Government and the macroeconomy

A government organisation with the authority to administer a range of

Local government
policies within an area of the country
An industry where a single firm can produce at a lower average cost than
Natural monopoly two or more firms because of the existence of significant economies of
scale
industries are important for the economic development and safety of the
Strategic industries
country
National champions Industries that are, or have the potential to be, world leaders
Trade blocs Regional group of countries that remove trade restrictions between them
Free international trade Exchange of goods and services between countries without restriction
An increase in the output of an economy in the long run, an increase in the
Economic growth
economy's productive potential
Actual economic growth An increase in the output of an economy
Potential economic growth An increase in an economy's productive capacity
Aggregate demand Total demand for a country's product at a given price level
Total amount of goods and services that domestic firms are willing to
Aggregate supply
supply at a given price level
Full employment Lowest level of unemployment possible
Economically active Being a member of the labor force
Percentage of the labor force who are willing and able to work but are
Unemployment rate
without jobs
Price stability Price level in the economy not changing significantly over time
Inflation rate Percentage rise in the price level of goods and services over time
Balance of payments Record of a country's economic transactions with other countries
Budget Relationship between government revenue and government spending
Budget deficit Government spending is higher than government revenue
Budget surplus Government revenue is higher than government spending
National debt Total amount the government has borrowed over time
Multiplier effect Final impact on aggregate demand being greater than initial change
Direct taxes Taxes on income and wealth
Indirect taxes Taxes on expenditure
Progressive tax As income rises the percentage of their income paid in the tax rises
Proportional tax As income rises the percentage of their income paid in tax stays the same
Regressive tax As income rises, the percentage of their income paid in tax falls
Forms of government expenditure and taxations that reduce fluctuations
Automatic stabilizers
in economic activity, without any change in government policy
Inflation Rise in the price level of goods and services over time
Informal economy Part of the economy that is not regulated, protected or taxed by the
 government
Flat taxes Taxes with a single rate
Decisions on government spending and taxation designed to influence
Fiscal policy
aggregate demand
Rises in government expenditure and/or cuts in taxation designed to
Expansionary fiscal policy
increase aggregate demand
Cuts in government expenditure and/or rises in taxation designed to
Contractionary fiscal policy
reduce aggregate demand
Decisions on the money supply, the rate of interest and the exchange rate
Monetary policy
taken to influence aggregate demand
Foreign exchange rate Price of one currency in terms of anther currency or currencies
Expansionary monetary Increases in the money supply and/or the reduction in the rate of interest
policy designed to increase aggregate demand
Contractionary monetary Cuts in the money supply or growth of money supply and/or rises in the
policy rate of interest designed to reduce aggregate demand
Supply side policy Measures designed to increase aggregate supply
Deregulation Removal of rules and regulations
Gross domestic product GDP is the total value for all goods/services produced in an economy in a
(GDP) year
GDP can be calculated using the value of the expenditure in an economy
GDP = Consumption (C) + Investment (I) + Government spending (G) +
GDP calculation
Exports (X) - Imports (M)
GDP = C + I + G + (X-M)
Circular flow of income Movement of expenditure, income and output around the economy
Difference between the sales revenue received and the cost of raw
Value added
materials used
Transfers of income from one group to another not in return for providing
Transfer payments
a good or service
Nominal GDP GDP at current market prices and so, not adjusted for inflation
Real GDP GDP at constant prices and so, adjusted for inflation
Adding together the final spending of consumers firms government and
National expenditure
net exports
National income
Subsistence agriculture Output agricultural goods for farmers' personal use
Recession a reduction in real GDP over a period of six months or more
Sustainable economic Economic growth that does not endanger the country's ability to grow in
growth the future
Employment Being involved in a productive activity for which a payment is received
Unemployment Being without a job while willing and able to work
Measure of unemployment which counts as unemployed these in receipt
Claimant count
of unemployment benefits
Labour force survey (ILO) Measure of unemployment which counts as unemployed people who
Measure identify as such in a survey
Frictional unemployment Temporary unemployment arising from workers being in between jobs
Unemployment caused by long term changes in the pattern of demand and
Structural unemployment
methods of production
Cyclical unemployment Unemployment caused by a lack of aggregate demand
Unemployment arising from workers who have lost their jobs, looking for a
Search unemployment
job they are willing to accept
Unemployment arising from workers regularly being between periods of
Casual unemployment
employment
Seasonal unemployment Unemployment caused by a fall in demand at particular times of the year
Unemployment caused by a decline in job opportunities in a particular area
Regional unemployment
of the country
Technological
Unemployment caused by workers being replaced by capital equipment
unemployment
Deflation Sustained fall in the prices of goods and services
Disinflation Fall in the rate of inflation
Cost Push inflation rises in the price level caused by higher costs of production
Demand Pull inflation rises in the price level caused by excess demand
Price spiral wage rises leading to higher prices, in turn, lead to further
Wage
wage claims and price rises
Monetary inflation Rises in the price level caused by an excessive growth of the money supply
Very rapid and large rise in the price level changing payments in line with
Hyperinflation
changes in the inflation rate
Index Linking changing payments in line with changes in the inflation rate
Menu costs Costs involved in having to change prices as a result of inflation
Shoe Leather costs Costs involved in moving money around to gain higher interest rates
 - Economic Growth
- Low unemployment
Macroeconomic aims
- Low and Stable Inflation rate
- Redistribution of wealth and income
To provide public goods, welfare and necessities, and to stimulate the
Why do governments spend
economy

These include the daily payments required to run the government and
How does current
public sector wages and salaries of public employees like teachers,
expenditures link to why
police and also includes payments for goods and services like medicines
Governments spend?
for hospitals

Capital expenditures:
Infrastructure investments such as airports, hospitals, railroad
Government
How does earning
government revenue link to Governments need money to provide essential services, public and
reasons why the merit goods revenue to found this is raised through taxation
government tax?

How does supporting poorer Poverty has multiple impacts on both the individuals and the economy,
households link to why the intervention seeks to redistribute income tax the rich a give to the poor
government taxes? reducing the impacts of poverty.

Income tax is an example of a direct tax which is took of the consumers

income this gives them less disposable income meaning that they
How does Direct tax affect
cannot spend as much on luxury’s and may have to cut down on
consumer spending?
necessities if the rate of income tax is increased this prevents the
consumer from spending more money

An example of an indirect tax is VAT which is a tax on products or

services when sellers add value onto them this directly effects the
How does indirect tax affect consumer as the VAT tax is usually pushed onto the consumer meaning
consumer spending? that if it is addictive and or a necessaries consumers will still continually
buy the product meaning they will have less disposable income. VAT
makes products more expensive

1. Growth Caused by a Change in Total Demand

Actual economic growth occurs when there is an increase in the
quantity of goods/services produced in an economy in a given period of
Causes of economic growth time
This is often measured by the percentage change in real gross domestic
product (GDP)
If any component of real GDP increases (consumption, investment,
 government spending, net exports), there will be an increase in total
demand
2. Growth Caused by a Change in the Quantity/Quality of Factors
of Production
Potential growth is the increase in the productive potential of an
economy
This occurs when there is an increase in the quantity or quality of the
factors of production available in an economy
One example of how the quality of a factor of production can be
improved is through the impact of training and education on labour. An
educated workforce is a more productive workforce and the production
possibilities increase
Economic growth is considered to be the main contributor to an
improvement in the standards of living
National income increases to spend on luxuries and necessities
economic growth increases and national output increases. Increased
Consequences of economic
derived demand for labour, firms produce more output. Unemployment
growth
falls.
Higher national expenditure there is an increase in taxation more
government budget increased taxes and redistribution of goods and
services

Increased incomes lead to better standards of living

Decreased levels of absolute poverty
Improvement in the quality/quantity of environmentally friendly
technologies
Higher sales revenue for firms & greater profits
Increased investment by firms increases the potential output of the
Benefits of economic growth
economy
Reduced expenditure by governments on benefits
Higher government tax revenue due to rising incomes and surging
corporate profits
Increased employment resolves some of the negative social impacts of
unemployment

Rising total demand causes demand pull inflation & the purchasing
power of people on fixed incomes may fall
Lack of equity in the distribution of income - the rich may get richer &
Cost of economic growth the poor poorer
Environmental damage caused by negative externalities of production &
consumption increases
Increased inflation can harm export sales
 The level of imports usually increases negatively impacting the current
account
Increased income usually leads to greater consumption of demerit
goods
Greater output often requires more time from workers and can
decrease leisure time & well-being
Resources are depleted more rapidly
Aggregate Demand increases firms will respond by increasing their
Conflict between Economic
prices. Higher rate of economic growth causes higher levels of
Growth and inflation
consumer spending. Economic growth causes inflationary pressures

Conflict between Economic Economic growth often increases pollution, negative externalities & the
Growth and Environmental depletion of non-renewable resources
Sustainability The higher the growth, the faster the depletion
Conflict between Low
The closer an economy moves to full employment the less workers will
unemployment and Low
be available for hire & wage inflation will help increase overall inflation
inflation
Conflict between Low Firms have difficulty employing sufficiently skilled labour when
unemployment and economic growth occours, growing quickly this leads to wage inflation
economic growth and higher prices.
A fall in consumer confidence reduces consumption
A fall in business confidence reduces investment
Increasing levels of unemployment reduce consumption
What are the some of the Decreasing levels of government spending
demand- side factors that Increased interest rates require borrowers to repay higher amounts on
can cause a recession their loans - this reduces discretionary income which reduces
consumption
Shocks to other economies can reduce demand for a country’s exports
thus reducing total demand
National output (rGDP) falls
More firms go bankrupt
Both unemployment & underemployment increase
Both exports & imports fall
Consequences of a recession Domestic & foreign investment by firms decreases/stops
Deflation may become an issue leading to even lower wage levels
Government spending on unemployment benefits increase
Governments may have to spend significant amounts of money to
support the economy which carries several major opportunity costs
Examples of Fiscal policy When the government increase spending for example on supporting key
used to boost economic industries, providing subsidies or providing public goods they can also
growth use expansionary fiscal policy to lower taxes and increase disposable
 income which ill increase economic growth cutting income tax means a
larger disposable income
Why might
One country may have a higher welfare payments to the unemployed
Frictional unemployment be
means more people may chose to be out of work than in, therefore
higher in one country than
voluntary unemployment rate is higher
another?
Loss of sales and revenue
How does Unemployment
Loss of output and productivity
effect Firms?
Changes in skill level of the economy
Increased crime
How does Unemployment
Increased Anti-social behavior
effect the economy?
Increase homelessness
Increased spending on retraining
How does Unemployment
Less tax revenue
effect the government?
Increased spending on benefits
How does Expansionary Increase gov spending and lowering taxes. This may include spending on
Fiscal Policy reduce schemes to advertise jobs, or increased the productivity of the
Unemployment? workforce which helps improve frictional unemployment
An increase in gov spending will increase AD and therefore the real GDP
of an economy because labor is a derived demand and real GDP is made
up of national output, national expenditure . Increase in real GDP
How does government means there is an increase is he demand for labor thus reducing cyclical
spending reduce unemployment
unemployment? Gov may spend on increasing education which will increase the human
capital of workers. Because workers are more skilled their productivity is
more attractive to employers and there will be an increase the demand
for their labor reducing the risk of structural unemployment
Expansionary fiscal policy & expansionary monetary policy aim to
increase total (aggregate) demand in an economy
How do demand side The demand for labor is derived from the demand for goods/services
policies help with If total demand for goods/service increases there will be a higher
unemployment? demand for labor leading to lower unemployment
Total demand can be increased through any policy which increases one
of the components of real gross domestic product (rGDP)
Uncertainty: Rapid price changes create uncertainty and delay
investment
How does inflation effect Menu change cost: price changes force firms to change their menu
firms prices too this can be expensive
Lenders financial firms that lend money are worse off as the money lent
out is now worth less than before
How does inflation effect International competitiveness: inflation erodes international
 competitive ness of exports as their products now look more expensive
Tradeoffs: There are involved in tackling inflation it can cause an
the Government increase in unemployment or reduce economic growth
Government debt: Inflation erodes the value of government debt as the
repayments are worth less than when the money was borrowed
Purchasing power decreases which worsens the quality of life for
consumers as they spend a higher proportion of their disposable
income on necessities rather than luxuries
Savings: There is a decrease in the value of savings as their money will
How does Inflation effect
be worse less and won’t be able to spend it saved money often spent on
consumers
luxuries
Real income: There is a fall in real income for those on fixed incomes
Borrowers: anyone who borrows money will benefit as the repayments
are worth less than when the money was originally borrowed
Demand side deflation is caused by a fall in total aggregate demand in
the economy being the sum of all expenditure in the economy as
How can Demand side
measured by real GDP if any one of the four components of rGDP
policies cause deflation?
decreases there is a decrease in the total demand and the general price
level will fall