Another trade-off is between economic growth and negative externalities as increased output can produce spill-over effects on third-parties such as increased noise/air pollution (from road congestion etc.). For example, increased production and consumer spending will cause more air pollution from factories and more traffic congestion on roads. Increased spending which leading to more household waste. Another example would be if tourist areas were booming, this would cause more litter from tourists and if people were spending and therefore eating more, obesity would increase which has spill-over costs.
The issues governments face in managing the macroeconomy
The government faces issues in managing the macroeconomy:
- Policy conflicts and trade-offs – when one macroeconomic policy has a larger impact than another, which conflicts or reduces the effectiveness of the other policy.
- There is a struggle between environment and competitiveness as if the government introduce policies such as ‘green tax’ the competitiveness of domestic firms could be compromised as firms become limited in their production or have increased costs.
- Interest rates and inequality are linked as a low interest rate affects the distribution of incomes as savers only receive a small return of their savings.
- Some events are beyond the control of the government, which limits how well policies will work. As well as this, some policies will take a long time to implement and show effect.
- When reducing the government deficit, they may need to reduce spending and increase the tax rate but this makes them politically unpopular.
How different macroeconomic perspectives influence policy decisions
There are three main types of economies: Free market, command and mixed.
Free market economy
- Governments leave markets aka laissez-faire economies, so the market forces of supply and demand allocate scarce resources.
- Economic decisions are made by private individuals and firms who own everything and there is no government intervention.
- Adam Smith was a famous free market economist and his theory of the invisible hand described how prices are determined by the ‘spending votes’ of consumers and firms. He realised the abuse of monopoly power that may occur in a free market.
- Firms will be more efficient and are likely to lower average costs, making better use of scarce resources. Overall output of the economy will increase.
- However, the free market ignores inequality and there is no help (benefits) for those on low incomes.
- Monopolies could exploit the market by charging higher prices.
- There may be overconsumption of demerit goods, a lack of public goods and merit goods are underprovided.
- This is when the government allocates all the scarce resources in an economy to where they think is a greater need. This is known as central planning.
- They are known as interventionists, Karl Marx was a believer in this and argued for the ‘common ownership of the means of production’.
- This makes it easier to coordinate resources in times of crises (wars) and the government can compensate for market failure by reallocating resources and will make sure everyone can access basic necessities.
- Inequality of society could be reduced and society might maximise welfare rather than profit and the abuse of monopoly power could be prevented.
- Governments may not be fully informed and may fail. It also limits democracy and personal freedom and may not meet consumer preferences.
This has features of both command and free market economies and is the most common economic system nowadays. Governments often provide public goods such as street lights etc, and merit goods such as healthcare and education but for the latter, there are also private options available.
The likely effects of individual policy instruments on specific problems; possible unintended consequences
When governments employ a policy, there could be unintended consequences as consumers and producers could react in unexpected ways. A policy could be undermined which could make government policies expensive to implement as it is harder to achieve their original goals. Examples are:
- An increase in the minimum wage could be intended to raise living standards. However, this could mean employers can’t afford as many workers so may unintentionally increase unemployment.
- Increasing corporation tax may be intended to raise funds for the Government whilst it has the consequence of companies moving abroad.
- Austerity is intended to reduce the government deficit which will lead to a reduced level of public services and consequently reduces living standards.