ECONOMICS- 4TH ESO UNIT 10: STATE ACCOUNTS AND BUDGET 1. THE ROLE OF THE STATE 1.1. THE ECONOMIC CYCLE. 1.2. EXTERNALITIES 1.3. PUBLIC GOODS 1.4. LACK OF COMPETENCE 1.5. INEQUALITY 2. MACROECONOMIC POLICY 3. THE FISCAL POLICY 4. THE GENERAL STATE BUDGET 1. THE ROLE OF THE STATE We studied how the market works through demand and supply to allocate goods and services. However, sometimes, the free market does not work properly and the governments have to act and play a role in economies. The governments intervene because the market fails and they have to mend these failures. Therefore, market failure is the economic situation defined by an inefficient distribution of goods and services in the free market. The main market failures are: 1) The economic cycle. 2) Externalities. 3) Public goods. 4) The lack of competence. 5) Inequality https://www.youtube.com/watch?v=13JOGWzY8kE 1.1. THE ECONOMIC CYCLE. The economic cycle is the fluctuation of the economy between periods of expansion (growth) and contraction (recession). Factors such as gross domestic product (GDP), total employment, and consumer spending, can help to determine the current stage of the economic cycle. The economic cycle has four stages: expansion, peak, contraction, and trough. a) During the expansion phase, the economy is characterized by increasing employment, economic growth, and upward pressure on prices. b) The peak of a cycle is reached when growth hits its maximum rate and the economy is producing at maximum allowable output. Peak growth typically creates some imbalances in the economy that need to be corrected as employment is at or above full employment, and inflationary pressures on prices are evident. c) This correction occurs through a period of contraction when growth slows, employment falls, and prices stagnate. d) The trough of the cycle is reached when the economy hits a low point and growth begins to recover. 1 ECONOMICS- 4TH ESO 1.2. THE EXTERNALITIES Externalities occur in an economy when the production or consumption of a specific good or service impacts a third party that is not directly related to the production or consumption of that good or service. An externality can be both positive or negative and can stem from either the production or consumption of a good or service. A positive externality provides a positive effect on the third party. For example, providing good public education mainly benefits the students, but the benefits of this public good will spill over to the whole society. The open-source software involves positive externalities as well. On the other hand, a negative externality is a negative effect resulting from the consumption of a product, and that results in a negative impact on a third party. For example, even though cigarette smoking is primarily harmful to a smoker, it also causes a negative health impact on people around the smoker. Or, for instance, a negative externality is a business that causes pollution that diminishes the property values or health of people in the surrounding area. Externalities are negative when the social costs outweigh the private costs. To solve the problem of externalities, governments may implement: ✓ Taxes. To help reduce the negative effects of certain externalities such as pollution, governments can impose a tax on the goods causing the externalities. ✓ Subsidies can also overcome negative externalities by encouraging the consumption of a positive externality. One example would be to subsidize orchards that plant fruit trees to provide positive externalities to beekeepers. ✓ Regulations to offset the effects of externalities. Regulation is considered the most common solution to change behaviour. For example, by banning cars from city centre, having a licensing system for the sale of alcohol, environmental regulations or health-related legislation. 1.3. PUBLIC GOODS Public goods are goods or services which, if produced, the producer cannot limit its consumption to paying customers and for which the consumption by one individual does not limit consumption by others. Public goods are both non-rivalrous as well as non-excludable. Non-rivalrous consumption means that the goods are allocated efficiently to the whole population if provided at zero cost, while non-excludable consumption means that the public goods cannot exclude non-payers from its consumption. Public goods create market failures if a section of the population that consumes the goods fails to pay but continues using the good as actual payers. For example, police service or national defence is a public good that every citizen is entitled to enjoy, regardless of whether or not they pay taxes to the government. Governments must provide these goods since no private company would be willing to provide them. 1.4. LACK OF COMPETENCE Market control occurs when either the buyer or the seller possesses the power to determine the price of goods or services in a market. The power prevents the natural forces of demand and supply from setting the prices of goods in the market. On the supply side, the sellers may control the prices of goods and services if there are only a few large sellers (oligopoly) or a single large seller (monopoly) in the market. The sellers may collude to set higher prices to maximize their returns. The sellers may also control the quantity of goods produced in the market and may collude to create scarcity and increase the prices of commodities. 1.5. INEQUALITY Inequality is the unfair situation in society when some people have more opportunities, money, etc. than other people. Markets may also fail to limit the size of the gap between income earners. Market transactions reward consumers and producers with incomes and profits, but these rewards may be concentrated in the hands of a few. 2 ECONOMICS- 4TH ESO Governments try to narrow the gaps of income and wealth among the population. 2. MACROECONOMIC POLICY An economic policy is a course of action that is intended to influence or control the behaviour of the economy. Economic policies are typically implemented and administered by the government. The main goals of economic policies are: - Economic growth: Economic growth means that the incomes of all consumers and firms are increasing over time. - Full employment: The goal of full employment is that every member of the labour force who wants to work is able to find work. - Price stability: The goal of price stability is to prevent increases in the general price level known as inflation, as well as decreases in the general price level known as deflation. For these purposes, governments use the following economic policies: 1) Monetary policy. Monetary policy is conducted by a nation's central bank using the interest rate and the supply of money. 2) Fiscal policy. Fiscal policy is conducted by government using government spending and taxation. 3) External trade policy. It promotes easier trade by reducing barriers to trade (tariffs). In the EU, the external trade policy is common to all members. 4) Incomes policy. It is the policy used to control the increase in wages and prices, it is essentially an anti-inflationary device. For example, a wage freeze. 3. THE FISCAL POLICY All countries experience regular ups and downs in the growth of output, jobs, income and spending. To attempt to end a recession or to stop the economy from overheating during expansions, the government can employ fiscal policy. The two main instruments of fiscal policy are government expenditures and taxes. The government collects taxes in order to finance expenditures on a number of public goods and services—for example, highways and national defence. Fiscal policy can be: a) Expansionary. Expansionary fiscal policy is defined as an increase in government expenditures and/or a decrease in taxes that causes the government's budget deficit to increase or its budget surplus to decrease in order to fight against a recession. b) Contractionary. Contractionary fiscal policy is defined as a decrease in government expenditures and/or an increase in taxes that causes the government's budget deficit to decrease or its budget surplus to increase in order to reduce general spending (consumption, investment). https://www.youtube.com/watch?v=otmgFQHbaDo 3 ECONOMICS- 4TH ESO 4. THE GENERAL STATE BUDGET A government budget is a document prepared by the government presenting its anticipated tax revenues (inheritance tax, income tax, corporation tax, import taxes, social contributions) and proposed spending/expenditure (health care, education, defence, roads, state benefit) for the coming financial year. The main government spending is on current spending (healthcare, wages, justice), investment (infrastructures) and transfers and subsidies to keep the welfare state. In most parliamentary systems, the budget is presented to the lower house of the legislature and requires approval of the legislature. Through this budget, the government implements economic policy and realizes its program priorities. Deficits arise when the government spends more than it takes in, that is, the government expenditures exceed government tax revenues in a given year, the government is running a budget deficit for that year. There are two types of budget deficit: 1) The cyclical deficit is caused by the ups and downs of the business cycle. When the business cycle is in an expansion phase and the economy is doing well, two things happen: a. Government receipts increase because more people are working and paying taxes. An expanding economy also mean corporate and business profits are getting bigger, so they are paying more taxes on their profits too. b. Government expenditures drop because fewer people are collecting unemployment checks and relying on social programs to make ends meet. Therefore, when the economy is doing well and people have jobs, this cyclical part of the deficit disappears. But when the economy is doing poorly, the opposite happens. Tax receipts fall as workers get laid off and business profits go down. Expenditures go up since people who used to be working and paying taxes are collecting unemployment checks instead. 2) The structural deficit comes from automatic spending for ongoing government programs (pensions, medical care), it is underlying and persistent. The problem of the budget deficit can be solved: a) By reducing government spending (e.g. raising the retirement age) and increasing taxes in expansionary stages of the economic cycle. Either of those can slow economic growth. b) By government borrowing. The government issues bonds to finance the deficit. The total stock of government bonds and interest payments outstanding, from both the present and the past, is known as the national debt. Thus, when the government finances a deficit by borrowing, it is adding to the national debt. National debt is the total outstanding borrowing of a central government, comprising of internal debt (owing to national creditors) and external debt (owing to foreign creditors), incurred in financing its expenditure. c) By raising the money issued, which can lead to inflation. When government expenditures are less than tax revenues in a given year, the government is running a budget surplus for that year. The budget surplus is the difference between tax revenues and government expenditures. The revenues from the budget surplus are typically used to reduce any existing national debt. In the case where government expenditures are exactly equal to tax revenues in a given year, the government is running a balanced budget for that year. 4 ECONOMICS- 4TH ESO 5 ECONOMICS- 4TH ESO ACTIVITIES 1. What kind of market failure are the following? a. Pollution. b. Scarcity of public parks. c. The economy has ups and downs. d. There is a monopoly in a market. e. Some people are poor. 2. What kind of macroeconomic policy are the following? a. Setting a fixed price for milk. b. Restrictions on the importation of foreign goods. c. Raising spending on education. d. Raising the minimum wage. e. Raising taxes. f. Reducing the quantity of money in circulation. g. A new gasoline tax. 3. Classify the following government spending into current spending, investment or transfers: a. Pensions. b. Civil work constructions. c. Healthcare spending. d. Study grants. e. A subsidy for job creation. f. Hiring civil servants. g. Unemployment subsidy. GLOSSARY BALANCED BUDGET: Presupuesto en equilibrio o equilibrado. BARRIERS TO TRADE: Barreras u obstáculos al comercio. BOND: Bono. BUDGET DEFICIT: Déficit presupuestario. BUDGET SURPLUS: Superávit presupuestario. CORPORATE TAX: Impuesto de sociedades. CYCLICAL DEFICIT: Déficit cíclico. STRUCTURAL DEFICIT: Déficit estructural. ECONOMIC CYCLE: Ciclo económico. ECONOMIC GROWTH: Crecimiento económico. EXTERNAL TRADE POLICY: Política comercial exterior. EXTERNALITY: Externalidad. FISCAL POLICY: Política fiscal. CONTRACTIONARY FISCAL POLICY: Política fiscal contractiva. EXPANSIONARY FISCAL POLICY: Política fiscal expansiva. FREE MARKET: Libre mercado. 6 ECONOMICS- 4TH ESO FULL EMPLYMENT: Pleno empleo. GENERAL STATE BUDGET: Presupuesto General del Estado. GOVERNMENT EXPENDITURE/SPENDING: Gasto público. INCOME TAX: Impuesto sobre la renta. INCOMES POLICY: Política de rentas. INEQUALITY: Inequidad, falta de igualdad. INHERITANCE TAX: Impuesto de sucesiones. LACK OF COMPETENCE: Falta de competencia. MARKET FAILURE: Fallo del mercado. MONOPOLY: Monopolio, donde una única empresa controla todo el mercado (ej. De Beers, que controla el mercado de diamantes). NATIONAL DEBT: Deuda pública. OLIGOPOLY: Oligopolio, donde unas pocas empresas controlan todo el mercado (ej. Empresas petroleras). PEAK: Pico, auge o cima del ciclo económico. PRICE STABILITY: Estabilidad de precios. PUBLIC GOOD: Bien público. REGULATION: Regulación, legislación. REVENUE: Ingreso. SUBSIDY: Subvención. TARIFFS: Aranceles. TAXES: Impuestos. TO ISSUE: Emitir. TRANSFER: Transferencia. TROUGH: Depresión o fondo del ciclo económico. WAGE FREEZE: Congelación salarial. WELFARE STATE: Estado del bienestar. 7
