1. This chapter will explain: government economic objectives
the main stages of the business cycle the tax and spending changes
that governments can make the interest rate changes that
governments can make the impact these changes have on businesses
and how they can react to these changes.
2. Government economic objectives Most governments have the
following economic objectives: low inflation low unemployment
economic growth balance of payments between imports and
exports.
3. Low inflation Inflation occurs when prices rise. Low
inflation is an important objective. When prices rise rapidly it
can be serious for the whole country. These are the problems a
country will have if there is rapid inflation: Workers wages will
not buy as many goods as before. This means that peoples real
incomes will fall. Real income is the value, in terms of what can
be bought, of an income if a worker receives a 6 per cent wage
increase but prices rise by 10 per cent in the same year, then the
workers real income has fallen by 4 per cent. Workers may demand
higher wages so that their real incomes increase. Prices of the
goods produced in the country will be higher than those in other
countries. People may buy foreign goods instead. Jobs in that
country will be lost. Businesses will be unlikely to want to expand
and create more jobs in the near future. The living standards are
likely to fall. Therefore low inflation can encourage businesses to
expand and it makes it easier for a country to sell its goods and
services abroad.
4. Definitions to learn Inflation is the increase in the
average price level of goods and services over time. Unemployment
exists when people who are willing and able to work cannot find a
job. Economic growth is when a countrys Gross Domestic Product
increases more goods and services are produced than in the previous
year. The balance of payments records the difference between a
countrys exports and imports. Real income is the value of income,
and it falls when prices rise faster than money income.
5. Low unemployment When people want to work but cannot find a
job, they are unemployed. These are the problems unemployment
causes: Unemployed people do not produce any goods or services. The
total level of output in the country will be lower than it could
be. The government pays unemployment benefit to those without jobs.
A high level of unemployment will cost the government a great deal
of money. This cannot be spent on other things such as schools and
hospitals. Therefore, low unemployment will help to increase the
output of a country and improve workers living standards. High
unemployment reduces output and can reduce living standards
6. Economic growth An economy is said to grow when the total
level of output of goods and services in the country increases. The
value of goods and services produced in a country in one year is
called gross domestic product (GDP). When a country is experiencing
economic growth, the standard of living of the population is likely
to increase. When a countrys GDP is falling there is no economic
growth. The problems this causes are: As output is falling, fewer
workers are needed and unemployment will occur. The average
standard of living of the population the number of goods and
services they can afford to buy in one year will decline. In
effect, most people will become poorer. Business owners will not
expand their firms as people will have less money to spend on the
products they make. Economic growth, however, makes a country
richer and allows living standards to rise.
7. Economic growth will make a country richer and will allow
living standards to rise
8. The business cycle The business cycle (sometimes known as
the trade cycle) has four main stages, as shown on the diagram. A
business cycle diagram
9. Growth this is when GDP is rising, unemployment is generally
falling and the country is enjoying higher living standards. Most
businesses will do well at this time. Boom this is caused by too
much spending. Prices start to rise quicldy and there will be
shortages of skilled workers. Business costs will be rising and
firms will become uncertain about the future. Recession often
caused by too little spending. This is a period when GDP actually
falls. Most businesses will experience falling demand and profits.
Workers may lose their jobs. Slump a serious and long-drawn-out
recession. Unemployment will reach very high levels and prices may
fall. Many businesses will fail to survive this period. Clearly,
governments will try to avoid the economy moving towards a
recession or a slump, but will also want to reduce the chances of a
boom. A boom with rapid inflation and higher business costs can
often lead to the conditions that result in a recession. Balance of
payments Exports are goods and services sold by one country to
people and businesses in another country. These bring money
(foreign currency) into a country. Imports are goods bought in from
other countries. These must be purchased with foreign currency so
these lead to money flowing Out of a country. Governments will aim
to achieve equality or balance between these over a period of time.
The difference between a countrys exports and imports is called the
balance of payments. If the value of a countrys imports is greater
than the value of its exports then it has a balance of payments
deficit. These are the problems that could result: The country
could run out of foreign currencies and it may have to borrow from
abroad.
10. Definitions to learn Recession a period of falling Gross
Domestic Product. Exports are goods and services sold from one
country to other countries. Imports are goods and services bought
in by one country from other countries. The exchange rate is the
price of one currency in terms of another, for example El: $1.5.
Exchange rate depreciation is the fall in the value of a currency
compared with other currencies.
11. The price of the countrys currency against other currencies
the exchange rate will be likely to fall. This is called exchange
rate depreciation. The countrys currency will now buy less abroad
than it did before depreciation. A balance of payments deficit can
lead to major problems for a country
12. Activity 26.1 a) The GDP of Country A was $500 million in
2010. The population was 1 million. The average income per person
was therefore $500. By 2013, as a result of economic growth, GDP
was $1500 million. The population had also risen to 2 million. What
was the average income per person in 2013? b) Joe earned $20 000 in
2012. He had a pay rise of 10 per cent in 2013. Inflation was 15
per cent in 2013. i) How much did Joe earn in 2013? ii) Did his
real income rise or fall in 2013? Explain your answer. c) For
Country A, identify which of the following are imports or exports:
i) washing machines purchased from Country B ii) cars made in
Country As factories and sold to a garage in Country B iii)
machines sold to Country A from Country B iv) tourists from Country
B who spend two weeks on holiday in a hotel in Country A.
13. Government economic policies Governments have a great deal
of economic power. They raise taxes and spend this money on a wide
range of services and state benefits. It is not unusual for
governments to have control over 4050 per cent of a countrys GDP
through the taxes they raise. Governments use this power to try to
achieve the objectives we have just looked at. The decisions made
by government can have a great effect on all businesses in a
country. Business managers need to know how their firm could be
affected by government economic decisions. The main ways in which
governments can influence the economy sometimes called economic
policies are: fiscal policy taxes and government spending monetary
policy interest rates supply side policies.
14. Fiscal policy: taxes and government spending All
governments spend money. They spend it on schools, hospitals,
roads, defence, and so on. This expenditure is very important to
some businesses. For example: construction firms will benefit from
a new road building scheme defence industries will gain if the
government re-equips the army bus manufacturers will benefit from
government spending on public transport. Q: Where do governments
raise this money from? A: Largely from taxes on individuals and
businesses. Q: What are the main types of taxes? A: Direct taxes on
the income of businesses and individuals and indirect taxes on
spending. Q: How do these taxes affect business activity? A: In a
number of different ways. We will look at these effects by studying
the impact of four common taxes: income tax profits tax or
corporation tax indirect taxes, for example Value Added Tax (VAT)
import tariffs.
15. Income tax This is a tax on peoples incomes. Usually, the
higher a persons income the greater will be the amount of tax they
have to pay to the government. Income tax is set at a certain
percentage of income, for example 25 per cent of income. In many
countries, income tax is progressive. This means that the rich pay
tax at a higher rate than the poor. How would businesses be
affected by an increase in the rate of income tax? Individual
taxpayers would have a lower disposable income. They would have
less money to spend and save. Businesses would be likely to see a
fall in sales. Managers may decide to produce fewer goods as sales
are lower. Some workers could lose their jobs.
16. Which businesses are likely to be most affected by this
increase in income tax rates? Businesses which produce luxury goods
which consumers do not have to buy are likely to be the most
affected. Businesses producing essential goods and services will be
less affected. Consumers will still have to buy these products.
;1]
17. Definitions to learn Fiscal policy is any change by the
government in tax rates or public- sector spending. Direct taxes
are paid directly from incomes for example, income tax or profits
tax. Indirect taxes are added to the prices of goods and taxpayers
pay the tax as they purchase the goods for example, VAT. Disposable
income is the level of income a taxpayer has after paying income
tax.
18. Activity 26.2 Here are eight products: bread petrol TVs
foreign holidays cooking oil jewellery salt home computers. The
sales of four of these products are likely to fall following an
increase in income tax rates. Sales of the other four will not be
much affected. Identify the four products likely to be most
affected.
19. Profits tax (or corporation tax) This is a tax on the
profits made by businesses usually companies. How would an increase
in the rate of corporation tax affect businesses? There would be
two main effects. Businesses would have lower profits after tax.
Managers will therefore have less money or finance to put back into
the business. The business will find it more difficult to expand.
New projects, such as additional factories or shops, may have to be
cancelled. Lower profits after tax is also bad news for the owners
of the business. There will be less money to pay back to the owners
who originally invested in the business. Fewer people will want to
start their own business if they consider that the government will
take a large share of any profits made. Companies share prices
could fall. INDIRECT TAXES Indirect taxes, such as Value Added Tax
(VAT), are added to the prices of the products we all buy. They
obviously make goods and services more expensive for consumers.
Governments often avoid putting these taxes on really essential
items, such as food, because this would be considered unfair,
especially to poorer consumers.
20. Prices of goods in the shops would rise. Consumers may buy
fewer items as a result. This will reduce the demand for products
made by businesses. As prices rise so the workers employed by a
firm notice that their wages buy less in the shops. It is said that
their real incomes have declined. Businesses may be under pressure
to raise wages, which will force up the costs of making products.
Import tariffs and quotas Many governments try to reduce the import
of products from other countries by putting special taxes on them.
These are called import tariffs and they raise money for the
government. Many international organisations, such as the World
Trade Organisation, are trying to reduce the number of governments
which do this. How would businesses in a country be affected if the
government put tariffs on imports into the country? There are three
possible effects.
21. Firms will benefit if they are competing with imported
goods. These will now become more expensive, leading to an increase
in sales of home-produced goods. Businesses will have higher costs
if they have to import raw materials or components for their own
factories. These will now be more expensive. Other countries may
now take the same action and introduce import tariffs too. This is
called retaliation. A business trying to export to these countries
will probably sell fewer goods than before. Another method a
government can use to limit imports is to introduce an import quota
or physical limit on the quantity of a product that can be brought
in. Quotas can be used selectively to protect certain industries
from foreign competition that may be seen as unfair or damaging to
jobs. Changes in government spending Governments in most countries
spend the tax revenue they receive on programmes such as: education
health defence law and order transport roads and railways.
22. Definitions to learn An import tariff is a tax on an
imported product. An import quota is a physical limit to the
quantity of a product that can be imported.
23. MONETARY POLICY INTEREST RATES An interest rate is the cost
of borrowing money. In most countries, the level of interest rates
is fixed by the government or the central bank via monetary policy.
In some societies, the charging and the payment of interest is
against the customs and traditions of the population. In most
countries, however, businesses and individuals can borrow money,
from a bank for example, and they will have to pay interest on the
loan. The following are likely to be the main effects of higher
interest rates. Firms with existing variable interest loans may
have to pay more in interest to the banks. This will reduce their
profits. Lower profits mean less is available to distribute to the
owners and less is retained for business expansion. Managers
thinking about borrowing money to expand their business may delay
their decision. New investment in business activity will be
reduced. Fewer new factories and offices will be built.
Entrepreneurs hoping to start a new business may not now be able to
afford to borrow the capital needed. If consumers have taken out
loans such as mortgages to buy their houses, then the higher
interest payments will reduce their available income. Demand for
all goods and services could fall as consumers have less money to
spend.
24. Definitions to learn Monetary policy is a change in
interest rates by the government or central bank, for example the
European Central Bank. Exchange rate appreciation is the rise in
the value of a currency compared to other currencies
25. SUPPLY SIDE POLICIES In recent years many governments have
tried to make the economy of their country more efficient. They aim
to increase the competitiveness of their industries against those
from other countries. This would allow their businesses to expand,
produce more and employ more workers. Some of the policies which
have been used to achieve these aims are listed below they are
called supply side policies because they are trying to improve the
efficient supply of goods and services. Privatisation privatisation
is now very common. The aim is to use the profit motive to improve
business efficiency. Improve training and education governments
plan to improve the skills of the countrys workers. This is
particularly important in those industries such as computer
software which are often very short of skilled staff. Increase
competition in all industries this may be done by reducing
government controls over industry or by acting against
monopolies.
26. 26.3: IMPACT OF ECONOMIC POLICIES You are the Managing
Director of the largest computer manufacturing company in your
country. Your business sells products at home and in foreign
markets. Materials are imported from abroad. You employ hundreds of
skilled workers to develop, assemble and test the computers. Your
business is planning a major expansion programme. The government of
your country has recently announced the following policies. Explain
the likely impact of each of these policies on your business: a) a
reduction in income tax rates on high income earners b) lower
corporation tax rates c) higher import tariffs on all imports d)
higher interest rates e) higher expenditure taxes on luxury goods
f) new training colleges to increase the supply of qualified
workers g)strict controls on monopoly businesses to encourage new
businesses to be formed.
27. Case study Spanish people protest over economic policies
Huge protests have taken place in Spain as people and business
leaders voice their worries over the governments economic policies.
The Spanish Governments finances are deeply in debt so it is having
to cut government spending and increase direct and indirect taxes.
The countrys GDP fell last year and is expected to decline again in
2013. Living standards are falling especially amongst the growing
numbers of unemployed. About 23 per cent of the total workforce are
now unemployed.
28. Activity 26.4 Read the case study above. a)Explain what is
meant by the countrys GDP fell last year. b)Explain how falling
living standards could affect: a farm producing milk a manufacturer
of luxury leather goods. c) Identify and explain two reasons why
the Spanish government might aim to reduce the level of
unemployment.