UNIT 4: GOVERNMENT AND THE MACRO

ECONOMY
 SECTION 4.1.1
THE ROLE OF GOVERNMENT

1. The Govt As An Employer

 Public sector employees include civil servants
employed in govt departments, members of the
armed forces, police and judiciary, teachers,
doctors and nurses
 2. THE GOVT AS A PRODUCER

A Govt may own factors of production such as land and capital and may combine
with labour to produce and supply merit goods and services that private sector
firms may undersupply.

Examples are education, healthcare, defense, street lighting, public transport,

postal services, power and water supplies etc.
 OTHER ROLES OF GOVT

3. Govt as a provider
4. Govt as a consumer
5. Govt as a law maker and regulator
6. Govt as a tax setter and collector
 GOVT ROLES, FUNCTIONS AND
RESPONSIBILITIES

1. Central Government is the national Govt of a country and is responsible for

planning and decision-making on issues that affect the whole country including
macroeconomic management, national security and the legal system.
2. Local and Regional Government authorities are usually responsible for
decision making on issues that affects the towns, cities and administrative areas
they govern as well as implementing many national policies, laws and regulation
at their local levels.
SOME EXAMPLES OF RESPONSIBILITIES
 MACRO ECONOMIC AIMS OF GOVT
• Macroeconomics is concerned with issues, objectives and policies that affect the whole economy.
• Every country has macroeconomic goals that it wants to achieve; these goals or objectives are key to ensuring
long-term stable economic success.
• These are the four main macroeconomic goals that countries aim to achieve.

1. Stable
1. Low 1. Low
Economic 1. A stable BOP
Inflation Unemployment
Growth
THE ADDITIONAL MACROECONOMIC GOALS

To reduce poverty and inequalities in income and

wealth

To reduce pollution and waste, protect the natural

environment and

Encouraging sustainable economic growth

Improved access to public services

 1. STABLE ECONOMIC
GROWTH
• What is economic growth?
• An increase in the total output of goods and services in a national economy measured by the annual increase in its gross domestic
product (GDP). Gross domestic product (GDP) is the total monetary or market value of all the finished goods and services produced
within a country's borders in a specific time period.

• Why is negative growth bad for business and an economy?

• There will be sustained reduction in total output or GDP
• Fewer people will be employed
• Income and consumer spending will be falling
• Firms will lose sales and profits
• Firms may go bankrupt
• There will be fewer business opportunities
• Entrepreneurs will not invest in new firms and may move to other countries with belter opportunities
• As incomes and profits fall, Govt revenue from taxes will fall and Govt spending on public welfare services n facilities will reduce

• Why aim to have a control economic growth?

• Sustained economic growth will create new business opportunities and jobs. Output, employment and incomes will rise and living
standards will improve
 2. LOW AND STABLE
INFLATION
• What is inflation?
• A sustained increase in the average price of goods and services available for sale in an economy.

• Why is high price inflation bad for business and an economy?

• As prices rise, consumers cannot afford to buy as many goods or services as they did before so demand and
sales falls.
• Rising prices reduce real incomes which is a measure of the purchasing power of money.
• Business costs increase as the cost to produce rises
• Workers may also demand higher wages and salaries

• Why aim to have a controlled inflation rate?

• If Govt can reduce rate of inflation and keep it low, it will make it easier for firms to manage their costs, for
exporters to sell their products overseas and for consumers with low incomes to continue buying the goods
and services.
 3. LOW UNEMPLOYMENT
• What is unemployment?
• People who are willing and able to work are unable to find work because of a lack of suitable job opportunities.

• Why is high unemployment bad for business and an economy?

• As unemployment rises, fewer people will be in work and so fewer goods and services will be produced. Total
output in the economy will fall.
• Fewer people will be in paid work so total income will be lower. As a result consumer spending will fall and
business will lose revenue.
• The Govt may have to spend more on welfare or social security payments to support the unemployed and their
families
• Taxes on firms and employed people may be increased to pay for the additional Govt spending. This will reduce the
disposable income s and aggregate demand in the economy will fall.
• People who are unemployed for a long time may get deskilled.

• Why aim to have a controlled unemployment rate?

• If Govt can reduce rate of unemployment and expand employment opportunities, more people will be in paid work
and earning regular incomes. As employment increases, total output will expand, consumer spending will rise, more
business opportunities are created and Govt spending on welfare can be reduced as living standards will improve.
 4. STABLE BOP
• What is Balance of Payment?
• The Balance of payment of a country provides a record of the value of all its international trade and financial
transactions with other countries.

• Why is unfavourable BOP bad for business and economy?

• Unfavourable BOP means import expenditure for the year is more than export revenue.
• The current account may run into deficit.
• The country has to borrow money from overseas to manage buying for imports.
• The national currency may lose value against other currencies.
• Imports will further be costly and can lead to inflation.

• Why aim to have a controlled BOP?

• A favourable BOP provides opportunities for business to export and build up job opportunities. Which in return
can improve standard of living of the population and aggregate demand of the economy.
COMPLIMENTARY AND CONFLICTING
OBJECTIVES

• Growth & Employment

• Growth & higher living standards
Complimentary • Growth & foreign investments (Favourable
Objectives BOP)
• Growth & Equity

• Inflation & Unemployment

• Growth & Inflation
Conflicting • Growth & Sustainability
•
Objectives •
Growth & Inequity
Growth & Demand for imported products
(Unfavourable BOP)
 WHAT IS MEANT BY MACRO ECONOMIC
STABILITY?
• Macro Economic stability occurs when there is low volatility in key indicators such as prices,
jobs, economic growth, interest rates, investment and trade.

• Broadly, the objective of macroeconomic policies is to maximize the level of national income,
providing economic growth to raise the utility and standard of living of participants in
the economy.

• It is managed through Govt Budget.

 GOVT BUDGET

• A budget is simply a forecast of what it will spend and how much it expects to earn from revenue over
the next 6 to 12 months.
• Govt plans for areas of public spending and changes in taxation rates.
• Types of Govt Budget:
• Balanced Budget: Public expenditure = Public Revenues (If a Govt plans to spend no more than it will
raise in taxes in the same year, there will be a balanced budget)
• Budget Surplus: Public expenditure < Public Revenues (If a Govt plans to spend less in total than it is
forecast to receive from total tax, there will be a budget surplus)
• Budget Deficit: Public expenditure > Public Revenues (If a Govt that plans to spend more in total than it
is expects to raise in revenue in the same year, there will be a budget deficit)
ANSWER THE QUESTIONS
 PUBLIC SECTOR BORROWING
• In addition to revenues from taxes, a Govt may also receive other public revenues like interest payments on
Govt loans to private firms, rents or sale from publicly owned land or building, revenues from Govt
agencies and public transport, entry fees of Govt properties and national monuments.
• When a Govt spends more than it raises from taxes and other sources of revenues, then it borrow the
difference.
• The amount of money a Govt needs each year to finance any shortfall of public revenues below total public
expenditure is called the Public Sector Borrowing.
• Govt debt can be internal debt owed to private firms, individual and the banking system within its
economy or external debt owed to overseas banks, govt or international organizations as World Bank and
IMF.
• The total amount of money borrowed by the public sector of a country overtime that has yet to be paid is
called the public sector debt or national debt
 TAXES AS GOVT REVENUE
• Taxes are compulsory payments imposed on a taxpayer by a governmental organization in
order to fund government spending and various public expenditures.
• Non payment of tax, or tax evasion is a punishable offence.
• Importance of taxes:
• Taxes raise revenue to fund public expenditure
• Taxes are used to manage the macro economy
• Taxes can reduce income inequalities
• Taxes can discourage spending on imported goods
• Taxes can discourage consumption and production of harmful products
• Taxes can be used to protect the environment
 WHY DO WE PAY TAXES?

• So that the
government
can pay for
goods n
services the
general public
uses
 WHAT IS A GOOD TAX?

Equity Certainty Administrative Efficient/Non- Simplicity Convenience

• It means taxing • People and firms Efficiency distortionary • Taxes should be easy • It must be convenient
people & firms should know the time • A good tax needs to • Taxes should not to understand, for the taxpayers to
according to their and amount of tax to be practical and affect or distort calculate and pay as pay the taxes on a
ability to pay. Taxes be paid to plan their efficient to collect. sensible economic complex tax system regular basis
should be fair. finances accordingly. • It shouldn’t take up a behaviour. It can cause confusion
high percentage of shouldn’t discourage and encourage tax
the tax revenue. people to work. avoidance.
 TYPES OF TAXES
• It is taken directly from individuals or firms and their incomes
or wealth.
Direct • That is, the burden of a direct tax falls on the taxpayer
responsible for paying it.
Taxes • Direct taxes include income taxes, corporation taxes on
company profits, capital gains taxes on property and
inheritance taxes.

• An Indirect tax is one imposed upon expenditure. They are imposed on

spending to buy goods and services.
• Therefore at times they are known a outlay or expenditure taxes. They include
GST, VAT, Sales tax, consumption tax, excise tax etc.
Indirect • An indirect tax will normally be imposed on producers but they are paid partly
by consumers. Producers try to shift the burden of the tax to consumers through

Taxes higher prices.

• An Indirect tax will increase a firms variable costs of production and therefore
cause an upward shift of supply curve. This means less will be supplied at each
price and market price will rise.
 HOMEWORK

• Write in your notebook explaination of:

• Direct Taxes- (Income Tax, Corporation Tax and Capital
Gain Tax)
• Indirect Taxes- (Sales Tax, VAT and Excise Duties)
• Merits and Demerits of Direct and Indirect Taxes
TAXATION SYSTEM

Progressive Taxation

Proportional Taxation

Regressive Taxation
 PROGRESSIVE TAXATION SYSTEM

• Progressive Taxes: A progressive tax is based on the taxpayer's ability to pay.

• It imposes a lower tax rate on low-income earners than on those with a higher income.
• This is usually achieved by creating tax brackets that group taxpayers by income ranges.
• Tax rate, along with tax liability, increases as an individual’s income increases.
• The overall outcome is that higher earners pay a higher percentage of taxes and more
money in taxes than do lower-income earners.
• Example: The U.S. federal income tax is a progressive tax system.
In a Progressive Tax Structure, tax rates
increase with rising income
 PROPORTIONAL TAXATION

• A proportional tax is an income tax system that levies the same percentage of tax to
everyone regardless of income.
• A proportional tax is same for low, middle, and high-income taxpayers.
• Therefore they are sometimes referred to as flat taxes.
• Regardless of income, tax percentage remains the same.
• Example:
In a Proportional Tax Structure, tax rates
remain fixed even if income increases

Annual Income % tax rate Tax paid

$20000 10% $200
$50000 10% $500
$80000 10% $800
 REGRESSIVE TAXATION SYSTEM

• A regressive tax is a tax applied uniformly, taking a larger percentage

of tax from low-income earners than from high-income earners.
• It is in opposition to a progressive tax, which takes a larger
percentage from high-income earners.
• As income increases, tax percentage decreases.
In a Regressive Tax Structure, tax rates
decreases as income increases
SOLVE
Calculate the rate of tax and comment which
one is Proportional, Progressive Or Regressive
MACROECONOMIC POLICIES OF
GOVERNMENT

Fiscal policy

Monetary policy
Supply side
policy
 1. FISCAL POLICY

Fiscal policy is a demand side Macro Economic Policy of Govt

through use of taxation and government expenditure strategies to
influence the level of economic activity and macroeconomic
objectives such as employment, economic growth and the control of
inflation.
FISCAL POLICY MEASURES
 USE OF FISCAL POLICY

• Fiscal policy can be used either to expand or to contract economic activity in order to
achieve macroeconomic objectives and to promote economic stability.
• Fiscal policy is also used to redistribute income and wealth in the economy. Some
countries have quite high rates of income tax to reallocate resources from wealthier
individuals to the poorer members of society.
• Govt can use fiscal policy either as:

• Expansionary Fiscal Policy

• Contractionary Fiscal Policy
 EXPANSIONARY FISCAL POLICY

• If a Govt wants to increase aggregate demand in the economy to boost employment and output, it
can increase its expenditure or reduce taxation. This is called reflationary or expansionary fiscal
policy.
• Cutting taxes on profits may provide firms with an incentive to increase output and investments
in new productive capacity.
• Cutting taxes on personal incomes may encourage more people to participate in the workforce
and spend their income. This will increase aggregate demand in the economy.
• Govt will often implement an expansionary fiscal policy during an economic downturn or
recession to boost the economy.
CAN INCREASED PUBLIC EXPENDITURE CREATE JOBS?
 CONTRACTIONARY FISCAL POLICY

• A deflationary or contractionary fiscal policy aims to reduce pressure on prices in the economy
by cutting aggregate demand through reduction in public expenditure and/or by raising total
taxation.
• Raising taxes on profits may provide firms with a disincentive to restrict production and
investments in new productive capacity.
• Increased taxes on personal incomes may discourage people to participate in the workforce and
there will be fall in income. This will decrease aggregate demand in the economy.
• Govt will often implement a contractionary fiscal policy during an economic boom or expansion
to control the economy.
EXAMPLE
 LIMITATIONS OF FISCAL POLICY

• Fiscal policy is cumbersome to use

• Increases in public expenditure crowds out private spending
• Increasing taxes on incomes and profits can reduce incentives to
work and invest
• Expansionary fiscal policy may create inflationary pressure
• Time lags
 2. MONETARY POLICY

• Monetary policy is a demand side Macro Economic Policy which refers to the Govt’s use of interest
rates and the money supply to influence the level of Aggregate Demand and economic activity.
• It is carried out by the Central Bank of each country which is usually a government financial
institution.
• Interest rates can refer to the price of borrowing money or the return from saving money at
financial institutions like banks.
• Whereas money supply refers to the entire quantity of money circulating in an economy. An
increase in the supply of money leads to a fall in the rate of interest; a decrease in the supply of
money leads to an increase in the rate of interest.
 EXPANSIONARY (EASY) MONETARY POLICY

• An increase in the money supply

(Quantitative Easing) or decrease in
interest rates by the central bank is
referred to as an easy or cheap monetary
policy.
• It is also an expansionary monetary
policy, since the objective is to expand
aggregate demand and the level of
economic activity.
• If interest rates are reduced, people and
firms will be able to borrow money more
cheaply and savings will become
unattractive. So expenditure will
increase which can boost output and
employment in the economy.
 CONTRACTIONARY (TIGHT) MONETARY
POLICY

• A decrease in the money supply by the central bank is referred to as a tight monetary policy, or
contractionary monetary policy, as the objective is to contract aggregate demand and therefore
the economy.

• If interest rates are increased, people and firms will find it costly to borrow money and savings
will become more attractive. So expenditure will decrease which can reduce aggregate demand
and inflation in the economy.
 LIMITATIONS OF MONETARY POLICY

• Conflict between government objectives (Changes in Interest rates and stable

exchange rates)
• Possible ineffectiveness in recession
• Time lags
 SUPPLY-SIDE POLICIES

• Supply-side policies aims at boosting the productive capacity and supply side of the
economy by focusing on increasing the quantity and quality of factors of production,
as well as on institutional changes.
• There are two major categories of supply-side policies: interventionist and market-
based.
• Interventionist policies rely on government intervention to achieve growth in
potential output.
• Market-based policies emphasize the importance of well-functioning of competitive
markets in achieving growth in potential output
 SUPPLY-SIDE POLICIES

• Selective Tax Incentives • Competition policy

• Selective subsidies • Removing trade barriers
• Improving Training and • Privatization
education • Regulation and deregulation
• Labour market reforms
 SUPPLY-SIDE POLICIES

• Labour market reforms • Competition policy

• Control on trade unions • Control on Monopolies
• Control on welfare payments
• Minimum wages
 SUPPLY-SIDE POLICIES
• Deregulation:
• It helps to remove burdens on business, reduce
their production costs and free up resources by
simplifying or removing old and unnecessary
regulations.
• For example, removing restrictions on shop
opening and closing hours, reducing unnecessary
labeling requirements, allowing firms to fill tax
returns electronically etc.
• Regulations:
• Regulations are rules and laws that restrict
certain activities which may harm the society
as a whole like misleading advertisements,
limiting production and sales of demerit
goods, setting standards for hygiene and
safety in work place.