Understanding Indifference Curves and Fiscal Policy

Indifference Curves

Indifference curves are lines on a plane representing combinations of goods that produce the same satisfaction. As we move away from the axes, satisfaction increases. However, satisfaction remains the same along any single indifference curve. Consumers always aim to be on the highest possible indifference curve their income allows.

Automatic Stabilizers

Automatic stabilizers in fiscal policy are instruments that activate automatically without government intervention. They respond to changes in income, employment, or prices, stabilizing the economy.

Existing Tax Deductions

1. If income increases and demand holds or increases, existing deductions remain unchanged, potentially hindering growth.
2. If income falls and demand decreases, more money is available to spend as fewer taxes are retained.

Same Taxes Imposed

The same taxes, such as income tax, collect more revenue during economic expansion but less during a recession, slowing both processes.

Discretionary Fiscal Policy

Interest Rate Hikes

Raising interest rates to curb inflation can make borrowing more expensive, potentially reducing investment and inflation.

Tax Increases

Increasing tax rates reduces disposable income, lowering demand and curbing inflation.

Direct vs. Indirect Taxes

Direct Taxes

Direct taxes are paid directly by the taxpayer and are based on personal circumstances, such as income (e.g., Personal Income Tax - PIT).

Indirect Taxes

Indirect taxes are paid by the consumer but collected by an intermediary. They are levied on goods and services, affecting consumption spending (e.g., Value Added Tax - VAT). Indirect taxes are considered objective as they do not account for personal circumstances.

Main Economic Functions of the State

Short-Term

• Price stability
• Full employment
• Balance of foreign trade

Long-Term

• Improvement in income distribution
• Economic growth and development

Fiscal Policy Types

Expansionary Fiscal Policy

Expansionary fiscal policy involves lowering taxes, increasing disposable income, and boosting demand.

Restrictive Fiscal Policy

Restrictive fiscal policy is used during economic booms or inflationary periods to restrain inflation by reducing demand.

State Budget Outcomes

Deficit

A deficit occurs when state revenues are lower than expenditures (expenditure > revenue).

Surplus

A surplus occurs when state revenues are higher than expenditures (expenditure < revenue).

Balanced Budget

A balanced budget occurs when state revenues equal expenditures (expenditure = revenue).