Abstract

This chapter provides an overview of fiscal policy and demand management. According to Keynesian theory, economic instability is caused by erratic fluctuations in aggregate demand. When aggregate demand is deficient, unnecessary high unemployment result occurs. On the other hand, when an economy is already operating at capacity, excess aggregate demand generates inflation. If aggregate demand could be managed properly, then full employment and economic stability could be attained. As the government's taxation and expenditure policies influence aggregate demand, the federal budget is a useful weapon to combat economic instability, unemployment, and inflation. Government spending is a component of aggregate demand. It directly influences the level of demand. Taxes alter the disposable income of consumers and the profitability of business firms. Thus, taxation policy has an indirect impact on the consumption and investment components of aggregate demand. Taxes and government expenditures are fiscal policy tools. Fiscal policy is the use of government spending and taxation policy as a vehicle for managing the determinants of aggregate output.

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