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MicroEconomics > Chapter 10 - Government policies to influence economic activity > Flashcards

Chapter 10 - Government policies to influence economic activity Flashcards

1
Q

Federal government finance consists of what two items?

A

Federal expenditures & federal revenues

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2
Q

What does federal expenditures include?

A
  • Final consumption of goods & services
  • Expend on new fixed assets
  • Large expenditure on social security and welfare
  • Specific purpose grants
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3
Q

What does federal revenues include?

A
  • Personal income tax
  • Company income tax
  • Indirect and other taxes (GST & Excise)
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4
Q

What is discretionary fiscal policy?

A

It is the deliberate manipulation of taxes and spending by government for the purpose of altering real GDP and employment, controlling inflation and stimulating economic growth.

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5
Q

Is all fiscal policy deliberate?

A

No

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6
Q

What is expansionary fiscal policy?

A

Expansionary fiscal policy is the use of increased government spending and/or lowering of taxes, thereby increasing the government budget deficit to stimulate economic activity and move the economy out of recession or depression.

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7
Q

When in a recession what dos an expansionary fiscal policy look to achieve?

A
  • Increase government spending, or
  • Lower taxes, or
  • A combination of both
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8
Q

When demand-pull inflation is prevalent what type of fiscal policy is appropriate?

A

Contractionary fiscal policy as it reduces government spending and/or increases taxes, thereby reducing the deficit or increasing the surplus in the government’s budget to control demand-pull inflation.

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9
Q

What does a government do to initiate a contractionary fiscal policy?

A
  • It decreases government spending, or
  • Increases taxes, or
  • A combination of both
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10
Q

What issues affect the intentions of fiscal policy, which could reduce its effectiveness?

A
  • Timing
  • Politics
  • Crowding out
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11
Q

What are the problems of timing in regards to fiscal policy?

A
  • recognition log - time lapsed between beginning of recession or inflation and recognition
  • administrative log - time lapsed between recognition and action
  • operational lag - time lapsed between fiscal action and when that action has an impact on output.
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12
Q

What are the problems of politics on fiscal policy?

A
  • Other economic goals - not just stability
  • Expansionary bias - deficits are politically attractive and surpluses are painful
  • Political business cycle - manipulation of fiscal policy to maximise voter support
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13
Q

What is the crowding out effect and why is this a problem for fiscal policy?

A

It suggests that where the government competes for funds with private industry, its debt issue will increase the cost of investment funds and reduce the level of private investment.

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14
Q

How can inflation affect the outcomes of an expansionary fiscal policy?

A

Inflation can dissipate some of the real output and employment gains. On a graph, Aggregate demand will increase and increase, but because the supply curve is curved, the price increases as opposed to giving purely extra quantity.

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15
Q

How does fiscal policy on inflation affect the net exports?

A

Through the foreign-purchases effect - so an increase in the price level reduces net exports, reducing aggregate expenditures and equilibrium GDP.

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16
Q

Why does this occur?

A

Because higher prices for Australian goods reduce exports and increases imports of the now cheaper foreign goods.

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17
Q

How is the crowding out effect drawn on a graph in relation to expansionary fiscal policy?

A

Aggregate Demand will increase and increase as a result of expansionary fiscal policy, however the impact of inflation, the reduction of private investment and reduction in exports will push back on the aggregate demand reducing the effectiveness of the fiscal policy.

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18
Q

How can the effectiveness of fiscal policy be altered by international conditions?

A
  • Shocks originating from abroad

* Net export effect

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19
Q

What are ‘shocks originating from abroad’?

A

Small economies are susceptible to international shocks that can alter our GDP and render our fiscal policies inappropriate

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20
Q

What is the net export effect?

A

this is the impact of interest-rate-induced changes in the level of the exchange rate and thus net exports following changes in fiscal policy.

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21
Q

How does the net export effect reduce the effectiveness of both expansionary and contractionary fiscal policy?

A
  • Expansionary - higher interest rates = higher demand for $A = appreciation of $A = decline in net exports
  • Contractionary - lower interest rates = lower demand for $A = depreciation of $A = increase in net exports.
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22
Q

How can fiscal policy affect aggregate supply?

A

Tax changes in the form of incentives to business and individuals can lead to a rightward shift in the aggregate supply providing a further stimulus to the economy in terms of lower prices and higher GDP

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23
Q

What is the objective of monetary policy?

A

To assist the economy to achieve a full employment, non-inflationary level of total output.

24
Q

What is monetary policy?

A

It is influencing the economy’s interest rates and credit availability to assist in stabilising real GDP, employment an the price level.

25
Q

Who has responsibility for managing monetary policy?

A

The Reserve Bank of Australia

26
Q

What are the three links in the cause-effect chain of monetary policy?

A
  • Cash rate - set by RBA for exchange settlement account (ESA) funds
  • Other short-term interest rates - cash rate sets the cost of short-term funds for banks and influences the rate at which banks are willing to lend
  • Aggregate demand - changes in cost and availability of bank credit in turn impact spending decisions of society, particularly investment decisions and therefore the level of output, employment, income and prices
27
Q

What are the two types of RBA actions?

A
  • Easy Money Policy

* Tight Money Policy

28
Q

What is easy money policy?

A

RBA actions designed to reduce the cash rate, lowering the cost of and increasing the availability of bank credit in order to expand spending and real GDP.

29
Q

What is tight money policy?

A

RBA actions designed to increase the cash rate, increase the cost of and reduce the availability of bank credit in order to constrain spending and reduce inflationary pressures.

30
Q

What impact has the increase of interest rate have on society?

A

It reduces the viability of many investment projects and the quantity of investment spending falls.

31
Q

What are the tools of monetary policy?

A

They are:

  • Open market operations (OMOs)
  • Foreign exchange swaps and intervention in the foreign exchange market.
32
Q

What is the purpose of the OMO?

A

To ensure the demand and supply of ESA funds are such that they are in balance at the target cash rate.

33
Q

How does the RBA’s action in relation to the cash rate provide an indication of the RBA’s monetary policy stance?

A
  • Sustained increases in the cash rate target level indicates tightening monetary policy
  • Sustained decreases in the cash rate target level indicate easing of monetary policy.
34
Q

What options does the RBA have each morning in relation to the OMO?

A

1) offer to buy govt securities or repos
2) offer to sell govt securities or repos
3) decide not to deal on the day.

35
Q

When is easy monetary policy implemented?

A

When the economy is faced with the prospects of substantial unemployment or deflationary pressure.

36
Q

When is tight monetary policy implemented?

A

When the economy is facing significant inflationary pressures.

37
Q

When is expansionary policy used and how is it implemented under fiscal policy and monetary policy?

A

To reduce unemployment and bring the business cycle into recovery phase

  • Fiscal - reduce tax
  • Monetary - by reducing interest rates
38
Q

When is contractory policy used and how is it implemented under fiscal policy and monetary policy?

A

To reduce inflation and bring the business cycle into recessionary phase

  • Fiscal - increase tax
  • Monetary - increase interest rates
39
Q

State the three phases of a tightening money policy and how they would be shown on graphs?

A

1) interest rate increased so supply moves to the left
2) because Supply intersects the demand curve earlier, the quantity decreases
3) As such aggregate demand also decreases and the equilibrium GDP is changed

40
Q

What does policy effectiveness depend upon?

A
  • shape of the demand for money curve

* shape of the investment demand curve

41
Q

What are feedback effects?

A

they are caused by the reduction in GDP and as a result reduce business profits causing the business to reduce investment.

42
Q

What is the net export effect?

A

The change in interest rate will affect the value of the exchange rate under floating exchange rates. An increase appreciates the currency resulting in lower net exports and a decrease decreases the currency resulting in higher net exports.

43
Q

What are the shortcomings of monetary policy?

A
  • Cyclical asymmetry
  • Conflict with treasury goals
  • Cost-push inflation
  • Investment sensitivity
44
Q

What is cyclical asymmetry?

A

Imbalance that occurs due to cyclical reactions by a market or nation, eg. banks may make loans easy to obtain but it doesn’t mean consumers will borrow.

45
Q

why is cost-push inflation a short coming of monetary policy?

A

Monetary policy controls inflation by restraining excess aggregate expenditures concerned with demand-pull inflation, not cost-push inflation which lie on the supply or cost-side of the market.

46
Q

Why is investment sensitivity a shortcoming of monetary policy?

A

There is debate about how sensitive investment actually is to monetary policy.

47
Q

What are the strengths of monetary policy?

A
  • Speed and flexibility - monetary policy can be altered quickly
  • Politically acceptable - due to its broad impact
48
Q

What are the two approaches to GDP?

A

The expenditure approach and the income approach.

49
Q

What is the expenditure approach?

A

It measures GDP as the sum of all the expenditures involved in taking that total output off the market.

50
Q

What is the income approach?

A

It measures GDP as the sum of the incomes derived or created from the production of GDP.

51
Q

How do these two approaches relate to each other?

A

They are equal

52
Q

What is the calculation to determine the expenditure approach to GDP?

A

Personal consumption expenditure (C) +
Gross private investment (I) +
Govt purchases of goods and services (G) +
Net exports (NX)

53
Q

What is included in gross private investment?

A

1) all final purchases of machinery, equipment and tools
2) all building and construction
3) changes in stocks or inventories

54
Q

What two components is the Govt purchases of goods and services broken down into?

A
  • consumption component

* investment component

55
Q

How is the income approach calculated?

A
  • Wages & salaries +
  • Gross operating surpluses +
  • Gross mixed income +
  • Indirect taxes less subsidies

MicroEconomics (10 decks)

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