Chapter 4 - Government and the macroeconomy Flashcards
What is local government intervention?
Local governments are responsible for delivering government services on a town/regional basis.
They usually receive funding from the central government and are held accountable for the quality of goods and services provided by the voters in their area. Local government branches are often referred to as ‘councils’, ‘federal’ or ‘state’
What is national government intervention?
Determining the best combination of policies that will help them to meet all of their macroeconomic aims.
What is international government intervention?
International trade is vital to economic growth in many economies. Governments have a role to both protect domestic industry and to help it compete internationally.
What are some examples of local government intervention?
Local health services
Refuse collection
Parking fines
Local prosecutions
Parks are recreational facilities
Public services
What are some examples of national government intervention?
Central government
Fiscal policy
Monetary policy
Supply-side policy
What are some examples of international government intervention?
Exchange rate interventions
Protectionism
What are the five macroeconomic aims of the government?
The 5 macroeconomic aims of the government are economic growth, full employment/low unemployment, stable prices/low inflation, balance of payments stability and redistribution of income.
What is economic growth as a macroeconomic aim of the government?
Economic growth is the central macroeconomic aim of most governments. Many developed nations have an annual target growth rate of 2-3%. Growth at this rate is less likely to cause excessive demand-pull inflation. Economic growth has positive impacts on confidence, consumption, investment, employment, incomes, living standards and government budgets.
What is full employment/low unemployment as a macroeconomic aim of the government?
Full employment/low unemployment - The target unemployment rate often depends on the size of the country. (e.g. India finds a rate of 6.5% good whereas Singapore aims for it to be under 2%) The closer an economy is to the full employment level of labour, the more efficiently it is using its human resources. Unemployment tends to be inversely proportional to real GDP growth.
What is low and stable rate of inflation as a macroeconomic aim of the government?
Low and stable rate of inflation - Most economies have a target inflation rate of 2%. A low rate of inflation is desirable as it is a symptom of economic growth. Demand side policies will ease demand pull inflation and supply side policies will ease cost pull inflation. Cost push inflation is an increase in average prices caused by an increase in the costs of production. Demand pull inflation is caused by a rapid growth in aggregate demand. Aggregate supply cannot keep up and prices will rise. Demand side policies ease pull inflation and supply side policies will ease cost push inflation. A low and stable rate of inflation is important as it allows firms to confidently plan for future investment and offers price stability to consumers.
What is cost push inflation?
Cost push inflation is an increase in average prices caused by an increase in the costs of production.
What is demand pull inflation?
Demand pull inflation is caused by a rapid growth in aggregate demand. Aggregate supply cannot keep up and prices will rise.
How do you ease inflation?
Demand side policies ease pull inflation and supply side policies will ease cost push inflation.
What is balance of payments stability on the current account as a macroeconomic aim of the government?
Balance of payments stability on the current account for a country if a record of all the financial transactions that occur between it and the rest of the world. The current account focuses mainly on the financial transactions related to exports and imports of goods and services. Governments aim for balance of payments equilibrium. If exports > imports, it will create a current account surplus and if imports > exports, it will create a current account surplus. A current account deficit if more problematic in the long run.
What is redistribution of income as a macroeconomic aim of the government?
Redistribution of income aims to reduce income inequality in an economy. High levels of income inequality create social unrest and can ultimately lead to revolutions. Perfect income inequality is not desirable as it removes the incentive to work and study. Governments aim to redistribute income by taxing the wealthy and providing welfare payments to the poor. Unchecked capitalism has a natural outcome of high income inequality because the wealthy are able to keep buying the factors of production and the concentration of ownership becomes more narrow with fewer individuals owning the bulk of the worlds wealth. There is a need for governments to intervene to maintain acceptable levels of income inequality.
What causes a trade off in the macroeconomic objectives?
Policy decisions by governments often create a trade off in the macroeconomic objectives. Achieving one objective may come at the cost of worsening progress in another objective.
What is the trade off between economic growth and inflation?
Increasing economic growth causes the economy to move closer to full employment.
Prices for remaining resources are bid up leading to inflation which may outpace the target inflation rate.
What is the trade off between economic growth and environmental sustainability?
Economic growth often increases pollution, negative externalities and the depletion of non-renewable resources.
The higher the growth, the faster the depletion.
What is the trade off between economic growth and income inequality?
During periods of high economic growth, the profits the owners of the factors of production receive are disproportionate to any increase in workers’ wages leading to greater inequality.
What is the trade off between economic growth and balancing the current account?
Economic growth usually leads to higher incomes which leads to an increase in imports by households thereby worsening the current account balance.
What is the trade off between low unemployment and low inflation?
The closer an economy moves towards full employment, the less workers will be available for hire and wage inflation will help increase overall inflation.
What is the trade off between low unemployment and balancing the current account?
When unemployment is low, incomes are higher and imports increase which worsens the current account balance.
Additionally, with low unemployment, wages tend to increase which increase the cost of production for firms and if they increase their prices, then the level of exports is likely to fall.
What is the government budget?
The government budget is a document that presents the governments revenue and expenditure plans for the fiscal year ahead.
A balanced budget means that government revenue = government expenditure.
A budget deficit means that government revenue < government expenditure.
A budget surplus means that government revenue > government expenditure.
A budget deficit has to be financed through public sector borrowing which gets added to the public debt.
What are the four reasons for government spending?
Public expenditures, current expenditures, capital expenditures and transfer payments.
What is public expenditure?
Public expenditure (government spending) represents a significant portion of the total aggregate demand in many economies. The expenditure can be broken down into three categories.
What are current expenditures?
Current expenditures include the daily payments required to run the government and public sector. e.g. the wages and salaries of public employees such as police and members of parliament. It also includes payments for goods and services such as medicines for government hospitals.
What are capital expenditures?
Capital expenditures are investments in infrastructure and capital equipment. e.g. high speed rail projects, hospitals and schools.
What are transfer payments?
Transfer payments are payments made by the government for which not goods or services are exchanged. e.g. unemployment benefits and subsidies to producers and consumers. This type of government spending does not contribute to GDP as income is only transferred from one group of people to another.
What is the main source of government revenue?
Taxation is the main source of government revenue.
What are the give reasons for taxation?
Correct market failure, earn government revenue, promote equity, support firms and support poorer households.
How does taxation correct market failure?
Correct market failure - in many markets there is a less than optimal allocation of resources from society’s point of view. The government aims to subsidise merit goods and tax demerit goods to address this market failure.
How does taxation earn government revenue?
Earn government revenue - governments need money to provide essential services, public and merit goods. Revenue to fund this is raised through taxation.
How does taxation promote equity?
Promote equity means the wealthy are taxed to provide funds that can be utilised in reducing the opportunity gap between the rich and the poor.
How does taxation support firms?
Support firms - in a global economy, governments choose to support key industries so as to help them remain competitive and taxation provides the funds to do this.
How does taxation support poorer households?
Support poorer households - poverty has multiple impacts on both the individual and the economy. Intervention seeks to redistribute income by taxing the rich and giving it to the poor so as to reduce the impact of poverty.
What are direct taxes?
Direct taxes are taxes imposed on income and profits. They are paid directly to the government by the individual or the firm. e.g. income tax
What are indirect taxes?
Indirect taxes are imposed on spending. The less a consumer spends, the less indirect tax they will pay. e.g. value added tax (vat)
What is progressive tax?
Progressive tax - as income rises, a larger percentage of income in paid in tax.
what is regressive tax?
Regressive tax - as income rises, a smaller percentage of income is paid in tax.
What is proportional tax?
Proportional tax - as income rises, the same percentage of income is paid in tax.
What are six principles when developing a good tax?
Simple, fair, convenient, efficient, fit for purpose and flexible
Why is a good tax simple?
Taxpayers should know what, when where and how to pay the tax.
What is a good tax fair?
Taxes should reflect a taxpayer’s ability to pay - progressive taxation aims to achieve this as the wealthy can afford to pay more than the poor do.
Why is a good tax convenient?
Systems to collect the payment should be easy and provide choice for taxpayers.
Why is a good tax efficient?
The management of the tax system by the government should not be overly expensive or wasteful.
Why is a good tax fit for purpose?
There should not be any unintended side effects of the system. e.g. disincentivising workers from working.
Why is a good tax flexible?
It should be easy to adjust as required by changes in the economy.
What seven things impacted by tax rate changes?
Incentive to work, government tax revenues, income distribution, economic growth, inflation, the trade balance and business location
How does a tax rate change impact the incentive to work?
The higher the tax rate, the lower the incentive for the unemployed to seek work - or for existing workers to work overtime.
How does a tax rate change impact government tax revenues?
There is a relationship between increasing tax rates and the level of government revenues received.
The broad idea is that as tax rates increase, a point will be reached where disincentivized workers work less, resulting in lower incomes and less government tax revenue.
More people will actively seek to avoid paying tax or try to move their income elsewhere.
How does a tax rate change impact income distribution?
A progressive tax system redistributes from those with higher income to those with lower income and reduces income inequality.
Sometimes the benefits of a good progressive tax system are lost by the penalties imposed through multiple regressive indirect taxes.
How does a tax rate change impact economic growth?
Tax rate increases will likely cause a reduction in total aggregate demand as firms and households have less disposable income.
Tax rate decreases will have the opposite effect.
As total aggregate demand slows down, fewer workers may be required for production and unemployment may increase
How does a tax rate change impact the trade balance?
An increase in taxes can reduce disposable income which is likely to reduce the level of imports.
This may improve the trade balance (exports - imports)
How does a tax rate change impact inflation?
Increasing indirect tax rates increases the costs of production for firms and possibly leading to cost-push inflation.
An increase in indirect taxes reduces disposable income and so workers may petition their employer for a salary increase.
If they receive the increase, the economy may face a wage-price spiral.
How does a tax rate change impact business location?
If the rate of corporation tax increases relative to other countries, it may result in less inward foreign direct investment by multi-national corporations.
What is fiscal policy?
Fiscal policy involves the use of government spending and taxation to influence the total aggregate demand of an economy.
What is expansionary fiscal policy?
Fiscal policy can be expansionary in order to generate further economic growth. Expansionary policies include reducing taxes or increasing government spending.
What is contractionary fiscal policy?
Fiscal policy can be contractionary in order to slow down economic growth or reduce inflation. Contractionary policies include increasing taxes or decreasing government spending.
How is fiscal policy presented?
Fiscal policy is usually presented annually by the government through the government budget.
A balanced budget means that government revenue = government expenditure/
A budget deficit means that government revenue < government expenditure.
A budget surplus means that government revenue > government expenditure.
A budget deficit has to be financed through public sector borrowing which gets added to the public debt.
How do you calculate total aggregate demand?
Total aggregate demand = household consumption + firms investment + government spending + exports - imports.
What are some strengths of fiscal policy?
Spending can be targeted on specific industries, effects are seen sooner, redistributes income through taxation, reduces negative externalities, increased consumption of merit and public goods and short term government spending can lead to an increase in the total supply of an economy.
What are some weaknesses of fiscal policy?
Policies can fluctuate significantly when new governments are elected, increased government spending can create budget deficits and there may be conflicts between objectives.
What is monetary policy?
Monetary policy involves adjusting the money supply so as to influence total aggregate demand.
What is money supply?
Money supply is the amount of money in an economy at any given moment in time.
Who sets monetary policy?
The central bank is responsible for setting monetary policy
What are the three main monetary policy measures?
The three main monetary policy measures are changing interest rates, money supply and foreign exchange rates
What is expansionary monetary policy?
Monetary policy can be expansionary in order to generate further economic growth. This includes reducing interest rates, increasing the money supply and depreciating the exchange rate.
What is contractionary monetary policy?
Monetary policy can be contractionary in order to slow down economic growth or to reduce inflation. Contractionary policies include increasing interest rates, decreasing or stopping the money supply and appreciating foreign exchange rate.
What are some strengths of monetary policy?
Strengths of monetary policy: able to consider long term outlooks, targets inflation and maintains stable prices and depreciating the currency can increase exports.
What are some weaknesses of monetary policy?
Weaknesses of monetary policy: conflicting goals, time lags, firms and consumers may not reposing to lower interest rates when confidence is low, cheaper loans may inflate asset prices and interest rates have limitations on downward adjustment.
What is supply side policy?
Supply side policies aim to increase the total supply of the economy.
How can you increase the total supply of the economy?
This is achieved by increasing the quality or quantity of the factors of production.
It can be represented by an outward shift in the production possibility curve.
More consumer goods and more capital goods can now be produced using all of the available resources.
What are seven strategies to increase total supply?
The strategies used to increase total supply include education and training, labour market reforms, lower direct taxes, deregulation, improving incentives to work and invest, subsides, and privatisation.
How do supply side strategies impact the governments macroeconomic aims?
Economic growth: potential national output increases leading to a higher real gross domestic product (rGDP).
inflation: a greater supply in the economy results in reductions in the prices of goods and services which leads to disinflation.
Unemployment: unemployment will decrease as more workers are required to produce the higher levels of output.
Current account balance: due to the increased supply, the prices of goods and services often decrease which makes them relatively more attractive to international consumers. Therefore, exports will increase and the current account balance improves.
Redistribution of income: this often worsens with the use of supply side policies as wages fall and government tax revenue has also fallen.
How does education and training increase supply?
Increasing government spending on education and retraining increases the quality of labour.
How does labour market reforms increase supply?
Decreasing trade union power so wages can be decreased which encourages firms to hire more workers as they are ‘cheaper’.
Decreasing minimum wages to lower the cost of production and encourages firms to hire more workers as they are ‘cheaper’.
Increased government spending to improve occupational mobility.
How does lower direct taxes increase supply?
Reducing income tax rates incentivises workers to work harder and provides firms with more money which they can use to invest in new machinery or technology.
How does deregulation increase supply?
This is the process of removing government controls or laws from markets in order to increase competition.
Any regulation increases costs of production for firms and deregulation decreases costs which may result in greater supply from firms.
How does improving incentives to work and invest increase supply?
Restructuring the unemployment benefits system to incentivise the unemployed to seek work.
Increased government spending on innovation increases the supply of potential jobs in the economy.
Direct support to firms (subsidies) increases output and promotes international competitiveness.
How does privatisation increase supply?
Government firms are usually so big that private enterprise refrains from trying to compete with them. Privatisation encourages new firms to enter the market and compete, this then increases the total supply of the economy.
What are some strengths of supply side policy?
Strengths of supply side policy: increase the rate of growth of an economy, reduce inflation, reduce unemployment, increase the value of net exports and increase in total supply often leads to lower prices and more exports.
What are some weaknesses of supply side policy?
Weaknesses of supply side policy: the distribution of income worsens as labour market forces reforms and wage policies lower workers’ wages, they are expensive to implement, there are significant time lags and long term nature could be affected by a change in government.
What is economic growth?
Economic growth is the annual increase in the level of national output as measured by the gross domestic product (GDP).
What is gross domestic product?
Gross domestic product is the total value for all goods and services produced in an economy in a year. GDP = household spending + investment + government spending + net exports.
What is nominal GDP?
Nominal GDP is the actual value of all goods and services produced in an economy in a one-year period. There has been no adjustment based on inflation.
What is real GDP?
Real GDP is the value of all goods and services produced in an economy in a one-year period and is adjusted for inflation.
What is GDP per capita?
GDP per capita = GDP / the population. This shows the average wealth of each citizen in a country. This makes it easier to compare the standards of living between countries
What is a recession?
A recession is a period of at least six months (2 quarters) of economic decline which causes a decrease in the rGDP.
How can a recession be caused?
It can be caused by a fall in any of the factors that influence total demand. For example, consumption fell during COVID-19 lockdowns causing many economies to experience a recession. It can also be caused by supply-side shocks that create challenges for firms and consumers. For example, the Russian war on Ukraine has reduced the supply of natural gas, oil and petrol resulting in major disruptions and increased energy costs.
What demand side factors reduces total demand?
A fall in consumer confidence reduces consumption.
A fall in business confidence reduces investment.
Increasing levels of unemployment reduce consumption.
Decreasing levels of government spending.
Increased interest rates require borrowers to repay higher amounts on their loans, this reduced discretionary income which reduces consumption.
Shocks to other economies can reduce demand for a country’s exports thus reducing total demand.
What supply side factors reduce total supply?
Unexpected supply shocks such as the war between Russia and Ukraine or the Japanese Tsunami of 2011.
A gradual decline in the productive capacity of the economy when capital grows old and is not replaced.
A gradual decline in the level of education and training available in an economy.
On going industrial action such as worker strikes which disrupt the supply of labour to an economy.
Weather events which destroy agricultural products or interrupt supply chains.
What is actual economic growth?
Economic growth can be caused by a change in total demand. Actual economic growth occurs when there is an increase in the quantity of goods and services produced in an economy in a given period of time. This is often measured by the percentage change in real gross domestic product. If any component of real GDP increases, there will be an increase in total demand.
What is potential growth?
Economic growth can be caused by a change in the quantity or the quality of the factors of production. Potential growth is the increase in the productive potential of an economy. This occurs when there is an increase in the quantity or quality of the factors of production available in an economy. An example of how the quality of a factor of production can be improved is through the impact of training and education on labour. An educated workforce would be more productive workforce and the production possibilities will expand. An example of how the quantity of a factor of production can be increase is through a change in the migration policies. If an economy allows more foreign workers to work productively in the economy, then the production possibilities will expand.
How is economic growth and economic decline shown on a PPC?
Outward shifts in a PCC show economic growth and inward shifts show economic decline (recession).
How does economic decline occur?
Economic decline occurs when there is any impact on an economy that reduces the quantity or quality of the available factors of production depicted by the movement ‘A’. One example of how this may happen is to consider how the Japanese tsunami of 2011 devastated the PPC of Japan for many years. It shifted their PPC inwards which caused economic decline.
How does economic growth occur?
Outward shifts of a PPC show economic growth caused by the changes to the quantity and quality of the factors of production. Economic growth occurs where there is an increase in the productive potential of an economy. More consumer goods and more capital goods can now be produced using all of the available resources.
What are the benefits of economic growth?
Increased incomes lead to better standards of living.
Decreased levels of absolute poverty.
Improvements in the quality and quantity of environmentally friendly technologies.
Higher sales revenue for firms and greater profits.
Increased investment by firms increases the potential output of the economy.
Reduced expenditure by governments on benefits.
Higher government tax revenue due to rising incomes and surging corporate profits.
Increased employment resolves some of the negative social impacts of unemployment.
What are the disadvantages of economic growth?
Rising total demand causes demand pull inflation and the purchasing power of people on fixed economies may fall.
Lack of equity in the distribution of income - the rich get richer and the poor get poorer.
Environmental damage caused by negative externalities of production and consumption increases.
Increased inflation can harm export sales.
The level of imports usually increases negatively impacting the current account.
Increased income usually leads to greater consumption of demerit goods.
Greater output often requires more time from workers and can decrease leisure time and wellbeing.
Resources are depleted more rapidly.
What causes a recession?
A recession is a period of at least 6 months (2 quarters) of economic decline which causes a decrease in the real GDP. It can be caused by a fall in any of the factors that influence total demand or any supply side shocks.
What demand side factors cause a recession?
A fall in consumer confidence reduces consumption.
A fall in business confidence reduces investment.
Increasing levels of unemployment reduce consumption.
Decreasing levels of government spending.
Increased interest rates require borrowers to repay higher amounts on their loans which reduces discretionary income and reduces consumption.
Shocks to other economics can reduce demand for a countries exports therefore reducing total demand.
What supply side factors cause a recession?
Unexpected supply shocks such as wars or natural disasters.
A gradual decline in the productive capacity of the economy when capital grows old and is not replaced.
A gradual decline in the level of education and training available in an economy.
On going industrial action such as worker strikes which disrupt the supply of labour to an economy.
Weather events which destroy agricultural products or interrupt supply chains.
What are some consequences of recessions?
National output (rGDP) falls
More firms go bankrupt
Unemployment and underemployment increase
Exports and import fall
Domestic and foreign investment by firms decreases
Deflation may become an issue which leads to lower wage levels
Government spending on unemployment benefits increase
Opportunities for entrants to the workforce decrease
Government may have to spend significant amounts of money support the economy which carries several opportunity costs
What policies are used to generate economic growth?
Demand side policies aim to influence the total demand in an economy. The two demand side policies are fiscal policy and monetary policy.
Supply side policies aim to influence the total supply in an economy.
What is employment?
Employment refers to the economic use of labour as a factor of production.
What is unemployment?
Unemployment is someone who is considered to be unemployed if they are not working but actively seeking work.
What is the labour force?
Labour force is when a countries population- is divided into the labour force and non-labour force. This consists of all workers who are actively working plus the unemployed people who are seeking work.
What is the non labour force?
The non-labour force includes all those not seeking work who are economically inactive.
What is full employment?
Full employment describes the ideal situation when everyone in the economy who is willing and able to work has a job.
What are some causes of changing employment patterns?
Structure of the economy, proportion of women employed, formal and informal work, proportion of workers in the public and private sector, part time and full time and work from home
How does the structure of the economy cause a change to employment patterns?
As economies develop over time, they tend to progress through the different sectors resulting in changes to the employment pattern.
E.g. more manufacturing jobs in the secondary sector attract workers who had previously worked in the primary sector.
How does the proportion of women employed cause a change to employment patterns?
Changing social attitudes have increased the number of women entering the workforce.
The proportion of women in the workforce still varies significantly between different economies.
E.g. Sweden has a much higher proportion of women in the workforce than in India or Saudi Arabia.
How does formal or informal work cause a change to employment patterns?
Workers doing informal work are not included in employment statistics.
Informal employment is much higher in less developed economies and tends to decrease as an economy develops.
How does part time or full time work cause a change to employment patterns?
Working part time provides more flexibility to workers and in recent years there has been an increase in the number of part time workers.
In some economies, many workers may not be able to find full time work and may be working 2 or 3 part time jobs to pay the bills.
How does the proportion of workers in the public and private sector cause a change to employment patterns?
Between the second world war and the late 1980’s, the number of public sector employees was large in many economies.
With an increase in privatisation and a move towards more market based economies, the percentage of employees in public sector work has decreased in many countries.
How is unemployment measured?
Unemployment is measured using the international labour organisation survey or the claimant court.
How does working from home cause a change to employment patterns?
Covid-19 caused many people to think about their pattern of work.
Many workers are reluctant to return to a commuting lifestyle and wherever possible, are continuing to work from home.
What is the ILO survey?
The ILO survey is an extensive survey sent to a random sample of around 60,000 households every quarter. Respondents self-determine if they are unemployed based on the ILO criteria. The same survey is used globally so it’s useful for making international comparisons.
The claimant court counts the number of people claiming unemployment benefits. There is more stringent requirement to be considered unemployed than in the ILO survey. This requires claimants to meet certain criteria and excludes many.
How do you calculate unemployment rate?
Unemployment rate = number actively seeking/total labour force x 100.
How do you calculate employment rate?
Employment rate = number in employment/population of working age x 100.
How do you calculate participation rate?
Participation rate = labour force/total population x 100.
What is structural unemployment?
Structural unemployment occurs when there is a mismatch between jobs and skills in the economy. This usually happens as the structure of an economy changes. e.g. there is no longer a need for a specific type of worker. Unless workers receive help to retain, they are often left unemployed or underemployed.
What is cyclical unemployment?
Cyclical unemployment is caused by a fall of total aggregate demand in an economy. This usually happens during a slow down or recession.
What is frictional unemployment?
Frictional unemployment occurs when workers are between jobs. This is usually short-term unemployment and workers have voluntarily left their previous job to search for another.
What are the consequences of unemployment for an individual?
Loss of income, health issues, sense of failure, marital failure, mental instability, stress increases and possibly suicide.
What are the consequences of unemployment for a firm?
Loss of sales revenue, loss of output/production and changes the skill level in an economy.
What are the consequences of unemployment for a government?
Increased spending on benefits, less tax revenue and increased spending on retraining.
What are the consequences of unemployment for an economy?
Increased crime, vandalism, increased anti-social behaviour and increases homelessness.
What is the aim of different government policies?
Expansionary fiscal policy and expansionary monetary policy aim to increase total aggregate demand in an economy. Supply side policies aim to improve the quantity and quality of the factors of production. Protectionist policies involves the use of government policies that restrict international trade in order to protect domestic industries, income employment in domestic industries.
What is inflation?
Inflation is the sustained increase in the general price of goods and services in an economy. The general price is measured by checking the prices of a ‘basket’ of goods or services that an average household will purchase each month. This ‘basket of goods’ in turned into an index and is called the consumer price index (CPI)
What is deflation?
Deflation occurs when there is a fall in the general price level of goods and services in an economy. Deflation only occurs when the percentage change in prices fall below 0%.
