An economy is operating with a significant negative output gap. The government wants to stimulate aggregate demand (ADADAD) but is constrained by a fiscal rule requiring a balanced budget, meaning any increase in government expenditure or transfer payments must be matched by an equal increase in tax revenue.
Assume the following:
Which of the following revenue-neutral policy packages will result in the largest initial increase in ADADAD?
Increasing transfer payments (such as unemployment benefits) to lower-income households by £10 billion, funded by a £10 billion increase in income tax on higher-income households.
Increasing government spending on healthcare by £10 billion, funded by a £10 billion increase in income tax on higher-income households.
Increasing government spending on healthcare by £10 billion, funded by a £10 billion increase in value-added tax (VAT) paid entirely by lower-income households.
Increasing transfer payments to lower-income households by £10 billion, funded by a £10 billion increase in VAT paid entirely by lower-income households.
245 exam-style questions on AQA A Level Economics 2.5 Fiscal policy and supply-side policies, covering 2.5.1 Fiscal policy and 2.5.2 Supply-side policies. Each one has a worked solution and a mark scheme showing where the marks go.