4.5 The role of the state in the macroeconomy Flashcards
why does the government spend money?
- to correct market failure (i.e. through preventing underconsumption of merit goods + providing public goods to prevent the free-rider problem)
- to achieve macroeconomic goals (e.g. stimulating eco. growth, low and stable inflation, balanced current account and low unemployment)
- equity + inequality by providing low-income households access to essential services
what are the major areas of government expenditure
- pensions (20%)
- healthcare (18%)
- welfare (15%)
- education (12%)
impact of gov. expenditure on productivity + growth (evaluate as well)
- investment in education -> increased human capital -> more skills -> more productivity
- investment in healthcare -> healthier workers -> more productivity + efficiency
- investment in roads + other infrastructure -> reduces AC
- spending on benefits -> incentivises people to get back into employment
- spending -> injection into the circular flow -> +ve multiplier effect
EVAL: - time lag
- opportunity cost
- accumulation of national debt
impact of gov. expenditure on crowding out
- gov. may fund its services through taxes or running a budget deficit -> reduced funds for private sector firms to use -> crowds them out of the market
- increased gov. borrowing -> increased interest rates -> discourages spending and investment -> reduced private sector investment -> “crowding out of investment”
- may lead to no real increase in AD
what are the demand-side impacts of public expenditure?
- gov. spending (injection into circular flow) -> component of AD (21%) -> AD increase -> real GDP increase -> actual eco. growth (SR)
- +ve multiplier effect -> e.g. spending on infrastructure -> firms involved recieve income -> increased wages for workers -> more disposable income -> consumption increased -> higher demand for goods + services -> higher DFL -> wages increase -> consumption increased more -> AD increased even more
- reduction in -ve output gap -> cyclical unemployment falls
demand-side impacts of public expenditure (evaluate)
- if UK economy operating near full capacity -> trade off (MOBJ) - inflation + unemployment [Phillips Curve]
- crowding out effect [if gov. borrows to fund spending] -> higher demand for loans -> interest rates rise -> discourages private investment -> investment down -> AD does not increase significantly
what are the supply-side impacts of public expenditure (investment in human capital)?
- spending on education + training -> more skilled workers -> increased labour productivity -> LRAS up -> real GDP up -> potential eco. growth
what are the supply-side impacts of public expenditure (investment in physical capital)?
- transportation - easier to transport goods/services + workers -> reduced geographical immobility of labour -> more productivity -> increased LRAS
- healthcare - healthier workforce -> less worker absenteeism -> higher labour productivity -> increased LRAS
- R&D - funding for innovation + technological advancement
- welfare benefits spending reduced - can incentivise people to start work -> more workforce participation -> LRAS up
supply-side impacts of public expenditure eval
- costly projects
- opportunity cost
- time lag
drawbacks of public expenditure
- worsened gov. budget deficit -> increase existing national debt -> increase interest payments
- lack of profit motive -> inefficiency
- may require taxation levels to rise to pay for the expenditure -> impacts growth + productivity
- if spending not spread evenly -> creates inequality
- “dependency culture” -> too much spent on unemployment benefits -> people less encouraged to work -> reduced workforce participation -> LRAS down
application point: uk budget deficit in 2023/24 + what % of GDP
£40.8 billion in Quarter 4 2023, equivalent to 6.0% of GDP.
application point: uk national debt 2024
2.8 trillion £
effects of direct/indirect tax on AD/AS
- fall in tax = expansionary fiscal policy
FALL IN INCOME TAX - AD: disposable income increased -> consumption up -> AD up -> more workers may be required for production -> employment up
- AS: incentive for unemployed workers to join labour force/ existing workers encouraged to work harder -> workforce participation up -> productivity up
FALL IN CORPORATE TAX - AD: increased retained profits -> more funds for investment -> investment up; AD up
- AS: incentive to innovate, expand + develop -> more productivity
effects of direct/indirect tax on trade
INCOME TAX
- fall in income tax -> more disposable income -> more purchasing power -> increased demand for imported goods by UK citizens
CORPORATE TAX
- increased retained profits -> reduced cost of production -> increased investment/innovation (R&D) -> prices fall -> exports = more price competitive -> exports up
IMPORT TARIFFS
- rise in tariffs -> imports more expensive -> imports down
- EVAL: other countries may retaliate
effect of direct/indirect tax on FDI
- high taxes -> discourage FDI flows as investors would want to invest elsewhere
- gov provide predictable tax rates
example of countries with low tax rates to remain competitive and what is the effect of this
Republic of Ireland + Luxembourg -> low corporate tax rates = attracts lots of FDI
example of a country that uses a regressive income tax system
Brazil
effect of direct/indirect taxes on revenue
SR: tax revenue increases
LR: tax revenue falls ad tax rates increase -> people lose incentive to work if tax rate too high, tax evasion/avoidance up, people migrate elsewhere if geographically mobile
what is the Laffer curve and what does it show
- shows the relationship between tax rates and tax revenue
- initially TR rise up to a point T at a diminishing rate, before decreasing
- this would limit eco. growth + tax output
what is meant by brain drain and what could be a cause of it
- the emigration of highly trained or qualified people from a particular country
- cause: high tax rates -> people move to countries with lower tax rates
