CFA Level 1: Impact of Expansionary Fiscal Policy on Employment

The Impact of Expansionary Fiscal Policy on Employment

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Question

Which of the following correctly describes how expansionary fiscal policy through tax cuts eventually impacts employment?

Answers

A. Tax cuts result in more income for consumers, which shifts the aggregate demand curve upward, which increases the price level. This inflationary effect encourages firms to use more flexible labor and less inflexible capital.

B. A tax cut shifts the aggregate demand curve out. This causes upward movement along the aggregate supply curve, which increases resource utilization.

C. Tax cuts result in more government debt which causes the interest rate to rise and therefore unemployment to fall.

D. Tax cuts result in a multiplier effect, as politicians showing confidence in the economy encourages businesses to spend on expansions.

E. The tax cut causes an increase in quantity demand. This causes an outward shift in the aggregate supply curve and hence more employment.

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Explanations

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A. B. C. D. E.

Consumers react to tax cuts as if it were an increase in income. This causes more demand for goods and services at every price level. The demand curve would therefore shift to the right. This causes movement along the supply curve, expanding output. This expansion in output should reduce slack resources, i.e. unemployment.

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