Government Macro Intervention AS Level Edition

Question 1

What Are Government Objects/Targets Of Macroeconomic Policy?

Answer 1

1.Steady and sustainable economic growth: Sustainable growth is current growth in the GDP of an economy which does not lead to a fall in the future economic growth potential. It does not deplete non-renewable resources. They are conserved for future generations.

2. Low and stable rate of inflation: Governments wish to maintain low and predictable rates of inflation. Countries set and maintain low inflation targets to avoid the negative consequences of a high rate of inflation. Low inflation makes it is easy for government to achieve the other macroeconomic objectives.
3. Low unemployment or full employment: Unemployment has economic and social costs. Governments wish to maintain it at the lowest possible level known as the natural rate unemployment.
4. Current account balance of payments equilibrium: It implies avoiding large and persistent current account deficits and surpluses because of their negative economic effects.
5. Stable exchange rate: It implies avoiding large fluctuations in the exchange rate of a currency because they lead to uncertainty which reduce trade and
   investment.
6. Balanced government budget: It involves equating G and T to avoid large and persistent budget deficits which they are inflationary because they increase AD and budget surpluses they are deflationary because
   they reduce AD.
7. Productivity growth and competitiveness
   Productivity is a measure of output per factor input e.g. labour. Governments wish to raise productivity for several reasons:
   (i) to reduce production costs and prices of products
   (ii) to increase competitiveness of a country’s products
   (iii) to improve the current account BOP
8. Greater income equality or reducing income inequality
9. Clean environment (Protection of the environment)

Question 2

What Are Tools Of Macro Economic Policy?

Answer 2

1. Fiscal policy (demand-side)
2. Monetary policy (demand-side)
3. Supply-side policy

They aim at influence AD to achieve the macroeconomic objectives.

Question 3

What Is A Fiscal Policy?

Answer 3

It is a demand-side policy. It involves changes taxation and government spending to influence
AD.

Question 4

What Is An Expansionary(Reflationary) Fiscal Policy?

Answer 4

It increases AD and GDP through an increase in G and a cut in income tax rates to increase disposable income and C.

It may lead to a budget deficit (government spending > tax revenue).

Question 5

What Are Aims Of An Expansionary (Reflationary) Fiscal Policy?

Answer 5

Increase rate of economic growth (increase real GDP)

Lift the economy out of recession

Reduce demand-deficient (cyclical) unemployment

Question 6

What Are Downfalls Of An Expansionary (Reflationary) Fiscal Policy?

Answer 6

Could cause demand-pull inflation and worsen the current account BOP as residents demand more imported goods while exports decrease as they become
uncompetitive due to the rise in price level

Question 7

What Is An Contractionary (Deflationary) Fiscal Policy?

Answer 7

It reduces AD through a decrease in G or a rise in tax income rates to reduce disposable incomes. It may lead to a budget surplus (tax revenue > government spending).

Question 8

What Are Aims Of A Contractionary (Deflationary) Fiscal Policy?

Answer 8

Reduce demand-pull inflation

Reduce current account BOP deficit

Question 9

What Are Downfalls Of An Contractionary (Deflationary) Fiscal Policy?

Answer 9

May slow down the rate of economic growth and cause
demand-deficient unemployment as firms cut down output and lay off workers.

It may also slow down the rate of economic growth.

Question 10

What Is A Government Budget?

Answer 10

It is an annual fiscal statement that outlines government expenditure and tax revenue plans for the year ahead.

A budget may be balanced or unbalanced. A balanced budget equates government sending with tax revenue.

Question 11

What Is A Government Budget Surplus?

Answer 11

It is the excess tax revenue exceeds government spending.

It represents a net withdrawal of income from the circular flow of income.

Question 12

What Is A Government Budget Deficit?

Answer 12

It is the excess of government spending over tax revenue.

It represents a net injection into the circular flow of income.

Question 13

What Are Types Of Budget Deficits?

Answer 13

Cyclical budget deficit

Structural budget deficit

Question 14

What Is A Cyclical Budget Deficit?

Answer 14

It is caused by changes in the level of economic activity.

During recession tax revenue from income tax, indirect taxes and corporate tax falls yet the government has to spend more on unemployment benefits.

A cyclical deficit is temporary and self-correcting. It decreases as the level of economic activity increases leading to higher tax revenues and a decease in G on
unemployment benefits.

Question 15

What Is A Structural Budget Deficit?

Answer 15

It is caused by an imbalance in government spending and taxation e.g. when the government commits to too much spending relative to its tax revenue.

Such deficit may be long term not disappear when GDP increases.

Question 16

What Is National Debt?

Answer 16

It is the total amount of money borrowed by the government which has not been repaid.

Fiscal deficits and surpluses have direct impact on the size of the national debt.

Fiscal deficits increase the national debt and fiscal surpluses reduce it.

Question 17

How Can National Debt Be Measured?

Answer 17

Monetary terms

Percentage of GDP

Question 18

What Are Reasons For Taxation?

Answer 18

To pay for government expenditure

To correct market failure such as externalities e.g. taxes on tobacco and alcohol.

To manage the economy through changes in AD (fiscal policy) which affect GDP, inflation, unemployment and balance of payments.

To redistribute income and wealth by imposing higher taxes on low income groups and using the money collected to increase income and wealth of high income groups.

Question 19

What Are Types Of Taxes

Answer 19

Direct Taxes

Indirect Taxes

Question 20

What Are Direct Taxes?

Answer 20

A direct tax is levied directly on income and wealth of individuals or firms.

Question 21

What Are Examples Of Direct Taxes?

Answer 21

Income tax on individual incomes like salaries

Corporation tax on company profits

Capital gains tax on profit made when assets like shares and bonds are sold. The tax is based on the gain in value of the asset.

Inheritance or estate tax paid by a person who receives money or property at the death of the previous owner.

Question 22

What Are Indirect Taxes?

Answer 22

Tax levied on a good or service.

Question 23

What Are Examples Of Indirect Taxes?

Answer 23

VAT

Customs duties on import or export of goods and services.

Excise duties on specific gods e.g. tobacco.

Question 24

What Are Types of Taxes?

Answer 24

Progressive tax

Regressive tax

Proportional tax

Question 25

What Is A Progressive Tax?

Answer 25

A progressive tax takes an increasing proportion of income as the income of the taxpayer rises e.g. income tax.

The MRT rises with income. MRT> ART.

Question 26

What Is A Regressive Tax?

Answer 26

A regressive tax takes a decreasing proportion of income as the income of the taxpayer rises.

Indirect taxes are regressive.

They take a larger proportion of income from low income groups.

The MRT falls as income rises. MRT< ART

Question 27

What Is A Proportional Tax?

Answer 27

A proportional tax takes a constant proportion of income from the taxpayer.

Both ART and MRT are constant and ART=MRT.

Question 28

What Is Marginal Rate Of Taxation (MRT)?

Answer 28

It is the proportion of any additional income that is paid into tax.

The MRT of a progressive tax rises with income. The ART< MRT (or MRT>ART)

Formula: change in tax paid/Change in income X 100

Question 29

What Is Average Rate Of Taxation (ART)?

Answer 29

It is the proportion of incOme paid into tax at a given level of income.

Formula: ART = tax paid/income X 100

Question 30

What Are Reasons For Government Spending?

Answer 30

To provide public goods and services
To provide welfare benefits
To improve/maintain infrastructure

Question 31

What Are Types Of Government Spending?

Answer 31

Capital expenditure: Government spending on investment goods like new roads, schools and hospitals used over a long period of time.

Transfer payments: They are payments for which there is no corresponding real output. In government
expenditure they are welfare payments such as state pensions and unemployment benefits.

Current expenditure: It is spending by the government on goods and services consumed in the short-run e.g.
salaries of teachers and doctors, medicine.

Question 32

What Is Monetary Policy?

Answer 32

It involves changes in interest rates and money supply to influence AD in order to achieve the macroeconomic objectives.

Question 33

What Are Tools Of Monetary Policy?

Answer 33

Interest rates: Changes in the rate of interest affect the cost of borrowing leading changes in C, I and AD.

Changes in money supply:
(i) Change in cash reserve ratio (cash ratio or liquidity ratio): It is the proportion of deposits that commercial banks are required to keep in liquid reserves. Changes in the cash ratio influences the amount of money
banks can lend out and hence money supply in the economy.

(ii) Quantitative easing: It refers to buying of government securities by the central bank from commercial banks. It increases deposits of banks and enables them to lend out more money. This leads to
an increase money supply.

Changes in lending criteria (credit regulations): Making borrowing/lending easy to increase lending by banks. This would increase money supply in the economy.
When borrowing/lending is made difficult lending by banks will decrease. This would reduce money supply in the economy.

Question 34

What Is An Expansionary (Reflationary) Monetary policy?

Answer 34

It increases AD through:
- Cut in rate of interest
- increase in money
- increase in lending by banks
- lowering the exchange rate

Question 35

What Are Aims Of An Expansionary (Reflationary) Monetary Policy?

Answer 35

Reduce demand-deficient (cyclical) unemployment

Increase the rate of economic growth

Question 36

What Is A Contractionary (Deflationary) Monetary Policy?

Answer 36

It reduces AD through:
- rise rate of interest
- reduction in money
- reduction in lending by banks
- raising the exchange rate

Question 37

What Are The Aims Of A Contractionary (Deflationary) Monetary Policy?

Answer 37

Reduce demand -pull inflation

Reduce current account BOP

Question 38

What Are Supply - side Policies?

Answer 38

These are microeconomic policies aimed at affecting the LRAS. They are aimed at:
- increasing productivity (efficiency)
- increasing the productive capacity of the economy.

Supply-side policy shifts the LRAS curve (and PPC) to the right. They increase potential economic growth, and employment through increased productivity, competition, incentives to work and invest. However, in the short run they could lead to inflation as the increase in government spending increases AD.