GOVERNMENT ECONOMIC POLICIES

GOVERNMENT ECONOMIC POLICIES The UK Economy (Macroeconomics) TOPIC 4

DEMAND SIDE OF THE ECONOMY • This refers to aggregate demand. • This is C + I + G + (X - M) • Too little demand leads to cyclical unemployment and too much demand leads to inflation. • The government can change the level of demand by using: • Fiscal Policy • Monetary Policy • THESE ARE CALLED DEMAND – SIDE POLICIES

SUPPLY SIDE OF THE ECONOMY • This refers to the part of the economy that produces goods and services. • The performance of any economy is limited by its productive potential. This is affected by the quality and efficiency of the resources available. • Governments can influence the supply side by using SUPPLY SIDE POLICIES

DEMAND SIDE POLIICES (Fiscal and Monetary) Topic 4 The UK Economy (Macroeconomics)

FISCAL POLICY • Fiscal policy is when the government changes the level of its spending or the level of taxation to influence the economy. • The policy aims to change the level of aggregate demand.

MACROECONOMIC OBJECTIVES AND FISCAL POLICY • UNEMPLOYMENT High unemployment occurs because of insufficient demand in the economy.They could increase demand by: • Spending more itself. (G) • They could increase capital spending e.g. new hospitals or current spending e.g. employing more. This would be an injection. • Reducing taxation • Reducing corporation tax may increase investment from firms (I) or by reducing income tax will mean consumers will have more to spend (C)

MACROECONOMIC OBJECTIVES AND FISCAL POLICY • INFLATION If there is inflation in the economy then there is too much aggregate demand, the government will try to cut demand by; • Cutting its own spending (G) • Increasing taxation to cut consumer spending (C) or investment by firms. (I)

PROBLEMS WITH FISCAL POLICY • CONFLICTING OBJECTIVES A policy that wants to raise demand to increase employment and encourage economic growth could; • Worsen the balance of payments • Cause inflation A policy used to reduce inflation could; • Cause unemployment • Lower economic growth

PROBLEMS WITH FISCAL POLICY • FORECASTING THE REQUIRED CHANGE IN DEMAND • The data used to make plans is not always reliable • It is difficult to predict the multiplier effect of increasing G or reducing T • Difficult to estimate when the policy will take effect • FINE TUNING • As fiscal policy is not a precise instrument. This is because either too little demand was injected so unemployment remained or too much was injected and inflation occurred.

MONETARY POLICY • Monetary policy is one that uses interest rates or controls the money supply as a means of achieving objectives. • Interest rates are set by the Monetary Policy Committee (MPC) of the Bank of England. They have to keep inflation within the government’s target. • They BoE are the: • Governments Bank • Bankers Bank

MONETARY POLICY AND GOVERNMENT OBJECTIVES INFLATION • If a government wanted to reduce demand to control inflation then it would increase interest rates or reduce the money supply. • By increasing interest rates there would also be an increase in the exchange rate. This can reduce inflation in three ways: • Lowers the price of imported finished goods • Lowers the price of imported raw materials • Puts pressure on domestic firms to lower costs to remain competitive.

ECONOMIC GROWTH AND UNEMPLOYMENT • To boost demand in order to achieve economic growth they would lower interest rates. • This would encourage people to spend and borrow. • It will also lower the exchange rate making exports cheaper and therefore increase employment.

BALANCE OF PAYMENTS DEFICIT • An increase in the rate of interest will cut aggregate demand which includes the demand for imports. • This helps to improve the Balance of Payments as it means less imports coming into the country.

INTEREST RATES AND INFLATION When interest rates are changed, demand can be affected in a number of ways. • Spending and savings • Increased interest rates makes savings more attractive and borrowing less attractive. • Cash-flow • rising interest rates will reduce consumers cash-flow, less to spend. • Exchange rates • Increased interest rates will increase the amount of foreigner investors.

Supply Side Policies • These are mainly microeconomic measures, which are designed to improve competition in PRODUCT MARKETS and improve working in LABOUR MARKETS.

PRODUCT MARKETS • The main reason for supply-side policies in this type of market is that increased competition will increase efficiency. • Policies include: • Privatisation • Deregulation • Commitment to Free Trade • Reduction in Corporation Tax • Strict control of inflation

LABOUR MARKETS • A labour market that is perfect can clear surpluses and shortages quickly. It is called a FLEXIBLE LABOUR MARKET • An imperfect or inflexible labour market finds it difficult to adjust. • Policies include: • Trade Union reforms – less power = less industrial action • Increased spending on education • Increased spending on training • Improved incentives to work. E.g. reducing income tax, making benefits less attractive.

ECONOMIC GROWTH Topic 4 The UK Economy (Macroeconomics)

WHAT IS ECONOMIC GROWTH? • This is the rate of growth in a country’s potential output. • It is represented by a shift to the right of the country’s production possibility curve and the annual percentage change in GDP.

CAUSES OF ECONOMIC GROWTH • SUPPLY-SIDE POTENTIAL GROWTH • QUANTITY OF RESOURCES • Land – usually fixed in quantity but can increase in the long run. E.g. new oil field. • Labour–any increase in the number of people willing and able to work or the hours worked. • Capital – an increase in investment is usually the most important cause of economic growth.

CAUSES OF ECONOMIC GROWTH • PRODUCTIVITY OF RESOURCES • Moving resources from low-productivity industries to high-productivity ones. Depends on occupational and geographical mobility. • Improving the quality of resources – Land, Labour, Capital • Using resources in a more economically efficient way e.g. specialisation, economies of scale.

ACTUAL GROWTH • Determine by two factors: • The growth in potential output • The growth in aggregate demand.

GOVERNMENT POLICY LEFT WING RIGHT WING Private sector and enterprise generate growth. Government should only get involved to remove controls and regulations. Reduce direct taxes on income and profits. Strict control of inflation is necessary. • Believe the government should intervene. • They want the government to invest in industries and supply subsidies. • Strong belief that the government should invest heavily in infrastructure. • Increase aggregate demand through fiscal and monetary policies.

GROWTH Benefits Costs resources are diverted to making capital goods Pollution Depletions of non-renewable resources Increased pressure on industrial and urban life e.g. stress and crime. • Standards of living improve • Increased productivity • Increased incomes • Higher Tax revenues – better public services

SOURCES OF GROWTH Demand Supply Increase in female participation has increased the workforce Increased flexibility of labour Higher investment has added to the country’s productive capacity. • Low unemployment • Consumers have been able to increase borrowing • Interest rates have been low • Significant spending by the government.

ENVIRONMENT POLICY TOPIC 4 The UK Economy (Macroeconomics)

ENVIRONMENT PROBLEMS • Global warming • Air pollution • Water pollution • Traffic congestion • Depletion of non-renewable energy resources • Landfill waste

MARKET BASED POLICIES • These aim to influence the producer or the consumer by the price they have to pay. • They hope to discourage producers or consumers by making them pay for the external cost they create. • Policies include: • Landfill Tax • Climate change levy • Road Pricing • Petrol Tax • VAT on domestic fuel

NON-MARKET POLICIES • These are designed to impose direct controls on polluters or involve the government in investing in areas. • Can include setting pollution standards and enforcing them. • Government investment has included: • Park and ride schemes • Improved sewage disposal • Research into renewable forms of energy • Providing recycling projects such as bottle banks.

OTHER FACTORS • Firms are becoming environmentally friendly because they have discovered: • Going green is good for business • Cutting down on waste, conserving energy and recycling can save money • Pressure groups can put customers off irresponsible firms.

MARKET FAILURE TOPIC 4 The UK Economy (Macroeconomics)

WHAT IS MARKET FAILURE? • This happens when a market fails to supply the type or quantity of goods or services that consumers want. • This means there is economic inefficiency in that market. Causes: • COMPETITION IS RESTRICTED • EXTERNAL COST AND BENEFITS ARE IGNORED • PUBLIC GOODS ARE NOT PROVIDED • MERIT GOODS NOT PROVIDED TO ALL WHO NEED THEM.

RESTRICTED COMPETITION • Competition is good in an economy. As it encourages firms to be more efficient. Restricted competition result in: • Poorer quality goods • Limited supplies • Inefficient use of resources • Higher prices.

RESTRICTIVE TRADE PRACTICES • These can include: • Resale price maintenance. • Predatory pricing. • Distributing only to certain retailers. • Cartels. All of which are ILLEGAL in the UK

GOVERNMENT POLICY • Their aim is to encourage competition.It is the responsibility of the OFFICE OF FAIR TRADING to investigate breaches of competition law. EU COMPETITION LAW • Any merger or take over on a European scale can be investigated by the European Commission

MONOPOLY INVESTIGATIONS • Any firm with a market share of above 25% may be referred to the COMPETITION COMMISSION if it is felt that they are acting against the public interest. MERGER INVESTIGATIONS • Any takeover or merger, which would mean a firm has more than 25% of a market or assets worth more than £30m will be looked at. • If it is against public interest then the merger will not be allowed to take place. E.g. Lloyds TSB and Abbey

WHAT IS THE PUBLIC INTEREST? A monopoly or merge will be allowed if: • Competition is maintained. • The competitive strength of a UK firm is increased overseas • The development of new products is likely • Costs of production are reduced • Interests of consumers are improved e.g. more choice

EXTERNAL COSTS AND BENEFITS PRIVATE COSTS • This is the costs that a firm has to pay and is taken into account when making decisions. PRIVATE BENEFIT • This is the benefit the consumer expects to receive when buying a product.

COSTS EXTERNAL COSTS • These are costs that are not paid by producers and not included in the price charge to consumers. • External costs can be things such as a firm polluting a river or a chip shop not taking into account the cost of tidying up the wrappers. SOCIAL COSTS • Cost to society of all resources used as a result of production and consumption • Social Cost = Private Cost + External Cost

BENEFITS EXTERNAL BENEFIT • This is the benefit someone gets even if they have not paid for it. • E.g. someone who pays for medicine does not just benefit them but benefits those around them SOCIAL BENEFIT • Social benefit = private benefit + external benefit

EXTERNAL COSTS AND MARKET FAILURE • If a producer does not consider the external costs of their products then production will exceed what it should ideally be. • Resources will be over-allocated to the production of that good. • If a firm creates external costs then the government can intervene and: • Impose direct controls on the industry. E.g. limit pub opening hours, or limit number of consumers by age. • Impose a tax which would be equal to the external cost. This would move the supply curve to the left, increasing price and quantity fall.

EXTERNAL BENEFITS AND MARKET FAILURE • If a producer does not consider an external benefit then output is lower than it should be. • Price would fall and consumers would demand more. • To encourage production the government could intervene and give a subsidy equal to the external benefit.

PUBLIC GOODS ARE NOT PROVIDED • All public goods have three characteristics: • A consumer can use it without reducing the amount available to others. • The producer (i.e. government) cannot exclude consumers from using it. • A consumer cannot choose to consume the product. • Public goods cannot be provided by a free market system because of the FREE RIDER PROBLEM. • Government need to provide them and pay for them through taxation.

MERIT GOODS ARE NOT PROVIDED • These are given to people who merit them, either free or at a reduced price. • They differ from public goods in that they are: • Rival – if you are using it someone else can’t. • Excludable – you can be excluded from using it • Rejectable – in most cases the consumer can decide not to use the service. • In a free market economy there would be wide differences in income and wealth so that people on low incomes could not afford certain desirable services. • In a mixed economy the government will intervene to provide things such as education and healthcare

INEQUALITIES OF INCOME AND WEALTH TOPIC 4 The UK Economy (Macroeconomics)

INCOME It includes: • Investment • Work • Social Benefits UNEVEN DISTRIBUTION • This is because of: • Age and unemployment • Uneven distribution of skills and talents • Different education opportunities • Unequal ownership of wealth

WIDENING OF THE GAP • The gap between rich and poor has widened since the 1980s because: • Few jobs in manufacturing but more in service industries, which tend to be part-time and low paid • Reduced bargaining power for workers • An ageing population • More regressive taxation

WEALTH • This is what people own. It refers to their assets e.g. house, bank account, shares • It is unevenly distributed by: • Savings • Inheritance

GOVERNMENT POLICIES • Introduction of National Minimum Wage • Helping people into employment • Providing job training • More progressive taxation on income and wealth • Reducing tax and National Insurance for those on low incomes • Restructuring welfare payments • Providing more merit goods or increasing cut off points for free provision

CASE AGAINST INTERVENTION • More taxation will have to be paid – less incentive to work • Reduced incentives would lower National Income

GOVERNMENT ECONOMIC POLICIES