Flashcards · 2281 · Topic 4

Government and the macroeconomy flashcards

44 cards on Topic 4, subtopics 4.1 to 4.8. Pick a subtopic or study them all.

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4.1 The role of government

Local, national and international roles of government: Local: services near home, local planning (e.g. waste collection). National: laws, defence, taxing and spending, education and health, regulating markets, macroeconomic aims. International: agreements, trade deals, cross-border problems, aid.
Why is government needed in an economy?: Private firms under-provide public goods; the market ignores external costs such as pollution; markets alone leave some people in poverty; markets alone do not guarantee jobs or stable prices.
How do you decide which level of government should deal with a problem?: Match the level to the scale: if one council can solve it, local; if it needs a national budget or law, national; if it crosses a border, international.

4.2 The macroeconomic aims of government

The five macroeconomic aims of government: Economic growth; full employment (low unemployment); stable prices (low inflation); balance of payments stability; redistribution of income.
Aim vs criterion: An aim is a goal (e.g. stable prices). A criterion is the measurable target or range used to judge it (e.g. inflation between 1% and 3%).
Explain the conflict between full employment and stable prices: Higher total demand → firms hire → unemployment falls → labour becomes scarcer and wages rise → costs and prices rise → inflation. The conflict is strong near full capacity and weak with spare capacity.
Explain the conflict between economic growth and balance of payments stability: Incomes rise → spending on imports rises → imports grow faster than exports → current account moves towards deficit. Weaker if growth is export-led.
Nominal GDP rises from 800 to 852.8 while the price index rises from 100 to 104. Find real growth: Real GDP = 852.8 ÷ 104 × 100 = 820. Real growth = (820 − 800) ÷ 800 × 100 = 2.5%.
Inflation falls from 5% to 2%. Is that a percentage change or a percentage point change?: It is a fall of 3 percentage points. Prices are still rising, only more slowly.

4.3 Fiscal policy

Government budget: The government's plan of expected spending and revenue for a set period, usually a year.
Direct tax vs indirect tax: Direct tax: collected from the person or firm that earns the income or owns the wealth (income tax, profits tax). Indirect tax: added to spending; the seller collects it and hands it over (sales tax, customs duties).
Progressive, regressive and proportional tax: Progressive: takes a bigger share of income from richer people. Regressive: takes a smaller share of income from richer people. Proportional: takes the same share from everyone. It is about the share, not the amount.
Qualities of a good tax: Equitable (based on ability to pay), certain, convenient, economical (low collection cost), efficient (does not damage incentives) and flexible.
Fiscal policy, and the budget balance formula: Fiscal policy: the government altering its spending and its taxes to steer the economy towards its aims. Budget balance = revenue − spending: negative is a deficit, positive a surplus. Revenue 64, spending 70 → deficit of 6.
Expansionary fiscal policy: what it is and a chain to lower unemployment: Higher government spending and/or lower taxes. Example: an income tax cut raises take-home pay → households spend more → shops sell more → firms hire → unemployment falls. Risks: higher deficit, inflation near capacity, time lags, more imports.

4.4 Monetary policy

Monetary policy: Government action, usually through the central bank, on borrowing costs (interest rates), the quantity of money and the currency's value, to steer the economy towards its aims.
Money supply: The stock of money in a country at a given moment: notes, coins and bank deposits.
What happens when the central bank raises interest rates?: Borrowing becomes dearer and saving more rewarding → consumer spending and investment fall → output and demand-pull inflation fall. Higher rates also tend to attract foreign savers, so the currency appreciates.
How might a cut in interest rates affect the balance of payments?: Lower rates tend to make the currency depreciate (fewer foreign savers buy it), so exports become cheaper abroad and imports dearer at home. Exports tend to rise and imports to fall, if demand is price elastic enough.
Evaluation: why might an interest rate cut fail to raise spending?: Time lags; banks may not pass the cut on; low confidence means households and firms will not borrow; a weaker currency raises import prices. It depends on confidence and how indebted households are.
A savings account pays 5% while inflation is 3%. What is the approximate real interest rate? What if inflation is 6%?: Real interest rate ≈ nominal rate − inflation rate. 5 − 3 = about +2%. 5 − 6 = about −1%: savers lose purchasing power.

4.5 Supply-side policy

Supply-side policy: Government action to increase the economy's ability to produce, by raising the productivity and efficiency of labour, capital and markets.
Name six supply-side policy measures: Education and training; labour market reforms; lower direct taxes; deregulation; improving incentives to work and invest; privatisation.
How does more spending on education and training work as a supply-side policy?: Workers gain skills → output per worker rises and workers become more mobile → firms' costs fall and structural unemployment falls → capacity grows (PPC shifts out). Drawbacks: slow, costly, skills may not match jobs.
Deregulation vs privatisation: Deregulation removes rules and entry barriers to increase competition. Privatisation sells state-owned firms to the private sector, so the owner changes.
Supply-side policy vs demand-side (fiscal and monetary) policy: Supply-side policy works on capacity and costs, usually over years. Fiscal and monetary policy work on spending and usually act faster. Supply-side policy does little to cure cyclical unemployment.

4.6 Economic growth

Economic growth: A rise over time in how much an economy produces, measured by the percentage rise in real GDP.
GDP, and real GDP vs nominal GDP: GDP: the value of all goods and services made within a country's borders over a period. Nominal GDP: valued at current prices. Real GDP: valued at constant prices, so it tracks output only; real GDP = nominal GDP × 100 ÷ price index.
Recession: A fall in real GDP, often judged by the rule of thumb of two quarters in a row of decline. On a PPC diagram it is a move from the curve to a point inside it; the curve itself does not shift.
Two ways an economy can grow, shown on a PPC: A rise in total demand uses idle resources: the point moves from inside towards the PPC (can be quick). More capacity from investment, technology, or more or better factors: the whole PPC shifts out (usually slow).
Output per worker rises 5% and the labour force rises 2%. By how much does potential output rise?: Multiply the changes: 1.05 × 1.02 = 1.071, a rise of 7.1% (not 7%).
Two benefits and two costs of economic growth: Benefits: higher living standards, more jobs, more tax revenue for public services, less poverty. Costs: pollution and resource depletion, wider inequality if gains go to the rich, inflation if demand outruns capacity, imports rise with incomes.

4.7 Employment and unemployment

Unemployment and the labour force: Unemployment: being without a job, willing and able to work, and looking for one. Labour force: employed + unemployed. Full-time students, the retired and anyone not looking for work are outside it.
Unemployment rate formula. 144,000 unemployed in a labour force of 3,200,000: find the rate: Unemployment rate = unemployed ÷ labour force × 100. 144,000 ÷ 3,200,000 × 100 = 4.5%. Divide by the labour force, not the population or the employed.
Frictional, structural and cyclical unemployment: Frictional: short-term, moving between jobs. Structural: industry decline or a mismatch of skills or location; jobs exist but not for these workers. Cyclical: a fall in total demand in a recession.
Claimant count vs labour force survey: Claimant count: people claiming unemployment benefit; cheap and fast, but misses non-claimants. Labour force survey: a sample asked if they have no job and want one; includes non-claimants and is comparable, but costly with sampling error.
Consequences of unemployment for the economy: Lost output (a point inside the PPC); lower tax revenue and higher benefit spending; wider inequality; social problems. For the individual: lost income, stress and lost skills.
Match a policy to each type of unemployment: Cyclical: lower taxes, higher government spending, lower interest rates. Structural: education, retraining, help with relocation. Frictional: better job information, job centres.

4.8 Inflation and deflation

Inflation, deflation and disinflation: Inflation: a sustained increase in the general price level. Deflation: a sustained decrease in the general price level. Falling inflation (disinflation) is not deflation: if the rate drops from 5% to 2%, prices are still rising.
How is the Consumer Prices Index (CPI) built?: A basket of items households buy is priced each period. Each group carries a weight matching its share of spending. Weighted CPI = Σ(weight × group index) ÷ Σ weights. The base year is 100.
Weights 40 and 60, group indices 104 and 109. Find the CPI and say what it means: (40 × 104 + 60 × 109) ÷ 100 = (4,160 + 6,540) ÷ 100 = 107.0. Prices are on average 7% above the base year.
Demand-pull vs cost-push inflation: Demand-pull: total demand grows faster than output can (cheap borrowing, tax cuts, optimism). Cost-push: costs of production rise (wages, raw materials, energy, import prices), so firms raise prices.
Who gains and who loses from inflation?: Lose: people on fixed incomes; savers and lenders if interest is below inflation; workers whose pay rises more slowly than prices; exporters. Gain: borrowers, because debts shrink in real terms.
Why is demand-side deflation usually harmful but supply-side deflation often welcome?: Demand-side (weak spending): output falls, unemployment rises, purchases are delayed, debts are harder to repay. Supply-side (lower costs, new technology): prices fall while output rises.