Unit 4 - Government and the macroeconomy
The role of the government
Government roles
The government is involved:
Locally...
❏ Establishes local taxes
❏ Provides a number of local services
❏ Establish regulations and rules, for example: provide permits and licences.
❏ Invest in local infrastructure
Employs civil servants to work in their departments to develop policies and services.
National level…
❏ Establish national taxes
❏ Provide a number of national services
❏ Manage the economy through a range of fiscal, monetary and supply-side policies.
International level…
❏ Engage in bilateral or multilateral negotiations with other countries
Bilateral: a negotiation or agreement that takes place between two countries
Multilateral: a negotiated or agreement that takes place between a number of countries
❏ Take part in discussion if the country is in an economic union, such as the European Union or
NAFTA
❏ Interact with financial institutions, such as the International Monetary Fund or the World
Bank.
❏ Interact with other countries and institutions to create treaties and a
greements, EX: Kyoto
Protocol
The macroeconomic aims of government
The macroeconomic aims of the government
● Economic Growth
,Refers to an increase in the national output of an economy over time, usually measures by GDP.
Important that growth takes account of sustainability. (2-3% in normal countries, but 10% in India and
China)
● Full employment/ low unemployment
Having low unemployment will make the best out of the factor of production labour. Full employment
refers to a level of employment where everyone who can work, has a job. Normally around 95%
employment.
● Stable prices/ low inflation
They try to keep the increase in the general level of prices in an economy relatively stable and inflation
as low as possible. This is because inflation erodes the real value of money (purchasing power reduced).
Rate of inflation is measured through a price index. Normal aim is to try to keep it at 2% per annum
Inflation: the increase in the general level of prices in an economy over a period of time.
● Balance of payments
Refers to payments made that take place across a country’s borders. The current account of the balance
of payments consists of the value of trade in goods, trade in services, primary income and secondary
income. It is important that a country doesn’t spend more than they receive (deficit in accounts, the
opposite is surplus in accounts). The aim should be stability in balance over a number of years
● Redistribution of income
The aim is to try to reduce the inequality of income, but it is difficult to set precise criteria for this aim.
Possible conflicts between macroeconomic aims
Possible conflicts Explanation
between aims
Full employment versus If a government aims for full employment, the level of demand will
stable prices therefore be high. If the demand is higher than the supply (excess
demand) the prices will increase causing demand-pull inflation. It will be
hard for the government to achieve stable prices
Economic growth versus If a government aims for economic growth, it will therefore mean imports
the balance of payments will rise as firms need more resources (raw materials, component parts).
stability This will lead to a deficit in the balance of payments. This makes it hard
for governments to achieve a balance of payments stability.
Full employment versus If a government aims for full employment, it will mean more people will be
the balance of payments employed and therefore an increase in income. With an increase in
income, people are more likely to spend more, and this might involve
, buying more imports. It will make a deficit in the balance of payments
more likely.
Fiscal policy
Both Fiscal and monetary policy are demand-side policies. Fiscal deals with taxes and government
spending. Monetary policy deals with supply of money and interest rates
Definition of the budget and the reasons for government spending
Budget: a financial statement that sets out the income and expenditure of a government in a given year
● Budget surplus: Public revenue is greater than expenditure
● Budget deficit: Public expenditure is greater than public revenue
● Balanced budget: Public expenditure and revenue and equal
Reasons why governments intervene in an economy (spend):
❏ To influence economic activity: governments may increase their spending and to stimulate the
level of demand in an economy. (Ex: increasing output and creating a higher level of economic
growth)
❏ To try to correct market failure: May spend money on public goods, as the market sector does
not provide these (ex: defence and police). May spend on merit goods that are underproduced
and underconsumed in the market due to information failure (ex: education, healthcare)
❏ To promote equity: may provide benefits to those worse off, social welfare
❏ To pay interest on money borrowed: The government will need to pay interest on any money
borrowed. National debt: total debt of all money borrowed
Reasons for taxation
Tax: payment made by individuals/ firms to the government. It is a compulsory contribution to public
revenue. Governments levy tax from incomes and profits from costs of certain goods, services, and
transactions.
Reasons for levying taxation
❏ To raise revenue to finance government expenditure
❏ To reduce pollution: impose tax on firms that cause pollution
❏ To redistribute income: taxing richer more/ giving more benefits to the poor
❏ To influence economic activity: can impact level of demand in an economy
❏ To discourage imports: If you put taxes on imports (making them more expensive), if the
demand is elastic for the good, the demand for that imported good will decrease. This will
increase the demand for domestic products, which will protect domestic producers.
❏ To discourage the consumption of demerit goods: goods that are overproduced and over
consumed due to information failure
The role of the government
Government roles
The government is involved:
Locally...
❏ Establishes local taxes
❏ Provides a number of local services
❏ Establish regulations and rules, for example: provide permits and licences.
❏ Invest in local infrastructure
Employs civil servants to work in their departments to develop policies and services.
National level…
❏ Establish national taxes
❏ Provide a number of national services
❏ Manage the economy through a range of fiscal, monetary and supply-side policies.
International level…
❏ Engage in bilateral or multilateral negotiations with other countries
Bilateral: a negotiation or agreement that takes place between two countries
Multilateral: a negotiated or agreement that takes place between a number of countries
❏ Take part in discussion if the country is in an economic union, such as the European Union or
NAFTA
❏ Interact with financial institutions, such as the International Monetary Fund or the World
Bank.
❏ Interact with other countries and institutions to create treaties and a
greements, EX: Kyoto
Protocol
The macroeconomic aims of government
The macroeconomic aims of the government
● Economic Growth
,Refers to an increase in the national output of an economy over time, usually measures by GDP.
Important that growth takes account of sustainability. (2-3% in normal countries, but 10% in India and
China)
● Full employment/ low unemployment
Having low unemployment will make the best out of the factor of production labour. Full employment
refers to a level of employment where everyone who can work, has a job. Normally around 95%
employment.
● Stable prices/ low inflation
They try to keep the increase in the general level of prices in an economy relatively stable and inflation
as low as possible. This is because inflation erodes the real value of money (purchasing power reduced).
Rate of inflation is measured through a price index. Normal aim is to try to keep it at 2% per annum
Inflation: the increase in the general level of prices in an economy over a period of time.
● Balance of payments
Refers to payments made that take place across a country’s borders. The current account of the balance
of payments consists of the value of trade in goods, trade in services, primary income and secondary
income. It is important that a country doesn’t spend more than they receive (deficit in accounts, the
opposite is surplus in accounts). The aim should be stability in balance over a number of years
● Redistribution of income
The aim is to try to reduce the inequality of income, but it is difficult to set precise criteria for this aim.
Possible conflicts between macroeconomic aims
Possible conflicts Explanation
between aims
Full employment versus If a government aims for full employment, the level of demand will
stable prices therefore be high. If the demand is higher than the supply (excess
demand) the prices will increase causing demand-pull inflation. It will be
hard for the government to achieve stable prices
Economic growth versus If a government aims for economic growth, it will therefore mean imports
the balance of payments will rise as firms need more resources (raw materials, component parts).
stability This will lead to a deficit in the balance of payments. This makes it hard
for governments to achieve a balance of payments stability.
Full employment versus If a government aims for full employment, it will mean more people will be
the balance of payments employed and therefore an increase in income. With an increase in
income, people are more likely to spend more, and this might involve
, buying more imports. It will make a deficit in the balance of payments
more likely.
Fiscal policy
Both Fiscal and monetary policy are demand-side policies. Fiscal deals with taxes and government
spending. Monetary policy deals with supply of money and interest rates
Definition of the budget and the reasons for government spending
Budget: a financial statement that sets out the income and expenditure of a government in a given year
● Budget surplus: Public revenue is greater than expenditure
● Budget deficit: Public expenditure is greater than public revenue
● Balanced budget: Public expenditure and revenue and equal
Reasons why governments intervene in an economy (spend):
❏ To influence economic activity: governments may increase their spending and to stimulate the
level of demand in an economy. (Ex: increasing output and creating a higher level of economic
growth)
❏ To try to correct market failure: May spend money on public goods, as the market sector does
not provide these (ex: defence and police). May spend on merit goods that are underproduced
and underconsumed in the market due to information failure (ex: education, healthcare)
❏ To promote equity: may provide benefits to those worse off, social welfare
❏ To pay interest on money borrowed: The government will need to pay interest on any money
borrowed. National debt: total debt of all money borrowed
Reasons for taxation
Tax: payment made by individuals/ firms to the government. It is a compulsory contribution to public
revenue. Governments levy tax from incomes and profits from costs of certain goods, services, and
transactions.
Reasons for levying taxation
❏ To raise revenue to finance government expenditure
❏ To reduce pollution: impose tax on firms that cause pollution
❏ To redistribute income: taxing richer more/ giving more benefits to the poor
❏ To influence economic activity: can impact level of demand in an economy
❏ To discourage imports: If you put taxes on imports (making them more expensive), if the
demand is elastic for the good, the demand for that imported good will decrease. This will
increase the demand for domestic products, which will protect domestic producers.
❏ To discourage the consumption of demerit goods: goods that are overproduced and over
consumed due to information failure
