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Chapter 26 - Government economic objectives and policies (Government…
Chapter 26 - Government economic objectives and policies
Government Economic Objectives
low
inflation
(the increase in the average price level of goods and services over time)
These are the problems a country will have if there is rapid inflation:
people's
real incomes will fall.
(the value of income, and it falls when prices rise faster than money income) for example, if a worker receives a 6 per cent wage increase but prices rise by 10 per cent in the same year, then the worker's real income has fallen by 4 per cent. workers may demand higher wages so that their real incomes increase.
prices of 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
. living standards are likely to fall.
low inflation can encourage businesses to expand and it makes it easier for a country to sell it goods and services abroad.
low
unemployment
(when people who are willing and able to work cannot find a job)
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.
government pays unemployment benefit to those without jobs.
a high level of unemployment will cost the government a great deal of money
. this can't be spent on other things such as schools and hospitals.
low unemployment will help to increase the output of a country and improve workers' living standards.
economic growth
(when a country’s Gross Domestic Product increases - more goods and services are produced than in the previous year)
an economy is said to grow when the total level of output of goods and services in the country increases. when a country is experiencing economic growth, the standard of living of the population is likely to increase.
the problems
GDP
(the total value of output of goods and services in a country in one year) falling will cause:
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.
the business cycle
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 quickly and there will be shortages of skilled workers. business costs will be rising and firms will become uncertain about the future.
recession
(a period of falling Gross Domestic Product) - often caused by too little spending. this is when GDP 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.
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
between imports and exports (records the difference between a country’s exports and imports)
exports - goods and services sold from one country to other countries.
imports - goods and services bought in by one country from other countries.
governments will aim to achieve equality or balance between these over a period of time.
if the value of a country's 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.
the
exchange rate
(the price of one currency in terms of another) will be
likely to fall
. this is called exchange rate depreciation. (the fall in the value of a currency compared with other currencies.) the country's currency will now buy less abroad than it did before depreciation.
Government Policies
fiscal policy
- any change by the government in tax rates or public sector spending.
All government spends money 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 manufactures will benefit from government spending on public transport
Where do governments raise this money from?
Direct taxes
(paid directly from incomes - for example, income tax or profits tax) on the income of businesses and individuals
Indirect taxes
(added to the prices of goods and taxpayers pay the tax as they purchase the goods - for example, VAT) on spending
Taxes affect business activities. These are the effects:
income tax
- usually, the higher a person's income the greater will be the amount of tax they have to pay the government. income tax is set at a certain percentage of income.
individual taxpayers would have a lower
disposable income
(the level of income a taxpayer has after paying income tax). they would have less money to spend and save. business sees falling sales. business produce fewer goods. unemployment occurs.
businesses which produce luxury goods which consumers do not have to buy are likely to be most affected. business producing essential goods and services will be less affected.
profit tax
. an increase in rate of corporation tax affect businesses in two main effects:
businesses would have lower profits after tax. businesses will find it more difficult to expand and managers will have less money to put back into the business.
lower profits after tax is bad news fro owners. less money to owners who originally invested in the business. fewer people won't start their own business. companies' share prices could fall.
indirect taxes
such as Value Added Tax (VAT) are added to the prices of products we all buy. Government avoid putting these taxes on really essential items, such as food, because this would be considered unfair, esp. to poorer consumers. 2 main effects of an increase in an expenditure tax:
prices of goods in the shops rise. this may cause consumers to buy fewer items. this reduces demand for products made by the business. the increase in price for essential goods is less affected.
as prices rise so 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
(a tax on an imported product) and
Import quota
(a physical limit to the quantity of a product that can be imported)
three possible effects if government put tariffs on imports into the country:
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.
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
when government wants to boost economic growth, they can increase their spending on education, health, defence, law and order, transport - roads and railways. this will create more demand in the economy, more jobs and GDP rises.
if government wants to save money, these cuts could have a considerable impact on the business, for example:
produce equipment for schools and hospitals and defence equipment
build roads, bridges and railways
monetary policy
- a change in interest rates by the government or central bank, for example, the European Central Bank.
interest rate is the cost of borrowing money. main effects of higher interest rate:
firms with existing variable interest loans may have to pay more in interest to banks. this will reduce their profits. lower profits mean less is available to distribute to owners and less is retained for expansion.
managers thinking about borrowing money to expand may delay their decision. new investment in business activity reduces. 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.
if business makes expensive consumer items like cars or if they build houses then they will notice that consumer demand will fall. consumers will be unwilling to borrow money to buy these expensive items if interest rates are higher. these businesses may have to reduce output and make workers redundant.
higher interest rates in one country will encourage foreign banks and individuals to deposit their capital in that country. By switching their money into this country's currency they are increasing the demand for it. Exchange rate appreciation happens (the rise in the value of a currency compared to other currencies). This will make imported goods appear cheaper and exports will be more expensive.
supply side policies
(supply-side policies include a range of policies designed to reduce costs, improve efficiency, productivity, and international competitiveness so that the economy can grow without experiencing inflation)
some of the policies which have been used to increase the competitiveness of their industries agains those from other countries are called supply side policies because they are trying to improve the efficient supply of goods and services
privatisation
- the aim is to use the profit motive to improve business efficiency.
improve training and education
- government plans to improve skills of the country's 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.
how business might react to changes in economic policy
government policy change
increase income tax - reduces the amount of consumers have to spend
possible business decision
: lower prices on existing products to increase demand // produce 'cheaper' products to allow for lower prices
problems with this decisio
n: less profit will be made // brand image of a product might be damaged by using cheaper versions of it
increase tariffs on imports
possible business decision: focus more on domestic market as locally produced goods seems cheaper // switch from buying imported materials and components to locally produced ones
problems with this decision: it might still be more profitable to export // foreign materials and components might be of higher quality
increase interest rates
possible business decisions: reduce investments so future growth will be less // develop cheaper products that consumers will be better able to afford // sell assets for cash to reduce existing loans
problems with this decision: other companies might still grow so market share will be lost // depends on the product but could consumers start to think that the quality and brand image are lower? // assets might be needed for future expansion
overall impact of these decisions may depend on:
how big the changes are in government policy
what actions competitors take in response to these policies