LESSON 17- The Role Of Government in the Economy

    0
    48

     

     

    Main Lecture:-

     

    1. Aims of the government

     

     

    Most national governments share similar macro-economic objectives:

    • low and stable price

    inflation

    • a high and stable level of

    employment

    • economic growth and

    prosperity

    • a favourable balance of

    international payments.

     

    Governments use policy instruments, including taxes and regulations, to help achieve their objectives through the impact they have on the actions of producers and consumers.

     

     

    Fiscal policy involves changing the total level of taxation or government spending in an economy to influence the level of demand for goods and services

     

    Monetary policy uses the interest rate of the central bank to influence demand

     

    Supply-side policy instruments are used to encourage higher levels of output and employment. They include tax incentives, subsidies and regulations

     

    Policy aims and actions can sometimes conflict. For example, raising taxes or interest rates to reduce price inflation may reduce employment and economic growth in output and incomes.

     

     

    Macro-economics is the study of how a national economy works

    and the interaction between economic growth in output and national

    income, employment and the general level of prices.

    A macro-economy consists of all the different markets for goods and

    services, labour, finance, foreign exchange and other traded items.

    Changes in the behaviour of producers and consumers in individual

    markets will therefore have an effect on the macro-economy and the

    rate of economic growth, inflation, employment and trade.

     

     

    Most national governments share similar macro-economic objectives. These

    are:

    • low and stable price inflation
    • a high and stable level of employment
    • economic growth and prosperity
    • a favourable balance of international payments.

     

    Governments can use different policy instruments, including taxes and

    regulations, to help achieve their objectives through their impact on the

    actions of producers and consumers.

     

     

    1. Actions taken by the government and their impact

     

     

     

     

    (i) Fiscal policy involves varying total public sector expenditure and/or the overall

    level of taxation to influence the level of demand in an economy. If the demand in the economy increases (aggregate demand), so does the economic activity which in turn triggers economic growth.

     

    Types of fiscal policies are:-

     

    (a) Expansionary fiscal policy

    It may be used during an economic recession to

    boost demand for goods and services through tax cuts or increased public

    sector spending. Firms may respond by hiring more labour and increasing

    output. However, increasing demand can force up market prices and involve

    spending more on imported goods and services from overseas. Increasing

    imports will have a negative impact on the balance of payments.

     

    (b) Contractionary fiscal policy

    It may be used to reduce price infl ation. It involves

    reducing demand in an economy through tax increases or cuts in public sector

    spending. However, fi rms may respond to falling demand by cutting their

    output and reducing employment. Increased taxes may also reduce work

    incentives and therefore productivity.

     

    Fiscal policy

    instruments

    Impacts on consumers Impacts on producers
    Increase income taxes Disposable income is reduced

    and consumer spending falls

    Market prices and profits fall as consumer demand falls. Firms cut output and employment.
    Reduce income taxes Disposable incomes and

    consumer spending rise

    Market prices and profits start

    to rise so firms expand output

    and employ more labour

    Increase taxes on

    profits

    Consumers are not directly

    affected but may pay higher

    prices if firms cut output

    After-tax profits fall. Firms may

    increase their prices and/or cut

    output in response

    Cut taxes on profits Consumers may benefit from

    reduced prices as output rises

    After-tax profits rise so firms

    may expand their output and

    employment

    Increase indirect taxes

    on goods and services

    Consumers on low incomes

    may be hit hardest by price

    rises because they spend all or most of their incomes

    Consumer demand may

    contract and profits fall. Firms

    may cut output and reduce

    their demand for labour

    Cut indirect taxes on

    goods and services

    Consumers may expand

    their demand for goods and

    services as after-tax prices fall

    Expanding demand will boost

    profits which are an incentive

    to firms to raise their output

    and demand more labour

    Raise public

    expenditure

    Public sector workers could

    be paid more. Low income

    families may receive more

    benefits. More public services

    could be provided for free

    Firms supplying goods and

    services to government will

    enjoy increased revenues and

    profits, and may expand their

    output and employment

    Cut public

    expenditure

    Public sector workers could

    suffer pay cuts or be made

    unemployed. Welfare benefits

    may be reduced.

    A cut in public spending on

    capital projects, such as road

    and school building, will cause

    cutbacks in the construction

    industry. Subsidies paid to

    other firms may be cut

     

     

     

     

    (ii) Monetary policy involves varying the interest rate charged by the central bank for lending money to the banking system in an economy.

     

    There are two types of monetary policies:-

     

    (a) Contractionary monetary policy

     

    It may be used to reduce price inflation by increasing the interest rate. Because banks have to pay more to borrow from the central bank they will increase the interest rates they charge their own customers for loans to recover the increased cost. Banks will also raise interest rates to encourage people to save more in bank deposit accounts so they can reduce their own borrowing from the central bank. As interest rates rise, consumers may save more and borrow less to spend on goods and services. Firms may also reduce the amount of money they borrow to invest in new equipment. A reduction in capital investment by firms will reduce their ability to increase output in the future. Higher interest rates may therefore reduce economic growth and increase unemployment.

     

    (b) Expansionary monetary policy

     

    It may be used during an economic recession

    to boost demand and employment by cutting interest rates. However,

    increasing demand can push up prices and may increase consumer spending

    on imported goods and services.

     

    Monetary policy instruments Impacts on consumers Impacts on producers
    Raise interest

    rates

    Spending falls as consumers

    save more and borrow less.

     

    The foreign exchange rate of the national currency may rise. This will reduce the prices of imports.

     

    Consumers may buy more

    imports instead of home produced goods and services.

    Firms cut output and

    employment in response to

    falling demand

     

    Firms borrow less to invest in

    new capital equipment, which

    may harm economic growth.

     

    Prices of exports sold overseas will rise if the exchange rate

    increases. Exporting firms may suffer falling demand and profits

     

    Cut interest

    rates

    Spending rises as saving

    becomes less attractive and

    borrowing less expensive.

     

    The exchange rate may fall

    causing imported inflation.

    Firms increase output and

    demand more labour as demand rises.

     

    Firms may increase investment.

     

    Prices of exports sold overseas may fall if the exchange rate rises. Demand for exports may

    Rise.

     

     

     

    (iii) Supply-side policies aim to increase economic growth by raising the

    productive potential of the economy. An increase in the total supply of goods and services will require more labour and other resources to be employed, will reduce market prices, and provide more goods and services for export. Supply-side policy instruments aim to encourage firms and employees to become more productive, and to remove any barriers that may prevent this.

     

    Supply-side policy instruments
     

    Tax incentives

    Reducing taxes on profits and small firms can encourage enterprise. Tax allowances can also be used to encourage investments in new capital equipment and R&D.
     

    Subsidies or grants

    These reduce production costs and also help firms to fund the research and development (R&D) of new technologies.
     

    Education and training

    Teaching new and existing workers new skills to make them more productive at work.
     

    Labour market regulations

    Include minimum wage laws to encourage more people into work, and legislation to restrict the power of trade unions.
     

    Competition policy

    Regulations that outlaw unfair and anti-competitive trading practices by monopolies and other large powerful firms.
     

    Free trade agreements

    Removing barriers to international trade to allow countries to trade their goods and services more freely and cheaply.
     

    Deregulation

    Removing old, unnecessary and costly rules and regulations on business activities.
     

    Privatization

    The transfer of public sector activities, such as refuse collection, to private firms to provide them more efficiently.

     

     

    END OF UNIT QUESTIONS:-

     

    Q1. How might a reduction in taxation help any two macro-economic aims of a government?

     

    Q2. What actions could a government take to help reduce unemployment?

     

    Q3. Discuss the actions that a government might take to control inflation.

     

    Note:- You can find the answers to all of these questions in the lecture above!