Topic 4: Government and the Macroeconomy

Question 1

What is the role of the government?

Answer 1

• improve living standards
• try to achieve macroeconomic objectives:
  1. economic growth
  2. low and stable inflation
  3. low unemployment
  4. equity (fairness) in the distribution of income
  5. balance of payments

Question 2

Role of the government (local vs national vs international)

Answer 2

Local:
1. Municipal
National:
1. Taxes (Fiscal Policy)
2. Infrastructure (Supply side policy)
3. Educational reforms (Supply side policy)
4. Interest rates (monetary policy)
International:
1. Quotas (protectionism)
2. Tariffs (protectionism)
3. Trading Blocs (removes barriers to trade with other countries)

Question 3

What is GDP?

Answer 3

Amount of goods/services produced in an economy in a year

Question 4

What are the limitations of GDP?

Answer 4

1. Exclusion of non-market transactions (informal economic activity)
2. The failure to account for the degree of income inequality in society
3. Economic bads (failure to account for costs imposed on human health and the environment of negative externalities arising)

Question 5

What is a recession?

Answer 5

A period of temporary economic decline, identified by a fall in GDP in 2 successive quarters (6 months)

Question 6

Causes of a recession

Answer 6

1. Oversupply (economic boom - companies tend to increase production to meet consumer demand, but when demand peaks and starts to decline, the excessive supply of goods/services that aren’t consumed can lead to a recession
2. Uncertainty (war and pandemics, people are worried to spend)
3. Financial crisis (if banks have a shortage in liquidity, they reduce lending and this reduces investment)
4. Rise in interest rates (cost of borrowing increases)

Question 7

Describe economic growth in the economic cycle

Answer 7

economic activity is increasing rapidly

Question 8

describe an economic boom in the economic cycle

Answer 8

aggregate demand, sales, profits peak. may have rapid inflation bc demand exceeds the amount of goods/services can produce/supply. consumer confidence + spending begins to decline as inflation + interest rises

Question 9

describe an economic recession in the economic cycle

Answer 9

general slowdown in economic activity
unemployment rises, incomes start to fall
firms reduce investment
competition between rival firms increase
government may increase public spending
recession that is prolonged may become a slump/depression. deflation may be a result

Question 10

describe an economic recovery in the economic cycle

Answer 10

business and consumer confidence start to recover
spending on goods and services starts to rise
unemployment falls, incomes rise
economy expands

Question 11

consequences of economic growth

Answer 11

good:
1. increase in standard of living
2. reduction in unemployment
3. increased tax revenue, can be spent on public goods
bad:
1. inflation
2. environmental damage
3. inequality of income (trickle down theory)

Question 12

define unemployment

Answer 12

those who are WILLING, ABLE AND ACTIVELY SEEKING, but are not working

“economically inactive”, or exceptions to unemployed: disabled, retired, students etc

Question 12

define unemployment

Answer 12

those who are WILLING, ABLE AND ACTIVELY SEEKING, but are not working

“economically inactive”, or exceptions to unemployed: disabled, retired, students etc

Question 13

how to get the number of unemployed?

Answer 13

1. international labour organisation
   - out of work for 4 weeks, ready to start within 2 (easier to qualify)
2. clairmont count
   - those claiming unemployment benefits

Question 14

changing trends in labour markets

Answer 14

1. later entry into labour market
2. later withdrawal from labour market
3. rise of “the gig” or informal economy

Question 15

define cyclical unemployment

Answer 15

unemployment caused by a reduction in total demand in an economy

↓ consumption ↓ demand for labour

Question 16

define structural unemployment

Answer 16

unemployment caused by a geographical change of location of jobs, the demand for skills and labour market rigidities

Question 17

define seasonal unemployment

Answer 17

unemployment caused by a change in season or trend

Question 18

define frictional unemployment

Answer 18

unemployment caused by workers transitioning between jobs

Question 19

consequences of unemployment

Answer 19

1: low/no income
2: social issues
3: government expenditure
4: decline in profit for firms as ↓ incomes = less demand
5: lower tax revenue
6: deskilling can reduce international competitiveness

Question 20

define inflation

Answer 20

a sustained increase in the general price level

Question 21

define deflation

Answer 21

a sustained decrease in the general price level

Question 22

consumer price index

Answer 22

based on a basket of goods
- household expenditure survey
- retail price data

↑ CPI = inflation
↓ CPI = deflation

Question 23

limitations of cpi

Answer 23

1: establishing a common basket of goods
2: might have discounts/trends/seasonal items
3: items not being consumed disappear from markets
4: battle to be constantly updated with basket of goods

Question 24

types/causes of cpi

Answer 24

1: demand pull inflation - increase in price due to aggregate demand > aggregate supply
2: cost push inflation - increase in cost of production

3: demand side deflation - deflation caused by a decrease in total spending in an economy
4: supply side deflation - caused by a reduction in costs of production

Question 25

what is the difference between disinflation, inflation and deflation?

Answer 25

disinflation - fall in growth of prices
inflation - positive % growth in prices
deflation - negative % growth in prices

Question 26

consequences of inflation

Answer 26

1. menu costs
2. business uncertainty
3. lower purchasing power
4. borrowers -> better position
5. lenders -> worse position
6. savers -> value of money ↓
7. people on benefits miss out

Question 27

define fiscal policy

Answer 27

a set of gov policies relating to government spending and taxation (demand-side policy) -> aims to change aggregate demand in an economy

Question 28

government spending

Answer 28

current spending - salaries, supplies, day to day expenditure
capital expenditure (main) - bridges, new buildings, major projects
transfer - gives money to people ~> consumption vouchers

Question 29

define taxation

Answer 29

a government levy on income, expenditure or wealth

Question 30

types of taxation

Answer 30

direct taxation - taxation taken directly from income, profits and wealth
indirect taxation - taxation taken indirectly from income through the consumption of goods/services

Question 31

income tax

Answer 31

progressive taxation - when income increases, rate of tax increases. takes a larger percentage of the income or wealth of the rich
advantage: more able to pay tax
disadvantage: disincentivised - work less, less income, less tax

regressive tax - when income increases, the rate of tax decreases. takes a larger percentage of the income or wealth of the poor

proportionate/proportional taxation: the rate of tax remains the same as income increases

Question 32

qualities of good tax

Answer 32

1. economical - shouldn’t be expensive for government to collect
2. equitable - fair, shouldn’t be placing a large burden on low income earners, should be based on ability to pay
3. convenience - reasonably convenient to pay for
4. certainty - rate of tax shouldn’t change frequently

Question 33

aggregate demand calculation

Answer 33

AD = C + I + G + (x-m)

c = consumption
i = investment
g = gov spending
x-m = net exports (exports-imports)

Question 34

define expansionary fiscal policy

Answer 34

increases aggregate demand, lower unemployment and increase in economic growth

Question 35

define contractionary fiscal policy

Answer 35

decreases aggregate demand, lower demand pull inflation