This document contains a comprehensive summary of all readings for Week 7 - so, for both lecture 13 and 14 - of the first-year IRIO course Introduction to Economics at the RUG.
Introduction to Economics International Relations and International Organization
Week 7: Lecture 13 - Economic growth II
There are no readings for this lecture; please study the contents and readings of lecture 12 again.
, Introduction to Economics International Relations and International Organization
Week 7: Lecture 14 - Macroeconomic government policy
Fiscal policy (p. 695-697)
Government budgets
A government’s budget is an annual statement of projected outlays and receipts during the next
financial year. A government’s budget has three major purposes:
1. To plan and finance the government’s activities
2. To stabilise the economy
3. To encourage the economy’s long-term growth and balance regional development
Today, the budget is the tool used by a government in pursuit of its fiscal policy. Fiscal policy is a
government’s use of its budget to achieve macroeconomic objectives.
The three main items in a government budget are:
1. Receipts: receipts come from five sources: (1) taxes on income and wealth; (2) taxes on business;
(3) taxes on expenditure; (4) national insurance contributions; and (5) other receipts and royalties.
2. Outlays: outlays are classified in three broad categories: (1) expenditure on goods and services; (2)
transfer payments; and (3) debt interest.
3. Budget balance: the government’s budget balance = receipts - outlays. If receipts exceed outlays,
the government has a budget surplus. If outlays exceed receipts, the government has a budget
deficit. If receipts equal outlays, the government has a balanced budget.
Fiscal policy (p. 699-704)
Deficit, debt and capital
Government debt is the total amount of borrowing by the government. It is the sum of past deficits
minus the sum of past surpluses plus payments to buy assets minus receipts from the sale of assets.
- A budget deficit or the purchase of assets increases government debt, and a budget surplus or the
sale of assets decreases government debt.
Supply-side effects of fiscal policy
How do taxes on personal and corporate income affect real GDP and
employment? Some economists, known as supply-siders, believe these effects to
be large, and an accumulating body of evidence suggests that they are correct.
The tax on e.g. labour income influences potential GDP and aggregate supply by
changing the full-employment quantity of labour. The tax on labour weakens the
incentive to work and drives a wedge between the take-home wage of workers
and the cost of labour to firms. The result is a smaller quantity of labour and a
lower potential GDP. The gap created between the before-tax and after-tax
wage rates is called the tax wedge.
A tax on interest income weakens the incentive to save and drives a wedge
between the after-tax interest rate earned by savers and the interest rate paid
by firms. These effects are analogous to those of a tax on labour income. But
they are more serious for two reasons:
1. A tax on labour income lowers the quantity of labour employed and lowers
potential GDP, while a tax on capital income lowers the quantity of saving and
investment and slows the growth rate of real GDP
2. The true tax rate on interest income is much higher than that on labour
income because of the way in which inflation and taxes on interest income
interact: inflation increases the effects of a tax rate
A tax on interest income has no effect on the demand for loanable funds, but it
weakens the incentive save and lend and decreases the supply of loanable funds.
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