Role of the State in the Macroeconomy Flashcards
what are the 3 types of expenditure
- capital government expenditure = investment goods
- transfer payment = no corresponding output
- current government expenditure = interest payments for national debt
composition and size of public expenditure in low income vs high income countries
- the lower the average income of the country, the lower the percentage of GDP spent by the government
- low income countries tend to have a lower tax revenue
- higher income countries demand more services from their governments
- amongst developed countries, there are significant differences in the size of gov spending due to attitudes
what are the 5 main impacts of government expenditure
- productivity and growth
- living standards
- crowding out
- level of taxation
- equality
what is the impact on productivity and growth from gov spending
bad:
- free market economists = gov spending is wasteful and causes inefficiency
good:
- economies of scale
- infrastructure
- education = human capital
- healthcare = reduces number of days workers lose
- research and development = give businesses a long term competitive edge
- can create a multiplier effect
what is the impact on living standards from gov spending
good:
- corrects market failure and provides public goods
- reduce absolute poverty
- political system chosen by society
bad:
- output overall is reduced - misallocation of resources
- principal agent problem = they make decisions on behalf of the people and individuals may have spent differently
what is crowding out and why is it an impact of gov spending
- spend money above their tax revenues
- gov has to borrow from individuals and businesses
- amount of money in the economy available to borrow does not increase
- gov competing with the private sector for finance and will cause higher interest rates
- discourage firms from investing and individuals buying on credit
- limited num of resources in the economy = less available for the private sector = no real increase in AD
- investment would be more efficient if done by the private sector
- felt mostly at full employment
- transfer payments have no impact on output so should not cause crowding out
- unemployment high = crowding in
what is the impact on the level of taxation from gov spending
- gov spending is high = level of tax must be high
- oil-rich countries are an exception
what is the impact on equality from gov spending
- increase equality
- redistribution
- minimum standard of living
- access to basic goods
what is the use for tax
- pay for the number of goods and services that the government provides
- correct market failure
- manage the economy and redistribute income
what is progressive tax
those on higher incomes pay a higher marginal rate of tax
- direct tax
what is regressive tax
the proportion of income paid in tax falls as the income of the taxpayer rsies
- indirect tax
what is proportional tax
the proportion of income paid on tax remains the same whilst the income of the taxpayer changes
what are the 7 impacts of tax changes
- incentives to work
- tax revenues
- income distribution
- real output and employment
- price level
- trade balance
- FDI flows
how does tax impact incentives to work
- high rates of tax will discourage individuals from working
- supply of labour is elastic
- higher taxes on high income earners could encourage them to move abroad and taxes on the poor may leas to a poverty tax
- biggest impact is income tax
evaluation:
- higher taxes mean people have to work longer hours in order to maintain their income
- increases the incentive to work
how does tax impact tax revenue
- laffer curve = rise in tax rate does not necessarily increase tax revenue
- revenue from indirect taxes can be uncertain as they depend on consumer spending patterns
how does tax impact income distribution
- progressive tax = increase equality of income distribution as more money is proportionally taken from the rich than the poor
- regressive tax = will decrease income equality
- inheritance taxes =progressive
- high corporation taxes = money from shareholders
- using tax to redistribute income is that it does not give the poor anything so the system needs to be supported with benefits
how does tax impact real output and employment
- some taxes affect AD while others AS
- direct taxes = affects disposable Y = affects AD
- indirect taxes/NICs = affects costs for firms = affects SRAS
- income taxes = affect incentive to work = affect LRAS
how does tax impact price level
- taxes can impact LRAS, SRAS and AD
- change price level
- cost-push and demand-pull inflation
how does tax affect FDI flows
- low taxes on profit and investment encourage businesses to invest
- ‘race to the bottom’ where countries have to continue to lower taxes in order to encourage investment
what is an automatic stabiliser
- mechanisms that reduce the impact of changes in the economy on national income
- example: gov spending and taxation
- cannot prevent fluctuations
- reduced size of a problem
what is discretionary fiscal policy
the deliberate manipulation of government expenditure and taxes to influence the economy
what is national debt
sum of all government debts built up over many years
what is a cyclical deficit
part of the deficit that occurs because government spending and tax fluctuate around the trade cycle
- recession = low tax revenues
what is a structural deficit
fiscal deficit which occurs when the cyclical deficit is zero
- long term and not related to the state of the economy
why are structural deficits bad and why can’t they be solved
- structural deficit = national debt will grow over time as the government has to consistently borrow
- impossible to know what part of the deficit is structural and what is cyclical
what are the 7 factors influencing the size of the fiscal deficit
- trade cycle
- unforeseen events
- interest rates
- privatisation
- government aims
- high revenues from commodities (oil)
- number of dependents
what are the factors influencing the size of national debts
- government running a deficit - fiscal deficits over 3% will lead to growing national debt as a proportion of GDP
- ageing populations - structural deficit
why is national debt significant
- gov has to spend money on servicing their debt through interest repayments
- value of debt falls overtime because inflation erodes its value and because a country’s GDP grows
- high levels of debt = reduced gov credit rating
- getting enough foreign currency to make repayments on its debt
why are fiscal deficits significant
- grow national debt
- inflation
what are some gov policies to reduce fiscal deficits and national debts
- austerity
- demand stimulus by high spending
- rely on automatic stabilisers
- default on their loans
how does austerity help reduce fiscal deficits and national debt
- decrease gov spending
- increase tax revenue
cons: limit growth, lower living standards and equality
how does demand stimulus by high spending reduce fiscal deficits and national debt
- gov increase spending
- cause economic growth
- bring higher tax revenue
- budget surpluses and eventually a reduction of national debt
how does relying on automatic stabilisers reduce fiscal deficits and national debt
- allow the economy to grow
- debt/fiscal deficit reduce as a percentage of GDP
how does defaulting on loans reduce fiscal deficit and national debt
- failure to pay back national debt
cons: economic cost, loss of credit
what are some gov policies to reduce poverty and inequality
- redistribution from rich to poor
- progressive tax system
- gov spending on benefits and transfer payments
- provide goods and services
- reduce wage differentials
- access to education and training opportunities
- price controls
- trickle down
- law of diminishing marginal utility
how does a progressive tax system reduce poverty and inequality
- more equal distribution of income after tax
- money taken from the rich and given to the poor
cons: - reduction in incentives
- laffer curve
how does gov spending on benefits and transfer payments reduce poverty and inequality
targeted at people who need the most help and provide a safety net/minimum standard of living and are better at improving inequality since they directly affect the poor
what are the two forms of benefits
- universal
- means tested
what are universal benefits
available to everyone who meet a vertain criteria, respective of personal income
- child benefits
what are means tested benefits
only available to people who have sufficiently low levels of income/wealth
negative impact of gov spending on benefits and transfer payments
reduce incentive to work
how does providing goods and services reduce poverty and inequality
- give citizens equal opportunities and access to services they many not otherwise be able to afford
- helps to ensure that everyone is given an equal start in life
cons: also benefit higher incomes, high opp cost
what are the ways the gov can reduce wage differentials
- national minimum wage
- maximum wages
- pay ratios
- equal pay legislation
- trade union friendly legislation
- provide benefits to workers
how does a national minimum wage reduce poverty and inequality
improve imcomes of the poor
cons: increases unemployment
how does maximum wages or pay ratios reduce poverty and inequality
reduce the incomes of the rich and could even mean companies increase the pay of their lowest income workers
cons: loss of skilled workers
how does equal pay legislation reduce poverty and inequality
prevent inequality between men and women or different ethnic groups
how does trade union friendly legislation reduce poverty and inequality
allow the wages of workers to rise, and those in unions are more likely to be low paid so this will positively affect equality
how does providing benefits to workers reduce poverty and inequality
employers forced to provide benefits for their workers
- effectively increase wages as less money spent on basic needs for employees
how does access to education and trading opportunities reduce poverty and inequality
- prevent children from poorer backgrounds achieving less than others, which would reduce learning potential
- pupil premium scheme, contextual offers
how do price controls reduce poverty and inequality
- essential goods
- increase spending power of the poor
cons: excess supply, lead to black markets
how does trickle down reduce poverty and inequality
- increasing the income of the rich will lead to an increase in the income of the poor
- rich create jobs by spending their money and employing others therefore reducing their income = reduce employment and lower living standards
- inequality is necessary to encourage people to work hard and therefore increase their income
how does the law of margining utility reduce poverty and inequality
- law = redistribution of imcome increases total utility
- better allocation of resources
- higher spending of an individual = less satisfaction gained
- money for poor would increase satisfaction more than money to the rich
why do central banks change interest rate and supply of money
- domestic reasons = inflation
- global issues = low exchange rate, change in world commodity prices
why do central banks struggle to control domestic money supply
- not a simple relationship between supply of money and inflation
- cannot control the ability of the financial system to create credit
- globalisation of the financial market
- central banks should allow inflation caused by supply side shocks but manage demand side inflation
how can the government increase international competitiveness
- supply side measures
- exchange rate policies
- WTO or sign trade agreements
what are the 8 main reasons policies are used
- reduce fiscal deficit and national debts
- reduce poverty and inequality
- changes in interest rate and supply of money
- international competitiveness
- external shocks
- transnational companies
- regulation of transfer pricing
- ability to control external companies
how do supply side measures increase international competitiveness and some examples
- improve productivity and flexibility
- taxes and dergualtion
- force firms to be efficient
- emphasis on quality of products
- education = improved skills of workforce and felxibility
what are the 4 main examples of external shocks
- commodity price shock
- financial crisis
- changes in exchange rates
- political instability
why do policies need to be used on external shocks
globalisation = increasingly interdependent economies
how are policies used in a commodity price shock
- expansionary policy to reduce impact on GDP
- deflationary policy to reduce inflation
how are policies used in a financial crisis
expansionary policy to increase AD
why are policies used when there are changes in exchange rates
changes = inflation
why are policies used on transnational companies
- can bring huge gains to economy through creation of jobs, raise in tax revenue, knowledge and investment
- can have negative economic and social impact: destroying local culture, affecting the environment, withdrawing more in profits than they inject through investment and influencing politicians to take decisions that will favour their interests and tax avoidance
how are policies used on transnational companies
- some developing countries don’t allow TNCs to set up without first setting up a joint company with a local partner
- some profits are retained within the country
- knowledge/technology is transferred
- import contacts - at least some part of the value of the order must be manufactured in the country
what is transfer pricing
- way for firms to avoid tax
- firm produces a good in one country and then transfers it into another good that which it then sells
- varying tax rates in each countyr
- aim is to increase their profit made in the low tax country and decrease in the high tax county = lower tax bill
how are policies used to reduce transfer pricing
- UK = companies hwich don’t allow sufficient profits are challenged by HMRC = earn more tax
- Transfer Pricing Guidelines = aim for price to be the same as if the two parties were independent on each other
why is it hard to control global companies
- hard for individual gov so requires worldwide agreement
- benefiting one country = losses for other countries
- division within countries
- allows TNCs to prevent any agreement they do not like through lobbying
- solutions are time consuming and costly
what are the 3 problems facing policy makers
- inaccurate information
- risk and uncertainies
- external shocks
why is inaccurate information an issue for policy makers
- information too short-term and inaccurate
- gov lacks full picture
- time consuming and costly for gov to gain every single bit of information needed
why are risks and uncertainties issues for policy makers
- cannot predict the future
- is spending necessary
- cannot know the full impact of their decisions
- consumers are irrational and could undermine gov policy
why are external shocks an issue for policy makers
- unable to control and prepare
- can only lessen impact
- difficult to know the best method to solve the problem
- may not have intended impact
- may undermine current policies in place
