Gov macroeconomic intervention 5

Question 1

What are some macroeconomic objectives?

Answer 1

Price stability
Low unemployment
Economic growth

Question 2

What is price stability?

Answer 2

a low and stable inflation rate

Question 3

Why should govts not aim for a zero inflation rate?

Answer 3

1) Any measure of inflation tends to overstate any rise in prices
2) Aiming for zero inflation can lead to deflation
3) Low + stable inflation rate caused by higher spending can encourage firms to increase their output.

Question 4

What is An inflation target?

Answer 4

The inflation rate a central bank is set to achieve by the govt.

Question 5

What is the usual inflation rate govts want their banks to achieve?

Answer 5

3% - 6%

Question 6

What are the benefits of a inflation target?

Answer 6

Banks are more accountable. Reduces inflationary expectations. If firms + households think there will be price stability + that central banks will meet their targets, they won’t act in a way to push prices up.

Question 7

Name some advantages of low unemployment?

Answer 7

High output, high tax revenue, low expenditure on unemployment benefits etc.

Question 8

Is low unemployment always good?

Answer 8

Quality of employment is just as NB as quantity of employment. Workers may not be beneficial if jobs are unskilled, insecure and/or low-paid

Question 9

How to determine good economic growth?

Answer 9

A govt should take into account changes in size of labour force, changes in productivity and advances in technology

Question 10

What are consequences of negative/slow economic growth?

Answer 10

If country’s growth is falling, unemployment can increase and with fewer g+s, living standards may decline.

Question 11

Why should govts avoid high rates of economic growth?

Answer 11

Economy could overheat with AD increasing faster than AS. Pressure on the resources and inflationary pressure builds. Entrepreneurs become over-optimistic + set up firms with no long-term future. Households expect incomes to continue rising at higher rate = may take out a loan and struggle to repay it if their expectations are wrong

Question 12

What is fiscal policy?

Answer 12

the use of taxation and govt spending to influence aggregate demand

Question 13

What is a govt budget?

Answer 13

An annual statement in which the govt outlines plans for its spending and tax revenue.
It is an indicator of fiscal policy intentions and economic performance.

Question 14

What is a budget surplus?

Answer 14

Govt revenue exceeds govt expenditure

Question 15

What is a budget deficit?

Answer 15

Govt expenditure exceeds govt revenue

Question 16

What is a balanced budget?

Answer 16

Govt revenue = Govt expenditure

Question 17

What are automatic stabilizers?

Answer 17

changes in govt spending and taxation that occurs to reduce fluctuations in aggregate demand without any alteration in govt policy

Question 18

What is the better type of budget in low economic activity?

Answer 18

In the short term, Budget Deficit because of deliberate gov action and automatic stabilizers. If rise in unemployment, gov can cut tax rates + increase gov spending (especially on unemployment benefits) while tax revenue falls as automatic result of economic slowdown.

Question 19

What is a cyclical budget deficit?

Answer 19

a budget deficit caused by decline in economic activity
It will move towards balance as economic activity increases

Question 20

What is a structural budget deficit?

Answer 20

a budget deficit caused by an imbalance between gov spending and taxation

Question 21

Why are govts concerned with structural deficits more than cyclical deficits?

Answer 21

Too much spending relative to tax revenue. The deficit won’t disappear when GDP increases like a cyclical deficit would.
In reality, budget deficits have both cyclical and structural elements

Question 22

How to increase economic activity in relation to budget deficits?

Answer 22

In short run, budget deficits will decline if tax rev rises and/or fall in gov expenditure. But a rise in gov spending and/or cut in tax rates can reduce budget deficit.
increase gov expenditure on training = workers more skilled = earn higher wages = pay more taxes

Question 23

What is national debt?

Answer 23

Total amount of gov debt. Often expressed as % of GDP. Budget deficit in 1 year are added country’s national debt. Extra rev from budget surplus can pay off part of national debt

Question 24

How does national debt rise?

Answer 24

1) During economic downturns when gov expenditure rises faster than tax rev. Govs spend more than its rev during economic boom (structural deficit)
2) Military conflict

Question 25

How does national debt reduce?

Answer 25

National debt to GDP ratio will reduce if some repayment of debt or GDP rises.

Question 26

What are disadvantages of national debt?

Answer 26

Opportunity cost of interest payments on national debt. It can make firms, individuals, foreign govs reluctant to lend causing doubt about gov's ability to pay interest in debt or repay sum. Borrowing large sum pushes up interest rate to be paid.

Question 27

Types of Taxes?

Answer 27

Indirect tax Direct tax

Question 28

What is indirect tax?

Answer 28

a tax levied on g+s like a general sales tax, largely paid by consumers, collected by firms that supply products

Question 29

What is direct tax?

Answer 29

taxes on income and wealth

Question 30

How can firms pay less taxes to gov?

Answer 30

pass on as much tax as possible to consumer through higher prices. Depends on price elasticity of demand. more inelastic = higher proportion of tax passed on to consumer

Question 31

What are specific indirect taxes?

Answer 31

taxes that are charged as a set amount per unit

Question 32

What are excise duties?

Answer 32

Indirect tax on particular products a.k.a. sin taxes

Question 33

What are sin taxes?

Answer 33

Taxes on products considered harmful to consumers. They are imposed to discourage consumers from buying products bad for their health like high fat foods.

Question 34

Name types of direct taxes.

Answer 34

Income tax (income of individuals) Corporate tax (tax on profits of a firm)

Question 35

Advantages of indirect tax?

Answer 35

1) they can changed quicker + easily. 2) Cheaper to collect than direct tax as firms part of the administrative work. 3) Can discourage purchase of particular products. 4)Doesn't discourage effort, innovation and saving.

Question 36

Disadvantages of direct tax?

Answer 36

1)Higher direct tax can put people off from joining labourforce, working overtime, cut the standard hours they work because disposable income will be reduced 2) Disincentive to save (income taxed twice - when earned + when interest is earned when saved) 3) Stops firms introducing new methods + product post-tax income too low 4) Encourages tax avoidance + tax evasion

Question 37

Advantages of direct tax?

Answer 37

Some workers may work more hours to maintain level of disposable income

Question 38

Disadvantages of indirect tax?

Answer 38

1) reliance of indirect taxes makes income less evenly distributed. (regressive tax) 2) Can be inflationary, pushing up price level 3) increasing indirect tax can lead to cost-push inflation. Extra cost on supplier = higher prices = people expect price to continue to rise 4) High rates of indirect tax encourages people to try avoid paying them

Question 39

Define tax avoidance.

Answer 39

legal bending of the rules of the tax system to pay less tax

Question 40

Define tax evasion.

Answer 40

illegal non-payment or underpayment of a tax

Question 41

What is a regressive tax?

Answer 41

tax which takes a large % of the income or wealth of those on low incomes. Indirect tax is regressive. smaller % of income as income rises. (mrt lower than art)

Question 42

What is progressive tax?

Answer 42

tax that takes a higher % of person's/firm's incomes as their income rises. (Usually direct tax is progressive) (mrt higher than art)

Question 43

What is proportional tax?

Answer 43

a fixed % of tax and doesn't change as income changes, same % of income or wealth of all groups (mrt = art)

Question 44

Name the 2 types of rates of taxation.

Answer 44

Marginal rate of taxation (mrt) Average rate of taxation (art)

Question 45

Define marginal rate of taxation.

Answer 45

the proportion of extra income taken in tax

Question 46

Define average rate of taxation.

Answer 46

the proportion of income that is taxed

Question 47

Why do govts have taxation?

Answer 47

To raise rev to finance gov spending on merit goods (education) and public goods (defense). To influence AD: to reduce AD gov ( main reason for imposing taxes) they raises tax rates. To reduce public sector demand to free up resources for gov use Taxes imposed to discourage consumption of certain products (imports/demerit goods)

Question 48

Types of gov spending:

Answer 48

Transfer payments Current spending Capital spending

Question 49

What are transfer payments?

Answer 49

welfare payments to certain people like unemployment benefits, state pensions, interest payments on national debt

Question 49

What is capital spending?

Answer 49

gov spending on investment/ capital goods used in public sector (building state schools, hospitals)

Question 50

What is current spending?

Answer 50

Gov spending on providing g+s, covers operational costs of state-financed services like medicines in state-hospitals, wages of state school teachers.

Question 51

What is exhaustive gov spending?

Answer 51

gov spending which makes use of resources, it covers current and capital spending and is counted in AD and GDP.

Question 51

What is non-exhaustive gov spending?

Answer 51

gov spending which allows others (people who receive payments) to decide how resources are used, covers transfer payments.

Question 52

Reasons for Gov spending?

Answer 52

Linked to taxation. To influence AD and thus the level oof economic activity. If private spending too low, gov can inject more spending into economy, aiming for budget deficit, spending more than it raises in taxation. Gov uses spending to influence AS (education, healthcare, infrastructure) to raise economy's productive potential. Spending on transfer payments = people have basic level of income, reducing income inequality + poverty. Spending on merit + public goods, people's expectation of higher quality. For political popularity too. etc.

Question 53

What is expansionary fiscal policy?

Answer 53

increase in gov spending and cuts in taxes designed to increase AD. Increasing existing budget deficit can make larger net injection into circular flow of income.

Question 54

What is contractionary fiscal policy?

Answer 54

decreases in gov spending and increases in taxes designed to reduce growth of AD. may aim for budget surplus

Question 55

What is discretionary fiscal policy?

Answer 55

deliberate changes in gov spending and taxation resulting in changes in gov policy or economic activity

Question 56

How can govts use automatic stabilizers?

Answer 56

To influence AD, to offset fluctuations in GDP. Tax rev and gov expenditure changes automatically as GDP changes. As GDP rises, gov spending on benefits falls, tax rev rises with more people in employment

Question 57

Explain the impact of expansionary fiscal policy on the macroeconomy.

Answer 57

Can increase country's output and raise unemployment. If high cyclical unemployment = gov can increase AD by cutting direct + indirect tax rates to stimulate consumer expenditure + investment. Too much gov spending = causes demand-pull inflation

Question 58

Explain the impact of contractionary fiscal policy?

Answer 58

To reduce demand-pull inflation, income tax may be increased, reduced starting point where people pay taxes. Higher taxes + lower gov spending reduces AD or at least growth of AD. Higher costs generate cost-push inflation. Higher income tax rates create disincentive effects, workers may leave labour force which will reduce economy's productive capacity and AS.

Question 59

What is monetary supply?

Answer 59

the use of interest rates, money supply, credit regulations and the exchange rate to influence aggregate demand. Any policy tools that affect price or quantity of money.

Question 60

What are the tools of monetary policy?

Answer 60

Interest rates Money supply Exchange rate Credit regulations

Question 61

Define interest rates.

Answer 61

the price of borrowing money and the reward for saving. Main tool central banks use to control inflation and influence economic activity. Changes in interest rat used to achieve price stability

Question 62

Define money supply.

Answer 62

the total amount of money in a country Changes in money in the economy can influence AD. Main cause of changes is lending by commercial banks. Central banks want to influence lending by commercial banks.

Question 63

Define credit regulations.

Answer 63

Rules affecting bank lending Imposed by central banks on commercial banks to maintain financial stability and to influence bank lending.

Question 64

How is the exchange rate used as a tool of monetary policy?

Answer 64

Central banks may manipulate the exchange rate to raise or lower AD and influence price stability.

Question 65

What is the difference between expansionary and contractionary monetary policy?

Answer 65

Expansionary monetary policy can increase AD. Cut in interest rate, increase in money supply and reduction in restrictions on bank lending can achieve an increase To reduce AD or growth of AD contractionary monetary policy can be used, rise in interest rate, decrease in money supply and restrictions on bank lending.

Question 66

What is a target for inflation?

Answer 66

rate a central bank is set to achieve

Question 67

How does monetary policy reduce demand-pull inflation?

Answer 67

To reduce demand-pull inflation, monetary policy (interest rate) is used. Central banks give a target rate of inflation and use interest rate changes to achieve it. If rising outside target, raise interest rate to reduce AD. Cost of borrowing will rise = discourages big purchases, saving can increase = return from saving will rise. Opportunity cost of saving = spending.

Question 68

How could a gov reduce bad deflation?

Answer 68

Try to reverse fall in AD using expansionary monetary policy. But decrease in interest rate/increase in money supply might not work if firms+households are pessimistic in deflation and won't spend even if its cheaper to borrow.

Question 69

Other reasons why monetary policy may not increase AD when inflation rate is low or negative?

Answer 69

1) Low interest rates = can't reduce further so any cuts will have little effect 2) Central banks can increase supply + increase commercial bank borrowing, but banks may be reluctant to lend if there's absence of creditworthy borrowers

Question 70

What happens when there is spare capacity in an economy?

Answer 70

Expansionary monetary policy can result in higher national income. A cut in interest rate or increase in money supply can encourage consumer expenditure and investment. Higher AD can increase real output.

Question 71

How effective is Monetary Policy?

Answer 71

Its difficult to control money supply, commercial banks may get around any limits central banks place on their growth of lending. Thee is a time-lag between interest rates changing and the full effect on the macroeconomy (18months) but this is less than some fiscal policies. Rising interest rate s benefits savers but harms borrowers. High interest rate = adverse effect on unemployment and economic growth like deflationary fiscal policy

Question 72

What is supply-side policy?

Answer 72

gov policy tools designed to increase aggregate supply by improving workings of a product and factor markets. Can reduce gov intervention. Increase productive capacity shifts economy's LRAS to the right. Main way increase productivity

Question 73

What are some supply-side tools?

Answer 73

Education and training Promoting infrastructure development Support for technological improvement Other tools

Question 74

How is education and training used as a supply-side policy?

Answer 74

Spending on this can raise quality of education and training, workers' skills, flexibility + productivity will increase. More efficient labour force will increase country's productive capacity, increase innovation and entrepreneurship.

Question 75

How is promoting infrastructure development a supply-side policy?

Answer 75

Good quality infrastructure, efficient transport, power, energy and telecommunication networks keeps costs low and enables firms to get products to the market more quickly.

Question 76

How is support for technological improvement a supply-side policy?

Answer 76

This can enable capital equipment to produce greater output at lower cost. Gov subsidies can encourage development and new tech to increase output.

Question 77

What are other supply-side tools?

Answer 77

-Cuts in corporate tax: encourage investment which increases AD + AS -Cuts in income tax: encourages bigger workforce, workers to increase working hours and accept promotion and more responsibility -Trade union: increase worker flexibility through strikes, may increase productivity and production. -Privitisation and deregulation: firms operate more efficiently in private sector, removing barriers to enter markets and less regs that increase cost of production -Encouragement of immigration: of skilled workers increases quality and quantity of country's labour

Question 78

Explain the impact of supply-side policy on national income and real output.

Answer 78

By increasing productivity of labour and capital resources, its quality and quantity in production and transport of products. Tech improvements raise quality. Increases output and reduces costs of production

Question 79

Explain the impact of supply-side policy on price level.

Answer 79

It can correct cost-push inflation. AD increases over time, if AS increases keep pace with higher AD, country will have higher output (higher real GDP) without demand-pull inflation.

Question 80

Explain the impact of supply-side policy on employment?

Answer 80

Improves education + training will increase workers skills and reduce frictional and structural unemployment. Tech improvements = workers replaced by capital, but development may increase employment = lower costs of production = increase sales of g+s. Higher output

Question 81

How effective is supply-side policy?

Answer 81

-Spending on education very effective in long-run, not short run = increases AD before AS, only effective if high quality, develops skills in demand. -Infrastructure expensive takes long, can have harmful effects on environment. -Tech improvement overall beneficial, not evenly spread, harmful to some. Involves change, not all workers can adapt + cope. -Any ssp increasing AS may not raise output if operating in spare capacity = will increase productive potential but not if not enough AD.