Preliminary Economics Topic Six – Government and the Economy

Government intervention in the economy

1.1 Limitations of the operation of the free market:

Market failure can occur in five areas of economic activity: provision of goods and services, inequality in the distribution of income, negative environmental externalities, monopoly power, and fluctuations in economic activity

Provision of goods and services – market failure can arise from the inadequate provision of some collective goods and services (demanded by the community), and public goods (non excludable and non rival goods) and merit goods (goods that the government believes are beneficial to society that are not produced in adequate quantities because the market is too small and there is little incentive for producers)

Unequal distribution of income – can cause absolute poverty (below poverty line) and relative poverty (do not have enough income to have the average standard of living enjoyed by the majority); groups prone to poverty include: single people (57%), sole parents (20%), childless couples. women, young people, unemployed, migrants, Aborigines, the elderly, sick and disabled

Externalities are the social costs of private production

Monopoly power – natural monopolies may form (from PTEs and Public Utilities) if they supply the entire market demand with an efficient scale of plant, government reforms in this area to make PTEs more efficient include: privatisation – the sale of part or all of a PTE to the private sector, corporatisation – structuring PTEs like private sector enterprises by making them financially independent, commericialisation – PTEs guaranteeing a rate of return, principles of competitive neutrality, subjecting PTES to taxes, interest on loans, etc, and deregulation – removing restrictions

Fluctuations in economic activity – business cycle: boom downswing recession upswing. Problems caused by fluctuations include: higher rates of unemployment in recessions, higher rates of inflation in booms.

The role of government

2.1 Functions of the three levels of government and constitutional powers:

3.1 Size of the public sector: pg254

4.1 Economic functions of the Australian Government:

The economic functions of the Australian government are reallocation of resources, redistribution of income, stabilisation of economic activity, the provision of goods and services through public trading enterprises (PTEs) and the use of other economic policies such as competition and environmental policies

Reallocation of resources is done through changing the level and composition of taxation and expenditure (spending on collective goods, taxation alters relative prices, governments may use selective assistance or incentives to industries)

Taxation revenue = tax base x tax rate (percentage of tax base paid in tax)

Direct taxes (income & company) are paid by those individuals and firms upon whom they are levied, cannot be passed on to others

Indirect taxes (sales tax, GST, excise, customs duties) are imposed on one group but are usually passed on fully or partially to the final consumer of the good or service

Taxation criteria: equity (vertical – higher incomes paying a higher rate, horizontal – equal tax for same income), efficiency (leaves allocation of resources unchanged and doesn’t affect economy otherwise), simplicity (minimising tax avoidance and evasion)

Tax impact = initial point levied, tax incidence = who ultimately pays Government redistributes income to reduce equality by progressive

taxes and social welfare payments ART = (tax paid)/income, MRT = (change in tax paid)/change in

income

Government attempts to stabilise the economy through macroeconomic policies: fiscal and monetary policy

Monetary contractionary – rise in the cash rate Monetary expansionary – reduce interest rates (stimulating

spending, growth, employment) Fiscal contractionary – surplus budget (G<T) Fiscal expansionary - deficit budget (G>T) PTEs – The PTE sector is an important provider of social and

economic infrastructure in Australia and contributes revenue to government (dividends)

The Australian government uses competition policy enforced by the ACCC to achieve effective competition in markets

The Australian and state governments control negative environmental externalities through: taxes, licenses, quotas, permits, fines, laws and regulations, subsidies

5.1 Federal budget:

Two main components of budget: structural component (explicit changes in G or T) and cyclical component (changes in G or T caused by changing economic activity)

Surplus budget T>G Deficit budget G>T Balanced budget G=T Expansionary larger deficit, smaller surplus, contractionary smaller

deficit, larger surplus Pg 262 – budget. (Pg 271 – Figure 13.4)

6.1 Influences on government policies in Australia:

Political parties Businesses – Business council of Australia (BCA), Australian

Chamber of Commerce and Industry (ACCI), Confederation of Australian Industry (CAI), etc, are some major business lobby groups that attempt to influence government policy to favour business activity

Unions – ACTU (Australian Council of Trade Unions) campaigns for higher wages and better working conditions

Environmental groups/organisations – Australian Conservation Foundation, Greenpeace

Welfare agencies – Australian Council of Social Services (ACOSS), Salvation army, etc, lobby on social policies

The media – influence public opinion Other interest groups – National Farmers Federation (NFF),

Aboriginal groups, Women’s Electoral Lobby (WEL) International – foreign policies of allied governments and treaty

obligations