Key Economic Tools
Uploaded by cainen on Mar 31, 2002
"What economic tools does the government use to manage the economy and carry out economic functions? Outline how the government carries out these functions and discuss some of the constraints the government faces in performing these functions."
The government performs many different tasks and functions in the economy and management of the economy. The government has a variety of tools, which are used in the management of the economy, but along with these tools, constraints are often placed on the government.
One of the main economic functions of governments is the reallocation of resources. The government largely uses taxation and expenditure to affect resource allocation. If the government spends large amounts on collective goods and services and welfare and it is financed by taxation then some resources will have moved out of private production and into the public sector. Also, if the government places taxes on some products and services and not on others, then this will alter prices and have an effect on demand. This would have an impact on the allocation and resources in the production of these various goods and services that have been taxed. Another way taxation can be used as a tool for the reallocation of resources is if governments use various incentives to either encourage or discourage certain types of production. Some of these incentives could include subsidies, tariffs, quotas or various tax incentives.
The government can redistribute income, which in effect can attempt to correct inequalities in the distribution of wealth and income in the economy. E.g if a government were to place higher taxes on those on higher incomes, and use funds received to provide welfare for those on lower incomes, then the spread of income is more even. This can also assist in the reduction of poverty. When the government has an income taxation system that taxes higher income earners more than lower income earners, it is called a progressive taxation system. The more income you earn, you get placed in higher tax brackets and therefore pay more tax.
Governments attempt to stabilise the economy by using both fiscal and monetary policies. Governments try to avoid major fluctuations in economic activity by using a mix of policies. Fiscal policy refers to the use of taxation and spending of a government and monetary policy refers to controlling the cost and availability of money in the economy i.e. interest rates. By using a suitable policy...