Role Of The State In The Macroeconomy

Question 1

What are the 3 main types of public expenditure?

Answer 1

1. Capital expenditure – Spending on infrastructure (e.g. roads, rail, hospitals).
2. Current expenditure – Day-to-day government spending (e.g. wages of public sector workers).
3. Transfer payments – Redistribution payments without exchange of goods (e.g. pensions, benefits).

Question 2

What is the difference between a budget deficit and national debt?

Answer 2

• Budget deficit: When government spending exceeds tax revenue in a given year.
• National debt: The total accumulated borrowing of the government over time.

Question 3

What are the 3 problems associated with high national debt?

Answer 3

❌ Higher borrowing costs – If markets lose confidence, interest rates on debt rise.
❌ Opportunity cost – More money spent on debt interest, less on public services.
❌ Intergenerational burden – Future taxpayers may face higher taxes to repay debt.

Question 4

What is the difference between cyclical and structural deficits?

Answer 4

• Cyclical deficit: Temporary budget deficit due to economic downturns (e.g. recessions).
• Structural deficit: Long-term deficit due to weak tax revenue or high spending.

Question 5

What is crowding out?

Answer 5

• Financial crowding out: Government borrowing increases interest rates, reducing private investment.
• Resource crowding out: Government takes up too many resources, limiting private sector access.

Question 6

What is the difference between automatic stabilisers and discretionary fiscal policy?

Answer 6

• Automatic stabilisers: Policies that adjust without direct government action (e.g. tax revenue falls, welfare spending rises in recessions).
• Discretionary fiscal policy: Deliberate government actions (e.g. cutting VAT to stimulate demand).

Question 7

What are the 3 main types of taxation?

Answer 7

1. Progressive tax – Higher income earners pay a higher percentage (e.g. UK income tax).
2. Regressive tax – Lower-income earners pay a higher proportion (e.g. VAT, sugar tax).
3. Proportional tax – Flat rate for all (e.g. some countries’ income taxes).

Question 8

What are direct and indirect taxes?

Answer 8

• Direct taxes: Taxes on income and wealth (e.g. income tax, corporation tax).
• Indirect taxes: Taxes on spending (e.g. VAT, fuel duty).

Question 9

What is the Laffer Curve? (2 things)

Answer 9

The Laffer Curve suggests there is an optimal tax rate that maximises revenue.
• If tax rates are too low → Government raises little revenue.
• If tax rates are too high → People stop working/investing, reducing revenue.

Question 10

How does taxation affect the economy in? (2 pros and 1 cons)

Answer 10

✅ Higher direct taxes → Lower consumption, reduced inflationary pressure.
❌ Higher indirect taxes → Increases costs, may worsen the trade balance (higher import costs).
✅ Lower taxes → More disposable income, higher demand, potential economic growth.