Explain How Fiscal Policy Might Be Used to Bring About Supply-Side Improvements to an Economy. [15]

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Explain how fiscal policy might be used to bring about supply-side improvements to an economy. [15] K2 K2 K2 K2 Fiscal policy is the manipulation of public spending, taxation and borrowing to achieve the government’s macroeconomic objectives. For example an increase in government expenditure or a reduction in income tax should increase aggregate demand and real output. Fiscal policy is also used to improve the supply-side performance of the economy by affecting incentives to work and incentives to invest. Such policies aim to increase the capacity of the economy to produce more goods and services by increasing the quantity or quality of the factors of production. A supply-side improvement can be depicted as a positive rightwards shift of the LRAS curve (LRAS to LRAS1). Price level Real Output Y1 Y LRAS LRAS1 Price level Real Output Y1 Y LRAS LRAS1 AN1 AN1 AP1 AP1 AN1 AN1 AN1 AN1 AN1 AN1 AP1 AP1 AN1 AN1 One fiscal policy that might be used to bring about the supply-side improvement of a larger workforce is a reduction in income tax. A fall in the marginal rate of tax, for example a reduction in the additional rate of income tax from 50% to 45% for income earned above £150,000 or an increase in the Personal Allowance threshold from £10,000 to £10,500, will increase households disposable income (post-tax take home). The resultant decrease in households’ replacement ratio (disposable income out of work ÷ disposable income in work) will encourage more people to actively seek work and thus increase the participation rate (the proportion of all those of working age that comprise the labour force and in the UK this figure is 75%) and thus increase the size of the labour force. PPF1 Capital goods Consumer goods PPF PPF1 Capital goods Consumer goods PPF AN1 AN1 AP1 AP1 AN1 AN1 AN1 AN1 AN1 AN1 AP1 AP1 A second
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