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.

Stable Low
Low
Economic Unemploy A stable BOP
Inflation
Growth ment
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
Complimentar • Growth & foreign investments
y Objectives (Favourable 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
 WHY DO WE PAY TAXES?

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

Equity Certainty Administrati Efficient/ Simplicity Convenience

• It means taxing • People and firms ve Efficiency Non- • Taxes should be • It must be
people & firms should know the • A good tax needs distortionary easy to convenient for
according to time and amount to be practical • Taxes should not understand, the taxpayers to
their ability to of tax to be paid and efficient to calculate and pay the taxes on
pay. Taxes to plan their affect or distort pay as complex a regular basis
collect. sensible
should be fair. finances • It shouldn’t take tax system can
accordingly. economic cause confusion
up a high behaviour. It
percentage of and encourage
shouldn’t tax avoidance.
the tax revenue. discourage
people to work.
 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

Indirect
taxes. They include GST, VAT, Sales tax, consumption tax,
excise tax etc.
• An indirect tax will normally be imposed on producers but they

Taxes are paid partly by consumers. Producers try to shift the burden
of the tax to consumers through 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.
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 % tax rate Tax paid

Income
$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
• Labour market reforms deregulation
 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: • Regulations:
• It helps to remove burdens on • Regulations are rules and laws that
business, reduce their production costs restrict certain activities which may
and free up resources by simplifying or harm the society as a whole like
removing old and unnecessary misleading advertisements, limiting
regulations. production and sales of demerit
• For example, removing restrictions on goods, setting standards for hygiene
and safety in work place.
shop opening and closing hours,
reducing unnecessary labeling
requirements, allowing firms to fill tax
returns electronically etc.