IGCSE Economics
5.1 Government Economic Policy
Learning Outcomes
• Describe the government as a producer of goods
and services and as an employer
• Describe the aims of government policies
• Explain Monetary, Fiscal and Supply-side policies
• Analyse the use of fiscal, monetary and supply-side
policies
• Discuss the possible conflicts between government
aims
2
Recap…. Discuss in pairs
• What is a mixed economy?
• What is the public sector?
• Why do governments intervene in mixed
economies?
• How do governments intervene in mixed
economies?
3
INTRODUCTION TO
GOVERNMENT OBJECTIVES
AND POLICIES
4
Question….
• What’s the difference between a
• Government Objective?
• Government Policy?
5
Task- 10 mins
• Look at the newspaper headlines in activity 5.1
(Page 283 of the textbook)
• For each headline identify:
1. What is the government policy?
2. What objective are they hoping to achieve?
3. How will this work?
Write your answers in a table:
Government Action
Government Objective
How will it work?
6
Government Objectives
• Low and steady inflation
• Low unemployment
• Steady and sustainable economic growth (%change
in GDP
• - A positive balance of payments – to export more
than we import
Two other possibles:
- To reduce inequality in the country – to redistribute
income and wealth in order to help the poor
• - To protect the environment – to avoid pollution and
congestion
7
Group Task
• See what questions you can answer from the
‘Government objective questions’ sheet.
• See which questions you can answer yourselves
without using the internet.
• Now use the internet to help you find any missing
answers
• Make a note of any questions you might have as you
go
8
MACRO ECONOMIC
OBJECTIVES – LOW AND
STABLE INFLATION
9
Inflation Questions:
• What is inflation?
• How is it measured?
• What level do governments
generally like to keep inflation at?
• What problems can high inflation
cause for savers?
• What problems can high inflation
cause for businesses?
• What is deflation?
• What problems can deflation cause?
10
MACROECONOMIC
OBJECTIVES – LOW
UNEMPLOYMENT
11
Unemployment Questions….
• Which people do official
‘unemployment figures’ include?
• What problems can
unemployment cause for
governments?
• What might cause unemployment
to rise in an economy?
12
MACROECONOMIC
OBJECTIVES – ECONOMIC
GROWTH
13
Economic Growth
Questions….
• How is the size of an economy
measured?
• What are the benefits of
economic growth in an
economy to:
– Households?
– Businesses?
– Government?
14
MACROECONOMIC
OBJECTIVES – FAVOURABLE
BALANCE OF PAYMENTS
15
Balance of Payment
Questions….
• What is an import?
• What is an export?
• Why do governments want
to make sure that there are
more exports than imports?
16
A very brief introduction……
THE MACROECONOMY
17
Macroeconomics is…..
• The study of national economies
• Concerned with the allocation of a countries
resources
Is concerned with measuring an economy’s:
• total output of all goods and services (Aggregate
Supply)
• Total demand for all goods and services (Aggregate
Demand)
Aggregate Supply and
Demand
What is the difference between this diagram and the supply and demand
model we have looked at before?
Is the government in an economy a producer or a consumer?
What questions do you have about this diagram?
19
The Macro economy
The important bit….
• Governments are both producers and
consumers
• The contribute to aggregate demand
and aggregate supply within an
economy
• They can also affect aggregate
demand and aggregate supply using
other policies
Government policies can be described
as demand-side or supply-side
21
GOVERNMENTS AS
CONSUMERS – GOVERNMENT
SPENDING
22
Why do Governments spend
money?
A government can use its spending power to:
•
•
•
•
•
provide goods and services that are in the public and economic
interest, such as street lighting, national parks, universal education
and health care, affordable housing
invest in national infrastructure such as road and railway networks,
airports
support agriculture and key industries to provide jobs and output,
and to invest in staff training, new machinery, and the research and
development (R&D) of new products
manage the economy, for example to boost total spending during
an economic recession to help firms and reduce unemployment
reduce inequalities in incomes and help vulnerable people, for
example by providing welfare payments to people and families in
need
Government Expenditure
Current Expenditure
Government
Expenditure
Items that will be used
up within a year
Capital Expenditure
Purchase of long
lasting items
24
Current or capital?
Building new
roads
MR Scanner
Teachers Salaries
New Computers
Unemployment
Benefits
Stationery Supplies
25
GOVERNMENT POLICIES
26
Government Policies
Fiscal Policy
Government
Policies
What can you tell me about
these different policies?
What is the difference?
Monetary
Policy
Supply Side
Policies
27
Government Policies
Taxation
Fiscal Policy
Government
Spending
Government
Policies
Monetary Policy
Control of money
supply
Interest Rates
Supply Side
Policies
Boosting
productive
potential
28
Task – 2 mins
• Look back to your tables from Exercise 5.1
• Are the government actions outlined in the
headlines examples of:
• Fiscal Policy, Monetary Policy or Supply Side?
29
GOVERNMENT POLICIES –
FISCAL POLICY
30
Fiscal Policy
• Changing the total level of government
spending
and taxation
• To change the level of aggregate demand for goods and
services
• and therefore on output, employment and prices
Price Level
Changes in Aggregate Demand
AS
P
AD
Y
Real Output
Task - Whiteboards
• Draw a fully labelled diagram showing Aggregate
Supply and Demand
• Now show a shift to the right of the AD curve
• What happens to P and Y? What do you think would
happen to unemployment?
• Now draw a diagram to show a shift to the left of the
Aggregate Demand Curve
• What happens to P and Y What do you think would
happen to unemployment?
33
Expansionary Fiscal Policy
• When the government wants to increase Aggregate
Demand in order to boost output
and employment
???????????
• It will do this by………
Increase/Decrease
• Increasing
Government Spending
Increase/Decrease
• Decreasing
Taxation
• How will decreasing taxation cause aggregate
demand to increase?
34
Contractionary Fiscal Policy
• When the government wants decrease Aggregate
Demand in order to reduce inflation
???????????
• It will do this by………
Increase/Decrease
• Decreasing
Government Spending
Increase/Decrease
• Increasing
Taxation
• How will increasing taxation cause aggregate
demand to decrease?
35
Task - Problems with Fiscal
Policy
Use page 286-287 of your books to help you answer
the following questions:
1. What problems can be caused by an increase in
government spending?
2. What is meant by ‘crowding out’
3. What problems can be caused by increasing taxes
4. What are the other criticisms of Fiscal Policy?
5. What are the ‘Fiscal Rules’
Government Spending and
increased demand….The multiplier
effect
37
GOVERNMENT POLICIES –
MONETARY POLICY
38
Monetary Policy
• Monetary Policy refers to
actions taken by the government
• to try to control the supply
of
money or the price of
money
• In order to influence spending
(and therefore Aggregate
Demand) in the economy
Who will interest rates directly
affect?
People who
already have
debt
Businesses who
are deciding
whether to save
or invest their
money
People who may
want to borrow
in the future
Stakeholders
affected by
interest rates
Businesses who
need to borrow
money in the
future
How will each of
these groups be
affected by an
increase in
interest rates?
People who
have savings
Businesses who
already have
debts
INTEREST RATES AND
EXCHANGE RATES
41
Exchange Rate Policy….
• Interest rates can also be used to influence
the exchange rate of a national currency
Questions…….
• Why might a government wish to change the
exchange rate?
• If the government wanted to increase
exports, would it need the national currency
to appreciate or depreciate?
• How could interest rates help this to
happen?
42
Interest rates are increased
Foreign capital is attracted to
invest
Demand for the currency
increases
This causes the value of the
currency to appreciate
Domestic goods are now
expensive to foreign
customers
Exports are likely to decrease
(and imports increase)
Unfavourable for balance of
payments
Step
by
Step
In each of these
scenarios…..Wh
at will be the
impact on:
• AD?
• Employment?
• Inflation?
Interest rates are lowered
Foreign capital is not
attracted to invest
Demand for the currency
reduces
This causes the value of the
currency to depreciate
Domestic goods are now
cheap to foreign customers
Exports are likely to increase
(and imports decrease)
Favourable for balance of
payments
43
MONEY SUPPLY
44
Increasing the money supply
- Quantitative Easing
• The government increase the money supply by
printing more notes and coins
• However it can’t just randomly decide to print more
money!!
• Instead…..
• The government uses the newly created money to
buy financial assets (government and corporate
bonds) from banks and other private organisations
• This increases the amount of money that banks
have to lend to people and firms
45
Video…..
• It’s a bit complicated…… don’t worry, you only
really need to get the general idea of what
quantitative easing is
• Watch and see if you learn something!
46
Quantitative Easing….. Put
much more simply…..
47
Expansionary Monetary
Policy
• When the government wants to increase Aggregate
???????????
Demand in order to boost output
and employment
• It will do this by………
• Decreasing
Interest Rates
Increase/Decrease
Increase/Decrease
• Increasing
Money Supply
48
Contrationary Monetary
Policy
• When the government wants decrease Aggregate
Demand in order to reduce inflation
???????????
• It will do this by………
Increase/Decrease
• Increasing
Interest Rates
Increase/Decrease
• Decreasing
Money Supply
49
Video – Bank of England
• Watch the video ‘Interest Rates and Inflation in the
UK’
50
GOVERNMENT POLICIES –
SUPPLY SIDE POLICIES
51
Supply Side Policies
Supply-side policies attempt to boost the productive potential of
an economy and increase aggregate supply
Increased growth = more jobs + more incomes + lower inflation
Supply Side Policies…..
• selective tax incentives e.g. tax breaks to encourage investment
• selective subsidies e.g. to support development of new technologies
• improving education and training to raise skills and productivity
• labour market reforms to restrict trade union power
• competition policy to outlaw anti-competitive behaviour
• removing barriers to trade to increase choice and competition
• privatization transferring public sector activities to private sector
firms
• better regulation simplifying or removing old and unnecessary
regulations that otherwise raise costs and restrict business activity
53
Can Policies Conflict?
Yes
‘Raising public spending,
cutting taxes and interest
rates to boost demand and
employment will increase
inflationary pressures and
spending on imports.’
‘Cutting public spending,
raising taxes and interest
rates to control inflation will
reduce demand and therefore
increase unemployment and
reduce economic growth.’
No
‘Keeping price inflation low and stable
will make domestic goods and services
more competitive. Demand for them will
rise at home and overseas. This will help
to improve the balance of trade and will
boost jobs, incomes and tax revenues.’
‘If workers expect inflation to remain low
they are less likely to push for big wage
increases. This will boost the demand
for their labour. And if firms are more
confident in the future they are more
likely to invest in new capacity for
growth. In contrast, rising inflation raises
costs and lowers profits.’