2. How does the fiscal policy influence economic activity?

Analyse the impact of Indias

fiscal policy on the economy since the beginning of the last decade.
The use of Government Spending (GS) and Taxation (TX) to influence the economy is fiscal
policy. In considering how fiscal policy influences economic activity it is important to
understand it in the Short-Run(SR) and Long-Run(LR). Besides these dimensions, fiscal policy
effects on economic activity is expected to impact the Supply-side, Demand-side and Institutionside and is expected to deliver different results for Developed and Developing economies.
Fiscal policy impacts:

Aggregate Demand(AD)
Wealth distribution
Economys capacity to produce goods/services.

Changes to GS and TX will impact AD in the SR both in terms of scale and pattern. Over time,
this impacts the allocation of resources and production capacity. This is so because over time the
AD influences:

returns to factors of production

allocation of capital spending
investment in technology
human capital development

Tax rates through their influences on net returns to labor, saving and investment also influence
the productive capacity.
Typically, how the economy reacts to fiscal policy depends on whether the economy is operating
at full employment or operating below its capacity. There are two general macroeconomic views
namely the Equilibrium view and the Non-Equilibrium view. In the former, the economy quickly
returns to full capacity once the disturbances that displaced it from full employment are set right.
In this view, both fiscal and monetary policy play negligible role in influencing the economy. In
the alternate view, critical market failures take longer to adjust to the disturbances. In such a
case, fiscal policy and monetary policy play a major role.