Economics Unit 12

Macroeconomic objectives of the UK:

• Economic growth

• Full employment

• Price stability/low inflation

• Balance of payments equilibrium

The UK government believes that it is ethically right to aim to minimise poverty. The government also aims to minimise income inequality where incomes are too spread out and gap between rich and poor is too wide.

The main strategy to minimise poverty and reduce the rich/poor divide is to introduce taxes and the welfare benefit system. Where those with high incomes pay a higher proportion of their income as tax, which can help finance the benefit payments to those on lower incomes. This is done because the government believes that equality is a fairer outcome though the government does not want income to be distributed completely equally.

Economic growth: The percentage change in national income measured over time.

Benefits and Costs of Economic growth:

Benefits

Costs

Higher living standards: higher growth means higher income for the population. It may not affect each person in the same way but growth means that people can buy more and have a higher standard of living.

Reduction of poverty: economic growth helps to move poorer sections of the population out of poverty by providing opportunities for better living standards.

Investment in infrastructure: Higher growth means that governments collect more taxes revenue and therefore can afford to spend more on priority areas such as:

• Improving education provisions

• Providing improved health provisions

• Improving transport links

Lower crime: There appears to be a link between economic growth and levels of crime. As growth rises, some crimes fall as the incentive to commit crime is reduced.

Environmental Costs: higher growth means higher output. This may have negative effects. For example, higher factory output often generates higher pollution. Other problems of high growth also emerge, such as worsening traffic congestion and unaffordable house prices.

Inequality: Although growth is beneficial, all won’t benefit equally. It is most likely that those benefiting greatest are already earning above average incomes. Those with below average incomes often find incomes largely unchanged. This income inequality may lead to a significant part of the population falling into relative poverty, where incomes are low relative to the rest of the county.

The government attempts to reduce the gap between rich and poor through the welfare state.

Low inflation: high growth is likely to lead to higher inflation because growth and spending are closely linked. Higher spending often leads to rising prices throughout the economy. This is because higher growth means resources in the economy are more fully used and become scarcer, which leads to the prices of resources increasing.

Balance of payments: higher growth leads to higher consumer expenditure and this means more imports are purchased. This leads to current account section moving close to, or into, a trade deficit. The only way in which this can be avoided is if the economic growth itself arises out of an increase in demand for our exports. The higher exports would not have the same negative impact on the balance of payments. However in the UK, this type of export-led growth has rarely occurred.

Free-Market Economy: a system where all economic decisions are taken by private individuals and businesses.

Mixed Economy: A system that is partly a free-market economy but also has government involvement in economic decisions.

Free Market Economy

Benefits: Prices can be lowered as competition between businesses ensures prices cannot rise too quickly. Quality of output should be high, also due to competition.

Drawbacks: Some businesses may monopolise a market and will not have to provide low prices and high quality due the lack of competition. Consumers may not be able to afford vital products – especially if they cannot provide for themselves, meaning that poverty and inequality are more likely.

Market Failure: a failure of the market to allocate resources efficiently

Merit Good: goods that are under-consumed by society largely because the benefits of the good are not fully appreciated by society for example education and health care.

Public Good: goods that display the following two characteristics: consumption of them doesn’t prevent others consuming them; once they are provided, people cannot be prevented from consuming them for example a park.

Negative Externalities: occur when cost to society exceed the private cost to the business. The external cost is that paid by the rest of society. The negative externality does not result in an actual payment of money but society suffers from this external cost.

Positive Externalities: these occur when the benefits to society from consumption of a product exceed the private benefits to the individual consumer. For example, the private benefits to a town having a large business set up in the local area would include business gaining extra profits but it would be the society that gains from the external benefit of the new business in terms of the employment opportunities and the extra income generated.

These examples illustrate how governments might intervene:

• Car drivers don’t pay the negative externalities caused by exhaust fumes. Taxes placed on petrol attempt to reduce this external cost as the higher price for petrol should mean that fewer car journeys take place.

• Society benefits from a well-educated population because those educated usually earn more. Therefore, the UK government gives assistance to encourage more people to attend university, for example by giving grants.

1. Boom – economic growth will be above average. Consumer spending is likely to be high as people feel confident and are more likely to borrow money to finance more spending. Unemployment is likely to be falling or very low. Investment will rise as businesses seek to expand. There is likely to be upward pressure on prices because of the increased demand for goods and the resources to produce those goods. As a result inflation will start to rise.

2. Recession – economic growth will start to fall below the average growth rate, although the rate of economic growth will still be positive. Consumer spending will slow down and unemployment will start to rise. Business investment is likely to fall from its peak as managers feel less confident about future prospects. Inflation is likely to fall from its peak, but prices will still be rising. Imports may start to decline as consumers’ spending slows down.

1. Slump – In a slump growth will be low or negative. Consumer spending will be low and could actually be falling where consumer spending is lower than in earlier periods. This is likely to be because consumers feel pessimistic and insecure about their jobs, and the chances of keeping their jobs in the future. Inflation is likely to be low and/or falling in a slump, as businesses attempt to encourage more spending by keeping prices unchanged or even cutting them. In some slumps prices may even begin to fall over time. With low consumer spending, imports are likely to be low in growth or even falling – which could mean that trade section of the balance of payments moves into surplus, where exports exceed imports.

2. Recovery – economic growth will start to rise towards the average level again. If economic growth has been negative, it will start to reach positive rates again. Confidence will return to customers and businesses. Consumer spending will start to rise again and business will begin to invest again. Unemployment is likely to stop rising and may even begin to fall, although the level of unemployment may still be high. Inflation will stop falling.

Direct Tax: Taxes on expenditure for example VAT

Indirect Tax: Taxes on income for example income tax.

Fiscal Policy

Governments spend large amounts in the economy. Therefore changes in government expenditure have a major impact on economic performance and the government’s ability to reach its economic objectives.

The high expenditure means that taxes are also a significant proportion of both expenditure and income. Changes in taxation have a significant effect on the performance of the economy.

Fiscal policy refers to the choices and decisions made for government spending and the taxation that will go towards financing for expenditure.

Inflation – increases in government spending can lead to high inflation. If spending in the economy is already rising, any extra government spending might contribute to higher inflation. If spending in the economy is generally low and/ or falling, it is possible that any increases in government spending will not lead to higher inflation.

A reduction in taxation also encourages more expenditure. This is because consumers will now keep a higher proportion of any income earned. This may lead to higher consumer spending, which could push inflation higher. Therefore, governments may consider raising taxes to reduce upward pressure on inflation because higher taxes reduce people’s ability to spend.

Economic growth – as the government contributes to a major proportion of overall spending, any changes in the level of spending will lead to changes in the level of economic growth. Higher government spending should encourage faster economic growth – a strategy used by many governments when facing either a slump or a recession.

Cuts in taxation may also lead to faster economic growth. Tax cuts mean consumers have higher disposable income, which normally encourages more consumers spending.

Unemployment – higher government spending is likely to reduce unemployment as higher spending creates more demand for output, meaning that more workers are required. Similarly, lower taxation encourages more spending and has the same effect. The opposite is also true. Higher taxation and lower government spending are both likely to contribute to rising unemployment.

Balance of Payments – higher government spending and lower taxation both leads to faster economic growth through overall spending. This is likely to conflict with the government’s objective of achieving a balance on the current account. Higher growth means that more people are willing to spend, which leads to rising imports. However, there will be no positive effect on exports – these are affected by economic growth in other countries and therefore the balance of payments will decline.

Monetary Policy: policy to control the supply or cost of the money.

• Poverty is reduced; the welfare state provides support in the form of money transfers and other benefits, such as income support for the unemployed and a state retirement pension for those who have retired from work. This means that the poorest members of society avoid falling into absolute poverty.

• Inequality is reduced; the welfare state is funded by the government taxing the population. Those with higher incomes provide more tax. This means that the richest proportion of the population is taxed more heavily, which provides income for the poorest proportion of the population and narrows the gap between richest and poorest. Reducing inequality is seen as ethically correct, but many believe that societies with a more equal distribution of income suffer fewer social problems, like crime.

• Overall health of the population is increased; through universal access to health care and education. The NHS provides health care and medical treatment free of charge for all. If health care was left to solely to private firms to provide, those on lower incomes might not receive the full benefits of the health care and may not, as a result, enjoy the same level of health.

• Removal of incentives to find work; some people think that providing the unemployed with benefit payments removes incentive to find employment. This is because the benefit received will, in some cases, almost provide the same income as from a low-paid job. Therefore, it is possible that some unemployed people will not search for a job as urgently as if there was no benefit.

• Higher Taxation; those in employment, especially on average and above-average incomes, find that they are paying a higher proportion of their incomes in taxes than if there was no welfare state. Some argue that it is unfair to make those who are making high contributions to the nation’s income pay higher taxes.

• Increase the role of the voluntary sector; the voluntary sector can contribute to providing support to those who rely on the welfare state. Charities and voluntary organisations employ over 500,000 workers in the UK. Famous charities, such as Oxfam and British Heart Foundation, raise money for particular concerns. There are also many small-scale charities that provide support for those without jobs or homes.

• Modify the welfare State; some argue that the welfare state should continue to exist but could be changed:

  • Make benefits universal; some benefits are paid out regardless of the income of those receiving benefits. Child benefits are paid to all the families with children. This could be applied to all benefits. It would be easier to administer but may cost a lot more in total.

  • Have benefits only for those meeting certain conditions; this would mean that only those who need the benefits would receive them. Although this may seem as though it would save money, there would be a need for costlier administration to find out who meets the conditions for the benefits.