Theme 4: The role of the state in the macro-economy

Question 1

What is the total amount that the government spends known as?

Answer 1

Total managed expenditure

Question 2

3 types of public expenditure

Answer 2

• Capital expenditure- long term investment expenditure
• Current expenditure- day to day expenditure on goods and services
• Transfer payments- payment by state to individuals without exchange of goods and services. In the aim of redistributing income.

Question 3

What % of GDP in 2018-19 was planned to be spend on public expenditure?

Answer 3

just below 40%

Question 4

What is an issue with using public expenditure as a % of GDP?

Answer 4

It can appear as though public expenditure changes when in fact it’s a change in GDP.

Question 5

5 reasons for changes in public expenditure?

Answer 5

1. The economic cycle- In periods of recession public expenditure rises
2. Changing age distribution- Ageing populations place greater pressure on established healthcare systems
3. Changing expectation- New technology results in increased expectations.
4. Financial crises- Government may have to spend money bailing out financial institutions.
5. Economic philosophy- A country’s model of economy varies. eg European countries have higher taxation and higher public expenditure in comparison to the USA.

Question 6

What impact can changes in the size of public expenditure have on productivity and growth?

Answer 6

• Public spending on infrastructure leads to improved supply side performance in an economy.
• Free market economists argue that cutting public expenditure will lead to spending on the private sector resulting in more efficient and productive outcomes.

Question 7

What impact can changes in the size of public expenditure have on living standards?

Answer 7

With 0 public expenditure there would be be market failure and absolute poverty would exist.

Question 8

What impact can changes in the size of public expenditure have on crowding out?

Answer 8

Resource crowding out when the economy is working at full employment expansion of the public sector means that there is a shortage of resources in the public sector.

Financial crowding out when the the expansion of the state sector is financed by increased government borrowing. Causing increased demand for loanable funds that drive up interest rates and crowds out private sector investment.

Question 9

What impact can changes in the size of public expenditure have on level of taxation?

Answer 9

If public expenditure is high then level of taxation must also be high to fund this.

Free market economists favour lower levels of public expenditure to allow free enterprise to grow and generate economic growth.

Question 10

What impact can changes in the size of public expenditure have on equality?

Answer 10

Public spending on education can help to create more equal opportunities for citizens.

High levels of public expenditure can mean higher benefits and pensions, which improved living standards.

Question 11

What are the 3 categories of taxation?

Answer 11

• Progressive- as income rises a larger % of tax is paid
• Proportional- the % of income paid is constant, no matter what the level of income.
• Regressive- as income rise a smaller % of income is paid in tax

Question 12

What are Adam Smith’s ‘canons of taxation’?

Answer 12

1. The cost of collection should be low relative to the yield
2. The timing should be certain and clear.
3. The means of collections should be convenient for the taxpayer
4. Taxes should be levied based on the ability to pay of the taxpayer.

Question 13

Draw and explain the Laffer Curve

Answer 13

If taxation is too high it becomes a disincentive to work. The reasons behind the fall in revenue is:

• increased disincentive to work.
• An increase in tax avoidance and evasion
• a rise in the number of tax exiles (leave the country to avoid paying tax)

Question 14

Why is VAT a regressive tax?

Answer 14

As the poorest 10% of households pay almost 20% of net household incomes as VAT, where as richest 10% are impacted much less since lower-income households spend a greater share of their income on consumption

Question 15

What impact will an increase in taxes have on real output and employment?

Answer 15

An increase in tax will reduce aggregate demand because taxes are a leakage from the circular flow of income . This might reduce real output and cause an increase in unemployment.

However, in the long run changes in tax rate can impact on aggregate supply. Lower direct tax rates can lead to higher incentives, which lead to increased investment by firms and increased participation in the labour market. In effect resulting in an increase in economic growth and a rise in employment.

Question 16

What impact will an increase in taxes have on the price level?

Answer 16

An increase in indirect taxes can be inflationary if it causes a wage-price spiral. (Increase in prices leads to increased wage demands which increases prices again)

Question 17

What impact will an increase in taxes have on the trade balance and FDI?

Answer 17

Increase in income tax would reduce disposable income and consumption. In turn this would reduce demand for imports and so result in an improvement in the balance of trade.

A higher rate of corporation tax might deter FDI if rates are lower in other countries.

Question 18

Discretionary fiscal policy

Answer 18

Government making decisions about its spending or taxes. Not the same as automatic changes that occur.

Question 19

What is an example of an automatic stabiliser?

Answer 19

Such as an increase in spending on benefits when more people become unemployed.

Question 20

Fiscal deficit VS national debt?

Answer 20

Fiscal deficit- When government spending exceeds tax revenue in a financial (fiscal) year so the government needs to borrow money.

National debt- The cumulative total of past government borrowing.

Question 21

Cyclical vs structural fiscal deficit?

Answer 21

Cyclical fiscal deficit- During a downturn in the economy because tax revenue will be falling and government expenditure will be rising.

Structural fiscal deficit- Remains even when an economy is operating at its full potential.

Question 22

3 factors effecting the size of fiscal deficits?

Answer 22

1. Economic cycle
2. Housing Market- during periods of growth in the housing market tax income rises due to the amount of stamp duty.
3. Political priorities and unplanned events- Government might have to respond to unforeseen events.

Question 23

What are recent examples of government policy contributing to national debt in the short run?

Answer 23

Crossrail and HS2 which should improve productivity in the long run.

Question 24

What impact might a rise in government borrowing have on interest rates?

Answer 24

A rise in government borrowing may lead to a rise in interest rates. This is because the demand for funds rises relative to their supply. May lead to crowding out.

Question 25

What might government spending have on the rate of inflation?

Answer 25

The government needs more money as tax receipts do not cover expenditure, they have 2 options: borrow money or print money. If the government prints more money this would likely lead to inflation.

Question 26

What impact can the size of fiscal deficits and national debt have on inter-generational equity?

Answer 26

Government borrowing today can lead to future generations having to pay this back, however they might benefit due to the benefits of the infrastructure built as a result of the money. However a country with too large of a debt may be less likely to attract investors due to investment seeming too risky.

Question 27

What impact can size of fiscal deficit have on a country’s credit rating?

Answer 27

Countries are given credit ratings by private investment companies. They use data such as size of national debt and a country’s financial history.

Question 28

What are the two types of fiscal policy?

Answer 28

Expansionary fiscal policy- the use of taxes, public spending and government borrowing to stimulate the economy and increase AD.

Deflationary fiscal policy- the rise of taxation and reduced public expenditure to reduce the level of AD in the economy.

Question 29

What is Demand management?

Answer 29

When taxation and government spending were used as well as other approaches such as monetary policy, to manage demand.

Question 30

What is the impact of expansionary fiscal policy on fiscal balance?

Answer 30

• Reduces taxes to stimulate spending and investment. Increase public expenditure,
• Increased public sector borrowing- leads to higher fiscal debt.
• Increased AD

Question 31

What is the impact of deflationary fiscal policy on fiscal balance?

Answer 31

• Increase taxes to discourage consumer spending. Reduce public expenditure.
• Reduced public sector borrowing- leads to lower fiscal debt or fiscal surplus
• Reduced AD

Question 32

What effect can fiscal policy have on poverty and inequality?

Answer 32

1. Welfare benefits
2. Provisions of certain goods and services
3. Progressive taxes- narrow the gap between peoples disposable incomes

Question 33

What impact does expansionary fiscal policy have on national debt?

Answer 33

Increased fiscal deficit which leads to increased national debt

Question 34

What impact does deflationary fiscal policy have on national debt?

Answer 34

Reduced fiscal deficit which leads to reduced national debt.

Question 35

What is monetary policy?

Answer 35

Monetary policy involves decisions on interest rates, the money supply and exchange rates.

Question 36

What impact has globalisation had on policy makers and reaching goals?

Answer 36

It is now more difficult as decisions and changes around the world cause changes in other countries such as growth in china has pushed up prices of commodities, including food, causing cost push inflation.

Question 37

What is the aim of monetary policy?

Answer 37

To keep inflation between 1% and 3%

Question 38

What are the aims of supply side policies?

Answer 38

To increase the productive potential of the country and therefore increase its long-run aggregate supply.

Question 39

How do supply-side policies increase economic development? What do they include?

Answer 39

• Improving education
• Improving healthcare
• Advocating entrepreneurship
• Encourage increased labour force participation

Question 40

What are the effects of supply-side policies?

Answer 40

Improved international competitiveness due to improved competitiveness, which leads to lower average costs for firms.

Improved competitiveness should lead to increased exports and less reliance on imports, leading to higher economic growth and lower unemployment.

Question 41

What polices can the Government and bank of England use to reach their goals?

Answer 41

• Exchange rates
• Direct controls
• Monetary policy
• Supply side policy
• Fiscal policy

Question 42

What is the impact of exchange rate policies?

Answer 42

Effecting international competitiveness and can increase/decrease imports and can also increase/decrease exports.

Question 43

What are direct controls?

Answer 43

Forms of control that work outside the market system. They are a government measure that is imposed on the price or quantity of a product or a factor of production.

Question 44

What are examples of direct controls?

Answer 44

• Maximum price controls
• minimum guaranteed prices
• fixing quotas on imports
• limiting the amount of foreign currency that citizens can buy in a year
• Fixing max interest rates that payday lenders can charge their customers.

Question 45

What problems face policy makers?

Answer 45

• Inaccurate or out of date information
• Risks and uncertainties
• Inability to control external shocks

Question 46

Measures to control transnational companies?

Answer 46

• Requirement to use local factors
• Requirement that global companies exports a certain proportion of its output
• Requirement to set up joint ventures
• Transfer pricing

Question 47

Why might external shocks cause a rise in commodity prices?

Answer 47

DRAW THIS pg 198