The Changing Business

EnvironmentGovernment influence over decision making by using

economic policy measures

Key Words Inflation

Real income

Unemployment

Economic growth

Imports

Exports

Balance of payments

Policy instrument

Public expenditure

Interest rate

Direct tax

Disposable income

Indirect tax

Why Do Governments Intervene Directly in Business Activities?

To achieve their national economics objectives, governments will try to encourage more business activity in their economies because: It produces goods and services people need and

want. It creates jobs and incomes, and helps to raise living

standards. It earns foreign currency from goods and services

sold overseas. This can be used to buy imports that cannot be produced at home.

It helps to fund the provision of public services from taxes paid by businesses, workers and consumers.

Why Do Governments Intervene Directly in Business Activities?

While the governments work for the interest of the nation, most producers and consumers make decisions that are in their own best interests. E.g. business owners will choose a location, materials, workers and production methods that will help them make as much profit as possible. Consumers buy those products that give them the most satisfaction.

Why Do Governments Intervene Directly in Business Activities?

As a result, they may therefore fail to take full account of any negative effects their decisions can have on other people, businesses, workers, the environment or their national economy. Sometimes, their decisions can also be bad for themselves. E.g. if consumers ignore the risks of smoking to their health.

Thus, the governments often intervene to stop or correct those decisions that have negative impacts on others. E.g. high taxes on tobacco, requiring warnings printed on cigarettes boxes, laws to ban smoking under the age of 18.

Different Policy Instruments

A government will use different policy instruments to influence business decisions, activities and outcomes.

A policy instrument is a tool or action a government can use to help it achieve its objectives.

Different Policy Instruments

Public expenditure In many countries, the government is a major

consumer of goods and services. It also provides jobs and incomes for many people.

Government spending or public expenditure accounts for a large share of total spending in many economies.

The public sector in an economy may spend money on hospitals, education, roads, schools, a police force, national defence, welfare payments and much more.

Different Policy Instruments

Many businesses therefore benefit directly from different public expenditures or indirectly from their impact on consumer incomes and demand.

E.g. Construction firms benefit from contracts to build schools and other buildings.

Office equipment manufacturers benefit from spending on equipping public offices.

Public sector workers use their incomes to buy goods and services from businesses.

Different Policy Instruments

As a result, cutting or raising public expenditure can have a big impact on business decisions, activities and profitability.

E.g. many governments are increasing grants to businesses to encourage them to invest in electric vehicle development and manufacturing, and in other low carbon technologies and skills, not only to reduce damage to the environment but also to develop new products they can then sell, including to other countries, to meet growing consumer demand.

Example on Raising Public Expenditure

China goes green.

In 2009 the Chinese government launched the world’s largest green stimulus plan of $221 billion in support of its state-owned enterprises and private sector to develop the green technology industry.

China’s companies have since raced past competitors in Denmark, Germany and the United States to become the world’s largest producers of wind turbines. China has also become the world’s largest manufacturer of solar panels.

Different Policy Instruments

TaxationTo finance (support) public sector spending, many

governments collect taxes from businesses and individuals, either directly from their incomes and wealth or indirectly when they spend money.

Different Policy Instruments

When the government increases taxes, this will reduce the amount of income people have left to spend on goods and services. This policy may be used when there is high and rising price inflation caused by rapidly rising demand for goods and services.

But business revenues and profits are likely to fall and following this, output and employment may be cut.

In contrast, reducing the overall level of taxation can boost total demand for goods and services and boost business activity.

Different Policy Instruments

Government can also use taxes to:Discourage the consumption and production of

harmful products, such as cigarettes, by raising their prices.

Protect the environment by discouraging damaging and polluting activities, e.g. by taxing gasolline, air travel.

Encourage businesses to invest in new technologies and job creation by cutting and removing the taxes on their profits.

Reduce inequalities in income and wealth, by taxing people and businesses with higher incomes more than others

Different Policy Instruments

Interest rates = the price of money

If interest rate falls, people and firms will be able to borrow money more cheaply than before from banks or by using their credit cards.

Lower interest rates also make saving money less attractive.

Hence, reducing interest rates in an economy can help increase consumer spending on goods and services and increase business investment. This can help boost output and jobs.

Different Policy Instruments

If we raise interest rates, borrowing money becomes more expensive and reduce consumer spending.

Businesses that have borrowed money or are seeking to borrow money from banks or other lenders to finance their activities will face an increase in their repayment costs. This will reduce their profits and may cause them to delay their investment plans.

Different Policy Instruments

Most governments are able to change interest rates in their national economies using their central banks.

The central bank is at the centre of the banking system in an economy. Its main function is to maintain the stability of the banking system ad national currency on behalf of the government.

Different Policy Instruments

Laws and regulations These can be introduced or existing ones changed by a

government to control or even outlaw some business activities to:To protect key industries and businesses from unfair

competitionTo protect employment and the rights of employees to fair

treatment and to work in a healthy and safe environmentTo protect consumers from misleading advertising,

harmful products, powerful businesses and dishonest business practices.

To protect the environment and reduce harmful emissions to limit climate change.

Different Policy Instruments

In some cases, new or toughened laws and regulations can increase business costs. E.g. businesses may have to employ additional staff and invest in new equipment to ensure they comply with laws and regulations. These additional costs will reduce profits and businesses may have to find ways to offset them, for example, by cutting some jobs and production.

Different Policy Instruments

In contrast, some business can benefit from new laws and regulations. E.g. manufacturers of helmets for motorcycle riders enjoy increased sales when the government passed a law to mandate all motorists and passengers to wear helmets