Paper 2 - Economics Flashcards
(26 cards)
What is progressive tax?
As your income increase so does your tax rate.
What is Regressive tax?
High tax burden on lower income individuals. e.g VAT, a lower-income individual buying alcohol would be impacted more, income proportionality wise.
What is the Laffer curve?
It is an economical diagram indicating tax rate and its influence on tax revenue. The point where the tax revenue is the highest indicates the optimum point for the tax rate. This is because if the tax rate is too high then it may result in capital flight of high income earners to leave the country.
Give detailed analysis on the Laffer curve:
Tax rates high = high income individuals may want to tax evade = capital flight (moving money else where) = commercial banks would have lower deposits = commercial banks have less lending capacity = domestic consumers may struggle to obtain a loan = decrease in investment = decrease in domestic consumption = decrease in aggregate demand = decrease in economic growth and less tax revenue.
If tax rates are too low = would be a decrease in government tax revenue = result in a lower government budget = lead to a government budget deficit = the government might have to borrow more money from foreign markets = higher interest on money to be paid back = neglects private sector investment = resulting in a decline of economic growth. - this process is referred as to crowding out.
List tax types and their effect on income distribution.
Progressive tax aims at more income equality, this is because it is aimed relatively proportionally to your income whereas regressive tax is seen as more of a burden on lower income individuals. It is represented as more unequal, this is due to indirect taxes such as VAT, everyone pays the same amount, so a lower income would have the burden of being more affected relative to their income.
what is current spending?
Governments day to day spending, e.g running government agencies such as unemployment benefits and salaries maintenances etc.
what is capital spending?
Government spending on long-term investments / assets to provide benefits over the years.
What are transfer payments?
Transfer payments are government payments made to individuals or groups without any expectation of goods or services in return. e.g. unemployment benefits.
Effects on tax rates and employment?
Lower taxes such as (co-operation tax for example) = stimulate economic growth = firms and businesses would have greater profit left over = this can be reinvested to employ and expand = employment to increase = more people in the economy have a disposable income = increase in MPC (Marginal Propensity to Consume) = Aggregate Demand (AD) to increase = reflection of economic growth between Y to Y1.
What is crowding in?
Crowding in is when the government helps stimulate the private sector. This is done when the government increases their spending on the economy = Ideally when they are in a budget surplus but not always = e.g. spending on infrastructure = connectivity and proximity for consumers to producers is closer = increase in Aggregate Demand = increase in consumption (MPC - Marginal Propensity to Consume) = creating higher sales + profits for businesses = increasing business and firm confidence (Animal Spirits) = stimulating the private sector too.
Evaluation: Tim lag and Long Term vs Short Term effects
Impacts of indirect taxes increasing -
Impacts of direct taxes increasing -
Indirect Tax (+) - Firms may raise costs on taxed goods = prices are passed onto consumers = cost-push inflation = prices rise in the short term.
Direct Tax (+) - Disposable incomes would fall = consumers have less to spend = MPS increase and consumption would decrease domestically = price levels may fall or rise slowly = downwards pressure on inflation.
Impacts on trade balance from:
- Indirect taxes increasing
- Direct taxes increasing
(Trade balance = exports - imports)
- prices would rise domestically = domestic consumers disincentivised to import = negative wealth effect = domestic consumption will decrease on imports = worsens the trade balance
- disposable incomes would decrease = lower domestic consumer confidence = lower domestic consumption = decrease consumption on imported foreign goods = improved trade balance.
Evaluation points: direct tax: may impact firms and business confidence based on investment through cooperation taxes in the LR. Also may be retaliation to trade partners such as tariffs.
What are the roles of the financial market?
facilitate - aimed to make things easier.
equities - shares of ownership in a company
- To facilitate saving - money to save in banks plus money made on interest
- Lending to businesses and individuals - Can be spent on investment, mortgages aimed to stimulate growth.
- Facilitate the exchange of goods and services - online transactions, online currencies, debit and credit cards.
- Provide forward markets for currencies and commodities - can provide a guaranteed price at a specified future date by buying a “futures contract” - creates certainty and reliability = investment.
- Provide a market for equities - A share is a financial asset that gives the holder a small percentage stake in the company.
The shareholder makes money if they buy the share for a low price and sell the share for a high price.
The shareholder also makes money when part of the company profit is paid out directly to shareholders. This is known as a dividend payment.
Selling shares enables companies to raise funds for investment or expansion.
This can boost aggregate demand as investment is a component of AD. Higher investment also improves the quality of factors of production, increasing productivity and shifting LRAS right. As a result the economic growth rate rises.
Market failures opposed to the role of he financial market?
1.Asymmetric Information
Asymmetric information occurs when one party in a transaction has more information than the other. In the financial sector, this can lead to adverse selection and moral hazard problems.
- Externalities
Externalities are spill over effects that affect parties not directly involved in a transaction. In finance, externalities can result from risky behaviours of financial institutions.
Negative externalities: Financial institutions may engage in risky practices (e.g., excessive lending) that can lead to systemic risks affecting the entire economy. The 2008 financial crisis is an example of negative externalities.
Positive externalities: A well-functioning financial sector can benefit the broader economy by efficiently allocating capital and promoting economic growth. - Moral Hazard
Moral hazard refers to the risk that one party may take on excessive risks because they believe they are protected from the full consequences of their actions.
In the financial sector, moral hazard can arise when banks and financial institutions believe they will be bailed out by the government in the event of a financial crisis. This can lead to reckless behaviour and excessive risk-taking. - Speculation and Market Bubbles
Speculation involves buying assets (e.g., stocks or real estate) with the expectation of profiting from price increases, rather than from the asset’s intrinsic value.
Market bubbles occur when asset prices rise significantly above their fundamental values due to speculation and irrational exuberance. Bubbles often burst, leading to market crashes and financial instability. - Market Rigging
Market rigging refers to the manipulation of financial markets to gain unfair advantages.
Examples include insider trading (trading based on non-public, material information), market manipulation (e.g., pump-and-dump schemes), and collusion among market participants to distort prices.
Market rigging undermines market integrity and can lead to investor losses.
What are the roles of the financial bank?
- Central banks have the primary responsibility for formulating and implementing monetary policy, which involves managing the money supply and interest rates to achieve specific economic objectives, such as price stability and economic growth. - influence on interest rates and inflation.
- Central banks can act as a banker for the government by helping in facilitating payments
- Banker to the Banks – Lender of Last Resort
Central banks serve as a lender of last resort to financial institutions, especially during times of financial crises or bank runs.
In this role, central banks provide emergency funding to banks facing liquidity problems to prevent systemic financial instability.
By offering short-term loans (often referred to as the discount window), central banks help maintain confidence in the banking system.
- Role in Regulation of the Banking Industry
Central banks often play a critical role in supervising and regulating the banking sector to ensure its stability and soundness.
They set and enforce prudential regulations, including capital adequacy requirements and risk management standards, to prevent excessive risk-taking by banks.
Central banks may also conduct regular bank examinations to assess the financial health and compliance of financial institutions with regulatory standards.
“Run on the banks” - happens when a large number of people withdraw their money from a bank at the same time because they fear the bank will fail or go bankrupt.
What is the difference between automatic stabilizers and discretionary fiscal policy?
Automatic Stabilizers - policies that offset fluctuations in the economy, including transfer payments and taxes. e.g. unemployment benefits.
Discretionary fiscal policy - Deliberate changes in the government expenditure and taxes with the intention of influencing aggregate demand. e.g. During the 2008 financial crisis, many governments (like the US and UK) introduced stimulus packages, which included: Increased public investment and Temporary tax cuts.
What is the difference between a fiscal deficit and national debt.
A fiscal deficit is where the government spends more than they have of government revenue within one financial year.
National debt is the total money the government has borrowed at one time, (typically from foreign markets) or through the treasury
What are the effects of high national debt?
cost of borrowing could increase due to interest rates if borrowed from foreign markets. government loses confidence to pay back the debt and may increase interest rates domestically for consumers to incentivise them to purchase bonds to help finance the debt.
What is the difference between cyclical and structural deficit.
A cyclical deficit is normally implemented during a recession, this normally consists of an increase of government revenue due to a tax revenue fall and money is spent on transfer payments which temporarilty improves the budget deficit
what is a free floating exchange rate?
Determined by market forces, the price of one currency to another.
By market forces, this can influence Appreciation or Depreciation of a currency
What is a fixed exchange rate?
Government or central bank using currency reserves to manipulate a currency.
For example,
Increasing money supply = devaluation
Buying demand for currency = increase valuation.
What is the impact of a strong currency (appreciating) in the short run vs the long run?
In the long run: With a currency appreciation = Net exports (x-m) would decrease = AD would shift in to AD1 (in the long run) = MPC would decrease = higher unemployment in exporting industries = lower economic growth (Y to Y1).
In the short run: With a currency appreciation = imports are cheaper = domestic firms can import raw materials and commodities at a cheaper cost = efficiency gains for producers = domestic consumers can receive lower prices = increasing subjective happiness = increasing standards of living.
What is the impact of a weak currency (depreciating) in the short run vs the long run?
In the long run: With a currency depreciation = demand for exports would increase =
What is the terms of trade formula?
index of exports/index of imports x 100.
Greater the value, greater the price competitiveness.
