A pure market economy is one with only consumers and suppliers. However, the modified market economy is one where the government is involved. In the modified market economy, the government has four economic objectives: sustainable economic growth, price stability, full employment and external balance.

Economic growth is the increasing capacity of an economy to satisfy the wants of its people. This is done by increasing the gross domestic product (GDP), which is what economic growth is measured by. However, economic growth is only good if it can be sustained. If growth is too quick, it is bad as it increases inflationary pressure. However, if the economy is growing too slowly or even contracting, then it is also bad as the unemployment rate will go up. This is why the government prefers to keep economic growth steady at around 4% p.a.

Price stability is the avoidance of inflation and deflation. Inflation is the persistent and appreciable rise in the general level of prices and is measured by the consumer price index (CPI). Deflation is a general decline in prices. The RBA’s target range for inflation is 2-3% p.a. The objective of the government is to maintain low inflation. This is because high inflation can impact negatively on economic efficiency and the economic well-being of some people in the society.

Full employment is when everyone who wants to work as a job. This is virtually impossible so the goal of government is to maintain a low level of unemployment. The unemployment rate is measured as a percentage of the workforce. A low unemployment rate is favourable as it means the economy is working efficiently and maximising its ability to produce while reducing the level of income inequality.

The aim of external balance is to balance the external transactions between Australia and the rest of the world who are our trading partners. The goals are to achieve a sustainable trade balance which is usually in deficit (current account deficit – CAD), to avoid excessive exchange rate fluctuations and to have a sustainable foreign debt ratio as a proportion of GDP. This is because if the CAD is getting big, it means that there will be inflationary pressure, affecting price stability. This also applies with the exchange rate as if the dollar is too strong, then it will increase inflationary pressure too. The opposite of these two also has a negative effect on the economy. Also, if foreign debt is too low, it means that people aren’t spending enough money, which could indicate a high level of unemployment, while if it too high, then it indicates increased inflationary pressures.

Taxes can be put into two broad categories: direct and indirect tax. A direct tax is where where the tax is placed and group that pays for it is the same, for example, personal income tax and capital gains tax. An indirect tax is one where the group who finally pays the tax is different from the one it is initially placed on, for example, GST and tariffs.

There are 3 different types of taxes that government uses to help achieve the four economic objectives. These are: progressive tax, regressive tax and proportional tax.

A progressive tax is one where as income rises; the percentage of income paid in tax also rises. A few examples of this are Pay as You Go (PAYG) income tax and capital gains tax (CGT). A progressive tax can be used by the government to stabilise economic growth. If the economy is growing at too fast a rate, then the government can increase income tax so people have less disposable income, helping reduce economic growth to a more sustainable level. Similarly, if the economy is growing at a slow rate or contracting, the government can give out tax cuts so people have more disposable income, helping increase economic growth so it is sustainable.

In a similar way to sustainable economic growth, price stability can also be achieved through changes in levels of progressive tax. If inflation is too high, the government can increase taxes, thus reducing disposable income so spending falls, making inflation fall. If the economy is experiencing deflation, then the government can reduce taxes so people have more disposable income so more money can be spent, helping stabilise inflation at the RBA’s target range of 2-3% p.a.

Progressive tax can also be used to help achieve full employment. If the tax levels are too high, it may discourage people to work, especially the higher income earners who are taxed more. The government can solve this problem by lowering the amount of income taxed, which will encourage people to find a job as they will have increased disposable income.

A regressive tax is one where as income rises, the percentage of income paid in tax falls. An example of this is GST because it penalises lower income earners as a bigger proportion of their income is spent on it. This tax is used by the government to raise revenue while it can also help achieve full employment as it can encourage the unemployed or low income earners to get a job or work more so their income rise which will mean that the tax they pay as a percentage of their income falls.

A proportional tax is one where as income rises, the percentage of income paid in tax stays the same. An example of this is company tax where a company is taxed 30% of its profits.

All of the above taxes raise revenue. This revenue can be used by the government to help achieve its economic objectives. It can help sustain economic growth by giving out stimulus packages if the economy is slowing down or contracting. These stimulus packages increase people’s disposable income and are funded by the revenue raised from taxes. Other schemes and organisations set up by the government to help it achieve these four economic objectives are also funded by revenue collected from taxes, such as the RBA (although the RBA acts independently from the government). The aims of the RBA include the stability of the Australian dollar, maintenance of full employment and price stability, which are all part of the 4 economic objectives. The RBA helps the government achieve these objectives by using its control over interest rates and the amount of money printed.