4.5: The role of the state in the macroeconomy

Question 1

APPLICATION
UK National debt

Answer 1

£2.7 trillion

Question 2

APPLICATION
Percentage of national insurance if you earn over £4189 a month vs if you earn £1048 to £4189 a month

Answer 2

EXAMPLE OF A REGRESSIVE TAX

Above £4189 a month = 2%

Between £1048 and £4189 a month = 8%

Question 3

Reasons for tax

Answer 3

-Raise funds for public spending (Transfer payments e.g. Subsidies and benefits)
-Redistribute income (Progressive)
-Correct market failure (Carbon tax and excise duty e.g. demerit goods)
-Manage macroeconomy (Growth, inflation and unemployment)
-Protectionism (tax on M)

Question 4

Reasons for Gov spending

Answer 4

-Influence economic activity (Increased gov spending = Increase in AD)
-Correct market failure (missing market and underconsumption of merit goods)
-Decrease inequality and increase equity (Transfer payments )

Question 5

Examples of expansionary fiscal policy

Answer 5

-Decrease rate of income tax for lower income people meaning an increase tax free allowance (£14000)
-Decrease marginal rate of income tax for high earners = Increase spending so AD1 —> AD2
-Decrease regressive tax in economy = Increase MPC for lower income people
-Decrease corporation tax = Increase retained profits = Increased investment so AD1 —> AD2
-Increase Gov spending on Infrastructure (schools, roads, NHS) = Increase multiplier so AD1 —> AD2

Question 6

Evaluation for expansionary fiscal policy

Answer 6

-May cause inflation
-May deteriorate gov finances
-Time lags —> Gov may take time to have impact
-Public sector is X-inefficient
-Crowds out investment from private sector

Question 7

Capital expenditure

Answer 7

-Government spending on assets with long-term benefits

-E.g. Hospitals —> Improves the health of the population —> Enables them to work and earn an income —> More real disposable income —> Increased C

Or

Spending on Schools —> Improves levels of human capital —> workers more productive —> Increased incomes —> Fiscal drag into higher tax bracket —> Increased tax revenue for Gov —> Improves fiscal deficit

Question 8

APPLICATION
UK fiscal deficit

Answer 8

£128 billion (April 2025)

Question 9

Current expenditure

Answer 9

Government spending on recurring costs i.e. things that you need to keep spending money on. This could include wages for teachers or raw materials.

Question 10

Transfer payments

Answer 10

A transfer payment is when the government spends money without getting anything in return.
E.g. BENEFITS and subsidies to producers

Question 11

DIFFERENCE BETWEEN GOV SPENDING IN AD AND PUBLIC EXPENDITURE

Answer 11

Public expenditure includes current expenditure, capital expenditure and transfer payments. The government spending part of the aggregate demand formula is similar but it doesn’t include transfer payments.

Transfer payments are not included in ‘G’ because they don’t actually involve spending on goods and services. For example, benefits are just a transfer of money from the government to low-income families. The money spent on benefits usually appears in AD under consumption, as most of it is spent by the individuals receiving it.