Year 11 IGCSE Economics- Topic 5 Government Aims and Policies (20 marks)

a. Explain THREE macroeconomic aims a government might have. (6 marks) Government policies tend to achieve objects like full employment (or reduce unemployment), controlled inflation (price stability), and sustainable economic growth. Employment refers to the use of factors of production, such as labour, in the economy (Primary, secondary or tertiary sectors). It also includes those who are self- employed. Unemployment refers to people who are out of work, but who are of the working age, are physically, and mentally able to work, and are actively looking for a work. Governments strive to reduce the unemployment rate- the proportion of a country’s workforce who are unemployed. Inflation refers to a persistent rise in the general level of prices in the economy. Low and sustainable rates of inflation are vital to achieve economic stability and social well- being. For example, inflation reduces the international competitiveness of a country as its prices will be relatively higher. This will lead to lower export sales, thus causing potential job losses. Inflation can be caused by excessive aggregate demand (total demand) in the economy. This is known as demand- pull inflation. By contrast, cost- push inflation is caused by higher costs of production.

Economic growth is the increase in a country’s gross domestic product (GDP) over time. Achieving economic growth brings greater prosperity to an economy and therefore tends to raise the standard of living for most people. Economic growth can be achieved by increasing the quantity and/ or quality of factors of production, such as through education and training. Discovering resources such as oil will

increase the potential output of an economy. √

b. What is meant by fiscal policy? (2 marks)

Fiscal policy is the use of taxation and government expenditure strategies to influence the level of economic activities and macroeconomic objectives such as employment, economic growth and the control of inflation. For example, taxation can be used to redistribute income and wealth to benefit less wealthy members of society. Government spending can be used to improve standards of living, such as

building schools, hospitals and transportation networks. √

c. Explain how a government might finance its expenditure (4 marks) (3)

Government might finance its expenditure on income tax, corporation tax, inheritance tax, and import taxes. Fiscal policy can be used either to expand or to contract economic activity in order to achieve macroeconomic objectives and to promote economic stability. Expansionary fiscal policy is used to stimulate the economy, by increasing government and/ or lowering taxes. By contrast, contractionary fiscal policy is used to reduce the level of economic activity by decreasing government spending and/ or raising taxes. There are three limitation of using fiscal policy. Recognition lags- there is a time lag in recognizing that government intervention is needed to affect the level of economic activity. Administrative lags- There is a time delay between recognising the need for fiscal policy intervention and actually implementing appropriate action. Impact lags- There is a time lag between implementing fiscal

policy and seeing the actual effects on the economy. √

You should write 1 paragraph for each method, and make your points more clear.

d. Explain why the achievement of one government economic goal may be in conflict with other government economic goals. (8 marks)

Trade- offs is when government has to balance its various policy aims. For example it may have to trade off, or accept, a little more unemployment for a little less inflation. Economist may need to fine- tune the economy, creating the best possible balance between policy objectives. NAIRU is an example of this. Unemployment and involves allowing just enough unemployment in the economy to prevent inflation rising above a given rate figure. Prices are allowed to increase gradually and some unemployment is tolerated. NAIRU involves living with manageable inflation and acceptable unemployment.

As it is not possible simultaneously to achieve all five macroeconomic objectives, there is said to be a trade- off or conflict between targets. Example of possible conflicts between government's macroeconomic goals are considered below.

If an economy grow due to excessive consumer demand, this will force prices to increase, thus creating inflation in the economy, Similarly, the government might choose to deflate the economy to control inflation, but this limits the ability to achieve economic growth. Therefores, it is rather difficult to achieve both macroeconomic objectives at the same time. (Spending more money to stimulate the growth can to to rising prices, resulting from increased demand. If however spending is reduced to cut back demand that is causing inflation, this will lead to a fall in growth.)

Secondly, low employment (or full employment versus employment) inflation. In theory, there is an inverse relationship between the level of unemployment and the rate of inflation. For example, an attempt to reduce unemployment via the use of expansionary fiscal policy, such as lowering taxes or increasing government spending, can cause demand- pull inflation. Similarly when the government tries to control the inflation by using deflationary policies such as higher interest rates, the resulting fall in both consumer spending and investment will result in job losses. (If government create full employment, labour becomes increasingly scarce. Employers have to compete more strongly to attract labour. They raise wages, which in turn leads to rising wage inflation)

Thirdly, economic growth versus a balance of payments equilibrium. Consumer spending and business investments tend to be high during an economic boom. However, if this fuelled by a significant rise in spending on imports relative to exports, this leads to a worsening trade deficit on the country’s balance of payments.

Fourth, economic growth versus protection of the environment. Economic growth often leads to environmental problems such as land degradation, climate change, pollution and the depletion of nonrenewable resources.

Lastly, economic growth versus the redistribution of income and wealth. As an economy grows, there tends to be a widening income and wealth gap between the rich and the poor, which is known as poverty. (If the government tries to redistribute income, this may involve taxing richer people at higher

rates. Richer worker may feel that they are unfairly penalised for working hard and may decide to

migrate: this is the “brain drain”. This in turn might slow down economic growth. √

In your test, you should include points with clear definitions and refer back to examples/ question/ materials given.

Tips: For an 8 mark question, distribute 2 points for each one you write, which you should need to write 4 points in total.