Price
S2
F E S1
G K C
H J
D
0 A B Quantity
The imposition of an ad valorem tax will shift the supply curve upwards; the higher the price, the greater will be the amount of the tax. As shown by the diagram, the total tax revenue of the government is shown by FHJE. Consumers will pay FG tax per unit whilst the incidence of tax on producers will be HG. Because demand is relatively inelastic such as that for an inferior product, e.g. alcohol, producers will be able to pay a smaller proportion of the tax (GHJK) in comparison to consumers who will pay a higher proportion of it (CKEF).
3. Explain how an increase in government spending can lead to crowding out.
Government spending is a budget on how money within an economy will be used to provide public goods or services such as street lighting, hospitals, public schools, etc. In other words, it is the budget or plan set by a government to invest within its own economy. Governments spending tend to be greater than income from taxes, profits, rents and interest which therefore leads to an increase in the demand for borrowing in the form of, for example, loanable funds. A loanable fund is money which is available for lending to individuals and institutions. This increase in government spending and borrowing will have some effect on the rate of interest; in this case, an increase of it. Higher interest rates will raise the cost for borrowing and therefore investments will be most likely to fall. This can be described as the ‘crowding-out effect’.
Diagram showing crowding out
Price
AS
AD2
AD1
AD3
0 Quantity
As stated before, it is believe to take place because the increase in government borrowing will increase the demand for money for transactions which will eventually raise the rate of interest. Government’s use of loanable funds means that there is less available for private investment; some private sector spending will be crowded out.
6. Explain which is likely to be higher in a Less Developed Country – Gross National Product or Gross Domestic Product?
Gross Domestic Product (GDP) is a measure of the total flow of goods and services produced by the economy over a given period of time, normally a year. Gross National Product (GNP) is a measure of national income arising from abroad investment plus GDP. The main difference between the two of these is the net property income from abroad; GNP measures national income including net property income whereas GDP measures national income before property income.
Abroad investment may enter a less developed country (LDC) by the incoming of multinationals (MNC’s). MNC’s are companies operating in a number of countries while having its headquarters in another specific one. MNC’s bring many advantages for less developed countries such as increase in technology, employment and choice. This allows for the country to increase its growth and development yet they also have negative consequences. For example, if profits generated by the MNC leaves the country, or if the MNC itself decides to leave from that certain country, then this may result in a negative net property income from abroad which will therefore lead GNP to be lower than GDP. Therefore, in this case, GDP is higher than GNP. However, it may happen that GNP has a greater value than GDP in some LDC’s where there is a positive net property abroad.