Economics for Managers: Fiscal Policy and Impact of Food Taxes and Subsidies

This text discusses Keynesian economics and how government spending can boost business activity and output level. It also explains the impact of recession on fiscal position and how fiscal contraction can be expansionary. Additionally, it covers the impact of food taxes and subsidies on demand elasticity and how it varies for different food items.

ECONOMICS FOR MANAGERS
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Question 1
a) As per Keynesian economics, during a downturn the government spending must be
boosted which tends to higher business activity and results in higher level of output. In the
process, the consumer disposable income would also increase owing to higher income being
generated for the workers and employees on account of increased business activity. This
would further translate into increased consumer spending which in turn would lead to even
higher levels of business activity and output level. Thus, there is a multiplier effect associated
which essentially leads to higher output and GDP growth which pushes the economy out of
recession.
b) The fiscal position is automatically impacted in recession owing to changes in the revenue
of the government. A major cause of this would be on account of lower tax revenues for the
government driven by lower taxable income of individuals coupled with lower spending by
the consumers. Additionally, the trade also may be adversely impacted which could
adversely impact the trade balance and hence worsen the budgetary position. Discretionary
changes would take place in the form of tax cuts and higher government spending in order to
provide stimulus to economy leading to fiscal deficits.
c) Fiscal contraction can potentially be expansionary and may boost economic performance if
the government stops wasteful spending. A possible example is the reduction of government
role from providing key public utilities as the same may be open to the private section. On
one hand, this would provide indication for the future and also lead to expansion in business
activity as the sphere of private participation would work. Also, it might be possible that the
government would reduce the taxes on businesses and income owing to lesser functions. This
would again provide a boost to the economy and promote spending going forward.
d) It is best that fiscal measures should be used only as interim measures to provide stimulus
owing to the lag effect in monetary policy. The monetary policy otherwise is best suited in
order to employment and inflation are maintained at their desirable levels and suitable
monetary tools interventions are brought in as and when required. The monetary policy is
much more equipped to provide economic stimulus with limited implications unlike fiscal
policy where a fiscal deficit may be the result which can have adverse consequences on the
ability of the nation to serve the outstanding debts.
Question 2

The impact of food taxes and food subsidies would be dependent on the underlying price
elasticity of demand.
It is apparent from the above diagram that the subsidy is more effective where the demand is
more elastic and it has only limited effect in case of inelastic demand with regards to
increasing quantity by decreasing the price. A similar effect would be visible in case of
levying taxes on undesirable food items. The consumption decrease would be meaningful if
the demand is elastic. However, in case of inelastic demand the decrease in consumption is
not significant when compared to the price rise.
With regards to sweets and sugary snacks, the demand is highly inelastic and hence taxes
would not be effective. With regards to dairy products, the high calorie version has a highly
inelastic demand, hence levying tax would not be effective. However, for low calorie dairy
products, the demand is highly elastic and providing subsidy would be a viable proposal. In
terms of grain, pasta and bread, high calorie version has a highly inelastic demand and hence
tax would not discourage eating. Thus, it is apparent that food taxes and food subsidies would
have limited relevance with regards to changing the food habits.