4.1  The role of government

Locally

• Collect taxes to fund local services eg rubbish collection

Nationally

• Make decisions to achieve macroeconomic aims

Internationally

• Trading bloc: free trade area which promotes free movement of factors of production between member countries

4.2  The macroeconomic aims of government

Aims

1. Economic growth – increase in country’s GDP

economic growth has the potential to raise living standards

2. Full employment / Low unemployment

• ensure it is making best use of resources
• ↑ employment, ↑GDP, efficiency, standard of living

3. Price stability / Low inflation

• create certainty & encourage investment
• Control economics activity
• To reduce -ve consequences of inflation (Ch31)

4. Balance of payment in equilibrium 

   Balance of payment: financial record of country’s transactions with the rest of the world for a given time period

• Credit items: all payments received from other countries
• Debit items: all payment made to other countries
• To avoid balance of payment deficit (Ch39)

5. Redistribution of income

• To achieve greater equality
• Use of tax, subsidies & welfare benefits

Conflicts between aims

1. Low unemployment vs Low inflation

• Lower unemployment means higher incomes, ↑total demand, creating demand-pull inflation
• Lower unemployment means less spare capacity, wage demand ↑, wage-price spiral
• ↑ employment → cost-push inflation, wages inflation & demand-pull inflation (Ch31)

2. Economic growth vs Balance of payment in equilibrium

• ↑ consumption,↑ import expenditure → balance of payment deficit

3. Low unemployment vs Balance of payment in equilibrium

↑ employment → cost-push inflation, worsen balance of payment

4. Economic growth vs Low inflation

• Production ↑, faster than the ↑in resources, ↑total demand leads to higher prices rather than ↑output & employment
• ↑ investment & consumption → demand-pull inflation

5. Economic growth vs environment protection

Output↑, consumption↑, causing rise in external costs eg pollution

4.3  Fiscal policy

Budget: financial plans in terms of planned revenues & expenditure

Reasons for gov spending

• Services eg healthcare
• Redistribute income & wealth eg provide welfare benefits
• Correct market failure

Reasons for taxation

• ↑ gov revenue to ↑ spending

Tax: gov levy on income & expenditure

Direct taxation: paid from income, profit of individuals/firms	Indirect taxation: imposed on spending on goods/services
Income: on personal incomes	Sales: eg VAT
Corporation: on profits of businesses	Excise duties: on certain goods/services eg alcohol
Capital gains: on earnings made from investments	Customs duties: on foreign imports
Inheritance: on transfer of income/wealth	Carbon tax

Others

• Stamp duty: progressive tax paid on sale of commercial/residential property
• Carbon tax: on vehicle firms that produce excessive carbon emissions
• Windfall tax: on individuals/firms that gain unexpected one-off money eg winning lottery

Progressive taxation	Regressive taxation	Proportional taxation
↑ income level ↑ tax	With specific amount of tax paid ↑ income level ↓ proportion of income, tax	Same tax rate charged

Principles of taxation (quality of good tax)

1. Convenience – easy to pay
2. Certainty – taxpayer know what, when, where & how to pay tax
3. Efficiency – avoid -ve side-effects eg ↑tax rate, ↓incentive, ↓long-term tax revenue
4. Economical – easy & cheap to collect tax to maximise yield relative to cost of collection
5. Equitable (fair) – tax based on taxpayer’s ability
6. Flexibility – to adapt to change in economic environment without rewriting tax legislation

Impact of taxation

1. Price & quantity
2. Economic growth – ↑tax rate, ↓incentive, ↓production
3. Inflation – ↑tax rate, ↓inflation
4. Business location – ↓tax rate countries attract firms
5. Social behavior
6. Tax avoidance & tax evasion

Tax avoidance: legal act of not paying tax

Tax evasion: illegal act of not paying tax

7. Distribution of wealth

Fiscal policy: use of taxes & gov spending to affect economic activity & macroeconomic aims

Fiscal policy measures

Expansionary fiscal policy	Contractionary fiscal policy
↓ tax, ↑ spending & demand ↑employment & output, ↓recession	↑ tax, ↓ spending & demand ↑employment & output, ↓price inflation

Others

Redistribute income & wealth

Adv – Effects on gov macroeconomic aims

Economic growth	↑ gov spending eg on infrastructure projects ↓ taxation
Low unemployment	↓ tax through subsidies/tax concessions, ↑ incentive, ↑ employment
Low inflation	↓ tax, ↑FDI, ↑productive capacity, ↓price inflation Contractionary fiscal policy
Balance of payment in equilibrium	↓ tax, firms stay competitive
Redistribution of income	used progressive taxes & gov spending

4.4  Monetary policy

Money supply: amount of money in economy at particular pt in time

Monetary policy: use of interest, exchange rates & money supply to control amount of spending & investment

Monetary policy measures

Interest rates – ↑interest rates, ↓ borrowing, ↑ saving, ↓ spending, ↓ interest rate

Adv	Dis
↑borrowing, ↑consumption, investment, ↓saving, ↑total aggregate demand, ↑economic growth, ↑employment ↑spending on R&D, ↑productivity, ↑potential growth Value of currency↓, ↓exports prices, ↑import price, ↑net exports	May cause inflation due to increase levels of consumption Value of currency fall, increase import price, decrease choice / purchasing power, decrease standard of living, cost-push inflation

• Money supply – allow commercial banks lend more money, ↑ consumption & investment
• Foreign exchange rates – buying & selling of foreign currencies affect money supply

Expansionary monetary policy	Contractionary monetary policy
↓ interest rates, ↑ borrowing ↑ spending, ↑ economy	↑ interest rates, ↓ spending & investment ↓ inflation

Effects on gov macroeconomic aims

Adv

Dis

Economic growth – ↓ interest rates, ↑ economic growth Low unemployment – ↓ interest rates, ↑ spending, ↑ employment Low inflation – ↓ interest rates, ↑ economic growth, ↑ production without ↑ price – ↑ interest rates, ↓ consumption & investment, ↓ inflation Balance of payment in equilibrium – ↓ interest rates, ↑ competition, ↑ balance of payment Redistribution of income – used progressive taxes & gov spending Balance of payment in equilibrium – ↓ interest rates, ↑ competition, ↑ balance of payment Redistribution of income – used progressive taxes & gov spending Redistribution of income – used progressive taxes & gov spending

Time lags when interest rates changes – make monetary policy less certain & destabilize economy (Contractionary) ↑ interest rates, ↓ spending & investment, ↓ profit, economic growth, employment

4.5  Supply-side policy

Supply-side policy: Policy aimed to increase productive capacity of economy tp encourage economic growth

Supply-side policy measures

1. Education & training – raise skills of workers, increasing productivity, lower cop
2. Labour market reforms eg ↓ power of trade unions, unemployment benefits & min. wages

to ↑ competition & productivity

3. Lower corporation taxes – increase funds available for investment, improve tech, raise productivity, lower cop

4. Lower income tax – increase motivation of workers, raise productivity, lower cop

5 . Deregulation – removing laws and rules may reduce firm’s costs, enabling them to invest more

6. Incentives to work / invest – supply-side policy focus on R&D

7. Privatisation – introduce competition, increase profit incentive, encourage firms to be efficient/reduce costs

8. Subsidies – encourage firms to invest in advanced tech, engage in R&D or train workers, increase productive capacity

9. Cuts in direct tax & welfare payment

Effects on gov macroeconomic aims

Adv	Dis
Economic growth – ↑ productive capacity, ↑ economic growth Low unemployment – ↑ productive capacity, ↑ national output, ↑ employment Low inflation – ↑ productive potential,↑ economic growth without ↑ price Balance of payment in equilibrium – ↑productivity & nation output ↑ balance of payment Redistribution of income	Takes time to achieve benefits

4.6  Economic growth

Economic growth: annual increase in level of GDP

Gross domestic product (GDP): total output in a country over a given time period

GDP per capita: total output in a country over a given time period divided by population

 Components of GDP

1. Consumption expenditure (C): total spending on goods/services by individuals
2. Investment expenditure (I): total capital spending of firms
3. Government spending (G): total spending by gov
4. Export earning (X): monetary value of all exports sold to foreign buyers
5. Import expenditure (M): monetary value of all payment of import
6. Net exports: X-M

Calculation of GDP

GDP = C + I + G + (X-M)

Measurements of economic growth

1. Change in GDP over a period of time
2. Outwards shift of PPC – ↑productive potential

Business cycle

Recession: when there’s a fall in GDP for 2 consecutive quarters

During recession

• ↑ uncertainty in economy, ↓ confident ,↑ unemployment
• ↑ interest rates, ↓ spending
• ↓ income, ↓ spending

Causes of economic growth / boom

1. Quantity & quality of fop
2. Labour force
3. Labour productivity
4. Investment

Consequences of economic growth

Adv	Dis
↑ standards of living ↑ employment ↑ tax revenue for gov	-ve environmental impacts eg pollution Risk of demand-pull inflation Inequalities in income & wealth Reduction of resources due to eg deforestation

Policies to ↑ economic growth

1. Expansionary fiscal policy
2. Expansionary monetary policy
3. Supply-side policy

4.7  Employment and unemployment

Employment: use of labour as fop in economy

Unemployment: ppl willing & able to work, and actively seeking employment, but unable to find work

Causes

• High level of education meet the requirements needed for the jobs
• High level of gov spending on subsidising firms can lower cop & encourage output

Changing patterns & level of employment

1. Employment sector – as country develops, employment in primary sector ↓ & tertiary sector ↑
2. Delayed entry to workforce – ↑ education time
3. Ageing population – ↓ labour supply, employ older labour
4. Formal sector employment: officially recorded employment where workers pay income taxes & contribute to GDP

• As country develops, ↑ workers employed in formal economy & ↓ in informal economy

5. Female participation rates: proportion of women who are active in labour force

6.Public sector employment – as countries move towards market economy, ↓ ppl employed in public sector

7. Flexible working patterns – eg employ part-time workers, allow ppl work from home

Explain causes of low unemployment

• High level of education meet the requirements needed for the jobs
• High level of government spending on subsidizing forms can lower cop & encourage output, so more workers needed

Measuring unemployment

1. Claimant count: no of ppl who are out of work & claim unemployment benefits
2. Labour force survey: uses ILO’s standardised household-based survey to collect work-related statistics

Calculation of unemployment rate

Causes & types of unemployment

Frictional	occurs due to time delay when ppl change jobs
Structural	occurs when demand for products produced in a particular industry ↓
Cyclical (demand-deficient unemployment)	Caused by lack of demand, which ↓ national income

Consequences of unemployment

1. Individual become stress, depress
2. Family suffer low income → arguments
3. ↓ consumption, firms ↓ profits → business failure
4. ↓ spending & GDP, ↓ competition
5. Mass unemployment → poverty / ↑ crime rate

Policies to reduce unemployment

1. Expansionary fiscal policy
2. Expansionary monetary policy
3. Supply-side policies
4. Protectionist measures eg tariffs & quotas (Ch 37)

4.8  Inflation and deflation

Inflation: sustained rise in general price level of goods/services & fall in value of money in an economy over time

• More frequent problem than deflation in recent years

Causes of inflation

1. Cost-push inflation: caused by ↑ cop, firm focus to ↑ price
2. Demand-pull inflation: caused by ↑ demand, ↑ general price level
3. Imported inflation: caused by ↑ import price, ↑ cop, ↑ domestic inflation

Consequences of inflation

1. Menu costs: cost to a firm resulting from changing its prices
2. Shoe leather costs: cost of time and effort that ppl spend prevent inflation, eg holding less cash
3. Less saving – ↓ purchasing power, ↑ cost of living, ppl need more money to buy goods/services, ↓ saving, ↑ borrowing & spending, ↓ funds available for investment
4. Fixed income earner – ↓ real income
5. Low income earner – have high PED
6. Exports – ↑ cop, ↓ competitiveness & profits, ↓ economic growth
7. Importers – imported inflation
8. Employers – workers demand ↑ wages to maintain real income level
9. Wage-price spiral: when trade unions negotiate ↑ wages to keep in line with inflation, but firms ↑ price to main profit margins, so ↑ inflation
10. • Economic growth – ↑ uncertainty, ↓ investment, ↓ economic growth

Winners – borrowers & importers

Losers – consumers, lenders, savers, fixed & low income earners, exporters & employers

Deflation: sustained fall in general price level of goods/services & rise in value of money in an economy over time

Causes of deflation

1. Benign deflation: caused by ↑ level of supply of goods/services, ↑ productive capacity,

↓ general price level

      2. Malign deflation: ↓ level of demand, ↓ general price level due to excess capacity

Consequences of deflation

1. Unemployment – ↓ demand of goods/services, ↓ demand for labour
2. Bankruptcies – ↓ spending, ↓ profit, ↓ repay loads, ↑ bankruptcies
3. Gov debt – ↑ unemployment, bankruptcies & economy, ↑ spending coz malign deflation, create budget deficit → ↑ borrowing
4. Consumer confidence – ↓ confidence
5. Deflationary spiral –  firms ↓ profit, ↓ investment,↓ economy, ↓ cop by ↓ workers, ↓ consumption & confidence → deflationary spiral.

Calculation

Measurement of inflation & deflation

Consumer Price Index (CPI)

CPI measures changes of prices of a basket of goods/services in a basket based on a survey of households. It compares price index with base year (100) and reflect the importance in buying patterns. CPI also compares price index. Eg if CPI rises from 100 to 105, the inflation rate is 5%.

Eg

Assume 2016 is the base year, when total basket price was $20.

Step 1 – calculate price indices

Step 2 – calculate % change in price indices

Policies to control inflation & deflation

1. Contractionary fiscal policy
2. Contractionary monetary policy
3. Supply-side policies

Exam questions