5.2 Fiscal Policy

AS Level Economics | Cambridge 9708

2026 📋 Syllabus Objectives

By the end of these notes, you should be able to:

  1. Explain the meaning of a government budget
  2. Distinguish between a government budget deficit and a government budget surplus
  3. Explain the meaning and significance of the national debt
  4. Understand taxation — types of taxes, rates of tax, and reasons for taxation
  5. Understand government spending — types of spending and reasons for government spending
  6. Distinguish between expansionary and contractionary fiscal policy
  7. Use AD/AS diagrams to analyse the impact of fiscal policy on national income, real output, the price level, and employment

📖 Main Content

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Objective 1: The Government Budget

What is a government budget?

Think of a household budget — you look at how much money is coming in (your income) and how much is going out (your spending). A government does the same thing, just on a much larger scale.

The government budget is a plan that shows:

  • How much money the government expects to receive (mainly from taxes)
  • How much money the government plans to spend (on schools, hospitals, roads, defence, etc.)

Governments typically set their budget once a year. This plan guides all of the government's financial decisions for that year.

The budget can be written as a simple formula:

Budget Balance = Tax Revenue (T) − Government Spending (G)

This means:

  • If T is greater than G → the government has money left over (a surplus)
  • If T is less than G → the government has spent more than it earned (a deficit)
  • If T equals G → the budget is balanced

Objective 2: Budget Deficit vs Budget Surplus

🔴 Budget Deficit

A budget deficit occurs when the government spends more money than it collects in tax revenue.

Tax Revenue (T) < Government Spending (G)

Example: If the government collects USD 500 billion in taxes but spends USD 600 billion on public services, the deficit is USD 100 billion.

  • To cover this gap, the government must borrow money — usually by issuing government bonds (which are promises to repay lenders in the future with interest).
  • Budget deficits are common in developing countries that need to invest heavily in infrastructure and social services to stimulate economic growth.
  • A deficit can also be deliberate — if the government wants to boost a slow economy, it may purposely spend more than it earns to inject money into the economy.

🟢 Budget Surplus

A budget surplus occurs when the government collects more money than it spends.

Tax Revenue (T) > Government Spending (G)

Example: If the government collects USD 600 billion in taxes but only spends USD 500 billion, the surplus is USD 100 billion.

  • This extra money can be used to pay off previous debts, save for future spending, or reduce taxes.
  • Budget surpluses are more common in developed countries with strong, stable economies and large tax bases.

Quick Comparison Table

FeatureBudget DeficitBudget Surplus
Tax Revenue vs SpendingT < GT > G
Government Borrows?YesNo
Effect on DebtIncreases national debtCan reduce national debt
Common inDeveloping countriesDeveloped countries

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