Section 6 - Economic Management Policies

• Government Macroeconomic Objectives/Problems


  Managing economic growth, unemployment, price stability (inflation/recession), balance of payments and exchange rate stability
• Governments attempt to manage the circular flow of income

  To achieve their macroeconomic goals or to manage the macro-economic problems faced by their economies
• Instruments used by governments

  • Monetary policy
  • Fiscal policy
  • Interventionist or direct policies (minimum wages and price controls)
  • Trade policies (tariffs on imports, quotas which limits the amount of a good that can be imported, embargoes which ban any imports from a country to name a few)
  • Exchange rate policy
• Circular Flow of Income

  1. Firms provide productive services to households

  2. Firms produce goods and services for households (National Output/Product)

  3. Firms pay households for their services in the form of rent, interest, profits and wages (National Income/Rewards for the FOP)

  4. Households pay firms for the goods and services they purchase (National Expenditure)
• Injections


  On the firm side this involves Investments/Capital Accumulation, Government Spending and Exports. While on the household side this involves Government Spending on Services
• Leakages


  On the firms and households' sides this involves Savings, Taxes and Imports
• The total flow of money in the economy is termed as National Product, i.e., the total production of goods and services. The flow of payments in the other direction is known as Total Expenditure
• Increase in the circular flow of income


  Expansionary effect on the level of economic activity as Injections Increase and Withdrawal Decrease
• Decrease in the circular flow of income

  Contractionary effect on the circular flow of income as Injections Reduce and Withdrawals Increase
• Economic Growth


  Increase in Real per Capita GDP per head of population
• Real GDP


  The total value of all final goods and services produced in an economy within a year using a base year price to value goods and services to eliminate the effect of inflation
• Economic growth may be positive, constant or negative
• Factors that can result in economic growth

  • Availability of land (land, water and other natural resources)
  • Skilled and professional labor force
  • Increased availability of capital
  • Technical advancement
  • Increase in Entrepreneurship and innovation
• Economic development


  Great improvements in the quality of life of citizens which may result from continuous economic growth, improved education and health care, as well as conservation of the environment
• Indicators of economic development

  • Increase in Real Per Capita GDP
  • Movement towards more Secondary and Tertiary Production
  • Increased access to healthcare services
  • Increased access to education
  • Infrastructure development allowing for implementation of a modern transportation and communication network
  • Low levels of negative externalities
• Measures of economic development

  • Human Development Index (life expectancy, literacy rates and adjusted real income)
  • Human Poverty Index (percentage of people who die before 40, illiterate adults, without access to good water and proper health services, and children under 5 suffering from malnutrition)
• Reasons why countries remain poor and underdeveloped

  • Insufficient natural resources
  • Lack of human capital
  • Attitudes and culture of the people
  • Behavior in the elite groups in society
  • High birth rates and population growth rates
  • Breakdown of law
• Differences between developed and developing economies

  • Developing countries have high per capita GDP as compared to developing countries
  • Developed countries have higher literacy rates
  • Developed countries have better healthcare, education services and infrastructure
  • Developed countries are fully industrialized having primary, secondary and tertiary sectors as compared to developing countries which rely heavily on the primary and tourism sectors
  • Standard of Living tends to be higher in developed countries
  • Resources are more effectively and efficiently used in developed countries
  • Birth and death rates tend to be lower in developed countries
• Solutions to problems faced by developing countries

  • Develop Secondary and Tertiary Sectors to encourage full industrialization
  • Make education more accessible to all allowing for more productive labour force
  • Encourage more savings and investments to encourage more economic development
  • Manage population growth to reduce the burden on government
• Economic growth


  Can lead to positive effects such as improved SOL, economic development, technological improvements, increased employment and poverty reduction. However it may lead to negative effects such as pollution due to increased production, and depletion of resources
• Fiscal Policy


  Concerned mainly with influencing the demand for goods and services by manipulating Government Spending and/or Taxation
• Surplus Budget


  Government is earning more money that it intends to spend in the next financial year
• Deficit Budget


  Government is spending more than they are earning
• Expansionary fiscal policy (increased government spending)


  Stimulates economic activity and increases employment
• Contractionary fiscal policy (reduced government spending)

  Reduces production and increases unemployment to relieve demand-pull inflation
• Taxation


  Increases or decreases the disposable income of businesses and/or individuals which may influence the demand or supply of goods/services
• Types of taxes


  • Direct taxes (income tax, corporate tax, capital gains tax, stamp duty)
  • Indirect taxes (VAT, excise duties, customs duties/tariffs)
• Proportional tax


  Fixed rate of taxation regardless of income level
• Progressive tax


  Higher income earners pay a higher percentage of their income in taxes
• Regressive tax


  Higher income earners pay a lower percentage of their income in taxes
• Monetary Policy


  Attempts to manipulate the money supply of the economy using open market operations, interest rates, and reserve requirements
• Open Market Operations


  Government sells bonds (contractionary) or buys back bonds (expansionary) to influence money supply
• Increase in interest rates by government

  Leads to crowding out of private investment as it becomes too costly to borrow
• as not in the circular flow of income and thus would lead to a significant increase in NI/GDP
• If they sold bonds to the private sector

  They would have had to increase interest rates and give an incentive to the private sector
• Increase in interest rates by government

  Commercial banks would have to increase their interest rates also to compete for scarce finances
• Increase in interest rates

  Leads to a CROWDING OUT of private investment as it becomes too costly to borrow for consumer expenditure and business investment
• Expansionary monetary policy


  1. Government buying back bonds previously sold to increase the money supply

  2. Increase consumption
• Adjusting the Discount Rate by the Central Bank

  1. Commercial banks' cost to borrow would be higher and they would thus borrow less money

  2. Commercial banks would then raise interest rates

  3. Leads to a contractionary effect of the circular flow of income as it becomes too costly for individuals and private businesses to borrow to invest
• Lowering the Discount Rate by the Central Bank

  Commercial banks would have more money to lend and thus lower the interest rates on loans to individuals and private businesses to encourage more economic activity and economic growth