6.2 Economic Influences

How government might intervene to help businesses and encourage enterprise

Governments often intervene in the economy to:

• Promote economic growth

• Create jobs

• Encourage innovation and enterprise

• Increase international competitiveness

Ways governments support new businesses & encourage enterprise

1. Finance - Grants, Tax Incentives & Low interest loans

• no need to repaid → reduces start-up cost & improves cash flow

• offering lower tax rates/ reliefs → reduce costs

• offering lower interest rates → makes finance easier & cheaper to obtain → can invest in equipment → bus grows.

2. Providing Training & Advice

• entrepreneur gain skills → improves quality of bus. decisions → increase chance of bus. survival.

3. Improve Infrastructure

• invest in roads, transport & internet → reduce operating & distribution difficulties → bus. can operate more efficiently → encourage new firms to set up.

4. Reduce barriers to start a bus.

• Simplify registration & unnecessary regulations/paperwork → faster & cheaper to start bus.

How government might intervene to constrain business activity

1. Laws / Regulations

• eg. min wage, health & safety or env. regulations → compliance increases bus. cost

2. Taxation Policy

• gov. increase corporation/ indirect taxes → cost increase profit falls

3. Quotas

• gov. set max limit on how much product can be produced, sold or imported → protects resources & reduce harmful productions.

4. Competition law Enforcement

• preventing anti-competitive behaviour such as price fixing or abuse of monopoly power → protects consumer & small bus.

Market failure

When business fail to produce products efficiently

eg. goods or services are underprovided (healthcare/ education) while others are overproduced causing harm like pollution or when there’s limited access to (clean water/ housing).

Examples of Market Failure, Stakeholders affected by it and Gov. Intervention

1. Lack of Labour Training

• Consumers - receives bad customer service

• Gov. - worried abt int competitiveness if there’s insufficient skilled workers

• Shareholders - may see future profits fall as output falls

2. Increase in External Costs

• Damage to bus. reputation

• Gov. can impose fines on polluting bus. / impose strict limits on pollution levels.

3. Monopoly Producers

• Consumers - lack of choice, limited supplies & high prices

• Gov. concerned as prices are high & important industries lack competitiveness

Solutions to Market Failure

1. Government Provision

• directly providing public or merit goods such as healthcare → ensures these goods are provided even if private firms have little incentives to provide them → reduces underproduction.

2. Controlling negative externalities (pollution)

• enforce regulations, set limits or fine for polluting business & env. damage

3. Taxing or regulating Demerit goods (drugs, sugary drinks)

• introduce taxes/ regulation to reduce consumption & raise awareness of these goods.

Macroeconomic objectives

The main goals that a government tries to achieve in the wider economy to keep the economy stable and growing

What are some of the government macroeconomic objectives?

• Economic Growth (Increasing GDP)

• Low Inflation

• Low Unemployment

• Balance of Payments

• Exchange Rate Stability

Impact of Employment Levels on the Business

High Employment

• More people with incomes to spend → increase demand

• Boost business confidence → encourage firms to invest & expand

• Reduce availability of labour = harder to recruit → increase wage

Low Employment

• Demand fall = lower sales & bus. closures

• Recruit workers more cheaply & improve labour cost competitiveness

Inflation

The increase in avg price level of goods & services resulting in a fall in the value of the money.

Deflation

A fall in avg price levels of goods & services

Cost Push Inflation vs Demand Pull Inflation

Cost Push

• An increase in price level caused by higher cost of production

eg. higher wage demands, trade union intervention

Demand Pull

• An increase in the price levels caused by an increase in demand

eg. usually during boom period/ supply shortages / higher incomes

Monetary Inflation

When money supply (amt available for spending) grows to quickly relative to the amount of goods & services being produced

Impact of Low inflation rate on Business

1. Prices rise slowly

• consumers purchasing power is stable → demand more predictable

2. Smaller increase in cost

• profits margin are less pressured

3. Greater Business Confidence

• firms more likely to invest & expand

4. Low interest rates

• borrowing cost remain lower

Impact of High inflation rate on Business

1. Prices rise rapidly

• purchasing power falls → demand decrease

2. Cost of materials increase + Harder to predict future costs & price

• raw materials, wages become more expensive → profit margin fall

• Long-term planning become harder

3. Interest Rate increase

• borrowing more expensive → investment fall

Disadvantage of Deflation

1. Lower sales revenue

• prices fall → delay in purchases → demand decrease

2. Unemployment increase

• lower demand & profits → workers made redundant

3. Debts Increase

• Incomes fall while value of debt increase → risk of bankruptcy increase

Economic Growth

An increase in a country’s productive potential / national output, measured by an increase in its real GDP.

Real GDP

GPD data adjusted for the effect of inflations

Why Government wants Economic Growth

1. Higher Tax Revenue

• Gov. collect more income tax, corporation tax & VAT → more spending on public services

2. Higher Living Standards

• Higher employment & incomes → quality of life improves

3. Absolute poverty can be reduced/ eliminated

Causes of Economic Growth

1. Increase in labour

• More workers enter workforce → more product produced → real GDP increases

2. Technological Progress

• New tech allows product to be produced more efficiently→ productivity increases → output increase

3. Improved Education & Skills

• Better education & training → workers more skilled & productive → output per worker increase → economic grow

Economic Cycle

The regular swings in output, measured by real GDP that occur in most economies, varying from boom conditions to recession.

Stages of the Economic Cycle

1. Recession🍃 - when economic activity is falling

• Real GDP fall

• Consumer Spending fall

• Profit fall

• Tax revenue fall

• Unemployment rise

• Inflation reducing

→ lower consumer confidence = spending falls → sales fall → production fall → workers made redundant = high unemployment

2. Slump / Trough - lowest point of economic cycle

• GDP low

• Consumer spending weak

• High unemployment

• Inflation Low

3. Recovery / Upturn - economy improving after trough

• GDP starts increasing

• Consumer spending increase

• Production Increase

• Unemployment fall

• Inflation starts increasing

→ consumer confidence rise = spending increase → sales increase → production increase → firms hire more → income increase = spending increase

4. Boom 🚀 - rapid growth & high economic activity

• GDP grow rapidly

• Unemployment v low

• Consumer spending high

• Bus. profit high

• Inflation high

Unemployment

People who are members of the working population are willing & able to work but unable to find job.

What are the 3 main cause of Unemployment?

• Cyclical Unemployment

• Structural Unemployment

• Frictional Unemployment

Cyclical Unemployment

Caused by a fall in economic activity eg. during recession

• lower demand → sales fall → reduce production = need fewer workers → unemployed increase

Structural unemployment

Caused by mismatch between workers skill & job available

eg. New tech replaces factory workers - dh the skills needed for tech related jobs → unemployment.

Frictional Unemployment

When people are in-between jobs or left education waiting for first job.

Cost of unemployment to the Economy

1. Slows Economic Growth

• Unemployed not producing output → real GDP falls below potential level

2. Lowers Tax Revenue

• Unemployed = no/ less income tax + spends less = less indirect tax

3. Lower consumer spending

• Less disposable income → reduce spending = lower demand → reduce production & cut more jobs

4. Loss of skills

• Long term unemployment = workers losses skills

4 Mains Policies gov. try to use to achieve Macroeconomic Objectives

• Monetary Policy

• Fiscal Policy

• Supply side Policy

• Exchange Rate Policy

Monetary Policy

Government / central bank actions to influence interest rates & the money supply to achieve macroeconomic objectives.

eg. Increase interest rates → borrowing falls → spending falls → inflationary pressure decreases.

Fiscal Policy

Government changes taxation and government spending to influence aggregate demand and achieve macroeconomic objectives.

Supply-side policy

Government measures designed to increase the productive capacity & efficiency of an economy.

eg. education & training, privatisation

Exchange Rate Policy

Government/ central bank actions designed to influence the value of a country’s currency relative to other currencies.

Exchange Rate Appreciation

If the demand for a currency is greater than its supply, prices of currency rate rises

Effect of Appreciation

• Exports Decrease: Domestic goods become more expensive to foreign buyers

• Imports Increase: Foreign goods become cheaper to domestic buyers

• Inflation Decreases → imports cheaper = raw materials cheaper = reduce cost push inflation

• Economic Growth Slows → exports become less competitive = net export fall

Exchange Rate Depreciation

If the demand for a currency is lower than its supply, price of currency fall

Effect of Depreciation

• Exports Increase: Domestic goods become cheaper for foreign buyers

• Imports Decrease: Foreign goods become more expensive

• Inflation Increase: Imported goods become expensive = cost push-inflation increase

• Economic Growth Increase: Exports become more competitive = net export increase → GDP increase