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The BIG ideas! webnote 240 Syllabus 2.4 I.b Syllabus 2.4: Macroeconomic Objectives: Unemployment Syllabus 113-119 • • • • • • 240: Powerpoint summary 241: Laffer 242: Fiscal policy overview 243: Crowding out Sample Exam Question – see slide 2 244: Exam Questions 1 http://www.yellowsubmariner.com Webnote 240 Syllabus reference: items 129 +132 Fiscal Policy Key government policy to realloate wealth e.g progressive taxation 2. Key government policy to improve spending in the short run and therefore a key anti recession policy because it can have immediate short term effects 3. Typically described as a ‘Keynesian’ policy tool but it is of key importance for supply siders also. Remember demand and supply side economists do not “own” fiscal and monetary policy. They share the use of these policies to manage the macroeconomy 1. Webnote 330 2 Webnote 240 Ib question May 2013 - HP1 Macroeconomics 3. (a) Using a diagram, describe how expansionary monetary policy might be used to close a deflationary (recessionary) gap. [10 marks] (b) Discuss why, in contrast to the monetarist/new classical model, an economy can remain stuck in a deflationary (recessionary) gap according to the Keynesian model. Webnote 330 3 Webnote 240 Laffer Curve http://[email protected] A tax rate of 0r1 Diagram 1: Laffer Curve maximises tax A revenue because tax revenue more people want to work and firms will be inclined to expand 0 Webnote 330 r1 B r2 average tax rate % Q 4 Webnote 240 http://[email protected] note see 331 Fiscal policy and taxes For full details please see webnote 331 in section 2.4 tax paid Diagram 1: Progressive, regressive and proportional P taxation (Direct taxes) R t4 t3 P = progressive as average rate of tax increases as income Y increases Oy1 to Oy2 the tax paid increases from 0t1 to 0t2 Pro R = average rate of tax decreases as income Y increases. As income increases Oy1 to Oy2 the total tax paid increases from 0t3 to 0t4. Webnote 331 t2 t1 0 y1 y2 Q Income (Y) 5 Webnote 240 http://[email protected] Laffer Curve Critics of the Laffer curve argue that a cut in tax Diagram 2: Backward bending supply curve rates would in all probability lead to a fall in tax revenue. wages A Idea here is based on backward bending supply curve whereby at higher B wage rates workers may offer less hours of labour i.e. workers value leisure time more that additional hours at work subject of Supply of labour course to some minimum required standard of living 0 Webnote 330 for Labour Q hours worked 6 The BIG ideas! 2. “crowding out” 1. Webnote 240 Public sector (G) spending crowds out private sector (F+H) Ad 1 to ad 2 ad2 pl ad3 •C ad1 •I •G Syllabus 2.4 •X gdp 1 •M gdp2 2. As a result “crowding out” ( public sector can occur and therefore ad2 shifts back to ad3. Government spending rises but how is it paid for? 1. Borrowing interest rates will rise thus affecting the household spending 2. Tax increases- H and F spending will fall 7 3. Government can print the money higher inflation = higher prices Evaluate Fiscal Policy syllabus Webnote 240 119 Webnote 330 8 Webnote 240 syllabus 119 + 117 119 (weight = 5) Evaluate the effectiveness of fiscal policy through consideration of factors including the ability to target sectors of the economy, the direct impact on aggregate demand, the effectiveness of promoting economic activity in a recession, time lags, political constraints, crowding out, and the inability to deal with supply-side causes of instability. Webnote 330 117 Explain how factors including the progressive tax system and unemployment benefits, which are influenced by the level of economic activity and national income, automatically help stabilize short-term fluctuations. 9 Webnote 240 Exam November 2014 4a Using an appropriate diagram, explain how a recession might lead to more poverty. (10 marks) Webnote 330 4b Evaluate the view that attempts to achieve greater equity in the distribution of income will reduce economic efficiency (15 marks) 10 Webnote 240 http://[email protected] Laffer Curve Reading: See Glanville p.334 and McGee ‘The Good, the bad and the economist’ p.455 End Webnote 330 11