Fiscal policy entails the means by which a government adjusts the tax rates and spending levels in order to monitor and influence nation’s economy. It is a sister strategy to monetary policy through which the central bank influences a nation’s money supply(Hansen, 2003). The two policies are used in various combinations to direct country’s economic goals. The policy is based on theories of British economist John Maynard Keynes which states that governments can influence macroeconomic productivity levels done by decreasing or increasing the tax levels and public spending. Such influence curbs inflation, increases employment and maintains healthy money value.
Real GDP demanded is an inflation-adjusted measure which reflects value of all services and goods produced in a certain year which is expressed in base-year prices(Hansen, 2003). It accounts for changes in price level and provides more accurate figure as compared to nominal GDP. Government purchases are expenditures by government sector especially those by federal government on final services and goods. It covers that portion of GDP purchased by governments.A decrease in government purchases would in return decrease the real GDP demanded.
Taxes covers both personal income taxes levied by federal government and others used. These taxes are the involuntary payments the government sector imposes on the rest of the economy to generate revenue needed in order to provide public goods and undertake other government functions. An increase in net taxes would decrease the real GDP demanded.
Transfer payments covers payments made by government sector to household sector with no any expectations of productive activity in return(Hansen, 2003). Common transfer payments are welfare to the poor, unemployment compensation to unemployed and social security benefits to elderly and disabled.A reduction in transfer paymentswill decrease the real GDP demanded.
Marginal propensity to consume abbreviated as MPC is the proportion of aggregate raise in pay a consumer spends on consumption of goods and services as opposed to saving it. It is computed by dividing change in consumption by change in disposable income that caused it.A decrease in the marginal propensity to consume will decrease the real GDP demanded.
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