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
Government Economic Policies Most governments have four main objectives for their national economies. Low and stable price inflation (a continuous rise in the average level of prices in a national economy). If price inflation is high, people will not be able to afford to pay for a lot of things, including basic necessities. High and stable employment. People have jobs. Economic growth in the national output and income. The country is producing with people having jobs. A favorable balance of international trade and payments (hopefully one country doesn’t owe the other country too much money in international transactions. E.g. if a country is importing more than exporting, its trade balance will be in deficit, that is, negative. This is not good for the country as it is spending more money in another country. Hence, that country will have to counterbalance this situation, e.g. encourage foreign companies to invest in the country ).
Low and Stable Price Inflation Inflation = a continuous rise in the average level of price. If prices rise too quickly it can be bad for business and an economy. Why? It reduces real incomes so incomes buy less and less over time. E.g. if a person’s income rises by 2% but prices rise by 5%, real income will have been cut by 3%. As real incomes fall consumer demand will fall, hence businesses will be affected.
Low and Stable Price Inflation Why? It causes hardship for people on low incomes. It increases business costs, especially if workers demand higher wages. Goods and services produced in the economy become more expensive to buy than those purchased from other countries with lower rates of inflation. People may buy more imports instead and hence businesses at home will suffer falling sales. Some may close and jobs will be lost.
Low and Stable Price Inflation Low and stable price inflation makes it easier for businesses to manage their costs, for exporters to sell their products abroad and for consumers, particularly those on low incomes to afford goods and services.
High and Stable Employment People who want to work but are unable to find a job will be unemployed. A rise in unemployment is bad for the economy. Why? The total national output and income of the economy will fall as the country is producing lesser and people don’t have jobs. Therefore, a country wants to have high and stable employment.
High and Stable Employment Why? The government has to spend more money on welfare to help the unemployed and their families. This money comes from businesses and working people through taxes. As businesses and working people pay more taxes, this will reduce their incomes so they now have lesser money to spend and this causes demand to fall. Alternatively, the government may have to cut spending on building roads, on education or supporting new businesses.
High and Stable Employment Why? If people remain unemployed for a long time, they may lose the skills they need to work in new business sectors. Retraining will be necessary for them to return to the workforce.
High and Stable Employment High levels of employment therefore help to increase output, incomes, consumer demand and living standards. When people have jobs, they have the money to spend and the economy will remain strong.
Economic Growth in the National Output and Income Economic growth = if the total amount and value of goods and services produced in a national economy grows over time. E.g. a country which creates $9 billion in goods and services in 2010 and then creates $9.5 billion in 2011. Hence, there is economic growth in the country. Increased output helps increase incomes and living standards. If there is no economic growth, or if output falls over time, business and an economy will suffer.
Economic Growth in the National Output and Income Why? Employment, incomes and demand will fall. Government tax revenues will fall and government spending will have to be cut. Business revenues and profits will fall. Entrepreneurs will not invest in new businesses and may move production to other countries where economic conditions are better. As a result, people will lose their jobs.
A Favorable Balance of International Trade and Payments No country is self-sufficient. They always need to depend on others. Every country must import goods and services from other countries. Selling exports to other countries earn foreign currency. This can be used to buy imports. If a country pays more to overseas countries than it receives there will be a deficit on its balance of payments with other countries. Think of it this way: you are spending more than you earn.
A Favorable Balance of International Trade and Payments Consequences It may run out of foreign currency to buy imports of parts and materials its firms need to produce their goods and services. The value of its currency may fall against other foreign currencies and make imports more expensive to buy. This can cause inflation. Firms that need to import materials and parts from overseas to produce their own products will face rising costs as it now becomes more expensive to buy from overseas.
A Favorable Balance of International Trade and Payments A favorable balance of international trade and payments provide opportunities for businesses to export their goods and services overseas. It provides employment and incomes. It ensures an economy can afford to import a wide variety of goods and services to satisfy consumer needs and wants.