Government aims and policies
Governments aim for growth, low unemployment, stable prices, balance of payments stability and fairer incomes. They use fiscal, monetary and supply-side policies to achieve these aims.
📌 Key points
- The government acts as a producer, an employer and a regulator in the economy.
- The main macroeconomic aims are economic growth, full employment (low unemployment), stable prices (low inflation), balance of payments stability and redistribution of income.
- Aims can conflict: e.g. fast growth and low unemployment can lead to higher inflation and a current account deficit.
- Fiscal policy uses government spending and taxation to influence aggregate demand (total spending in the economy). The budget is in deficit when spending is greater than revenue, and in surplus when revenue is greater.
- Direct taxes are taxes on income and wealth (e.g. income tax, corporation tax); indirect taxes are taxes on spending (e.g. VAT, excise duty).
- A progressive tax takes a higher proportion of income as income rises; a regressive tax takes a lower proportion; a proportional tax takes the same proportion.
- A good tax should be equitable (fair), economical (cheap to collect), convenient and certain (clear to taxpayers).
- Monetary policy changes the money supply, interest rates and the foreign exchange rate. Lower interest rates encourage borrowing and spending; higher rates reduce them.
- Supply-side policies aim to increase the economy’s productive capacity: education and training, labour market reforms, lower direct taxes, deregulation, improving incentives and privatisation.
- Supply-side policies shift the PPC outwards and can lower both unemployment and inflation, but they often take a long time and cost money.
📖 Key terms
- Fiscal policy
- Government decisions on taxation and government spending.
- Monetary policy
- Changes in the money supply, interest rates and the exchange rate to influence the economy.
- Supply-side policy
- Measures to increase the productive capacity of the economy.
- Budget deficit
- When government spending is greater than government revenue.
- Progressive tax
- A tax that takes a higher proportion of income as income rises.
- Indirect tax
- A tax on spending on goods and services, e.g. VAT.
- Aggregate demand
- Total spending on an economy’s goods and services.
✏️ Worked example
Income tax: the first $10,000 earned is tax-free and all income above $10,000 is taxed at 20%. Person A earns $20,000; person B earns $50,000. Is this tax progressive?
- A’s tax = 20% × ($20,000 − $10,000) = $2,000, which is 2,000 ÷ 20,000 = 10% of income.
- B’s tax = 20% × ($50,000 − $10,000) = $8,000, which is 8,000 ÷ 50,000 = 16% of income.
- The proportion of income paid in tax rises from 10% to 16% as income rises.
- Answer: yes, the tax is progressive.
Progressive, regressive and proportional are about the proportion (percentage) of income paid, not the amount. A rich person can pay more dollars under a regressive tax.
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