Government Revenue, Taxation, and Fiscal Policy

Government revenue (taxation) and spending policy designed to achieve lower unemployment, low or no inflation, and sustained but controllable economic growth. Tools to achieve these goals:

  • Government Spending
    • Current Expenditure: repeated spending on things which are used up quickly (e.g. wages)
    • Capital Expenditure: spending on assets that will last a long time (e.g. infrastructure)
    • Transfer Payment: money transferred according to a need. Government gets no goods or services in return (e.g. unemployment checks)
  • Taxation affects consumer’s income, therefore consumption and GDP. They should be cheap to collect, easy to pay, and hard to avoid. Government may want taxes to achieve horizontal and vertical equity:
    • Horizontal equity: similar income = similar taxes
    • Vertical equity: high income = higher taxes

Fiscal Policy Types

A government can change either the level of taxation and/or the government spending in order to promote the achievement of a macroeconomic objective.

Expansionary Fiscal Policy

  • Decrease in taxes = increase in income = increase in consumption = increase in aggregate demand = increase in price = increase in output = decrease in unemployment.
  • Increase in government spending = increase in aggregate demand = increase in price level = increase in output = decrease in unemployment.

Deflationary Policy

  • Increase in taxes = decrease in consumption = decrease in aggregate demand = decrease in price = decrease in output = increase in unemployment.
  • Decrease in government spending = decrease in aggregate demand = decrease in price level = decrease in output = increase in unemployment.


Payment demanded by the public administrations without having a direct compensation to the taxpayer. Nature:

  • Direct: levied directly on people and companies
  • Indirect: levied on the consumption or use of goods


  • IRPF(D): levied on the income of people. It is a progressive tax.
  • IS(D): levied on companies that have obtained benefits. It is a proportional tax.
  • IVA(ID): levied on most economic transactions. Percentage of the value of goods.
  • IE(ID): levied on the manufacture, import, and consumption of certain goods (e.g. tobacco and alcohol).


It’s the act of exchanging a good or services for another good or service.


Is anything that functions as a medium of exchange, store of value, or standard of value. Characteristics:

  • Portability: which is why we don’t use real estate
  • Durability: which is why we don’t use wheat, corn, or rice
  • Acceptability: which is why we don’t use paper (it has value in itself)
  • Stability: which is why we don’t use iron
  • Divisibility: which is why we don’t use artwork


  • Commodity Money: gold, silver, minerals. Advantage: different use apart from money transactions. Disadvantage: it is not very useful.
  • Representative Money: coins and banknotes. Advantage: it is not heavy as gold. Disadvantage: can be affected by inflation or deflation.
  • Inconvertible Fiat Money: coins, banknotes, and virtual money. Advantages: its value comes from the relationship between demander and supplier. Disadvantage: based on the faith and credit of the company.

Money Supply

Is the amount of cash that is circulating in the economy, only includes cash. A monetary aggregate is a magnitude which gathers different kinds of money. They are established by the ECB. Types:

  • M1: cash + demand deposits
  • M2: cash + your savings → M1 + saving deposits + redeemable deposits
  • M3: cash + all the other savings → M2 + repurchase agreements + money market fund shares/units + debt securities with a maturity of up to 2 years.

Money Demand

Functions of money:

  • Standard of value: how much would you pay for a good or service
  • Medium of exchange: used for the purpose of buying, selling, or paying
  • Store of value: you get money today and you are still able to use it in the future.

Opportunity Cost of Money

The opportunity cost of holding money instead of investing it: the interest rate. The financial compensation for saving it as against spending it is that the money value will increase through the interest rate that he will receive from a borrower.

Variables Which Affect Demand

  • Real income: income > demand
  • Opportunity cost: interest rate < demand.

Bank Money

The commercial bank grant credits but they are obliged to reserve a percentage of the deposits received as a security measure. In their own banks and as funds deposited in the Central Bank.


  • a. WF = Production / W x H
  • b. P = PN – PN1 / PN1 x 100

Balance Sheet


  • Fixed
    • Intangible
    • Tangible
  • Current
    • Stock
    • Cash
    • Debtors


  • Long-term loans
  • Short-term loans
  • Owners equity

Retained Earnings: TA – TL Working Capital: Current assets – short-term liabilities


  1. Operating income
  2. Operating expenses (-)
  3. Financial income
  4. Financial expenses (-)
  5. A. Operating result (1 + 2)
  6. B. Final result (3 + 4)
  7. 5. Taxes (-)
  8. C. Result before taxes (A + B)
  9. Net profit