Chapter 5 POLICY CHOICES
5.1 GOVERNMENT AND
ECONOMIC MANAGEMENT
Policy
the deliberate use of a government’s economic and legal power
to try to achieve specified or understood outcomes.
E.G,laws,institutions,day-to-day management of government
services
Microeconomic policy
targets particular industries or products or markets.
e.g,government provides a subsidy to a particular industry in
trouble
Macroeconomic policy
thing that apply across all states and industries.
e.g,income and business tax rates,the overall rate of
unemployment in the economy,growth in GDP
5.2 OBJECTIVES OF
GOVERNMENT POLICY
1,Economic growth and efficiency
2,Stability of prices
3,High employment and low
unemployment
4,Healthy trade and exchange rate levels
5,Protecting the environment
6,Fairness and helping the disadvantaged
5.2.1 Economic growth
genuine growth
real GDP
5.2.2 Price stability and inflation
Stable Price and Stable Financial System
Rate of inflation
Consumer Price Index (CPI)
a measure of the overall cost of the goods and services
bought by a typical consumer.
Inflation rate in year 2 = × 100
GDP deflator
a measure of the price level calculated as the ratio of nominal
GDP to real GDP times of 100.
GDP deflator = [Nominal GDP/ Real GDP] × 100
CPI in year 2 – CPI in year 1
CPI in year 1
5.2.3 Employment
Outcomes of Unemployment
a loss of human capital for lost of skills
social costs resulting from depression and
poor health or anti-social behavior and crime
Reasons of Unemployment
individuals consciously choose not to work
increasingly rapid structural change in many
industries
5.2.4 Trade and trade indicators
Trade Balance
Current Account
Capital Account
Balance of Payment
Exchange Rate
reflects what others think the value of a currency
should be
TWI (trade-weighted index),value of the exchange
rate of the domestic dollar with all major trading
partner currencies
5.2.5 Care for the environment
Green Account
national accounts which include an
allowance for changing value of the
environment.
5.2.6 Fairness and equity
Fairness
caring for the disadvantaged and providing
reasonable equitable social outcomes.
5.3 CONSTRAINTS ON GOVERN
5.3.1 POLICY TRADEOFFS
5.3.2 MANAGEMENT THE ECONOMY
IN THE SHORT TERM
5.3.3 THE BUSINESS CYCLE
5.3.1 POLICY TRADEOFFS
efficiency and equity
size of the pizza
how the pizza is shared
E.G,
completely private
education system
mixed public/private
education system
free public education
system
equity
efficiency
A
B
The Economic Pizza,
Tradeoffs and Economic Growth
The Pizza with low
growth,greater equity
The pizza with high
growth,less equity
High-income
share
Low-income
share
High-income
share
Low-income
share
5.3.2 MANAGEMENT THE
ECONOMY IN THE SHORT TERM
governments cannot easily plan for the medium to long
term of five to ten years.
In the short term,the emphasis in economic
management is on dealing with unanticipated shocks
and the immediate conditions for business and
individuals.
Economic Forecasting
the better the governments can predict the future,the more
profits are made and the better the economy can be managed.
produced in four main ways
1,simple forecasts based on key assumptions (e.g,inflation,
exchange rate,major world economic growth,unemployment)
2,leading indicator forecasts
3,time series forecasts
4,econometric forecasts
5.3.3 THE BUSINESS CYCLE
Definition
sequence of events where the economy
moves from recession through recovery to
buoyant and boom conditions,following a
slowdown or collapse at the end of the boom,
the economy moves back into recession.
Boom – Downturn – Recession – Recovery
Time-lag
5.4 POLICY OPTIONS
Policy instruments
the particular pieces of policy that government employs
in pursuit of the policy objectives.
Types of policy for macroeconomic management
fiscal policy
monetary policy
5.4.1 FISCAL POLICY
Fiscal Policy
all those policies to do with the raising of government revenue
and with spending by government.
loosening vs tightening
stance of fiscal policy
budget surplus,an excess of government receipts over
government spending
budget deficit,an excess of government spending over
government receipts
budget
a statement of the revenue and expenditure of the government.
annual budget statement
a summary of past performance of the economy,of expected
future performance and a detailed statement of government
revenue and expenditure.
1,Income determination,saving
and investment
Components of consumption
autonomous consumption,the minimum amount of
money required to live in a society at an acceptable
standard,occurs when there is no income.
induced consumption,consumption directly related
to income
Marginal propensity to consume (MPC)
a ratio of spending out of disposable income
Multiplier effect
how much extra business is generated in the circular
flow model for a given change in investment
2,The Fiscal Policy Stance and
Stabilization
Loosening fiscal policy stance when recession
the government spends more than it receives in
taxes and other revenue,increasing GDP and
moves it more towards its full employment
equilibrium level
Tightening fiscal policy stance when booming
the government revenue exceeds government
spending,causing overall spending and GDP to
contract
5.4.2 MONETARY POLICY
1,Money
the set of assets in an economy that people regularly use to
buy goods and services from the other people
2,Functions of Money
medium of exchange,an item that buyers give to sellers
when they want to purchase goods and services
unit of account,the yardstick people use to post prices and
record debts
store of value,an item that people can use to transfer
purchasing power from the present to the future
liquidity
the ease with which an asset can be converted into the
economy’s medium of exchange
3,Kinds of Money
commodity money,
money that takes the form of a commodity with
intrinsic value
intrinsic value,the item would have value even if it
were not used as money,e.g.,gold,cigarettes…
an economy uses gold as money – gold standard
fiat money
money without intrinsic value that is used as money
because of government decree
,This note is legal tender for all debts,public and
private.”
4,Money in the Economy
Money stock
quantity of money circulating in the economy
Currency
the paper bills and coins in the hands of the
public
Demand deposits
balances in bank accounts that depositors
can access on demand by writing a check
5,MONETARY POLICY (1)
monetary policy
the setting of the money supply by policymakers in the central
bank
banking system
wider financial system
Coin – Australian Mint
Note – Reserve Bank of Australia (Central Bank,
Federal Reserve)
signatures
statement
Money is more than cash
paper (checks,promissory note,etc.)
electronic transfer
5,MONETARY POLICY (2)
quantity of money determined by
demand for money
interest rate on special financial assets
When interest rates rise throughout the economy,the demand
of money falls.
When interest rates fall throughout the economy,the demand
of money rises.
The interest rate on Treasury Bills is determined by the
Reserve Bank via the its sales and purchase of bills.
The higher the rate of interest on Treasury Bills,the
lower will be the demand for money.
6,Monetary Policy in Practice
Primary instruments,interest rate on Treasury Bills
Low interest rate’s effect
international investors will tend to withdraw funds
and invest more abroad,(devalue dollar)
encourage greater domestic investment activity.
businesses,costs of finance declined
households,cost of borrowing is cheaper
High interest rate’s effect
demand for investment will fall
drop in investment and drop in GDP because of tight
monetary policy
5.4.3 Unemployment (1)
Adults Categories
Employed
Unemployed
Not in the labor force
5.4.3 Unemployment (2)
Classification
natural rate of unemployment
the normal rate of unemployment around which the
unemployment rate fluctuates.
cyclical unemployment
the deviation of unemployment from its natural rate.
frictional unemployment
unemployment that results because it takes time for
workers to search for the jobs that best suit their tastes and
skills.
structural unemployment
unemployment that results because the number of jobs
available in some labor markets is insufficient to provide a
job for everyone who wants one.
5.4.3 Unemployment (3)
Discouraged worker
individuals who would like to work but have given up
looking for a job
Phillips curve
a curve that shows the short-run tradeoff between
inflation and unemployment
Stagflation
the situation when high rates of unemployment
coincide with high rates of inflation.
Phillip Curve
Rate of
inflation
Rate of
unemployment
10
8
a
b
PC
0
The higher the rate of
unemployment,the lower
the rate of inflation.
It’s a negative relationship.
5.4.4 INFLATION,
CAUSE AND CURES?
Causes of inflation
excessive increase in the money supply
demand-pull inflation
excessive demand in the economy which leads to
prices rising generally
cost-push inflation
many suppliers of goods and services of goods
and services increase prices of their items,
triggered by increased wages or other costs,such
as higher cost of import goods.
Quantity Theory of Money
Definition
an increase in the rate of inflation will be
closely associated with the change in the
quantity of money in an economy.
Algebraical summery
MV=PY
P=MV/Y
Fiscal or Monetary Policy?
1930s’-1940s’,intervention
1940s’,Bretton Woods Agreement
(exchange rates pegged against the US
dollars)
1970s’,floating exchange rate (from fixed
exchange rate) & deregulated financial
system
5.1 GOVERNMENT AND
ECONOMIC MANAGEMENT
Policy
the deliberate use of a government’s economic and legal power
to try to achieve specified or understood outcomes.
E.G,laws,institutions,day-to-day management of government
services
Microeconomic policy
targets particular industries or products or markets.
e.g,government provides a subsidy to a particular industry in
trouble
Macroeconomic policy
thing that apply across all states and industries.
e.g,income and business tax rates,the overall rate of
unemployment in the economy,growth in GDP
5.2 OBJECTIVES OF
GOVERNMENT POLICY
1,Economic growth and efficiency
2,Stability of prices
3,High employment and low
unemployment
4,Healthy trade and exchange rate levels
5,Protecting the environment
6,Fairness and helping the disadvantaged
5.2.1 Economic growth
genuine growth
real GDP
5.2.2 Price stability and inflation
Stable Price and Stable Financial System
Rate of inflation
Consumer Price Index (CPI)
a measure of the overall cost of the goods and services
bought by a typical consumer.
Inflation rate in year 2 = × 100
GDP deflator
a measure of the price level calculated as the ratio of nominal
GDP to real GDP times of 100.
GDP deflator = [Nominal GDP/ Real GDP] × 100
CPI in year 2 – CPI in year 1
CPI in year 1
5.2.3 Employment
Outcomes of Unemployment
a loss of human capital for lost of skills
social costs resulting from depression and
poor health or anti-social behavior and crime
Reasons of Unemployment
individuals consciously choose not to work
increasingly rapid structural change in many
industries
5.2.4 Trade and trade indicators
Trade Balance
Current Account
Capital Account
Balance of Payment
Exchange Rate
reflects what others think the value of a currency
should be
TWI (trade-weighted index),value of the exchange
rate of the domestic dollar with all major trading
partner currencies
5.2.5 Care for the environment
Green Account
national accounts which include an
allowance for changing value of the
environment.
5.2.6 Fairness and equity
Fairness
caring for the disadvantaged and providing
reasonable equitable social outcomes.
5.3 CONSTRAINTS ON GOVERN
5.3.1 POLICY TRADEOFFS
5.3.2 MANAGEMENT THE ECONOMY
IN THE SHORT TERM
5.3.3 THE BUSINESS CYCLE
5.3.1 POLICY TRADEOFFS
efficiency and equity
size of the pizza
how the pizza is shared
E.G,
completely private
education system
mixed public/private
education system
free public education
system
equity
efficiency
A
B
The Economic Pizza,
Tradeoffs and Economic Growth
The Pizza with low
growth,greater equity
The pizza with high
growth,less equity
High-income
share
Low-income
share
High-income
share
Low-income
share
5.3.2 MANAGEMENT THE
ECONOMY IN THE SHORT TERM
governments cannot easily plan for the medium to long
term of five to ten years.
In the short term,the emphasis in economic
management is on dealing with unanticipated shocks
and the immediate conditions for business and
individuals.
Economic Forecasting
the better the governments can predict the future,the more
profits are made and the better the economy can be managed.
produced in four main ways
1,simple forecasts based on key assumptions (e.g,inflation,
exchange rate,major world economic growth,unemployment)
2,leading indicator forecasts
3,time series forecasts
4,econometric forecasts
5.3.3 THE BUSINESS CYCLE
Definition
sequence of events where the economy
moves from recession through recovery to
buoyant and boom conditions,following a
slowdown or collapse at the end of the boom,
the economy moves back into recession.
Boom – Downturn – Recession – Recovery
Time-lag
5.4 POLICY OPTIONS
Policy instruments
the particular pieces of policy that government employs
in pursuit of the policy objectives.
Types of policy for macroeconomic management
fiscal policy
monetary policy
5.4.1 FISCAL POLICY
Fiscal Policy
all those policies to do with the raising of government revenue
and with spending by government.
loosening vs tightening
stance of fiscal policy
budget surplus,an excess of government receipts over
government spending
budget deficit,an excess of government spending over
government receipts
budget
a statement of the revenue and expenditure of the government.
annual budget statement
a summary of past performance of the economy,of expected
future performance and a detailed statement of government
revenue and expenditure.
1,Income determination,saving
and investment
Components of consumption
autonomous consumption,the minimum amount of
money required to live in a society at an acceptable
standard,occurs when there is no income.
induced consumption,consumption directly related
to income
Marginal propensity to consume (MPC)
a ratio of spending out of disposable income
Multiplier effect
how much extra business is generated in the circular
flow model for a given change in investment
2,The Fiscal Policy Stance and
Stabilization
Loosening fiscal policy stance when recession
the government spends more than it receives in
taxes and other revenue,increasing GDP and
moves it more towards its full employment
equilibrium level
Tightening fiscal policy stance when booming
the government revenue exceeds government
spending,causing overall spending and GDP to
contract
5.4.2 MONETARY POLICY
1,Money
the set of assets in an economy that people regularly use to
buy goods and services from the other people
2,Functions of Money
medium of exchange,an item that buyers give to sellers
when they want to purchase goods and services
unit of account,the yardstick people use to post prices and
record debts
store of value,an item that people can use to transfer
purchasing power from the present to the future
liquidity
the ease with which an asset can be converted into the
economy’s medium of exchange
3,Kinds of Money
commodity money,
money that takes the form of a commodity with
intrinsic value
intrinsic value,the item would have value even if it
were not used as money,e.g.,gold,cigarettes…
an economy uses gold as money – gold standard
fiat money
money without intrinsic value that is used as money
because of government decree
,This note is legal tender for all debts,public and
private.”
4,Money in the Economy
Money stock
quantity of money circulating in the economy
Currency
the paper bills and coins in the hands of the
public
Demand deposits
balances in bank accounts that depositors
can access on demand by writing a check
5,MONETARY POLICY (1)
monetary policy
the setting of the money supply by policymakers in the central
bank
banking system
wider financial system
Coin – Australian Mint
Note – Reserve Bank of Australia (Central Bank,
Federal Reserve)
signatures
statement
Money is more than cash
paper (checks,promissory note,etc.)
electronic transfer
5,MONETARY POLICY (2)
quantity of money determined by
demand for money
interest rate on special financial assets
When interest rates rise throughout the economy,the demand
of money falls.
When interest rates fall throughout the economy,the demand
of money rises.
The interest rate on Treasury Bills is determined by the
Reserve Bank via the its sales and purchase of bills.
The higher the rate of interest on Treasury Bills,the
lower will be the demand for money.
6,Monetary Policy in Practice
Primary instruments,interest rate on Treasury Bills
Low interest rate’s effect
international investors will tend to withdraw funds
and invest more abroad,(devalue dollar)
encourage greater domestic investment activity.
businesses,costs of finance declined
households,cost of borrowing is cheaper
High interest rate’s effect
demand for investment will fall
drop in investment and drop in GDP because of tight
monetary policy
5.4.3 Unemployment (1)
Adults Categories
Employed
Unemployed
Not in the labor force
5.4.3 Unemployment (2)
Classification
natural rate of unemployment
the normal rate of unemployment around which the
unemployment rate fluctuates.
cyclical unemployment
the deviation of unemployment from its natural rate.
frictional unemployment
unemployment that results because it takes time for
workers to search for the jobs that best suit their tastes and
skills.
structural unemployment
unemployment that results because the number of jobs
available in some labor markets is insufficient to provide a
job for everyone who wants one.
5.4.3 Unemployment (3)
Discouraged worker
individuals who would like to work but have given up
looking for a job
Phillips curve
a curve that shows the short-run tradeoff between
inflation and unemployment
Stagflation
the situation when high rates of unemployment
coincide with high rates of inflation.
Phillip Curve
Rate of
inflation
Rate of
unemployment
10
8
a
b
PC
0
The higher the rate of
unemployment,the lower
the rate of inflation.
It’s a negative relationship.
5.4.4 INFLATION,
CAUSE AND CURES?
Causes of inflation
excessive increase in the money supply
demand-pull inflation
excessive demand in the economy which leads to
prices rising generally
cost-push inflation
many suppliers of goods and services of goods
and services increase prices of their items,
triggered by increased wages or other costs,such
as higher cost of import goods.
Quantity Theory of Money
Definition
an increase in the rate of inflation will be
closely associated with the change in the
quantity of money in an economy.
Algebraical summery
MV=PY
P=MV/Y
Fiscal or Monetary Policy?
1930s’-1940s’,intervention
1940s’,Bretton Woods Agreement
(exchange rates pegged against the US
dollars)
1970s’,floating exchange rate (from fixed
exchange rate) & deregulated financial
system
