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
o Governments aim for economic growth because producing
more goods and services raises living standards, improves
health and housing, and supports other economic goals.
Growth increases employment and provides more tax revenue
to help the poor. In the long term, it can also stabilise prices
by matching demand and improve trade through exports.
 Low Unemployment
o Unemployment represents a waste of resources. The
unemployed may face various challenges, including reduced
income, while the government may need to allocate tax
revenue to support them.
 Low Inflation/Stable Prices
o Governments aim for price stability to ensure economic
certainty and maintain international competitiveness. It allows
firms, households, and workers to plan confidently without
fear of rising costs, preventing actions that could drive future
price increases.
 Balance of Payment Stability
o If a country’s spending on imports consistently exceeds its
income from exports, it will be living beyond its means and
accumulating debt. Conversely, if export revenue surpasses
import spending, the country's residents may not be enjoying
as many goods as they could.
 Redistribution of Income
o Income and wealth inequality can lead to poverty.
Governments aim to reduce poverty due to its hardships, but
inequality can worsen without intervention. The wealthy often
marry within their class, access better education, and have
more savings opportunities. A large gap between the rich and
poor can also lead to social unrest as the disadvantaged may
feel socially unjust.
Conflicts between the Macroeconomic Aims
 Full Employment vs Stable Prices
o Achieving full employment can lead to increased consumer
spending, which may drive up demand and result in inflation.
Higher inflation can compromise price stability, as rising prices
erode purchasing power.
 Economic Growth vs Balance of Payment Stability
o Rapid economic growth can lead to increased imports as
consumers and businesses demand more goods and services.
 This can worsen a country’s balance of payments, creating
deficits if exports do not keep pace with imports.
 Full Employment vs Balance of Payment Stability
o High employment levels can boost domestic consumption,
leading to increased imports. This may strain the balance of
payments if the increase in imports outpaces export growth,
potentially resulting in trade deficits.
 Economic Growth vs Stable Prices
o Economic growth often involves increased production and
consumption, which can lead to higher demand for goods and
services. If this demand outstrips supply, it can result in
inflation, compromising price stability.
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
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
Expansionary
spending to boost 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 make
Training them more productive.
 Instrument Effect on Macroeconomic Aims
Include minimum wage laws to encourage more
Labour Market
people to work and legislation to restrict the
Regulations
power of trade unions.
Competition Regulations that outlaw unfair trading practices
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
Real GDP=NominalCPI×100Real GDP=CPINominal×100
Real GDP Per Capita=Real GDPNumber of PopulationReal GDP Per Capita=
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
Labour force
has grown
Participation Rate: labour force Risen in many countries
as a proportion of total population especially among females as it is
of working age now socially acceptable
Poverty and rising living costs in
developing countries has forced
many women to work
Employment by Employment in services has been
Industry: Number of people growing while employment in
employed in different industrial agriculture and other primary
sectors sector industries 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
recessions
without 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 Persons / Labor Forc
eUnemployment Rate = Number of Unemployed Persons / Labor F
orce
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
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 Price in
Base Year×100CPI in Year x=Weighted Avereage Price in Base YearWeight
ed 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

Economic Development
Living Standards
 Standard of Living refers to the social and economic well-being of
the individuals in a country.
Real Gross Domestic Product (GDP) Per Capita
 GDP is the main measure of the total value of all 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 Capita=
Number of PopulationReal GDP
 If the economy has an extremely rich person & everyone else is
poor, it brings up the Real GDP per capita
Human Development Index (HDI)
 Used by the United Nations to make comparisons of human &
economic development in different countries
 Combines three different measures for each country
o Standard of living, measured by average incomes
o Being educated, measured by adult literacy rate
o Living a long, healthy life, measured by life expectancy
 Single index with a value between 0 and 1
 Greater than 0.8 = high human development. Less than 0.5 = low
human development
Reasons For Low/Varying Economic Development
 Over-dependence on agriculture
 Domination on international trade by developed nations
 Lack of capital
 Insufficient investment in education, skills & Healthcare
 Low levels of investment in infrastructure
 Lack of efficient production and distribution systems
 High population growth
 Other factors like a corrupt govt. or war
Poverty
Absolute poverty Relative poverty
Number of people living below a Measures the extent to which a
 Absolute poverty Relative poverty
certain income threshold or
number of households unable to household’s financial resources fall
afford certain basic goods & below an average income level.
services
Occurs when people are poor
Occurs when people do not have relative to other people in the
access to basic food, clothing country, unable to participate fully
and shelter in normal activities of the society
they live in
Causes of Poverty
 Unemployment
 Low wages
 Illness
 Age
 Poor Healthcare
 Low literacy rates
 High population growth
 Poor infrastructure
 Low FDI (Foreign Direct Investment)
 High public debt
 Reliance on primary sector output
 Corruption and Instability
Alleviating Poverty
 Governments will use policies to help alleviate poverty in their
country, or in another country:
What are the
Policy Why is it needed?
problems?
Free food supplies can
Poor farming methods
Food aid force farmers out of
produce insufficient food
business
LEDCs lack the capital to
invest in an industrial
Financial Loans have to be repaid
base and modern
aid sometimes with interest
machinery and
infrastructure.
LEDCs lack access to Most people lack the skill
modern machinery and to use modern technology;
Tech aid equipment and instead of using
knowledge of modern machinery, more jobs are
production methods. needed to employ people.
Debt relief Relieving LEDCs of debt This may encourage
will allow them to use LEDCs to borrow more
money for economic money, or corrupt
 What are the
Policy Why is it needed?
problems?
governments may misuse
development instead.
money.
Removing
LEDCs may have natural
overseas MEDCs will force down
supplies can be exported
trade their price
for money
barriers
Governments in LEDCs Advice is not enough;
Economic
lack economic LEDCs need more capital
Advice
knowledge & stability
Population
Factors that affect population growth
 Birth rate
 Death rate
 Net migration
 Immigration & emigration
Dependency Ratio
 Comparison of people in employment with the number of people
who are not in the labour force.
Reasons for different population growth rates
Varying Birth Rates
 LEDCs have:
o Large families to help produce food & work for money
o High infant mortality rate
o Low supply of contraceptives/forbidden to use them
 In MEDCs, people marry later in life, so birth rates fall
Varying Death Rates
 MEDCs have:
o Better food, housing, hygiene &high life expectancy
o Fatty foods, smoking, and lack of exercise have increased
rates of diabetes, cancer & heart disease
o Improved medicine & healthcare; prevents many diseases &
increased life expectancy
 LEDCS have:
o Widespread diseases which lower life expectancy
o Natural disasters, famines, wars
Population Structure
 The Demographic Transition Model:
 This shows that population growth occurs in stages
 Population Pyramid: a type of graph that shows the age and sex
structure of the country

 Stage 1: high birth rate; high death rates; short life expectancy; less
dependency (since there are few old people and children must work
anyway)
 Stage 2: high birth rate; fall in death rate; slightly longer life
expectancy; more dependency due to more elderly
 Stage 3: declining birth rate, declining g death rate, longer life
expectancy, more dependency
 Stage 4: low birth rate, low death rate, highest dependency ratio,
longest life expectancy