The Business Cycle And Policies Flashcards
demand side policies
mainly affect aggregate demand
supply side policies
mainly affect aggregate supply
who manages supply side policies
the government
what are the types of demand side policies
fiscal policy and monetary policy
Fiscal policy
Fiscal policy involves deliberate changes in either government spending or taxation to influence the economy.
What do expansionary fiscal policies do?
Expand the economy but worsen the budget deficit, as the government is spending more (gov spending), and receiving less tax revenue
what does contractionary fiscal policy involve
it occurs when the government decrease government spending and increase taxes. This contracts the circular flow of income and reduces aggregate demand
how could expansionary fiscal policy be used on the top earners?
the top rate of income tax on the UK’s highest earners could be reduced from 45% down to 40%
How can a reduction in income tax lead to the multiplier effect?
A lower income tax rate means that workers have a higher disposable income and therefore consume more. The increase in consumption increases aggregate demand. As consumers spend more, firms will make more sales and therefore more profit. This means that they can invest more. Because investment is a positive component of aggregate demand, AD will increase further.
As consumers spend more and firms make more profit, corporation tax and VAT revenues will increase. This means that the government can spend more and so AD will increase further. As firms expand, they will increase their derived demand for labour, so incomes will increase. This will further increase spending and income tax revenue, causing consumption and government spending to increase further. So, the overall impact on aggregate demand will be much larger.
Why does the government need to be careful when implementing expansionary fiscal policy?
The immediate impact of a reduction in the income tax rate is that revenue from income tax will decrease, which will lead do a decrease in government spending and decrease aggregate demand
in 2016 how much income tax revenue was from the richest 1%
27%
higher income tax downward multiplier effect
A higher income tax rate means workers have a lower disposable income and therefore consume less. The decrease in consumption decreases aggregate demand. As consumers spend less, firms will make fewer sales and therefore less profit. This means that they can invest less and so AD will decrease further as investment is a positive component of AD.
As consumers spend less and firms make less profit, corporation tax and VAT revenues will decrease. This means the government can spend less and so AD will decrease further. As firms contract, they will decrease their derived demand for labour and so incomes will decrease. This will further decrease spending and income tax revenue and so consumption and government spending will further decrease. So, the overall impact on aggregate demand will be much larger.
advantages of raising income tax
-decrease consumption and aggregate demand, which will help to bring the price level down and control inflation
-increase income tax revenue and help the government to balance its budget
disadvantages of raising income tax
-will reduce real GDP
-increase in income tax may increase tax evasion and avoidance which could even mean that income tax revenue decreases
benefits
payments made by the government to unemployed or low income workers
advantages of increasing benefits
-will increase consumption, shifting AD outwards
-Will help to reduce income inequality
disadvantages of increasing benefits
If benefits are too high, there is a significant disincentive for unemployed people to find a job, because they may earn more by claiming benefits. This is known as the benefits trap
Advantages of decreasing benefits
-the budget deficit will improve as the government is paying out less
-Lower benefits may get the unemployed out of the benefits trap by increasing their incentive to work, reducing unemployment
Disadvantages of decreasing benefits
-Poor households will have less to spend, so consumption will fall, which will decrease AD. Also, income inequality will worsen as the poor get poorer.
infrastructure
items needed for businesses to operate such as roads and telecommunications networks
crowding out
When government spending increases, the government demands more borrowed money, land, labour and capital. The price and interest rate increases which increases costs for firms and reduces supply
monetary policy
when the central bank manipulates the base interest rate or the money supply in order to influence aggregate demand
base interest rate
the interest rate offered by the central bank on savings and loans to high street banks
MPC
monetary policy committee. consists of nine members and meets monthly to consider recent developments and likely future developments of aspects of UK economic performance.
When inflation is below the target, the Bank of England is likely to…
decrease the base interest rate in order to increase aggregate demand. this will encourage consumers to save less and consumer more, and encourage firms to invest as it is cheaper to borrow.
When inflation is above the target rate, the Bank of England is likely to …
pursue contractionary monetary policy. This involves increasing the base interest rate in order to reduce aggregate demand and reduce inflation
Expansionary monetary policy
decreasing the base interest rate in order to increase aggregate demand and increase the rate of inflation
quantitive easing
when the central bank buys financial assets such as bonds from high street banks. This increases the money supply for high street banks, which increases the amount of money that banks can lend. This increases the exchange rate which shifts Ad out because exports are cheaper, also increases consumption and investment
disadvantage of quantitative easing
the increase in the money supply may cause an increase in the price level. High inflation could become hyperinflation
supply side policies
any government policies which aim to increase the aggregate supply in the economy
interventionist supply side policy
When the government increases intervention in the economy
market based supply side policy
When the government decreases intervention in the economy
recession
two or more consecutive quarters of negative economic growth
recovery
the part of the business cycle where real GDP is increasing
slump
the part of the business cycle where real GDP is decreasing
boom
the part of the business cycle where real GDP is at its highest
recession
when the economy experiences negative economic growth for two consecutive quarters
positive output gap
when actual gdp is above potential trend gdp
negative output gap
when actual gdp is below potential trend gdp
potential trend gdp
the sustainable rate of gdp growth due to improvements in productive capacity
