IB Economics SL — Demand Management: Fiscal Policy: Notes, Questions & Solutions

IB Economics SL — Demand Management: Fiscal Policy: Notes, Questions & Solutions

What is fiscal policy?

Fiscal policy is the use of government spending and taxation, set directly by the government (not a central bank), to influence aggregate demand and pursue macroeconomic objectives.

Key points

• Expansionary fiscal policy increases government spending and/or cuts taxes to raise AD.

• Contractionary fiscal policy cuts spending and/or raises taxes to reduce AD, often to control inflation.

• A budget deficit occurs when government spending exceeds tax revenue in a given period.

• Unlike monetary policy tools, fiscal policy is a political decision, which introduces implementation time lags.

Practice questions

1. Distinguish between expansionary and contractionary fiscal policy. (Expansionary: increased spending and/or lower taxes to raise AD; contractionary: reduced spending and/or higher taxes to lower AD.)

2. What is a budget deficit? (When government spending exceeds tax revenue over a given period.)

3. Give one advantage of fiscal policy over monetary policy for targeting a specific sector of the economy. (Government spending can be directed precisely, e.g. infrastructure investment in a particular region or industry.)

4. Explain one time lag associated with fiscal policy. (Implementation lag — the time it takes for government spending or tax changes to be approved and put into effect.)

5. Why might contractionary fiscal policy be used even though it risks slowing growth? (To control inflation when the economy is overheating, prioritising price stability over short-term growth.)

 

 Written by sortmyprep | Reviewed by IB Teacher | Last updated: September 15, 2026