Download Chapter 7: Government Sector

Chapter 7:
Government Sector
Kornkarun Kungpanidchakul, Ph.D.
Macroeconomics
MS Finance
Chulalongkorn University, Spring 2008
Fiscal policy
• The policy regarding government
expenditure, government revenue, and
transfers.
Government budgets
• Budget surplus : The amount by which a
government’s revenue exceeds its expenditures.
The government can lend the surplus.
• Budget deficit : The amount by which a
government’s expenditures exceed its revenue.
The government must borrow the shortfall via
bonds and we can expect future taxes sufficient
to cover the loan repayments.
• Balanced budget : revenue exactly covers its
expenditure.
Government Revenue
• The resources for government spending
come from:
– Selling the output as the owner of a private
business.
– Nationalization : take over or nationalize an
industry that has been set up by private
owners.
– Print money.
– Taxation (the most common method)
Taxation
• Variable tax : a tax in which the amount paid is
dependent on the value of some quantity that is
within an individual’s control.
• Lump-sum tax : a tax in which the amount paid
is not dependent on any variables that are within
an individual’s control.
• Head tax: a lump-sum tax in which each person
pays the same amount.
• Disincentive effect : the substitution effect that
results from taxing consumption or production of
a specific good resulting in a decrease in the
consumption or production of that good.
Government Spending
• Public goods
• Government consumption
• Temporary spending to stimulate the
economy.
• Income distribution, social security
Public goods
• Public goods are a good that tends to be
undersupplied in private competitive markets.
• The properties of public goods are
nonexcludable and nonrival.
• Nonexcludable means a good that people
cannot be excluded from using, e.g. unlocked
wireless internet, public restrooms, fish in the
ocean, environment.
• Nonrival means a good that unlimited numbers
of people can use without interfering with each
other’s enjoyment, e.g. fire protection,
uncongested toll roads.
Categories of Government
Spending
• Productive spending : Government
spending with benefits that exceeds its
cost. This happens when the government
supplies a public good that would be
inefficiently supplied by the private sector.
Categories of Government
Spending II
• The wasteful government spending is
government spending with benefits that
are less than its cost. This is the case that
the good that the government provides
creates the higher cost than when the
private sector provides.
Categories of Government
Spending III
• Pure transfers (transfer payment) : The
benefit of a government spending program
just happen to offset the cost. The
example of the case that this outcome is
expected is a transfer payment. For
example, the government taxes Peter
$100 in order to make a $100 cash
transfer to Paul. No resources are either
created or destroyed. There is only a
change in the resource distribution.
Fiscal policy for the
economic stability
• Keynes suggested that we can use the
fiscal policy to sustain the economic
stability
– Expansionary Fiscal Policy to stimulate the
economic growth when there is economic
recession or depression.
– Cotractionary Fiscal policy when the output
and the employment level is higher that the
full employment/stable level.
Haavelmo Theorem
• Even though the government decides to
cover all government spending via an
increase in taxes with an equal amount,
the balanced budget can still stimulate the
total expenditure and the economic
growth.
Crowding out effect
•
Classical crowding out effect
An increase in the government spending will be
substituted with a decrease in the private sector’s
spending
i) The government spending will decrease the
investment, so as the output in the long run (direct
crowding out effect)
ii) Ricardian Equivalence : When the government
increases its spending, consumers expect to have
higher tax in the future; therefore, consumers decide
to increase saving and decrease consumption in this
period.
Crowding out effect
• Indirect Crowding Out effect / Keynesian
Crowding out
– In the extreme Keynesian, there is no crowding out
effect.
– In the general Keynesian, the government spending
decreases the supply in the money market since the
government has to issue bonds. Therefore, the
interest rate increases, so as the cost of investment.
Therefore, the government spending has indirect
crowding out effect on investment via the higher
interest rate.