2.2.4 & 2.2.5 Government Expenditure (G) & Net Trade (X-M)

Question 1

Government expenditure

Answer 1

all the money spent by the government e.g public goods such as defence, judiciary, health, education

Question 2

Main influences on govt expenditure

Answer 2

• the trade (economic) cycle
• fiscal policy
• type of economy
• fiscal debt/financing/budget

Question 3

Types of govt spending

Answer 3

• transfer payments
• public services
• capital spending/state investment

Question 4

Types of govt spending (transfer payments)

Answer 4

The govt enacts a transfer from. One group of taxpayers, to another (eg job seekers allowance)

Question 5

Types of govt spending (public services)

Answer 5

Current spending
- e.g salaries of NHS, road maintenance

Question 6

Types of govt spending (capital spending)

Answer 6

E.g Hs2

Question 7

Significance of government spending

Answer 7

• a key component of AD
• important in providing public and merit goods
• can impact household income/distribution. Govt can help achieve greater equity

Question 8

National debt is damaging

Answer 8

• high and rising stock
• higher taxes & bond interest rates can ‘crowd out’ the private sector
• big state spending and borrowing = wasteful

Question 9

National debt is damaging (high and rising stock)

Answer 9

• increased future taxes (current borrowing/debt = tomorrow taxes & is expensive to service

Question 10

National debt is damaging (crowd out)

Answer 10

• higher taxes & bond interest rates can ‘crowd out’ the private sector
• increased govt borrowing = increased interest rates in debt markets (e.g bond yields)
• thereby increasing borrowing costs on loans 4 other participants in the economy
  (See ipad photo and graph)

Question 11

Benefits of govt borrowing

Answer 11

• Govt borrowing is required to fund investment
• Automatic stabilisers
• Better transport
• see photo on ipad

Question 12

theory of crowding out

Answer 12

• rise in public sector borrowing and debt might have th effect of crowding out investment in the private sector
• the theory rests on the financing impact of an increase in govt borrowing either through bond issues or via higher taxes
• fiscal conservatives argue: govt borrowing and debt therefore needs to be controlled to keep market interest rates and taxes low
• this then frees up scarce resources for the (dynamic) private sector to invest and grow

Question 13

Is a high level of national debt a concern?

Answer 13

• depends in part on the root causes (cyclical or structural)
• depends on the ability of govt to attract investors to buy new debt
• depends on value judgements about how best to fund public services and welfare & which generations should bear the cost of doing this

Question 14

Free market

Answer 14

prices are determined by unrestricted competition between privately owned firms (less govt spending)

Question 15

Mixed economy

Answer 15

an economic system combining private & state enterprise (some govt spending)

Question 16

Command economy

Answer 16

production is publicly owned and economic activity is controlled by a government (high govt spending)

Question 17

How does the trade cycle affect govt expenditure?

Answer 17

• recession phases = neg economic growth = less govt spending (pay for unemployment benefit)
• boom = low unemployment = less spending on benefits = tax receipts will increase

Question 18

How does fiscal policy affect govt expenditure?

Answer 18

high tax = increased spending

Question 19

Main influences on the net trade balance

Answer 19

• real income
• exchange rates
• state of the world economy
• degree of protectionism
• non price factors

Question 20

How does real income affect the net trade balance?

Answer 20

higher income = more demand for M (ceteris paribus) = more imports = worse net trade balance

Question 21

How does exchange rate affect the net trade balance?

Answer 21

• weak exchange rate = more exports (country can buy more/worth more)
• strong exchange rate = pound is worth more = cheap imports, expensive exports = worsen trade balance (but if competition is based on quality rather than price, then small changes in demand so trade balance won’t suffer)

Question 22

How does the state of the world economy affect the net trade balance?

Answer 22

the economic performance of other economics affects the trade balance e.g slow growth in Eurozone in 2012 to 2014 affected the UKs export sales

Question 23

How does protectionism affect the net trade balance?

Answer 23

high restrictions on free trade (e.g tariffs) = low imports which is good (ceteris paribus) but if other countries retaliate then it’s harder for you to export to them

Question 24

Policies to reduce UK’s future current account deficit

Answer 24

• demand side policy = rise in direct taxation
• Bank of England try to achieve a competitive depreciation of sterling

Question 25

How can a rise in direct taxation reduce a current account deficit?

Answer 25

• e.g increase in income tax = reduce real disposable income = causing contraction in household spending = reduce demand for import (expenditure reducing effect) - AD diagram
• assuming the value of export remain the same = improve net trade

Question 26

Evaluation of using direct tax to reduce current account deficit

Answer 26

• high direct tax not always effective in reducing spending
• could lead to a fall in planned investment = hinder productive capacity of businesses that export

Question 27

How will depreciation improve current acconut deficit?

Answer 27

• e.g by keeping interest rate low/ expanding QE
• weaker pound = increase import = export more competitive (Expenditure switching effects)

Question 28

Evaluation of using depreciation to improve current account deficit

Answer 28

• current account deficit likely to be structural
• UK has deficit for past 40 years and the value of pound has halved against the dollar = persistent productivity gap
• UK import lots of raw materials for their exports (so depreciation = high production costs)
• J curve

Question 29

Fiscal austerity

Answer 29

involves reducing government spending and/or increasing taxes in order to reduce budget deficits and debt.