroad.

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Difficulties in the Measurement of National Income

There are a number of difficulties in the measurement of national income of a country. The following are the important difficulties of national income analysis: 

• 1. National income is always measured in terms of money, but, there are certain goods and services whose money measurement is not possible. For example: the services performed by housewife for her family, voluntary services performed with a charitable object, etc. such items are excluded from the national income figures. This leads to an underestimate of the national income. 

• 2. Income obtained from illegal activities is not included in the national income and their exclusion results in an under-valuation of the national income. 

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Importance of National Income Analysis

Today, national income statistics are collected by all the countries of the world for a number of years. Raising national income is the important goal of all economic activity. Economic welfare of a country depends upon what goods and services are available for the consumption of its individuals. The changes in national income statistics show how the economy is developing and enables the government to lay down the appropriate economic policy necessary under the circumstances. With the help of national income statistics it is possible to chart cyclical movements, find out the inflationary gap, measure economic growth and development, and evaluate the country’s material standard of living in comparison with other countries. The following are the main uses of national income.

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Subject Matter of Macro Economics (Central Issues)

The subject matter of macro economics are as follows: 

1. Determination of National Income: 

The first major issue in macro economics is to explain what determines the level of employment and national income in an economy and therefore what causes involuntary unemployment. The level of national income and employment are very low in times of depression as in 1930s in various capitalist countries of the world. This will explain the cause of huge unemployment that emerged in these countries. Classical economists denied that there could be involuntary unemployment of labour and other resources for a long time. Classical economist thought that with changes in wages and prices, unemployment would be automatically removed and full employment established. But this did not appear to be so at the time of great depression in the thirties (1930) and after. Keynes explained the level of employment and national income is determined by aggregate demand and aggregate supply. With aggregate supply curve remaining unchanged in the short run, it is the deficiency of aggregate demand that causes under employment equilibrium with the appearance of involuntary unemployment. According to Keynes it is the changes in private investment that causes fluctuations in aggregate demand and is, therefore, responsible for the problems of cyclical unemployment.

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Limitations of Macro Economics

There are, however certain limitations of macro economic analysis. Mostly these stem from attempts to yield macro economic generalizations from individual experiences. 

1. Fallacy of Composition: 

In macro economic analysis the,’ fallacy of composition’ is involved, that is, aggregate economic behaviour is the sum total of individual activities. But what is true of individuals is not necessarily true of the economy as whole.

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Scope and Importance of Macro Economics

Macro economics is of theoretical and practical importance. They are:

1. To Understand the Working of the Economy:

The study of macro economics variables is indispensable for understanding of the working of the economy. Our main economic problems are related to the behaviour of total income, output, employment and the general price level in the economy. These variables are statistically measurable, thereby facilitating the possibilities of analyzing the effects on the functioning of the economy.

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Nature of Macro Economics

Macro economics is the study of aggregates or averages covering the entire economy, such as, total employment, national income, national output, total investment, total consumption, total savings, aggregate supply, aggregate demand, and general price-level, wage level and cost structure.

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Meaning and Definitions of Macro Economics

Introduction 

The term ‘macro’ was first used in economics by Ragner Frisch in 1933. But as a methodological approach to economic problems, it originated with the mercantilists in the 16th and 17th centuries. They were concerned with the economic system as a whole. From the 18th century physiocrats to modern economists have contributed to the development of macro economic analysis. But credit goes to Keynes who finally developed a general theory of income, output and employment in the wake of the great depression.

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