Flashcards · 9708 · AS Topic 5

Government macroeconomic intervention (AS Level) flashcards

21 cards on AS Topic 5, subtopics 5.1 to 5.4. Pick a subtopic or study them all.

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5.1 Government macroeconomic policy objectives

Price stability: Low, steady inflation.
The main macroeconomic objectives at AS Level, with the problem and fiscal response for each: Price stability: demand-pull inflation; contractionary policy. Low unemployment: cyclical unemployment; expansionary policy. Economic growth: weak growth; expansionary policy now, plus capital spending and incentives for capacity.
The three types of macroeconomic policy: Fiscal policy (government spending and taxation), monetary policy (interest rates, money supply, credit rules) and supply-side policy (raising productive capacity).
CPI rises from 120.0 to 123.6; 2.4 million are unemployed in a labour force of 40 million. Find inflation and the unemployment rate.: Inflation = 3.6 ÷ 120 × 100 = 3.0%. Unemployment rate = 2.4 ÷ 40 × 100 = 6.0%.

5.2 Fiscal policy

Budget deficit, budget surplus and national debt: Deficit: spending greater than revenue (a flow per year). Surplus: revenue greater than spending. National debt: total owed by the government from past borrowing (a stock).
Revenue 400, spending 430, GDP 1,250, opening debt 520. Find the budget balance and the new debt as a share of GDP.: Balance = 400 − 430 = −30, a deficit of 2.4% of GDP. Debt rises to 550, which is 44.0% of GDP.
Progressive, regressive and proportional taxes; average versus marginal rate: Progressive: takes a higher proportion of income as income rises; regressive: a lower proportion; proportional: the same proportion. Average rate = tax ÷ income. Marginal rate = the rate on the next unit of income.
Current versus capital government spending: Current spending is used up in the year (wages, benefits, interest). Capital spending adds lasting assets (roads, schools); it adds to demand now and may raise productive capacity later.
AD: Y = 1,000 − 5P, SRAS: Y = 400 + 5P. Government spending raises AD by 50. Find the new equilibrium.: Before: 10P = 600, so P = 60 and Y = 700. After: 1,050 − 5P = 400 + 5P, so P = 65 and Y = 725. Price level +8.3%, output +3.6%.
Why does an income tax cut shift AD by less than an equal rise in government spending?: Households save part of the extra disposable income, so first-round consumption rises by less than the tax cut. Government spending adds its full amount to AD at once. Leakages into saving and imports reduce both effects.

5.3 Monetary policy

Monetary policy and its tools: Changes by the government or central bank to interest rates, the money supply or credit regulations, aimed at aggregate demand and macroeconomic objectives.
Chain of reasoning: the central bank cuts the policy interest rate: Bank lending rates fall → borrowing cheaper, saving less rewarding → households spend more and firms invest in more projects → C and I rise → AD shifts right → real output, the price level and employment rise (if there is spare capacity).
Real interest rate: The nominal rate minus the inflation rate (approximately). Example: 5.5% − 2.0% = 3.5%.
How do credit regulations such as a loan-to-value cap work?: A cap limits the loan to a share of the price: at 85%, a 400,000 home allows a loan of 340,000 and needs a deposit of 60,000. Tightening the cap means fewer people can borrow, so AD shifts left.
Money market diagram: what happens to the interest rate when the money supply rises?: Demand for money slopes down; supply is vertical. A rise in supply shifts it right and the equilibrium rate falls. Example: demand L = 480 − 30r; supply 330 gives r = 5%, supply 360 gives r = 4%.
Monetary policy: "it depends on…" evaluation points: Time lags, low confidence, spare capacity, how much debt is on fixed rates, the split between borrowers and savers, and whether inflation is demand-pull (it works) or cost-push (it mainly cuts output).

5.4 Supply-side policy

Supply-side policy: Policy that raises the economy's capacity to produce, shifting the LRAS curve right. Its objectives are to raise productivity and productive capacity.
Three supply-side tools named in the syllabus, and how each works: Training and education: raise the skills and output of labour. Infrastructure development: cuts travel time and costs, links markets. Support for technological improvement: subsidies or grants lower the cost of research and investment.
AD: Y = 900 − 2P. A supply-side policy moves SRAS from Y = 300 + 4P to Y = 360 + 4P. Find the effect.: Before: P = 100, Y = 700. After: 6P = 540, so P = 90 and Y = 720. Output +2.9% and the price level −10%: unlike demand-side expansion, prices fall as output rises.
Monetary policy versus supply-side policy: Monetary policy is demand-side (shifts AD), usually quicker, but the price level rises with output. Supply-side policy shifts AS, is usually slower and costly, but output can rise while the price level falls.
Supply-side policy: main limits: Long time lags, high cost to government, uncertain take-up, and it needs enough demand to use the extra capacity.