Government policies and economic issues

How government control over the economy affects business activity

Government economic objectives

- every government has economic objectives, there are four main ones:
a. low unemployment
b. low inflation
c. economic growth
d. balance of payments between imports and exports

a. Positive balance of payments

Balance of payments- the difference between the values of export and import goods
and services of a country over a year
- the balance of payment of a country will be positive when the value of exports is
greater that the value of imports. This is called a balance of payments surplus
Exports- the goods and services sold by one country to other countries in return for
foreign currency
Imports- the goods and services bought by a country from other countries
- exports involve money coming into the country and imports involve money flowing
out of the country.

Balance of payments deficit- this is when there are more imports than exports, then
there is more foreign currency flowing out than coming into a country. This causes
shortages of foreign exchange
****this means that the country has to borrow foreign currency from other countries
at expensive rates of interests , which could also affect the country exchange rate

Balance of payment surplus- this is when there are more exports than imports, then
there is more foreign currency flowing in than going out of a country
- at this phase the country does not have to borrow foreign currency from other
countries
b. Low inflation
Inflation- is the price increase of goods and services over time
- when inflation is low, people enjoy a better standard of living as they can afford to
pay for goods and services
- they can also afford to pay for non-essential (luxury) items
- if inflation increases, people may not be able to afford to buy local goods and
instead may buy foreign goods(which may be cheaper)
- this affects local businesses in the country as they receive fewer sales

Low unemployment
Unemployment- is the percentage of the population that are capable of working but
are unable to find a job
- all countries want their economy to have low levels of unemployment
***a government wants as many people to have jobs as possible so that;
i. they contribute to the total output of the country and improve economic growth
ii. the people of the country can earn money and have a better standard of living
iii. the government does not have to spend money on unemployment benefits so can
that money on improving the country’s infrastructure or transport networks
iv. the higher the level of unemployment, the more income tax a government
receives

Economic growth
Gross domestic product (GDP)- the value of all goods and services produced by a
country in a year
- GDP shows whether a country’s economy is growing or not
- if GDP increases it means more goods and services have been produced locally
compared to the previous year and this means people’s standards of living will
increase
- if GDP falls, it could lead to lower output so fewer employees are needed and
generally people’s standards of living is lower
- GDP is a good measure of economic growth and it allows us to analyse the
economic growth of a country from one year to another
The business cycle- is the change in the economic activity as the economy grows and
shrinks over a number of years
- the business cycle has four main stages and each stage may last for months or even
years;
a. growth
b. boom
c. recession
d. slump

Growth
- this stage is when the economy recovers or grows. It has the following
characteristics;
i. a positive outlook for new businesses
ii. existing businesses grow and make profits
iii. growth in economic activity is measured by a rise in GDP until it reaches a
maximum (boom)
iv. falling unemployment as there are more jobs due to businesses doing well
v. raised standards of living as more people are employed

Boom
- this stage is the peak of the business cycle. Characteristics are;
i. businesses investments and profits are at their highest levels
ii. most sectors of the economy are performing at their best
iii. high levels of demand for goods and services causing prices to rise (inflation)
iv. very low unemployment rates and people have better jobs to choose from; this
leads to increased wage costs for businesses as well as a shortage of skilled
people
-too mush spending and high borrowing costs during this stage may be risky for
businesses.

Recession
- this is when the economy shrinks in size. Characteristics include;
i. businesses confidence falls leading to less investment in new and existing
businesses
ii. decline in economic activity until it reaches a minimum (slump)
iii. falling demand by consumers leads to falling profits
iv. unemployment rises as businesses are not doing well and have to cut costs;
employees are made redundant and some businesses even close down

Slump
- this is when the recession stage of the economy is at its worst. characteristics include;
i. very low business confidence with very little investment in new and existing
businesses
ii. low production of goods and services- many businesses close down
iii. low demand for goods and services
iv. high unemployment due to low business activity

How changes in taxes and government spending affect business activity

- to achieve their economic objectives, governments affect the economic activities of
a country by controlling interest rates (monetary policy), tax rates and government
spending (fiscal policies). Government mainly get their income from taxes
- when there is a slow economic growth rate, governments may change their
economic policies to encourage growth

Government economic policies

1. fiscal policy
2. monetary policy
3. supply side policies
 Fiscal policy- is any change by the government in tax rates or public sector spending
Fiscal policies
Government income Government spending
- taxes - public services e.g schools and hospitals
- borrowing e.g from financial institutions - subsidies on goods and services
- welfare benefits
- taxes are used by governments to pay for investments they make in public services
such as education, health and transportation. Taxes may be direct or indirect
Direct taxes- is the tax charged on personal income or tax on the profit made by a
business. They can be paid by an individual or a business
a. Income tax
b. Corporation tax

Income tax
- the amount of tax charged depends on the amount of income
- the higher the income tax rate, the smaller the disposable income of individuals
- if the economy is in recession, the government can use high tax rates to invest in
certain sectors in order to encourage growth
Disposable income- is the amount of income left for individuals after taxes been paid

Effects of an increase in income tax rates on consumers and businesses and how
businesses may respond
Effects of an increase in income tax on consumers and businesses
Effects on consumers Effect on business Business response
- a reduced disposable income so - less demand for goods and - businesses focus on cost reduction
consumers spend less on goods and services leading to fewer sales so that they can offer competitive
services for businesses pricing to attract customers
- employees may not be - firms reduce production levels
motivated to work as hard, which also leads to unemployment
affecting production
- businesses may decide to provide
more fringe benefits to compensate
and improve motivation
 Corporation tax
- this is the tax paid by businesses on the profit they make
- the higher the corporation tax rate, the smaller the profit after tax available to
businesses
- if a country is in recession and the government’s objective is to encourage economic
growth, it can lower the corporation tax rate

Effects of an increase in corporation tax rates on shareholders or owners and businesses

Effects on shareholders Effect on business Business response
- shareholders will receive fewer - a smaller profit after tax for - businesses may rethink their
dividends businesses, so smaller amount is growth strategy. They may relocate
available to reinvest and grow their operations in a foreign country
with a lower corporation tax rate
- this will discourage existing and - a smaller profit after tax also lead
new shareholders from investing to businesses increasing prices to
meet costs
- businesses may have to look at
other ways of obtaining funds

Indirect taxes- is the tax charged on the price of goods and services, which is added
to the price of goods and services before they are bought
- countries have different specific names of indirect taxes and the include;
i. value added tax (VAT)
ii. import tariffs or customs duty
iii. sales tax
iv. excise duty

Value added tax

- is added to the prices of some goods and services we buy
- this makes goods and services expensive and harder for us to buy, so the government
does not put VAT on essential items
Policy change Effect on consumer Effect on businesses Business response
Increase in VAT - goods and services become more - businesses make fewer - less production due to
or sales tax expensive sales decreased demand
- demand for related goods and - businesses will have to
services falls become more competitive
in price
Import tariffs or customs duty
- governments can also raise money by charging customs duty or import tariffs on
goods that are imported from other countries
- this helps government control the number of imports, so that local businesses do not
incur loss of sales
- import tariffs may increase the cost of local businesses that rely on imported raw
materials for making their goods
- the duty is calculated as per % of the value of goods being imported
Policy change Effect on consumer Effect on businesses Business response
Increase in - imported goods or goods using -low sales for businesses - businesses may decide to
import tariff or imported raw materials become selling imported goods use local raw materials
customs duty more expensive - increased cost of which may be cheaper, but
imported raw materials quality may suffer as a
may lead to higher cost result
of production - local firms may set up
- local firms may benefit more branches and expand
demand for their
products will increase
Sales tax
- this is tax paid by consumers on the purchase of some items
- there will be different rates of sales tax depending on the type of item
- sales tax can be known by different names in some countries, in Brazil its called IPI

Excise duty
- this is the tax paid by manufacturer on the production of specific goods within the
country
- in India, the government has different tariffs for different classes of good
Government borrowing
- government can also borrow money from the public in order to fund their spending
- this money can be borrowed locally by issuing treasury bills and bonds, which
people and organisations of the country invest in or can borrow from other countries

How businesses respond to changes in government spending

- when government want to boost economy growth they can increase their spending
in areas such as;
i. education
ii. health
iii. defence
iv. law and order
v. transport systems e.g road and rail systems
- this will create jobs in these and other dependant sectors
- if the government reduce its spending it will be discouraging businesses from
expansion

2. Monetary policy- is the change in interests rates by the government or central bank
- this is how a country’s government or central bank controls how much money there
is in circulation
- the government use interest rates to maintain economic growth and keep inflation
low
- interests rate determine;
a. the money that an individual or a financial organisation can gain when they
deposit money with a bank
b. the cost of borrowing money from a bank
- some Islamic countries follow Sharia law, which does not permit financial gain on
loan of money. These countries combine standard and Islamic banking principles-
which are based on profit sharing and non-interest- based lending and borrowing.
Policy change Effect on consumers Effect on businesses Business response
Increase in - cost of borrowing increases thus -credit/cost of borrowing - firms may delay or cancel
interests rates people will borrow less is more expensive, interests their plans to expand as the
- more incentive to save thus they costs rise cost of borrowing money is
will spend less - with people spending high
- consumers with mortgages to pay less, businesses sales will - businesses will have to
interests will have less disposable drop reduce output and make
incomes - attracts foreign banks and workers redundant
individuals to deposit their - sell assets for cash to
capital into that country reduce existing loans

- in the long term, an increase in interests rates may lead to the following effects on
the economy;
i. reduced business activity leading to slow economic growth
ii. high rates of return from savings will encourage individuals and financial
institutions from other countries to invest their money with the banks in that
country
- this strengthens the national currency and leads to exchange rate appreciation and
makes imports cheaper

3. Supply side policies

- governments try to increase competitiveness of their industries against those from
other countries
- this allows the business to expand, produce more and employ more workers
- the strategies which are used to improve efficient supply of goods and services
include;
a. Privatisation
b. Improving training and education- improving skills of the country’s workers
c. Increased competition in industries- by reducing government controls or by
acting against monopolies
Economic objectives

Economic policies