Government and Foreign Sector Flashcards
What are components of government spending?
Current spending: Government purchases of goods and services for current use to directly satisfy societal needs
- Capital spending: Government purchases on assets that create future socio-economic benefits (investment in infrastructure investment, R&D, etc.)
- Interest payments: Cost of government borrowing that finances expenditure in addition to tax revenues
- Transfer payments: transfers of money as redistribution mechanisms (i.e. social security payments, subsidies, etc.)
What is the budget balance?
The budget balance is the annual difference between Government Spending and Tax Revenues (G – T)
The budget deficit is the amount the Government must borrow to finance spending in excess of tax revenues
- The national debt is the stock of outstanding government debt
- With a budget surplus, the government can opt to repay some of the accumulated debt
- There is a very strong link between the budget balance and the economic cycle.
What are the variety of taxes a government can spend?
Direct taxes – taxes on earnings from labour, rents, dividends and interest. • e.g. income tax, corporation tax
- Indirect taxes – taxes levied on expenditures on goods and services • e.g. VAT, duty on alcohol
- Wealth taxes – capital transfer tax, tax on property
What is the rationale for government spending?
- Equity – a progressive tax and transfer system redistributes income from rich to poor
- Efficiency – correction of market failure may improve resource allocation
What is the Keynesian Cross?
A simple closed-economy model in which income is determined by expenditure
PLANNED EXPENDITURE is equal to C+I+G
For equlibirum conditions PE=actual expenditure Y
The difrrence between PE and Y is known as unplanned inventory investment
What happens when there is an increase in government purchases?
What is the government purchase multiplier?
WHat happens when there is an increase in taxes?
What is the tax multiplier?
What is the IS (investment- Saving curve)?
A graph of all combination of r and y that result in goods market equilibrium.
Why is the IS curve negatively sloped?
A fall in the interest rate motivates firms to increase investment spending, which drives up total planned spending (PE).
• To restore equilibrium in the goods market, output (a.k.a. actual expenditure, Y) must increase.
Arguments against Fiscal policy
Fiscal policy measures may lead to offsetting changes in other components of aggregate demand
2) Changing taxes to affect consumption spending may be offset by changes in saving.
3) Concern RE: inflation, interest rates and public debt associated with growth of spending
4) Difficulties in predicting the effects of fiscal policy E.g. Size of the multiplier is difficult to measure and may fluctuate
Exaplin inside and outside lag in active policy
inside lag: the time between the shock and the policy response.
- takes time to recognise shock
- takes time to implement policy, especially fiscal policy
outside lag: the time it takes for policy to affect economy.
If conditions change before policy’s impact is felt, the policy may destabilize the economy.
What is the marginal propensity to import?
– is the fraction of additional income that domestic residents wish to spend on additional imports
How does the multiplier in an open economy compare to one in a closed ecomony?
Each extra pound of national income increases consumption demand for domestically produced goods not by MPC’, but only by (MPC’ - MPM).
The multiplier is lower because there are leakages from the system not only through savings but also through imports.
- The multiplier in an open economy is smaller than for a closed economy.
- The multiplier for a small open economy, theoretically more dependent on import, is likely to be even smaller
What is the welfare costs of tarrifs?
The tafiff leads to both transfers and to net social losses.
The tarrif raises domestic price.
The EFIH box between Qs’ and Qd’ goes to the government
the ECJL goes to the producers
Triangle A and B are waste
Triangle A is extra that socaiety spends by prodcing cars domestically rather than than importing them at world prices
Triangle B is the excess of consumer benifits over social marginal cost that society sacrifices by reducing its consumption of cars from Qd to Qd’
Explain Subsidies and how they work
Under free trade, consumers demand Qd, production is Qs and exprots are Qs-Qd
With a subsidy on exports alone, domestic producers will restrict supply to home market to Qd’ so home owners pay, the same price producers cam make by exporting
Total output is Qs’.
K shows social cost of producing goods whose marginal costs exceed the world price for which they are sold
H shows the social cost of restricting consumption when marginal benefits exceed the world price of the good
