4.5 role of the state in macroeconomy

Question 1

what are the types of government expenditure?

Answer 1

Capital government expenditure, General government final consumption, Transfer payments, current government expenditure

Question 2

what is capital government expenditure?

Answer 2

spending on investment goods such as new roads, schools and hospitals which will be consumed in over a year.

Question 3

what is general final consumption?`

Answer 3

spending on goods and services that will be consumed within the next year, such as public-sector salaries

Question 4

what is transfer payments?

Answer 4

government payments for which there is no corresponding output, where money is taken from one group and given to another, for example benefits and pensions.

Question 5

what is current government expenditure?

Answer 5

general government final consumption plus transfer payments plus interest payments.

Question 6

how much of the expenditure is spent on defence?

Answer 6

6% is spent on defence

Question 7

how much of the expenditure is spent on protection?

Answer 7

4% is spent on protection

Question 8

how much of the expenditure is spent on education?`

Answer 8

12% is spent on education

Question 9

how much of the expenditure is spent on pensions?

Answer 9

20% is spent on pensions

Question 10

how much of the expenditure is spent on welfare?

Answer 10

15% is spent on welfare

Question 11

how much of the expenditure is spent on transport?

Answer 11

2% is spent on transport

Question 12

how much of the expenditure is spent on health care?

Answer 12

18% is spent on healthcare

Question 13

how much of the expenditure is spent on interest repayments?

Answer 13

7% of all government spending is on interest repayments of loans.

Question 14

what is the relationship between average income and government expenditure and why?

Answer 14

the lower the average income of the country, the lower is likely to be the percentage of GDP spent by the government. this is due to the fact that poorer countries have lower tax revenue (inefficient collection, small amounts of wealth to tax, avoidance). higher income countries usually demand more from government

Question 15

what is the US public spending like?

Answer 15

USA has much lower state spending, and

this is due to attitudes in that country.

Question 16

what is the effect of the global financial crisis on government expenditure?

Answer 16

the global economic crisis has increase government expenditure as there are increased welfare payments and some countries needed to bail out the banks for example the government bailed out Lloyds bank and the bank of Scotland

Question 17

what is austerity?

Answer 17

a set of economic policies, usually consisting of tax increases, spending cuts, or a combination of the two, used by governments to reduce budget deficits.

Question 18

how does government policy affect government spending?

Answer 18

policies such as austerity will reduce the expenditure so the amount of spending by the government may depend on policies and targets set by the government

Question 19

what is a demographic change that affects government expenditure?

Answer 19

an aging population will put more pressure on government expenditure as there will be a greater number of pensions and larger amount of care needed

Question 20

give an example of a demographic change affecting expenditure by governments

Answer 20

aging population is becoming an issue in Japan and Europe

Question 21

what are the impacts of government expenditure?

Answer 21

Productivity and growth, Living standards, Crowding out, Level of taxation, Equality

Question 22

what is the pros of government expenditure on productivity and growth?

Answer 22

the government can improve education -increase human capital, they can increase healthcare -productive workers, they can use their economies of scale when providing goods- increased productivity, they can do research and development which may not be done by private (positive externality), they can use multiplier effect to target areas of high unemployment - increased growth

Question 23

what are the cons of government expenditure on productivity and growth?

Answer 23

Free market economists argue that government spending is wasteful and causes inefficiency.

Question 24

what are the pros of government expenditure on living standards?

Answer 24

government corrects market failure and provides public goods , which improves social welfare. they also reduce absolute poverty by providing benefits and basic goods such as education and healthcare

Question 25

what are the cons of government expenditure on living standards?

Answer 25

the government may be inefficient at providing goods and will have a negative disincentive impact on workers, meaning that output overall is reduced and so living standards fall. government suffers from the principal agent problem since they make decisions on behalf of the people and individuals may have spent
that money differently therefore there is a welfare loss and a fall in living standards.

Question 26

what is the crowding out affect?

Answer 26

when government spending fails to increase overall aggregate demand because higher government spending causes an equivalent fall in private sector spending and investment.

Question 27

how does government expenditure create the crowding out effect?

Answer 27

if a governments wants to spend above the tax revenue, they then are competing with firms for funding. this will push up the interest rate which will discourage investment by firms and consumption by credit. the limited number of resources also mean that any resources used by governments cant be used by private sector therefore crowding out private investment which may lead to no real improvement in AD

Question 28

when is the crowding effect most impactful?

Answer 28

The crowding out effect is felt most at full employment

Question 29

why might government expenditure not impact the crowding out effect?

Answer 29

Transfer payments would not cause crowding out
as resources are simply taken from one group and given to another; the government isn’t taking resources from the economy. also when levels of unemployment
are high then extra government spending could lead to crowding in where it encourages investment through the multiplier.

Question 30

how does government expenditure affect the level of taxation?

Answer 30

where government spending is high, levels of tax must be high in order for spending to be sustainable. High levels of tax may have a disincentive effect. the exception is oil rich countries such as Saudi Arabia, where revenue from oil can pay for government spending

Question 31

how does government expenditure effect equality?

Answer 31

Spending should increase equality as it leads to redistribution and helps to provide a minimum standard of living for the poorest in society. It ensures everyone has access to basic goods, such as education and healthcare, which will help to give them a fair start in life.

Question 32

what are Adam Smiths 4 canons of taxation?

Answer 32

1- equity (taxes proportional to income) 2- certainty ( timing and amount should be known) 3- convenience ( timing and collection is convenient with tax payer) 4- economy ( costs of collecting tax are minimized)

Question 33

what are the UKs aims of taxation?

Answer 33

keeping the burden of tax low, improving incentives, using equitable taxes, correcting market failure and taxing spending rather than income.

Question 34

what are the uses of taxes?

Answer 34

used to pay for the number of goods and services that the government provides, used to correct market failure at a microeconomic level and to manage the economy and redistribute income at a macroeconomic one.

Question 35

what is a progressive tax?

Answer 35

those who are on higher incomes pay a higher marginal rate of tax; they pay a higher percentage of their income on tax. Direct taxes tend to be progressive, for example income tax

Question 36

what is a regressive tax?

Answer 36

where the proportion of income paid in tax falls as the income of the taxpayer rises. Those on higher incomes pay a smaller percentage of their income on the tax.

Question 37

what is a proportional tax?

Answer 37

where the proportion of income paid on tax remains the same whilst the income of the taxpayer changes. Everyone pays the same percentage of their income on the tax.

Question 38

what are the impacts of tax changes?

Answer 38

Incentives to work, Tax revenues, Income distribution, Real output and employment, Price level, Trade balance, FDI flows

Question 39

how do changes in taxation affect the incentive to work?

Answer 39

high marginal rates of tax will discourage individuals from working. as the supply of labour is inelastic, a reduction in marginal taxes will lead to a significant increase in work. higher taxes may encourage high income earners to move abroad. switch from direct to indirect tax would increase incentive to work.

Question 40

what evidence may counter the impact changes on taxation has on the incentive to work?

Answer 40

Nordic countries have high taxes and welfare benefits but have similar rates of growth compared to lower tax and government spending countries like US and UK

Question 41

what is the counter to lower incentive to work when taxes are high?

Answer 41

It can be argued that higher taxes mean people have to work longer hours in order to maintain their income and so even increases the incentive work.

Question 42

what is the laffer curve show?

Answer 42

it shows that as tax rate increases tax revenue will increase until its optimal point where revenue is maximised then it will fall again. it is an inverted U shape.

Question 43

when is the tax revenue 0?`

Answer 43

at 0% and 100% as people arent paying any tax at 0% and unwilling to work at 100%

Question 44

why does tax revenue fall after the optimal tax rate is exceeded?

Answer 44

the motivation and drive is reduced so output will fall, the opportunity cost of leisure is reduced, there will also be an increased incentive to use tax avoidance and evasion.

Question 45

why is tax revenue from indirect tax uncertain?

Answer 45

Revenue from indirect taxes can be uncertain as they depend on consumer spending patterns.

Question 46

how do tax changes affect the income distribution?

Answer 46

progressive taxes will increase equality whereas regressive will increase inequality. therefore a move from indirect taxes to direct taxes will therefore increase equality. inheritance tax is most progressive tax and transfers wealth from rich to poor.

Question 47

what is the issue with using tax changes to solve the income distribution?

Answer 47

just using taxes by themselves will not solve inequality, it needs to be supported by government benefits

Question 48

what is the effect on rise of direct taxes on real output and employment?

Answer 48

A rise in direct taxes will reduce the level of disposable income an individual has, which will cause a fall in their spending and thus a fall in AD. It could also cause a fall in leftover profits for businesses and therefore a fall in investment.

Question 49

what is the effect on rise of indirect taxes on real output and employment?

Answer 49

higher indirect taxes and NICs increase costs for firms and this will decrease SRAS.

Question 50

what is the effect on rise of income taxes on real output and employment?

Answer 50

It can be argued that income taxes cause a disincentive to work and therefore reduce LRAS as the most skilled workers go overseas and more people become inactive.

Question 51

what is the effect on price level of a change in taxation?

Answer 51

taxes can impact LRAS, SRAS and AD. Therefore, these
changes will impact price depending on where the economy is producing. Indirect taxes, particularly VAT, often cause cost push inflation.

Question 52

what is the effect on the trade balance of a change in taxation?

Answer 52

A rise in taxes will decrease income and therefore decrease consumption, theoretically this will also mean consumers spend less on imports . Imports in the
UK have been found to be highly income elastic. As a result, the trade balance will improve in the short run. However, in the long run, lower AD will reduce businesses’ need to invest and this could reduce competitiveness meaning that exports decrease.

Question 53

what is the effect on FDI flows of a change in taxation?

Answer 53

Low taxes on profit and investment tend to encourage businesses to invest in a country since it will help them to see a higher level of return.

Question 54

what is the issue with changes on taxation for FDI?

Answer 54

The problem with this is that it can be a ‘race to the bottom’ where countries have to continue to lower their taxes in order to make them the lowest to encourage investment; the eventual result is a fall in revenues for all countries.

Question 55

what are automatic stabiliser?

Answer 55

Automatic stabilizers are mechanisms which reduce the impact of changes in the economy on national income; government spending and taxation are automatic stabilizers. In a recession, benefits increase as more people are unemployed and so the benefits are a stabilizer as it means that the overall fall in AD is reduced, preventing too much change in the economy. On the other hand, during a boom, tax increases as people have more jobs and higher incomes, and this tax reduces disposable income so decreases consumption and AD, meaning that demand doesn’t grow too high.

Question 56

what is discretionary fiscal policy?

Answer 56

Discretionary fiscal policy is the deliberate manipulation of government expenditure and taxes to influence the economy; expansionary and deflationary
policies.

Question 57

what are evaluation points for automatic stabilisers?

Answer 57

These automatic stabilizers cannot prevent fluctuations; they simply reduce the size of these problem and there can be negative aspects to these stabilizers. Benefits may act as a disincentive to work and lead to higher unemployment whilst high levels of tax can decrease the incentive to work hard.

Question 58

what is the national debt?

Answer 58

The national debt is the sum of all government debts built up over many years

Question 59

what is a fiscal defecit?

Answer 59

a fiscal deficit is when the government spends more than it receives that year.

Question 60

why is debt measured in gdp usually better than in money terms?

Answer 60

The GDP measure is often more useful because it gives an indication of how easy to will be for the government to finance a deficit or repay the national debt.

Question 61

what is the public sector net cash requirement?

Answer 61

the total money that the government needs to borrow in order to fulfil its spending plans. it is the difference between revenue and spending

Question 62

what is a cyclical defecit?

Answer 62

A cyclical deficit is the part of the deficit that occurs because government spending and tax fluctuates around the trade cycle. When the economy is in recession, tax revenues are low and spending is high creating a larger deficit.

Question 63

what is a structural defecit?

Answer 63

At the peak of the boom, there is no cyclical deficit; any deficit at this point is a structural deficit. The structural deficit is the fiscal deficit which occurs when the cyclical deficit is zero; it is long term and not related to the state of the economy

Question 64

what is the actual defecit?

Answer 64

The actual deficit is the structural deficit plus the fiscal deficit.

Question 65

when does a structural surplus occur?

Answer 65

A structural surplus occurs when at the peak of the boom, there is an actual fiscal surplus

Question 66

when does a structural balance occur?

Answer 66

a structural balance occurs when at the peak of the boom, the actual fiscal balance is 0.

Question 67

what happens to national debt when there is a structural defecit?

Answer 67

If the government has a structural deficit, it is likely that national debt will grow over time as the government has to consistently borrow money to finance spending.

Question 68

why is it difficult to deal with structural defecit?

Answer 68

this is difficult since it is impossible to know what part of the deficit is structural and what part of it is cyclical, just as it is impossible to know the size of the output gap

Question 69

what are the factors that affect the size of the fiscal defecit?

Answer 69

trade cycle, unforeseen events, interest rates, privatization, government aims, high revenue from oil, number of dependents

Question 70

how does the trade cycle affect the size of the fiscal deficit?

Answer 70

During a downturn, government tax revenue decreases whilst government spending increases and so the deficit increases.

Question 71

how does unforeseen events affect the size of the fiscal deficit?

Answer 71

Unforeseen events, such as natural disasters or recessions, lead to huge increases in spending which increase the deficit.

Question 72

how does interest rates affect the size of the fiscal deficit?

Answer 72

If interest rates on government debt increase, the amount the government pays in interest repayments increases and this is likely to increase the deficit. The impact of this will depend on how significant interest repayments are in the size of the deficit. Interest rates depend on market rates and the credit ratings of the government.

Question 73

how does privatization affect the size of the fiscal deficit?

Answer 73

Events like privatization provide one-off payments to the government which will decrease the deficit in the short term; it will depend on the value of the company sold.

Question 74

how does government aims affect the size of the fiscal deficit?

Answer 74

Government aims are important in the size of the deficit, as this will influence their fiscal policy, for example the austerity aim has helped to decrease the size of the deficit but attempting to increase AD would increase spending

Question 75

how does high revenues from oil affect the size of the fiscal deficit?

Answer 75

Many countries with high revenues from oil , for example the OPEC countries, run a budget surplus and so government revenue is important in the size of the deficit.

Question 76

how does the number of dependents affect the size of the fiscal deficit?

Answer 76

Factors such as the number of dependents in a country affect both spending and tax revenues so influence the deficit.

Question 77

what are factors that affect the size of national debts?

Answer 77

continuous fiscal deficits, aging populations

Question 78

how does continuous fiscal deficits affect the size of the national debt?

Answer 78

If the government is continuously running a deficit, then the national debt will increase overtime. There is a consensus view that fiscal deficits over 3% will lead
to growing national debt as a proportion of GDP . It is only when the government runs a budget surplus that the size of the national debt decreases.

Question 79

how does an aging population affect the size of the national debt?

Answer 79

Ageing populations tend to contribute to a high national debt since the government runs a structural deficit in order to fund their pensions and care and this leads to a high national debt.

Question 80

what is the effect of the national debt on the interest rate?

Answer 80

High levels of borrowing may raise interest rates in the economy since an increase in the demand for money will increase the price of money, i.e. interest rates. This could cause crowding out of the economy.

Question 81

what is the effect of the national debt on the cost of servicing the debt?

Answer 81

Countries have to spend a large amount of money on servicing their national debt through interest repayments, which has a high opportunity cost. The UK spends £70 billion a year to service its debts but this is small as a percentage of GDP . A primary budget deficit is the actual budget deficit but does not include interest repayments on the national debt.

Question 82

what is the effect of national debt on intergenerational inequality?

Answer 82

Some economists argue that high fiscal deficits and national debts benefit citizens today at the expense of future generations and can cause intergenerational inequality. A current budget deficit is problematic as it means that future generations are forced to pay the bill for today’s expenditure.

Question 83

what is an evaluation for the effect of national debt on intergenerational inequality?

Answer 83

The concerns over a deficit depend on whether the deficit is caused by current expenditure alone or whether it is just caused by capital expenditure. if the deficit is due to capital expenditure, the future generations benefit from increased spending and so their extra tax bill to pay for today’s borrowing can be justified. The value of debt tends to fall overtime because inflation erodes its value and because a country’s GDP grows meaning the debt is easier to pay off, so this limits the impact on future generations.

Question 84

what is an evaluation point for the effect of the national debt on the cost of servicing the debt?

Answer 84

The impact will depend on the level of interest rates and the size of the primary deficit compared to interest repayments. In a liquidity trap (when interest rates are extremely low), the government can often borrow at very low rates for long periods of time.

Question 85

what is the evaluation point for the effect of the national debt on the interest rate?

Answer 85

crowding out may not always be the case as the government may borrow from overseas and during a recession, private sector investment falls which means interest rates may remain unchanged.

Question 86

what is the effect of high fiscal deficits on inflation?

Answer 86

High fiscal deficits can cause inflation. If the government increases their spending and there is no similar fall in private sector spending, AD will rise and this can be inflationary. More dangerously, if a government is unable to borrow money, they will
print more money and this can cause hyperinflation as in Germany in 1923 or Zimbabwe in 2008 .

Question 87

what is the evaluation point for high fiscal deficits on inflation?`

Answer 87

Printing money will not necessarily cause hyperinflation, it depends on how much is printed and where the economy is producing on the LRAS.

Question 88

what is the effect of national debt on the governments credit rating?

Answer 88

High levels of debt tend to result in a reduced credit rating for the government. Private sector companies estimate the likelihood that a government will default on its debt and give it a rating from AAA to D. Lower credit ratings mean that lending to the government is riskier and so higher interest rates are demanded from lenders.

Question 89

what is the evaluation point for the effect of the national debt on governments credit rating?

Answer 89

in reality, it is not the size of the debt that influences the level of risk involved with the lending the money, it is whether that country has ever defaulted on their loans before and their current economic/political climate.

Question 90

what is the effect of national debt on the governments foreign currency reserves?

Answer 90

If a government has borrowed from abroad, it may have difficulties getting enough foreign currency to make repayments on its debt. This could also cause problems for consumers as if there is not enough foreign currency, they will be unable to import goods.

Question 91

what is the effect of government borrowing on growth?

Answer 91

government borrowing can benefit growth if it used for capital spending since this will improve the supply side of the economy and thus reduce the deficit in the long term. On top of this, the budget deficit can be used as a tool for short term demand management: Keynesians argue a deficit is acceptable to use as a stimulus in demand during recessions.