Transcript Government Intervention File

GOVERNMENT
INTERVENTION IN THE
ECONOMY
Learning Objectives:
The role of government in the economy
Government provision of goods and services
Fiscal policy
Monetary policy
Supply side policies

Brainstorm all the things that you think the
government does which affects business
WHAT ROLE DOES GOVERNMENT
PLAY IN THE ECONOMY?

Creates the legal and regulatory framework
which govern the way in which businesses
and individuals relate to each other

Provides goods and services which would
otherwise be under provided by the market
mechanism

Uses taxes and subsidies to influence the
way individuals and businesses behave

Uses government spending and taxation to
influence demand in the economy
GOVERNMENT ROLES

Public goods

Merit goods
GOVERNMENT PROVISION OF
GOODS AND SERVICES
PUBLIC GOODS
 Possess
two characteristics:
 Non-rivalry
– consumption of the good by one
person does not reduce the amount available for
consumption by another person (also known as
non-diminishability or non-exhaustability)
 Non-excludability
– once provided, no person can
be excluded from benefiting
Street lighting
Light house
Defence

Public goods are not provided by the free
market (there has been market failure)

Once the good has been provided, it is
impossible to prevent others from benefitting
from it

There is little incentive for people to pay for it

Leads to the free rider problem – free rider:
someone who benefits from a good or service
without paying for it

Someone who doesn’t pay tax won’t be denied
the use of a public road, street lighting etc.
THE FREE RIDER PROBLEM
A
merit good is one which is
underprovided by the market
mechanism
 This
may be because individuals lack
perfect information (find it hard to make
decisions about costs today, for benefits
received in the future)
 Or
because there are significant positive
externalities present
MERIT GOODS

Suggest reasons why health care
might be considered a merit good
DEMERIT GOODS
 Goods
which are over provided by the market
mechanism
 Consumption
of demerit goods produces large
negative externalities
 Governments
intervene to correct this market failure
by banning consumption, taxation or persuading
consumers to stop using the product

Identify demerit goods which the government
has tried to prevent consumption of through:
 Banning
 Taxation
 Advertising

Why does the government want to prevent
consumption of these goods?
DEMERIT GOODS

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
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
A free market system would not distribute
resources equitably
The government sees it has a duty to reallocate
resources
EG over 30% of public spending is devoted to
social security payments
Some of these payments come form the National
Insurance fund and can be seen as merit goods
Benefits such as family credit are an explicit
attempt to redistribute income to those in need
The free provision of healthcare and education
also leads to a more equitable distribution of
resources
EQUITY
Can occur in three ways:
 Direct
provision
 Subsidised
provision
 Regulation
GOVERNMENT INTERVENTION
DIRECT PROVISION
 Governments
supply public and merit
goods directly to consumers free of
charge
 The
government may produce the good
or service itself (eg schools) or buy it from
firms in the private sector (eg GPs work
for themselves, the government buys
their services)







Advantage:
The government directly controls the supply of
goods and services
Disadvantage:
May lead to inefficiency
Employees of the state have no incentive to cut
costs to a minimum
May produce the wrong mix of goods,
particularly if goods are free to taxpayers
In a free market, if the wrong mix of goods was
produced, they would remain unsold and firms
would switch production
DIRECT PROVISION
SUBSIDISED PROVISION
The government may pay for part of the good or services
( subsidy) but expect the consumer to pay for the rest
 EG prescription charges

Subsidies increase consumption of a good, hopefully to a
level which maximises economic welfare, and helps
those on low incomes
 BUT subsidies can become ‘captured’ by producers
 EG CAP – instead of ministers deciding on the level of
farm subsidy, they bow to the pressure of the farming
lobby

 The
government may leave provision to
the private sector, but force consumers
to purchase a merit good
 EG motorists are forced to buy car
insurance by law
 The government may force producers to
provide a merit good
 EG motorway service areas are forced
to provide free public toilet facilities to
motorists whether they buy anything or
not
REGULATION
REGULATION
 Requires
little or no taxpayers’ money to
provide the good

consumers are free to shop around in
the free market for best value, ensuring
productive and allocative efficiency
 BUT
regulations can impose heavy costs
on the poor in society
 Regulations
are sometimes ignored, eg
many motorists do not buy insurance
In all, around one in 20 of all drivers on our
roads do not have insurance - adding
between £30 and £60 each year to the bills
everyone else pays. They are up to nine
times more likely to have a crash
PUBLIC, MERIT AND
DEMERIT GOODS
Explain the difference between
public, merit and demerit goods
Explain the ‘free rider’ problem
Explain three ways in which the
government intervenes
FISCAL AND MONETARY POLICY
FISCAL POLICY - DEFINITION

Decisions concerning Government spending,
taxation, and borrowing

The manipulation of government spending,
taxation and borrowing affects aggregate
demand

It can also affect the pattern of economic
growth
•
The main areas of Govt spending are:
–
–
–
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NHS
Defence
Education
Roads
Social Security
National Insurance benefits
Over the past 20 years, Govt spending has
accounted for between 40%-50% of national
expenditure
• All of this is financed mainly through taxes such as
income tax and VAT
•
GOVERNMENT SPENDING AND
INCOME

An increase in Govt spending, with the price
level constant, will increase aggregate demand

A cut in taxation will increase household’s
disposable income and lead to a rise in
consumer expenditure, leading to a rise in AD
EXPANSIONARY FISCAL POLICY

An decrease in Govt spending, with the price
level constant, will decrease aggregate demand

An increase in taxation will decrease household’s
disposable income and lead to a fall in
consumer expenditure, leading to a fall in AD
RESTRICTIVE FISCAL POLICY
MONETARY POLICY; A
DEFINITION

Is the manipulation of the rate of interest and the
amount of money circulating in the economy to
achieve government objectives
MONEY AND THE RATE OF
INTEREST

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The rate of interest is the price of
money (lenders receive interest as
money is supplied for loans to money
markets, borrowers pay interest on
the loans)
In the past the government has
restricted how much money can be
borrowed on a mortgage or on hire
purchase
Some governments have attempted
to directly control the supply of
money available for spending and
borrowing in the economy
In recent years, the rate of interest
set by the Bank of England has been
the main instrument of monetary
policy in this country

The rate of interest affects the economy through its
influence on AD

The higher the rate of interest, the lower the level of AD

Why would this be?

Interest rates affect AD:

Consumer durables

The housing market

Wealth effects

Saving

Investment

The exchange rate
AGGREGATE DEMAND
CONSUMER DURABLES

Many households buy consumer
durables on credit

The higher the rate of interest, the
greater the monthly repayments
will be on any loan

High interest rates lead to lower
sales of durable goods and lower
AD
SAVINGS

When interest rates rise, savings become more attractive

This reduces consumer spending
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If interest rates fall, saving becomes less attractive

Consumers spend now rather than save for the future,
increasing AD
INVESTMENT

Investment projects become more
attractive when interest rates fall

This increases AD

A rise in consumption will lead to an
increase in income for the firm

This will lead to increased investment

Increased investment is needed to
increase supply to meet increased
demand
INFLATION

If AD increases, it can lead to inflation

If interest rates are increased, it will reduce AD

This leads to a lower equilibrium price level

Inflation lowers

If monetary policy is loosened; ie interest rates
are lowered, AD will increase

Looser monetary policy can therefore be
inflationary
SUPPLY SIDE POLICIES

Fiscal and monetary policy is used to affect AD

By adjusting Government spending and taxation,
government influences the amount of spending
in the economy

A long term aim is to increase the productive
capacity of the economy

Policies to increase the productive capacity of
the economy are known as Supply Side policies

Eg reduce tax to encourage investment
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Raise spending on education and training