Government and The
Macroeconomy
The Role of Government
Local Role: Fund local services (Garbage Collection, Street Lighting,
Schools, Hospitals and more)
National Role: Achieve macroeconomic goals (Economic Growth,
Low Inflation, Stable Prices and more)
International Role: Trading of goods and services
The Macroeconomic Aims of the
Government
Economic Growth
Low Unemployment
Low Inflation/Stable Prices
Balance of Payment Stability
Redistribution of Income
Conflicts between the Macroeconomic Aims
Full Employment vs Stable Prices
Economic Growth vs Balance of Payment Stability
Full Employment vs Balance of Payment Stability
Economic Growth vs Stable Prices
Fiscal Policy
Budget: Financial planning of revenues and expenditures of the
government
Reasons for Government Spending
To supply goods and services that are not supplied by the private
sector, such as defence; merit goods, such as education
To achieve improvements in the supply side of the macro-economy,
like providing subsidies
Reasons to Tax
To finance public expenditure, building schools and infrastructure
To discourage certain activities, e.g. taxes on cigarette
To discourage the import of goods, tariffs are import taxes and can
be levied as a % of the value of imports or a set tax on each item
To redistribute income from the rich to the poor
To achieve other macro-economic objectives
Types of
Description Examples
Taxation
Progressive Tax rate rises with income; higher
Income tax
Tax income = higher tax
Regressive Tax rate falls with income; higher
VAT
Tax income = lower tax
Proportional Everyone pays same effective tax Corporate
Tax rate income tax
Capital gains
Direct Tax Levied on individuals
tax
Added to the price of
Indirect Tax Tariffs
commodities
Principles of Tax
Equitable
Economic
Transparent
Convenient
Fiscal Policy
It is the use of taxation and government spending to influence
aggregate demand
Policy About
Reducing taxes and increasing government.
Expansionary
Spending boosts demand, so employment and
Fiscal Policy
output rise. It may be used to reduce recession.
Increasing taxes and reducing government.
Contractionary
Spending to reduce demand. It may be used
Fiscal Policy
to reduce price inflation.
Effects of fiscal policy on govt. macroeconomic aims
Expansionary fiscal policy can reduce unemployment
Expansionary fiscal policy can increase economic growth
Contractionary fiscal policy can reduce high inflation
Monetary Policy
It is the use of interest rates, direct control of the money supply and
the exchange rate to influence aggregate demand
Policy About
It may be used to reduce price inflation by
Contractionary increasing interest rates charged by the central
Monetary Policy bank. This means commercial banks will also raise
interest to encourage more savings.
Expansionary May be used during a recession & to increase
Monetary Policy employment by cutting interest rates
Effects of monetary policy on government macroeconomic aims
Expansionary monetary policy can reduce unemployment
Expansionary monetary policy can increase economic growth
Contractionary monetary policy can reduce high inflation
Supply-Side Policies
Supply-side policies aim to increase economic growth by raising
productive potential of the economy
An increase in the total supply of goods & services will require more
labour &other resources to be employed
It will reduce market prices & provide more goods & services to
export
Instrument Effect on Macroeconomic Aims
Reducing taxes on profits and small firms can
Tax Incentives encourage enterprise. It can also encourage
investments in new equipment.
To reduce production costs and help firms fund
Subsidies/Grants
research and development of new technologies.
Education and Teaching new/existing workers new skills to
Training make them more productive.
Include minimum wage laws to encourage more
Labour Market
people to work and legislation to restrict the
Regulations
power of trade unions.
Regulations that outlaw unfair trading practices
Competition Policy
by monopolies and other large, powerful firms.
Removing barriers to international trade allows
Free Trade
countries to trade their goods and services more
Agreements
freely and cheaply.
Removing old, unnecessary and costly rules and
Deregulation
regulations on business activities
Economic Growth
Economic growth is the annual increase in the level of the national
output i.e the country’s GDP
Important as it increases the standard of living
Measurement of Economic Growth
Gross Domestic Product (GDP) is the main measure of total
value of all the goods and services produced in a
given period of time
An increase in prices will increase nominal GDP but this is
measured in current dollars thus includes inflations
=NominalCPI×100Real GDP=CPINominal×100
=Real GDPNumber of PopulationReal GDP Per Capita=Numbe
r of PopulationReal GDP
Recession
It is a significant decline in economic activity spread across the
economy, lasting more than a few months, normally visible in real
GDP growth, real personal income, employment, industrial
production, & wholesale-retail sales
A recession would cause the economy to produce at a point that is
within the PPC
Causes of Economic Growth
Discovery of more natural resources
Investment in new capital and infrastructure
Technical progress
Increasing the amount and quality of human resources
Reallocating resources
Consequences of Economic Growth
An increase in output can improve the living standards of people
Higher output and incomes increase government tax revenue. This
can increase govt. spending without increasing tax rates
However, it can increase pollution lead to the depletion of non-
renewable resources and damage the natural environment
Policies to Promote Economic Growth
Expansionary fiscal policy
Expansionary monetary policy
Supply-side policies
Employment and Unemployment
Indicators Recent Trends
Risen as the world population
Labour force
has grown
Participation Rate: labour force Risen in many countries
as a proportion of total population especially among females as it
of working age is now socially acceptable
Poverty and rising living costs in
developing countries has forced
many women to work
Employment in services has
Employment by
been growing while
Industry: Number of people
employment in agriculture and
employed in different industrial
other primary sector industries
sectors
has fallen
Employment Status: Number of
full-timers, part-timers or with Most employees work full-time
temporary contracts
Part-time employees have
grown rapidly, especially among
female employees
Unemployment: Number of
Tends to rise during economic
people registered as being without
recessions
work
Almost half the unemployed are
young unskilled workers
Unemployment Relatively stable in the recent
Rate: Unemployment as a years but did increase in 2008
proportion of labour force during a global financial crisis
Types of Unemployment
Cyclical Unemployment: occurs during recession due to falling
consumer demand & incomes
o Firms reduce output & lay off workers
Structural Unemployment: caused by changes in industrial
structure of an economy
o Entire industries close due to a permanent fall in demand for
their goods/services
Frictional Unemployment: refers to transitional unemployment,
which occurs when people are moving between jobs.
Seasonal Unemployment: occurs because consumer demand for
goods/services change with seasons; e.g. no job for a ski instructor
when/where there is no ice
Measurement of Unemployment
Taking claimant count
Labour force survey
Unemployment Rate = Number of Unemployed Perso
ns / Labor
Force
Consequences of Unemployment
Personal Economical
Loss of income and reduced ability Unemployment is a waste of
to buy goods & services human resources
Unemployed people de-skill if long Fewer goods & services
out of work produced
Unemployed people may become Total output & income in the
depressed & ill economy is lower
The strain on family relationships & Government tax revenues also
health services lower
People in work may have to
Personal Economical
pay more taxes
Government spending on
welfare may rise
Policies to Reduce Unemployment
Expansionary monetary policy
Expansionary fiscal policy
Increase in quality and quantity of education and training
Inflation and Deflation
Inflation: general & sustained increase in the level of prices of
goods/services in an economy over a period of time
Deflation: decrease in the general price level of goods and services
and occurs when the inflation rate falls below 0%
Measurement
Base year: the first year with which the prices of subsequent years
are compared
Inflation rate: percentage change in annual CPI
=Weighted Average Price in Year xWeighted Avereage Price i
n Base Year×100CPI in Year x=Weighted Avereage Price in B
ase Year Weighted Average Price in Year x×100
Causes of Inflation
Demand-pull Inflation: caused by total demand rising faster than
total output, causing market prices to rise
Cost-push Inflation: The cost of production increases, so firms try
to pass costs to consumers through higher prices
Causes of Deflation
Fall in the money supply
Decline in confidence
Lower production costs
Technological advances
Increase in unemployment
Increase in the real value of debt
Policies to Control Inflation & Deflation
Contractionary fiscal and monetary policy for inflation
Expansionary fiscal and monetary policy for deflation
Supply-side policy can increase aggregate supply and thus control
both inflation and deflation
