role of the state in the macroeconomy Flashcards
public goods
goods which would be under provided and under consumed because: they are non excludable and non rivalrous
external benefits
benefits to third parties who are not part of the transaction between a consumer and a producer
external costs
costs to third parties who are not part of the transaction between a consumer and producer
public expenditure
relates to expenditure by central governments, local authorities and public sector organisations
public expenditure: capital expenditure
long term investment expenditure on capital projects such as HS2, new school etc.
public expenditure: current expenditure
relates to the governments day to day expenditure on goods and services such as wages
public expenditure: transfer payments
payments made by the state to individuals without there being an exchange of goods or services. used to redistribute income. eg state pension
factors impacting the size of public expenditure
the level of GDP, demand for public services, size and age distribution of the population, the rate of inflation, state of economy, political priorities
social protection, health and education has high gov expenditure because:
ageing population, increased number of children school age, increased expenditure on tax credits, increased payments for housing benefits as a result of rising rents
significance of different levels of public spending as a proportion of GDP: productivity and growth
if expenditure high, then productivity and growth may be low, because of the absence of a profit motive and competition in the public sector
significance of different levels of public spending as a proportion of GDP: living standards
impact depends on the composition of public expenditure. eg proportion spent on transfer payments and on health relative to the amount spent on defence
significance of different levels of public spending as a proportion of GDP: crowding out
structural deficits imply that the size of the public sector is increasing, which could cause resource or financial crowding out
significance of different levels of public spending as a proportion of GDP: level of taxation
if public expenditure is high then its likely that taxation will be also high
significance of different levels of public spending as a proportion of GDP: equality
high public spending, greater equality, however some countries have high public spending and high inequality
progressive taxation
taxes which the proportion of income paid in tax rises as income increases
proportional taxes
taxes which the proportion of income paid in tax remains constant as income increases
regressive taxes
taxes which the proportion of income paid in tax falls as income increases
direct taxes
taxes on income and wealth, income tax, corporation tax, capital gains tax
indirect taxes
taxes on expenditure, VAT, excise duties, tariffs
effects of changes in direct tax rates: incentives to work if tax high
those unemployed less willing to take jobs, working currently working less willing to do overtime
effects of changes in direct tax rates: tax revenues if tax high
tax revenues will initially rise, but eventually fall as people do tax avoidance, there are disincentives to work, and there are a rising number in tax exiles(shown by the Laffer curve)
effects of changes in direct tax rates: income distribution
increase in income tax will make the tax system more progressive, so income distribution more equitable
Effects of change in direct tax: real output and employment
Higher rates of income tax would cause a fall in disposable income, fall in consumption and a fall in AD. The disincentive effects of higher rates of income tax might also cause a fall in AS. Consequently, there would be a fall in real output and employment.
Effects of change in direct tax: the price level
The fall in AD following higher income tax rates would cause a fall in price level. This may be partially offset by any fall in AS but the impact of the leftward Shift in the AD curve is likely to be more significant
Effects of change in direct tax: the trade balance
Increase in come tax would reduce disposable income. So there would be a fall in consumption, resulting in a decrease in imports. Consequently, there should be an improvement in the trade balance
Effects of change in direct tax: FDI flows
Increase in direct taxes is likely to deter inward FDI. Further an increase in income tax rates is also likely deter it because disposable income would fall, causing a decrease in comsumption
Effects of change in indirect tax: incentives to work
An increase in VAT rate might cause an incentive to work Moore because workers will try to maintain living standards by working harder
Effects of change in indirect tax: tax revenues
If VAT increases, then tax revenues will almost certainly increase as VAT is on most goods and services
Effects of change in indirect tax: income distribution
An increase in VAT would cause income distrust union to be less even, as its broadly regressive
Effects of change in indirect tax: real output and employment
Fall in real income if VAT higher, which would cause a fall in consumption and a fall in AD, leading to a reduction in output and employment. For businesses, the higher VAT rate would raise costs, so causing a fall in AS, which would lead to a reduction in output and employment
Effects of change in indirect tax: the price level
Increased indirect taxes will increase price level in short run. However, taxes are leakages from circular flow, so higher indirect tax will cause a decrease in AD and therefore fall in the price level in the longer term
Measures to reduce fiscal deficits and national debt
Government could: reduce public expenditure, increase taxes, implement policies to increase economic growth
Measures to reduce poverty and inequality
Improve quality of education and training for the poor, make tax system more progressive, higher inheritance taxes, measures to reduce unemployment, introduce minimum wage
Changes in interest rates and the supply of money
QE designed to make it easier and cheaper for businesses to borrow money, but may cause inflation. Central banks make decision about changing interest rates
Measures to increase international competitiveness
Policies to eliminate a BofP deficit on current account, subsidies, lower prices of raw materials
Use of macroeconomic policies to respond to external shocks to the global economy and examples of external shocks
External shocks take many forms e.g. sudden change in oil prices, financial crisis, contagious disease. What’s used depends on what the shock is
regulation of transfer pricing
Difficult for governments to control price, although attempts are being made to seek international agreement to ensure that global companies pay a fair amount of tax in each of the countries in which they operate
limits to government ability to control global companies
Have a monopoly on technological or intellectual property, threaten to withdraw investment, be ‘footloose’ ie they can move easily from one country to another in search of lowest wage costs
Problems facing policy makers when applying policies: inaccurate information
Forecasts are inaccurate (eg for future rate of inflation)
Estimates of last data for a variety of indicators are frequently revised significantly in subsequent years (GDP and BofP account)
Problems facing policy makers when applying policies: risks and uncertainties
Risk is present when future events occur with measurable probability , uncertainty is present when the likelihood of future events is indefinite or incalculable . Can be eliminated or insured against
Problems facing policy makers when applying policies: inability to control external costs
Most of the external shocks are difficult to predict and, consequently, to allow for when applying policies. Therefore policies being followed may no longer be appropriate
