Government & MacroEconomy

Question 1

The Role of the Government

Answer 1

The government aims to improve living standards by intervening in markets and correcting market failure. They also attempt to achieve the macroeconomic objectives.

Question 2

Local Government Functions

Answer 2

MUNICIPAL STUFF
Services: Garbage/Waste Disposal, Local Schooling, Social Care
Financial: Local Rates/Taxes, Business Support
Government: Councils, District Authority, Policing

Question 3

National Government Functions

Answer 3

Fiscal Policy: Taxes (Income Tax & Corporate Taxes)
Supply-Side Policy: Infrastructure Construction, Educational Reformations
Monetary Policy: Setting of Interest Rates

Question 4

International Government Functions

Answer 4

Protectionism: Quotas & Tariffs, Trading Blocs
Exchange Rates & Interventions
Growth: International Trade

Question 5

The Macroeconomic Objectives

Answer 5

Economic Growth - An increase in a country’s real GDP over time. It can be seen in an outward shift of the PPC curve, and typically raises standards of living.

Inflation - The sustained rise in the general price level in the economy. Governments aim to keep this low so that people are able to afford goods.

Unemployment occurs when people are able and willing to work , and are looking for jobs but cannot find employment. The less unemployed, the more efficient the country is.

Equity in Distribution of income is self explanatory, and the Balance of Payments is a record sheet of all country’s transactions. Countries want more exports than imports.

Question 6

Conflicts in the Objectives

Answer 6

Economic Growth Causes Inflation and damages the environment, worsens the BoP and raises Inequality, but helps with Unemployment.

Low Unemployment incomes are higher and therefore, there are more imports and the Balance of Payments becomes worse. It also causes wage inflation and overall inflation.

Question 7

The Budget

Answer 7

The Government Budget (Fiscal policy) is presented each year as a balanced budget, a budget deficit, or a budget surplus

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
This borrowing gets added to the public debt.

Question 8

Reasons for Government Spending & Taxation

Answer 8

Current Expenditures: These include the daily payments required to run the government & public sector. E.g. The wages & salaries of public employees such as teachers, police, members of parliament, military personnel, judges, dentists etc. It also includes payments for goods/services such as medicines for government hospitals

Capital Expenditures: These are investments in infrastructure & capital equipment. E.g. High speed rail projects; new hospitals & schools; new aircraft carriers

Transfer payments: Payments made by the government for which no goods/services are exchanged. E.g. Unemployment benefits, disability payments, subsidies to producers & consumers etc.

The government might also tax to correct market failure by taxing demerit goods more, or subsidise merit goods. They also tax to earn government revenue to fund their expenditures, or to promote equality by reducing the wealth gap. E.g Tax the rich, give to the poor.

Question 9

Types of Taxes

Answer 9

Direct taxes are taxes that are imposed on profits and income. Examples include Income Tax, Corporate Tax, Inheritance Tax and Capital Gains Tax.

Indirect Tax are taxes imposed on spending, such as Value Added Tax, Demerit Tax or Import Duty.

Question 9

Qualities of Taxes

Answer 9

The progressive taxation system is one where as income increases the rate of tax increases. Regressive tax is the opposite, when income increases the rate of tax decreases. Proportional taxation is when the rate of tax remains the same regardless of income.

Some form of taxes are inherently regressive such as sales tax, as is VAT

A good Tax is one that is economical to collect, something simple and easy, as well as equitable and fair. It should also be convenient to pay tax, and it cannot change mid-fiscal year.

Question 10

The Impact of Taxes

Answer 10

The main purpose of tax is to raise income for the government which can lead to higher spending on health care and education.

Consumers will have less disposable income to spend after income tax has been deducted. This is likely to lead to lower levels of spending and saving.

Producers will also have less incentive to produce if the corporate taxes are too high. Private firms aim on making profits, and if a major chunk of their profits are eaten away by taxes, they might not bother producing more and might decide to close shop.

Question 11

Definition and types of Fiscal Policies

Answer 11

The fiscal policy or demand-side policy is a set of government policies relating to government spending & taxation, and aims to change aggregate demand in an economy. It tries to manipulate demand to achieve macroeconomics objectives.

Fiscal policies that seek to increase aggregate demand are called expansionary policies, and contractionary policy is the opposite. Expansionary is used to address Cyclical unemployment and to increase growth. Contractionary is used to address demand-pull inflation.

Question 12

Aggregate Demand & The Effect of Fiscal Policy

Answer 12

Aggregate demand is calculated by adding Consumption, Investments Government Spending, and (Exports - Imports),

When decreasing Inflation and Aggregate Demand:
↑ Income Tax = ↓ Disposable income = ↓C = ↓AD
↓ Government Spending = ↓E = ↓Income = ↓C = ↓AD
↑ Corporate Tax = ↓I = ↓AD

To increase Economic Growth and Aggregate Demand:
↓ Income Tax = ↑ Disposable income, ↑C = ↑AD
↑ Government Spending = ↑E = ↑ Income = ↑C = ↑AD
↓ Corporate Tax = ↑I = ↑AD

Question 13

Strength and Weaknesses of Fiscal Policy

Answer 13

STRENGTHS:
Spending can be targeted on specific industries
Short time lag as compared with monetary policy (effects of fiscal policy are seen sooner)
Redistributes income through taxation

WEAKNESSES:
Long term infrastructure projects may lack follow-through
Increased government spending can create budget deficits

Question 14

Economic Growth

Answer 14

Economic Growth is an increase in the amount of G&S produced in the economy. Measured by Gross Domestic Product (Aggregate Demand), each nation goes through what is known as the economic cycle, a pattern of rises and falls in the economic growth.

First it starts with a Boom, with high-levels of consumer spending, business confidence profits and investments. Unemployment tends to be low.

Then comes the Recession, with falling levels of consumer spending and confidence meaning lower profits. Unemployment starts to rise.

Then there is the Depression, a prolonged period of declining GDP with weak consumer spending and investment. Unemployment rises sharply.

Lastly is Recovery, where consumers begin to increase spending, businesses start to invest again, but unemployment still takes time to recover.

Question 15

Causes & Consequences of Economic Growth

Answer 15

One cause for economic growth is increased spending (Aggregate Demand), which is represented as a movement from A to B on a PPC.

Another cause is increased investment which results in an outward shift in the PPC. The second occurs due to new technology, more resources, or investment in new capital and infrastructure.

The consequences of economic growth are that it increases standards of livings (↑Economic Activity, ↑Consumption & ↑Economic Freedom), decreases unemployment via derived demand, and increases tax revenue.

However, inflation will increases as more people spend more money and resource scarcity comes into play, environmental damage + resource depletion and Income Inequality.

Question 16

Cause & Consequences of Recession

Answer 16

Financial Crises, Rising Interest Rates, Trade Wars, Supply-Side shocks or cuts in government spending are all causes of recessions.

This leads to firms going out of business, people losing jobs, fall in incomes, rise in poverty and higher budget deficit.

Question 17

Definition of Monetary Policy

Answer 17

Monetary policy seeks to achieve macroeconomic objectives by changing the supply and price of (borrowing) money. The price of money meaning interest rates. The central bank is in charge of arranging the interest rates.

The Interest rates are affected by changing the supply of money which is done through the Reserve Requirement Ratio. The RRR means how much the banks need to keep in reserve and not loan. If RR is increased, the supply of money decreases and interest rates increase, due to scarcity.

Banks will want more reward if there is less money around and they want to be competitive if there is more money in circulation.

Question 18

Effect of Monetary Policy

Answer 18

↓IR = ↓Loan Repayments = ↓Outgoings = ↑C = ↑AD

Lowering interest rates causes loan repayments prices to fall, so people pay less bills (e.g mortgages & loans), so people can consume more G&S due to more money available, increasing aggregate demand.

↓IR = Cheaper Loans = Firms more incentive to invest = ↑I = ↑AD

Lower interest rates means loans are cheaper and less interest to pay, so firms are more likely to borrow and invest, which leads to higher aggregate demand.

↓IR = Less Incentive to Save = ↑C = ↑AD

Lowering interest rates means people earn less from keeping money in the bank, so they’d rather spend it, increasing consumption and aggregate demand.

THIS IS EXPANSIONARY. FLIP IT FOR CONTRACTIONARY

Question 19

Strengths & Weaknesses of Monetary Policy

Answer 19

STRENGTHS:
It is easier to change the interest rates than it is to change the taxes. Changing the tax rate takes a long period of time while the interest rates can be adjusted quickly.

Central Banks are also politically neutral and independent, which makes it safer.

WEAKNESS:
It is only effective at combating demand-pull inflation. In fact, if a country is suffering from cost-push inflation, a contractionary monetary policy could worsen the situation as it interest rates are a factor of production. It is also affected by how much the interest rate is changed, how long, how many people are borrowing and more.

Lastly, the banks can only lower interest rates by so much before they stop lending entirely as it isn’t profitable for them anymore.

Question 20

Definition of Unemployment

Answer 20

People who are unemployed are those who are willing, able and actively seeking work, but who are not working. This means those who are disabled, retired, imprisoned, students or stay-at-home parents are considered economically inactive, not unemployed.

This is counted either by the International Labour Organisation’s “Labour Force Survey” or the Claimant Count of people claiming UE benefits/support.

The unemployment rate is calculated via the Number of Unemployed divided by the Labour Force (UE+E), multiplied by 100.

Question 21

Causes/Types of Unemployment

Answer 21

SEASONAL UNEMPLOYMENT:
UE caused by changes in season or trends, such as Ski instructors or workers hired for CNY or Christmas purposes.

FRICTIONAL UNEMPLOYMENT:
UE caused by workers transitioning between jobs. So those who are searching for new jobs but currently don’t have one or students going from Uni to Jobs.

CYCLICAL UNEMPLOYMENT:
UE caused by a reduction in total demand in an economy. As derived demand decreases, jobs are lost. This form of UE is inevitable but temporary.

STRUCTURAL UNEMPLOYMENT:
By far the worst UE, it is caused by a change in geographical location of jobs, change in demand for skills or labour market rigidities. So factories going to different countries, declining professions like Bus Drivers or minimum wages and Trade Unions enforcing said minimum wages.

Question 22

Consequences of Unemployment

Answer 22

LOW/NO INCOME:
Reduced Purchasing Power & Lower Standard of Living

SOCIAL ISSUES:
Mental Health/Health Decline and Theft of Necessity

INCREASED GOVERNMENT EXPENDITURE:
UE benefits & Reskilling Programs

LESS PROFITS FOR FIRMS:
Lower income means less demand

LOWER TAX REVENUE:
Lower taxable income means less resources for the government

LESS INTERNATIONAL COMPETITIVENESS:
More time away from work makes it harder to get back in due to deskilling, and people don’t want to invest in a low skill high UE country

Question 23

Definition of Inflation & Deflation

Answer 23

Inflation is a sustained increase in the general price level of goods/services.

Deflation is a sustained decrease in the general price level of goods/services.

Inflation is measured via the CPI or Consumer Price Index. They use a “weighted index” based on a basket of goods & services. They send a survey to households asking how much they earn and what they’ve bought, then they take commonly purchased goods and find the retail price data to see how much it has changed. These goods are used in particular as they will affect households more

Question 24

How to Measure Inflation

Answer 24

Inflation is measured via the CPI or Consumer Price Index. They use a “weighted index” based on a basket of goods & services. They send a survey to households asking how much they earn and what they’ve bought, then they take commonly purchased goods and find the retail price data to see how much it has changed. These goods are used in particular as they will affect households more.

However, establishing a common basket of goods is hard as different income levels, different cultures, ethnic groups, religious and regional groups all get different things. It is also hard to keep the list updated, and to account for discount and offers which skew purchasing amounts.

Question 25

Types of Inflation/Deflation

Answer 25

DEMAND-PULL INFLATION:
Inflation caused by an increase in total spending in an economy. Scarcity is produced as more spending decreases amount of goods & services, leading to rising prices.

COST PUSH INFLATION:
Inflation caused by an increase in the costs of production (CELL). Decreased CELL leads to increases in price of CELLs, which cause supply to decrease and scarcity of goods to increase which increases price.

DEMAND SIDE DEFLATION:
Deflation caused by a decrease in total spending in an economy. It has the same causes as the Demand Pull Inflation.

SUPPLY SIDE DEFLATION:
Deflation caused by a reduction in costs of production and a increase in total supply of goods & services.

Inflation is not the same as deflation which isn’t the same as disinflation.

Question 26

Consequences of Inflation

Answer 26

MENU COSTS:
Companies and firms need to think about price setting and reprint menus, which takes effort and has an opportunity cost.

BUISNESS UNCERTAINTY:
There is a decreased amount of investment as people are hesitant to fund stuff due to not knowing when disinflation will occur and as people buy less, so shops will scale back or shut down.

LESS PURCHASING POWER:
People’s ability to purchase goods decreases causing a fall in standards of living, as the price of goods represents a larger chunk of their spending. Sometimes increased income combats this, but not always

OTHERS:
Borrowers win as they pay the same amount of money back but that amount is valued less. Savers will lose as the money they’ve saved will have reduced effective purchasing power. People with fixed incomes will lose too, such as pensioners as they’re receiving less than they would normally.

Question 26

Definition of Supply-Side Policy

Answer 26

A deliberate attempt by a government to increase long-run aggregate supply. This is done via increasing the quality and/or quantity of production. On a PPC curve, it can be both an increase in the total possibility or a shift further towards the edge of the curve.

Question 27

Examples of Supply-Side Policy

Answer 27

INCREASED INVESTMENT IN EDUCATION + TRAINING:
More educated/skilful employees = More Productivity = Greater Supply

PRIVITISATION:
Governments seek to fulfil a services to the bare minimum. Profit Incentivisation incentivises individual firms to improve the service to make as much profit as possible.

LOWERING TAX (INCENTIVE BASED POLICIES):
Lowering Income tax incentivises work force participation as households are prepared to work more, thus increasing productivity and increasing supply. Lowering Corporate Tax increased investment which also increases production and supply.

INCENTIVES TO INVEST:
Subsidies/Grants, Governmental advice and Training for new firms and creation of infrastructure all lead to higher investment, higher productivity and thus higher supply.

LABOUR MARKET REFORMS:
Abolishing Minimum Wage, Reducing power of Trade Unions & Zero Hour Contracts. Minimum wage causes unemployment as the quantity demanded for labour is much lower than quantity supplied. Same concept for Trade Unions. Zero Hour Contracts mean they can hire more people.

DERGULATION:
Trying to make it easier for firms to operate and new firms to join the market by getting rid of roadblocks such as barriers to entry.