MACRO Policies

Question 1

What are the three different types of fiscal policy

Answer 1

1. TAXATION
2. GOVT SPENDING
3. BORROWING (BUDGET)

Question 2

Define direct tax

Answer 2

o Taxes on income- cannot be passed on to someone else
• Income tax, inheritance tax, capital gains tax, corporation tax

Question 3

Define indirect tax

Answer 3

Indirect
• Taxes on spending- burden can shift depending on PeD and PeS
• VAT, excise duties (oil, tobacco and alcohol)

Question 4

Effects of progressive tax

Answer 4

Progressive taxes eg income tax
• As incomes rise, the proportion of income paid in tax also rises

Question 5

Effect of Regressive tax

Answer 5

Regressive taxes eg VAT
• As incomes rise the proportion of tax paid falls
• (Proportion of tax paid by the lower income groups is higher ie it takes more of their income than higher earning groups who pay less of their income as a proportion)

Question 6

Effect of proportional tax

Answer 6

Proportion of income paid in tax stays the SAME as income rises

Question 7

Benefits of direct tax

Answer 7

Huge sources of income to finance govt spending
To redistribute income from rich to poor - reduce inequality

Question 8

Drawbacks of direct tax

Answer 8

Incorrect level has huge impacts on level of spending in the economy
-too high => reduce AD=>damage
SREG and raise unemployment
-too low=> boosts
AD/overspending=>inflationary pressures
-effects on incentives to work

Question 9

Indirect tax benefits

Answer 9

Influences spending patterns
Correcting externalities
Incentive effects - lesser on work v leisure
More flexible than direct taxes
Choice - can be avoided

Question 10

Indirect tax drawbacks

Answer 10

Regressive in nature - more unequal distribution of income
Inflationary effects - cost push
Crime - black market
Not so clear - more unaware of them

Question 11

Evaluating fiscal policy

Answer 11

The success of fiscal policy will depend on several factors, such as The size of the multiplier. If the multiplier effect is large, then changes in government spending will have a bigger effect on overall demand.
The Time lag- it can take years for G to take effect
The current state of the economy. Fiscal policy is most effective in a deep recession where monetary policy is insufficient to boost demand.
It depends on other factors in the economy. For example, if the government pursue expansionary fiscal policy, but interest rates rise, and the global economy is in a recession, it may be insufficient to boost demand.
The national debt -Access to borrowing. If there is concern over the state of government finances and a poor credit rating, the government may not be able to borrow to finance fiscal policy.

Question 12

What is the effect of a lower corporation tax on businesses?

Answer 12

Government cuts the rate of corporation tax➡️Businesses get to keep a larger percentage of their profits➡️Increase in post-tax profitability may lead to a rise in planned investment➡️Investment can be by both domestic and overseas businesses➡️Increased capital spending is an injection into the circular flow model➡️Creates a multiplier effect on demand, output and employment

Question 13

The cause for lower taxes

Answer 13

Stimulates work incentives and labour productivity leading to faster growth
Helps to create more jobs because businesses have less tax to pay when employing people
Encourages an inflow of FDI from businesses looking for a low tax country
Incentivizes enterprise and business start-ups - a key source of long term wealth and jobs
Lower direct taxes might encourage an inflow of higher-skilled workers and entrepreneurs
Lower tax rates might end up increasing total tax revenues (suggested by the Laffer Curve)

Question 14

The case for higher taxes

Answer 14

Taxation is a key instrument for changing the final distribution of income and wealth. It is equitable for those with the greatest resources to pay more
Tax cuts don’t alwavs lead to an increase in total tax revenues - the effect on work incentives and effort can be challenged
Consider the relative success of countries such as Denmark, Norway and Sweden who have higher tax burdens & progressive tax and welfare systems
Taxes are needed to fund high quality public services such as education, transport and health which benefit millions of people in the long run
Tax competition between can lead to a race to the bottom which ultimately limits what the government can spend on essential public goods

Question 15

What is govt spending

Answer 15

2. Govt spending (G)
   Spending by central and local govts to provide public and merit goods
   Capital spending - creates assets for future generations
   Eg. hospitals, schools, infrastructure
   Current spending - does not create assets - day to day expenses
   Eg. Public sector wages, bills, medicines
   Transfers - money transferred where no service is given - from taxpayers to receivers of benefits eg
   Pensioners or the unemployed

Question 16

What are the three forms of monetary policy

Answer 16

I. INTEREST RATES
2. EXCHANGE RATES
3. INCREASING THE MONEY SUPPLY (QE)

Question 17

What is the purpose of monetary policy

Answer 17

Main purpose: to control inflation but to support other objectives of growth and employment

Question 18

What are the effects of AD from an increase in interest rates

Answer 18

C - consumer spending
I. Encourage people to save as more reward for savings
2. Cost of household borrowing increases eg mortgages so higher mortgage repayments reduces Yd available to spend.
3. Reduction in demand for credit as more money goes on interest payments so buying on credit more expensive so leads to lower C on retail spending
4. As C is a major component of AD this leads to a fall in AD
5. High IR may reduce consumer confidence-postpone /delay future spending plans so have longer term effects on AD
I - Business investment
1. The cost of taking out loans increases as firm have to pay back more to the bank at a higher rate of interest
2. Reduces business confidence for profitable capital spending so postpone/reduce plans for I and I falls
3. As I is a component of AD, this leads to a fall in AD
3. Reduces business confidence for future expansion so I may stay low for foreseeable future and so affect AD longer
(X-M) Net Exports
1. Increases the attractiveness of sterling as foreign investors can earn more on savings in UK banks so higher capital inflows from foreign investors (more hot money flows into the UK)
2. This leads to an increase in the demand for & so raises the price - ie exchange rate APPRECIATES - gets stronger
3. UK exports become more expensive and imports cheaper so demand for X falls and M rises so net exports falls
4. As Net exports is a component of AD, AD also fall.
5. The UK’s BOP on current account worsens as the deficit rises

Question 19

What is quantitive easing

Answer 19

An increase in the money supply.
• It’s aim is to get money flowing around the economy by buying up assets from institutions
• This increases the bank reserves, buoys up balance sheets so this increases lending which aims to increase the liquidity in the economy
• The increase in MS leads to lower interest rates so borrowing money is cheaper

Question 20

Evaluating interest rates and monetary policy the advantages

Answer 20

The advantages
1. Evidence shows that, in normal conditions, interest rates have a direct and powerful effect on household spending, which suggests that UK consumers are highly interest rate elastic.
2. The Bank of England’s Monetary Policy Committee is independent from government and can make decisions free from political interference.
3. Interest rates can be adjusted on a monthly basis, which contrasts with discretionary fiscal policy which cannot be adjusted at such regular intervals.
4. While the full effects of interest changes may not be experienced for up to a year, there is often an immediate effect on confidence. The time-lag on output is estimated to be around one year, and on the price level, around two years.

Question 21

Evaluating interest rates and monetary policy the disadvantages

Answer 21

There are still time lags to see the full effects, and there are some negative effects.
Raising interest rates can negatively affect investment spending and the housing market, and the exchange rate and hence the balance of payments.
The money supply is difficult to control in practice, so controlling interest rates is preferable. QE leads to demand pull inflation and no guarantee banks will pass on cheap money
If interest rates are persistently low eg since Credit crunch they can be rendered ineffective as any further cuts do not have any real effects-Also if consumers become accustomed to low rates they will increase debt fuelled consumption and be vulnerable once rates start to rise

Question 22

WHAT ARE SUPPLY SIDE POLICIES?

Answer 22

policies designed to increase the economy’s productive capacity by shifting the LAS curve to the right
increase output without inflationary pressure in the long run
Supply-side growth occurs when the quantity and/or qualify of the factors of production increase

Question 23

Explain the effects of supply side polices in the SR and LR

Answer 23

a In the short run at full capacity, an economy will produce output Y at price level
P. When AD rises to AD1, AD outstrips AS so firms will raise prices causing demand pull inflation and prices rise to P1. a In the long run an increase in the productive capacity of an economy (via s/side policies like training and education of the work force), output can now rise to Y1 to meet extra demand. The price level falls to P3. This shows how an economy can experience sustainable economic growth in the long term without inflationary pressure.

Question 24

Problems with supply side polices

Answer 24

• Investment in technology & better skills means that current workers are more productive - so do not necessarily mean more workers will be employed
o There is the argument that businesses will need less workers if they invest in more technology/machines!
(Technological unemployment-a form of structural unemployment)
• Supply side economics is a LONG TERM policy a Costs before benefits eg capital I.
a Its takes TIME - to improve literacy & numeracy skills, time to complete an apprentice or a degree! Around 5 years time lag