The Changing Business Environment Government influence over decision making by using economic policy measures
Key Words Inflation Policy instrument Real income Public expenditure Unemployment Interest rate Economic growth Direct tax Imports Disposable income Exports Indirect tax Balance of payments
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 ExpenditureChina goes green.In 2009 the Chinese government launched the world’slargest green stimulus plan of $221 billion in support of itsstate-owned enterprises and private sector to develop thegreen technology industry.China’s companies have since raced past competitors inDenmark, Germany and the United States to become theworld’s largest producers of wind turbines. China hasalso become the world’s largest manufacturer of solarpanels.
Different Policy Instruments Taxation To 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 competition To protect employment and the rights of employees to fair treatment and to work in a healthy and safe environment To 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
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