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
Tax rate rises with income; higher
Progressive Tax Income tax
income = higher tax
Tax rate falls with income; higher income
Regressive Tax VAT
= lower tax
Corporate income
Proportional Tax Everyone pays same effective tax rate
tax
Direct Tax Levied on individuals Capital gains tax
Indirect Tax Added to the price of commodities Tariffs
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 spending to
Expansionary
boost demand, so employment and output rise. It may be
Fiscal Policy
used to reduce recession.
Contractionary Increasing taxes and reducing government spending to
Fiscal Policy reduce demand. It may be used 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 increasing
Contractionary interest rates charged by the central bank. This means
Monetary Policy commercial banks will also raise interest to encourage more
savings.
Expansionary May be used during a recession & to increase employment
Monetary Policy 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 encourage
Tax Incentives enterprise. It can also encourage investments in new
equipment.
To reduce production costs and help firms fund research
Subsidies/Grants
and development of new technologies.
Education and Teaching new/existing workers new skills to make them
Training more productive.
Labour Market Include minimum wage laws to encourage more people to
Regulations work and legislation to restrict the power of trade unions.
Regulations that outlaw unfair trading practices by
Competition Policy
monopolies and other large, powerful firms.
Free Trade Removing barriers to international trade allows countries to
Agreements trade their goods and services more 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

Real GDP=NominalCPI×100Real GDP=CPINominal×100

Real GDP Per Capita=Real GDPNumber of PopulationReal GDP Per Capi

ta=Number 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 has
Labour force
grown
Participation Rate: labour force as a Risen in many countries especially
proportion of total population of working among females as it is now socially
age acceptable
Poverty and rising living costs in
developing countries has forced many
women to work
Employment in services has been
Employment by Industry: Number of
growing while employment in
people employed in different industrial
agriculture and other primary sector
sectors
industries has fallen
Employment Status: Number of full-
timers, part-timers or with temporary Most employees work full-time
contracts
Part-time employees have grown
rapidly, especially among female
employees
Unemployment: Number of people Tends to rise during economic
registered as being without work recessions
Almost half the unemployed are young
unskilled workers
Relatively stable in the recent years but
Unemployment Rate: Unemployment
did increase in 2008 during a global
as a proportion of labour force
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 Persons / Labor ForceUn

employment Rate = Number of Unemployed Persons / Labor Force

Consequences of Unemployment

Personal Economical
Loss of income and reduced ability to buy Unemployment is a waste of human
goods & services resources
Unemployed people de-skill if long out of
Fewer goods & services produced
work
Unemployed people may become Total output & income in the
depressed & ill economy is lower
The strain on family relationships & health Government tax revenues also
services lower
People in work may have to 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

CPI in Year x=Weighted Average Price in Year xWeighted Avereage Pric

e in Base Year×100CPI in Year x=Weighted Avereage Price in Base 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