The Role of Government in an Economy

Topics: Tax, Taxation, Inflation Pages: 27 (7547 words) Published: December 23, 2012
Chapter 7
The Role of Government in an Economy

Part 1
Government Objectives & Policies

Government Objectives
Most national governments have four main economic objectives for their national economies. These are: • To achieve a low and stable rate of inflation in the general level of prices • To achieve a high and stable level of employment, and therefore a low level of unemployment • To encourage economic growth in the national output and income • To encourage trade and secure a favorable balance of international transactions.

A government may also have additional objectives which aim to improve the economic welfare of people in the economy, including: • To reduce poverty and reduce inequalities in income and wealth • To reduce pollution and waste, and therefore encourage more sustainable economic growth. If government can achieve these aims it will creates a favorable economic climate for business and improve people's living standards. For example, when prices are rising rapidly, consumers may not be able to keep up and may have to cut their demand for goods and services. As a result firms may cut back production and their demand for labour. Unemployment and the loss of wage income may cause hardship for many families. In addition, exports from the economy will become less competitive because of high prices and the balance of trade may become unfavorable and cause the exchange rate to fall. What is the Macroeconomy?

Macroeconomics is the study of how a national economy works with a view to understanding the interaction between growth in national income, employment and price inflation. In contrast, macroeconomics examines the economic behavior of individual consumers, household and businesses and how individual markets work.

Total demand and supply in a simple macroeconomy
. The total output of goods and services is paid for by the total expenditure of consumers, firms and government. Workers and owners of land and capital supply their resources to private firms and public sector organizations to produce those goods and services. In return they are paid income; their total income is therefore the national income.

Total expenditure or aggregate demand in a macroeconomy is therefore the sum of: • Consumers' expenditure on goods and services
• Investment expenditure by firms on new plant and machinery • Government expenditure on goods and services
• Spending from overseas on exports of goods and services from the economy

Total expenditure in an economy is therefore spent on the total or aggregate supply of all goods and services in the economy. This is the sum of all goods and services provided by private firms and public sector organizations in the economy. You will note that in a macroeconomy, government is both a produce, organizing land, labour and capital to provide goods and services such as healthcare, defence, roads and street lighting, and also a consumer of goods and services produced by private firms, including computers, paper and furniture for government offices.

Policy Instruments:
Governments can use different policy instrument, including taxes and regulations, to help achieve their objectives through their impact on the actions of producers and consumers. 1. Fiscal Policy:-

Fiscal Policy Involves varying total public sector expenditure and/or the overall level of taxation to influence the level of demand in an economy.

Expansionary Fiscal Policy:-
Expansionary fiscal policy may be used during an economic recession to boost demand for goods and services through tax cuts or increased public sector spending. Firms may respond by hiring more labour and increasing output. However, increasing demand can force up market prices and involve spending more on imported goods and services from overseas. Increasing imports will have a negative impact on the balance of payments. Increasing...
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