Preliminary Economics Topic Six

Government and the Economy

Government intervention in the economy
1.1

Limitations of the operation of the free market:

Market failure can occur in five areas of economic

activity: provision of goods and services, inequality in the
distribution of income, negative environmental
externalities, monopoly power, and fluctuations in
economic activity
Provision of goods and services market failure can arise
from the inadequate provision of some collective goods
and services (demanded by the community), and public
goods (non excludable and non rival goods) and merit
goods (goods that the government believes are beneficial
to society that are not produced in adequate quantities
because the market is too small and there is little
incentive for producers)
Unequal distribution of income can cause absolute
poverty (below poverty line) and relative poverty (do not
have enough income to have the average standard of
living enjoyed by the majority); groups prone to poverty
include: single people (57%), sole parents (20%),
childless couples. women, young people, unemployed,
migrants, Aborigines, the elderly, sick and disabled
Externalities are the social costs of private production

Monopoly power natural monopolies may form (from

PTEs and Public Utilities) if they supply the entire market
demand with an efficient scale of plant, government
reforms in this area to make PTEs more efficient include:
privatisation the sale of part or all of a PTE to the
private sector, corporatisation structuring PTEs like
private sector enterprises by making them financially
independent, commericialisation PTEs guaranteeing a
rate of return, principles of competitive neutrality,
subjecting PTES to taxes, interest on loans, etc, and
deregulation removing restrictions
Fluctuations in economic activity business cycle: boom
downswing recession upswing. Problems caused by
fluctuations include: higher rates of unemployment in
recessions, higher rates of inflation in booms.

The role of government

2.1

Functions of the three levels of government and

constitutional powers:

3.1

Size of the public sector: pg254

4.1

Economic functions of the Australian Government:

The economic functions of the Australian government are

reallocation of resources, redistribution of income,
stabilisation of economic activity, the provision of goods
and services through public trading enterprises (PTEs)
and the use of other economic policies such as
competition and environmental policies
Reallocation of resources is done through changing the
level and composition of taxation and expenditure
(spending on collective goods, taxation alters relative
prices, governments may use selective assistance or
incentives to industries)
Taxation revenue = tax base x tax rate (percentage of tax
base paid in tax)
Direct taxes (income & company) are paid by those
individuals and firms upon whom they are levied, cannot
be passed on to others
Indirect taxes (sales tax, GST, excise, customs duties) are
imposed on one group but are usually passed on fully or
partially to the final consumer of the good or service

Taxation criteria: equity (vertical higher incomes paying

a higher rate, horizontal equal tax for same income),
efficiency (leaves allocation of resources unchanged and
doesnt affect economy otherwise), simplicity (minimising
tax avoidance and evasion)
Tax impact = initial point levied, tax incidence = who
ultimately pays

5.1

Government attempts to stabilise the economy through

macroeconomic policies: fiscal and monetary policy
Monetary contractionary rise in the cash rate
Monetary expansionary reduce interest rates
(stimulating spending, growth, employment)
Fiscal contractionary surplus budget (G<T)
Fiscal expansionary - deficit budget (G>T)
PTEs The PTE sector is an important provider of social
and economic infrastructure in Australia and contributes
revenue to government (dividends)
The Australian government uses competition policy
enforced by the ACCC to achieve effective competition in
markets
The Australian and state governments control negative
environmental externalities through: taxes, licenses,
quotas, permits, fines, laws and regulations, subsidies

Federal budget:

6.1

Government redistributes income to reduce equality by

progressive taxes and social welfare payments
ART = (tax paid)/income, MRT = (change in tax
paid)/change in income

Two main components of budget: structural component

(explicit changes in G or T) and cyclical component
(changes in G or T caused by changing economic activity)
Surplus budget T>G
Deficit budget G>T
Balanced budget G=T
Expansionary larger deficit, smaller surplus,
contractionary smaller deficit, larger surplus
Pg 262 budget. (Pg 271 Figure 13.4)

Influences on government policies in Australia:

Political parties
Businesses Business council of Australia (BCA),
Australian Chamber of Commerce and Industry (ACCI),
Confederation of Australian Industry (CAI), etc, are some
major business lobby groups that attempt to influence
government policy to favour business activity

Unions ACTU (Australian Council of Trade Unions)

campaigns for higher wages and better working
conditions
Environmental groups/organisations Australian
Conservation Foundation, Greenpeace
Welfare agencies Australian Council of Social Services
(ACOSS), Salvation army, etc, lobby on social policies
The media influence public opinion
Other interest groups National Farmers Federation
(NFF), Aboriginal groups, Womens Electoral Lobby (WEL)
International foreign policies of allied governments and
treaty obligations