role of the state in the macroeconomy

Question 1

capital expenditure, current expenditure and transfer payments

Answer 1

capital expenditure
- spending on assets which lasts a long period of time
- new buildings, schools, roads
- shift both AD and LRAS

current expenditure
- day to day running costs which reoccurs e.g. wages and salaries of public employees
- only affects AD

transfer payments
- welfare payments from the government
- benefits e.g. housing benefits, pensions, child benefits

Question 2

reasons for the changing size and composition of public expenditure:

Answer 2

1. level of income and development
   - high income economies - high tax revenue - high government expenditure
   - low income counties - low tax revenue - low government expenditure
   - as incomes increase, citizens demand a higher quantity and quality of government services
2. demographic factors
   - ageing population - more expenditure on healthcare
   - youthful population - more expenditure on education
3. economic cycle
   - following a recession/to stimulate growth in an economy, government spending must increase
4. corruption
   - rent seeking behaviour - public expenditure decreases

Question 3

significance of public expenditure

Answer 3

1. productivity and growth
   - education and training programmes - boost human capital/skills - quality of labour improves - LRAS will shift to the right
2. living standards
   - improvement of infrastructure could reduce geographical immobility of labour - allows individuals to access high paying jobs - can be used to purchase wants and needs
   - welfare provisions (transfer payments)
3. crowding out
   - refers to the negative impact that government spending has on private investment
   - government spending leads to increased demand pull inflation - as a result, the BOE will respond by raising IR - cost of borrowing increases - private investment will fall/crowd out

diagram:
- x axis: private investment (PI)
- y axis: government spending (GS)
- PPF curve
- point A moving to point B - as government spending increases, private investment falls

4. level of taxation
   - taxation is needed in order to pay for government expenditure
5. equality
   - if government spending is not spread evenly throughout different regions of the country, it can create inequality e.g. the north/south divide in the UK

Question 4

taxation

Answer 4

progressive tax:
- the rate of tax increases as income rises e.g. income tax

proportional tax:
- different income levels pay the same % of tax e.g. national insurance

regressive tax:
- taxes a greater proportion of income from the lowest earners e.g. VAT

Question 5

the economic effects of changes in direct and indirect taxes:

Answer 5

• direct tax - on income, wealth, profits e.g. income tax, inheritance tax, corporation tax
• indirect tax - on expenditure e.g. VAT

1. incentives to work
   - a rise in income tax reduces the incentive to work - lower disposable income - consumption decreases - AD shifts inwards
   - fall in corporation tax - higher retained profits - greater incentives to invest - AD shifts outwards - accelerator effect
2. tax revenues - the laffer curve
   - initially as tax rate increases, tax revenue increases
   - following point t, as tax rate increases, tax revenue decreases
3. income distribution
   - more progressive tax
   - fall in regressive tax
4. real output and employment
   - to see a rise in RO and employment, income tax needs to fall - consumption increases - AD shifts right - economic growth increases - labour is a derived demand
5. price level
   - to see a fall in the PL, income tax needs to rise - consumption falls - AD shifts inwards - PL falls
6. trade balance
   - to see an improvement in the trade position, income tax needs to increase - less disposable income - reduced demand for imports
7. FDI
   - corporation tax increases - makes the country less attractive for businesses due to lower after tax profits - FDI falls

Question 6

public sector finances

Answer 6

distinction between automatic stabilisers and discretionary fiscal policy:
- automatic stabilisers - when the economy automatically responds to different stages of the economic cycle
- discretionary fiscal policy - deliberate changes to government spending and taxation

fiscal deficit:
- government spending exceeds government revenue
- G is a component of AD - AD shifts outwards - economic growth - employment increases - consumption increases - business confidence increases - accelerator effect and multiplier effect - economic growth can lead to economic development as they’re mutually reinforcing - people are more able to purchase wants and needs - improves living standards - inequality falls - move closer to line of PE - gini coefficient value would move closer to 0 and HDI moves closer to 1
evaluation:
- phillips curve - conflict of objectives

national debt:
- accumulation of debt owed to creditors
- burdensome on future generations as they will face higher taxes
- laffer curve - beyond point t, a rise in tax will lead to a fall in tax revenue - due to a fall in productivity - fall in quality of labour - shifts LRAS - fall in economic growth
- additionally, borrowers have to pay interest on top of the debt that is owed - known as cost of servicing debt - leads to the debt trap as governments are borrowing more to pay off servicing debt - opportunity cost - less money to spend on public services
- countries with high levels of national debt - low credit rating - charged higher interest rates - known as risk premium
evaluation:
- inflation erodes the value of debt

structural and cyclical deficit:
- structural - could exist at any point in the economic cycle e.g. tax avoidance
- cyclical - exists when there’s a negative output gap e.g. government will receive less tax revenue and will have to spend more on benefits

factors influencing size of fiscal deficit:
- state of the economy - boom: government revenue increases and government spending decreases (opposite for recession)
- unforeseen events - e.g. wars, natural disasters - can lead to increases in government spending - increases deficit
- rate of unemployment - high unemployment - less tax revenue and increased spending on welfare benefits

factors influencing size of national debts:
- size of fiscal deficits - if fiscal deficit increases then national debt increases

Question 7

macroeconomic policies in a global context

Answer 7

1. to reduce fiscal deficits and national debt
   - contractionary fiscal policy - reduce government spending/increase taxation
   - supply side policy - government spending on education and job training - human capital increases - productivity increases - quality of labour increases - firms make more profits - higher tax revenues// more people find jobs - reduce government spending on benefits
2. to reduce poverty and inequality
   - supply side policy - government spending on education
   - more progressive tax, less regressive tax
3. changes in IR and money supply
   quantitative easing diagram:
   - y axis - IR (interest rates), x axis - QM (quantity of money supply)
   - demand curve - Dm
   - supply curve - inelastic MS1 - shifts right to MS2
   - as a result of quantitative easing, money supply increases from MS1 to MS2 - money supply increases through increasing the demand for bonds or electronic printing - as the demand for bonds increases, price of bonds increases - bonds and yields (interest rates) are inversely related - this leads to a fall in interest rates - banks are more willing to lend as they have more money - as interest rates fall from IR1 to IR2, cost of borrowing decreases and ROR on savings decreases - incentivises firms to invest and consumers to spend - C and I are components of AD - economic growth occurs
4. measures to increase international competitiveness
   - supply side policies
   - currency depreciation - WPIDEC

Question 8

macroeconomic policies in a global context monetary policy

Answer 8

measures to control global companies (TNCs):

transfer pricing:
- a TNC may deliberately move certain operations to low tax countries to maintain profitability

limits to government ability to control global pricing:
- TNCs bring many benefits to an economy - governments may face a threat to their autonomy/power - e.g. governments may hesitate to regulate too strictly because they fear losing investment and jobs

problems facing policy makers when applying policies:
1. inaccurate information
2. risks and uncertainty
3. inability to control external disasters