4.5: The role of the state in the macroeconomy Flashcards
(19 cards)
APPLICATION
UK National debt
£2.7 trillion
APPLICATION
Percentage of national insurance if you earn over £4189 a month vs if you earn £1048 to £4189 a month
EXAMPLE OF A REGRESSIVE TAX
Above £4189 a month = 2%
Between £1048 and £4189 a month = 8%
Reasons for tax
-Raise funds for public spending (Transfer payments e.g. Subsidies and benefits)
-Redistribute income (Progressive)
-Correct market failure (Carbon tax and excise duty e.g. demerit goods)
-Manage macroeconomy (Growth, inflation and unemployment)
-Protectionism (tax on M)
Reasons for Gov spending
-Influence economic activity (Increased gov spending = Increase in AD)
-Correct market failure (missing market and underconsumption of merit goods)
-Decrease inequality and increase equity (Transfer payments )
Examples of expansionary fiscal policy
-Decrease rate of income tax for lower income people meaning an increase tax free allowance (£14000)
-Decrease marginal rate of income tax for high earners = Increase spending so AD1 —> AD2
-Decrease regressive tax in economy = Increase MPC for lower income people
-Decrease corporation tax = Increase retained profits = Increased investment so AD1 —> AD2
-Increase Gov spending on Infrastructure (schools, roads, NHS) = Increase multiplier so AD1 —> AD2
Evaluation for expansionary fiscal policy
-May cause inflation
-May deteriorate gov finances
-Time lags —> Gov may take time to have impact
-Public sector is X-inefficient
-Crowds out investment from private sector
-RICARDIAN EQUIVALENCE
Capital expenditure
-Government spending on assets with long-term benefits
-E.g. Hospitals —> Improves the health of the population —> Enables them to work and earn an income —> More real disposable income —> Increased C
Or
Spending on Schools —> Improves levels of human capital —> workers more productive —> Increased incomes —> Fiscal drag into higher tax bracket —> Increased tax revenue for Gov —> Improves fiscal deficit
APPLICATION
UK fiscal deficit
£128 billion (April 2025)
Current expenditure
Government spending on recurring costs i.e. things that you need to keep spending money on. This could include wages for teachers or raw materials.
Transfer payments
A transfer payment is when the government spends money without getting anything in return.
E.g. BENEFITS and subsidies to producers
DIFFERENCE BETWEEN GOV SPENDING IN AND AND PUBLIC EXPENDITURE
Public expenditure includes current expenditure, capital expenditure and transfer payments. The government spending part of the aggregate demand formula is similar but it doesn’t include transfer payments.
Transfer payments are not included in ‘G’ because they don’t actually involve spending on goods and services. For example, benefits are just a transfer of money from the government to low-income families. The money spent on benefits usually appears in AD under consumption, as most of it is spent by the individuals receiving it.
Crowding in
Government are spending less so they dont need to borrow as much meaning there is less demand for loanable funds (+factors of production) which decreases interest rates, meaning the cost of borrowing is cheaper so more private firms borrow to invest into their business. Increases I which increases AD. AD shifts out …
Crowding out
Crowding out happens when increased government spending leads to a reduction in private sector spending or investment.
The government may borrow more to finance spending (e.g., infrastructure projects). This pushes interest rates up (higher demand for money). Private firms find borrowing more expensive → they invest less. Or, government spending directly replaces private sector activity.
Disincentivises investment from firms so I decreases and so does AD because I makes up about 15-20% of AD
Types of crowding out
Financial crowding out: Higher interest rates reduce private investment.
Resource crowding out: Government uses scarce resources (like workers), leaving fewer for private firms.
Consequences of High National Debt
-Higher Interest Payments: More resources are allocated to servicing debt, potentially crowding out other expenditures.
-Reduced Fiscal Flexibility: High debt limits the government’s ability to respond to economic crises.
-Intergenerational Equity Concerns: Future generations may bear the burden of repaying today’s debt.
Factors Influencing the Size of National Debt
-Fiscal Deficits: Persistent deficits accumulate over time, increasing the national debt.
-Government Policies: Decisions to cut taxes or increase spending without off setting measures can widen deficits.
-Interest Rates
Debt Servicing Costs: Higher interest rates increase the cost of servicing existing debt, potentially leading to higher deficits.
Stagflation
Low levels of economics growth but high level of inflation
Malevolent deflation
A persistent fall in the general price level, due to low AD
Benign deflation
A fall in the general price level brought about by an outward shift of the short run aggregate supply curve
