GOVERNMENT ECONOMIC POLICIES

GOVERNMENT ECONOMIC POLICIESThe UK Economy (Macroeconomics)TOPIC 4DEMAND SIDE OF THE ECONOMYThis 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 PolicyMonetary PolicyTHESE ARE CALLED DEMAND SIDE POLICIES

SUPPLY SIDE OF THE ECONOMYThis 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 POLICIESDEMAND SIDE POLIICES (Fiscal and Monetary)Topic 4 The UK Economy (Macroeconomics)FISCAL POLICYFiscal 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 POLICYUNEMPLOYMENTHigh 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 taxationReducing 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 POLICYINFLATIONIf 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 POLICYCONFLICTING OBJECTIVES

A policy that wants to raise demand to increase employment and encourage economic growth could;Worsen the balance of paymentsCause inflation

A policy used to reduce inflation could;

Cause unemploymentLower economic growth

PROBLEMS WITH FISCAL POLICYFORECASTING THE REQUIRED CHANGE IN DEMAND

The data used to make plans is not always reliableIt is difficult to predict the multiplier effect of increasing G or reducing TDifficult 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 POLICYMonetary 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 governments target.

They BoE are the:Governments BankBankers Bank

MONETARY POLICY AND GOVERNMENT OBJECTIVESINFLATION

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 goodsLowers the price of imported raw materialsPuts 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 INFLATIONWhen 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-flowrising interest rates will reduce consumers cash-flow, less to spend.

Exchange ratesIncreased interest rates will increase the amount of foreigner investors.Supply Side PoliciesThese are mainly microeconomic measures, which are designed to improve competition in PRODUCT MARKETS and improve working in LABOUR MARKETS.

PRODUCT MARKETSThe main reason for supply-side policies in this type of market is that increased competition will increase efficiency.

Policies include:

PrivatisationDeregulationCommitment to Free TradeReduction in Corporation TaxStrict control of inflationLABOUR MARKETSA 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 actionIncreased spending on educationIncreased spending on trainingImproved incentives to work. E.g. reducing income tax, making benefits less attractive.

ECONOMIC GROWTHTopic 4The UK Economy (Macroeconomics)WHAT IS ECONOMIC GROWTH?This is the rate of growth in a countrys potential output.

It is represented by a shift to the right of the countrys production possibility curve and the annual percentage change in GDP. CAUSES OF ECONOMIC GROWTHSUPPLY-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 GROWTHPRODUCTIVITY 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 GROWTHDetermine by two factors:

The growth in potential outputThe growth in aggregate demand.GOVERNMENT POLICYLEFT WINGBelieve 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.RIGHT WINGPrivate 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.

GROWTHBenefitsStandards of living improve

Increased productivity

Increased incomes

Higher Tax revenues better public servicesCostsresources are diverted to making capital goods

Pollution

Depletions of non-renewable resources

Increased pressure on industrial and urban life e.g. stress and crime.

SOURCES OF GROWTHDemandLow unemployment

Consumers have been able to increase borrowing Interest rates have been low Significant spending by the government.SupplyIncrease in female participation has increased the workforce

Increased flexibility of labour

Higher investment has added to the countrys productive capacity.

ENVIRONMENT POLICYTOPIC 4The UK Economy (Macroeconomics)ENVIRONMENT PROBLEMSGlobal warmingAir pollutionWater pollutionTraffic congestionDepletion of non-renewable energy resourcesLandfill wasteMARKET BASED POLICIESThese 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 TaxClimate change levyRoad PricingPetrol TaxVAT on domestic fuel

NON-MARKET POLICIESThese 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 schemesImproved sewage disposalResearch into renewable forms of energyProviding recycling projects such as bottle banks.

OTHER FACTORSFirms are becoming environmentally friendly because they have discovered:

Going green is good for businessCutting down on waste, conserving energy and recycling can save moneyPressure groups can put customers off irresponsible firms.MARKET FAILURETOPIC 4The 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 RESTRICTEDEXTERNAL COST AND BENEFITS ARE IGNOREDPUBLIC GOODS ARE NOT PROVIDEDMERIT GOODS NOT PROVIDED TO ALL WHO NEED THEM.

RESTRICTED COMPETITIONCompetition is good in an economy. As it encourages firms to be more efficient. Restricted competition result in:

Poorer quality goodsLimited suppliesInefficient use of resourcesHigher prices.RESTRICTIVE TRADE PRACTICESThese can include:

Resale price maintenance.Predatory pricing.Distributing only to certain retailers.Cartels.

All of which are ILLEGAL in the UKGOVERNMENT POLICYTheir aim is to encourage competition. It is the responsibility of the OFFICE OF FAIR TRADING to investigate breaches of competition law.

EU COMPETITION LAWAny merger or take over on a European scale can be investigated by the European CommissionMONOPOLY INVESTIGATIONSAny 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 INVESTIGATIONSAny 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 overseasThe development of new products is likelyCosts of production are reducedInterests of consumers are improved e.g. more choiceEXTERNAL COSTS AND BENEFITSPRIVATE 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.

COSTSEXTERNAL COSTSThese 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 COSTSCost to society of all resources used as a result of production and consumptionSocial Cost = Private Cost + External Cost

BENEFITSEXTERNAL 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 BENEFITSocial benefit = private benefit + external benefitEXTERNAL COSTS AND MARKET FAILUREIf 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 FAILUREIf 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 PROVIDEDAll 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 PROVIDEDThese 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 cant.Excludable you can be excluded from using itRejectable 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 WEALTHTOPIC 4The UK Economy (Macroeconomics)INCOMEIt includes:InvestmentWorkSocial Benefits

UNEVEN DISTRIBUTION

This is because of:Age and unemploymentUneven distribution of skills and talentsDifferent 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 paidReduced bargaining power for workersAn ageing populationMore regressive taxation

WEALTHThis is what people own. It refers to their assets e.g. house, bank account, shares

It is unevenly distributed by:

SavingsInheritanceGOVERNMENT POLICIESIntroduction of National Minimum WageHelping people into employmentProviding job trainingMore progressive taxation on income and wealthReducing tax and National Insurance for those on low incomesRestructuring welfare paymentsProviding more merit goods or increasing cut off points for free provisionCASE AGAINST INTERVENTIONMore taxation will have to be paid less incentive to work

Reduced incentives would lower National IncomeREGIONAL POLICYTOPIC 4The UK Economy (Macroeconomics)BACKGROUNDDifferences in prosperity exist between different parts of the country.

Areas of industrial decline/ no new industryNorth/South divideINTERVENTIONFORLabour is geographically immobile

Areas need new infrastructure to be made attractive

Training required for occupational immobile workforceAGAINSTWage rates will be less in poor areas therefore attracting investments

Prosperous regions become costly and congested driving business awayPrevious and Current AssistanceRegional Selective AssistanceRegional Enterprise GrantsHighlands & Islands EnterpriseLocal Enterprise CompaniesLocate in ScotlandEuropean Regional Development FundNew Assistance?See notes (93-94)THE SCOTTISH ECONOMYTOPIC 4The UK Economy (Macroeconomics)

OUTPUTIncrease in services and energy versus a decrease in manufacturing.This can also be reflected in employment figures.

REGIONSLothians and Borders higher GDP service sectorGrampian higher GDP oil and gas revenuesStrathclyde and Tayside GDP has fallen manufacturing sector

FOREIGN FIRMSThese firms are very important to Scotland, around 10% of manufacturing firms are foreign owned. Proportion of Scots employed is higher than UK average.

Advantages for firmsSkilled labourInside EUGood infrastructureGovt incentivesExternal Economies of Scale

ADVANTAGES FOR SCOTLANDEmploymentFirms with advanced skillsProfitable companiesBoosts exportsDISADVANTAGES FOR SCOTLANDR&D carried out in other countriesSqueeze on firms in times of recessionPotential for grants to stop