1.6 Government influences on business activity and objectives

Circular flow of income

The circular flow of income shows how money, goods and services flow in the economy between economic agents (i.e. firms and households).

Consumer spending

The amount of money that is spent by households to purchase goods and services.

Factor incomes

Incomes earned from the four factors of production. Rent earned from land, wages earned from labour, interest earned from capital and profit earned from enterprise.

Injections

Injections increase the demand for domestically produced goods and services.

Leakages

Leakages decrease the demand for domestically produced goods and services.

Gross Domestic Product

GDP is a measure of the size of an economy.

The formula:

GDP = C + I + G + (Ex - Im)

N.B. Savings are not taken into account while calculating GDP as it is unproductive (which means it is not circulating in the economy)

The role of the government in the economy:

1.      Promote economic growth

2.      Reduce inflation

3.      Reduce unemployment

4.      Reduce disparity

5.      Control the balance of payment (BOP)

6.      Legislation

Legislation

Legislation is law promulgated by government. The governments pass legislation such as:

·        Consumer legislation

Legislation to ensure the rights of consumers as well as fair trade, competition and accurate information in the market place

·        Health and safety legislation

Legislation to ensure health, safety and welfare at work of employees.

·        Employment legislation

Legislation to protect people’s right at work such as minimum wage, meal breaks, overtime, etc.

·        Environment legislation

To rescue environment and nature from pollution, traffic, destruction of wildlife and wasted resources.

The roles of government in the economy to promote competition:

·         Encourage the growth of small firms

·         Lower barriers to entry

·         Introduce anti-competitive legislation

Taxation

Taxes are government revenue paid by businesses and individuals.

Types of taxes:

1.     Direct tax

Taxes charged directly on income. E.g.

·         Income tax (paid by individuals on personal income)

·         Corporate tax (paid businesses on company profit)

2.     Indirect tax

Taxes charged indirectly on income i.e. tax paid on spending. E.g.

·         (VAT) Value Added Tax (paid on buying goods and services)

·         Duties/Tariffs (paid on buying goods and services from abroad)

·         Toll, etc.

Impact of tax in businesses:

·         If tax is lowered then consumer spending increases, thus businesses can either increase their production or price rises

·         Higher corporate tax causing cut down in investment or reducing dividends

·         Increasing VAT causes a fall in demand

 

 

Business Cycle

It is the upward and downward movement of gross domestic product (GDP). The different trends are categorized below:

•           Boom

•           Recession

•           Slump

•           Recovery

Economic Growth

It is an indication of the change in goods and services to be produced by an economy. To achieve the economic objectives government needs to influence the economy. Government policies are:

·         Fiscal policy

·         Monetary policy

·         Regional policy

Fiscal policy

It is a strategy by which government adjusts the level of demand in the economy by altering:

·         government spending

·         taxation

The government can help raise demand, firms produce more and employ more people. Also government can spend more on building roads and bridges. Thus, aims to reduce unemployment.

 

Monetary policy

It is a strategy by which government controls the economy through central bank by altering:

·         money supply

·         interest rate

The government sets a target rate for inflation and it is the job of the central bank to set interest rate and money supply. Thus, aims to reduce inflation.

                     

                                                                                                                               

Regional policy

Regional policy influences the regions and cities in European Union in order to support job creation, business competitiveness, economic growth, sustainable development and improve citizen’s living standard. Regional policy transfers from richer to poorer regions.

Schemes of regional policy:

1.     Regional Selective Assistance

Offers grants for job creation, encourage firms to locate in promising areas.

2.     Enterprize Zones

Offer rate-free accommodation, tax advantage to firms, etc.

International trade

International trade is the exchange of goods and services across international boundaries.

Determinants of international trade:

·        Export

Export is selling goods and services overseas.

·        Import

Import is buying goods and services from overseas.

·        Visible trade

Visible trade is export and import of tangible goods like materials, manufactured goods, etc.

·        Invisible trade

Invisible trade is export and import of intangible goods, i.e. services like banking, insurance, etc.

·        Balance of payments

Balance of payments is the difference between the values of total exports and imports of a nation’s economy.

Causes of international trade:

·         To obtain goods that cannot be produced domestically

·         To obtain goods that can be bought at cheaper rate from overseas

·         To improve consumer choice and living standard

·         To sell off surplus commodities

Protectionism

It is the government actions and policies restricting international trade. It is done to protect the domestic businesses from the threat of foreign competition.

Methods of protectionism

1.     Tariffs – Tax imposed on imports.

2.     Quotas – Physical limits on imports.

3.     Subsidies – Grants given by government to domestic producers, e.g. Tax rebate, etc.

4.     Administration barriers – To obscure imports various rules are used like environmental standards, health and safety regulations, etc.

5.     Depreciating exchange rate – Demand for import falls and demand for exports rises.

6.     Embargo – Ban or prohibition imposed on specific goods or region.

Exchange rate

It is also known as foreign exchange rate. The rate at which one nation’s currency is exchanged for another is called exchanged rate. E.g. if the dollar/sterling rate is £1=$1.50 and a British firm buying £70,000 of goods from an America firm will pay in US$:

£1          = $1.50

£70,000 = $70,000 x $1.50

              = $1, 05,000

              

Impact of appreciation of exchange rate on international trade

Demand for:

·         exports fall

·         imports rise

E.g. if dollar/sterling rises from £1=$1.50 to £1=$2

·        Impact on export

A British firm selling goods worth £70,000 to an American firm receiving payments of ($70,000 x $1.50) = $1, 05,000 @ original exchange rate. After the exchange rate rises, dollar price of goods also rises to ($70,000 x $2) = $1, 40,000.

Hence, demand for UK exports fall as they become expensive now.

·        Impact on import

A British firm buying goods worth £90,000 from an American firm paying ($90,000 / $1.50) = $60,000 @ original exchange rate. After the exchange rate rises, dollar price of goods falls to ($90,000 / $2) = $45,000.

Hence, demand for UK imports rise as they become cheaper now.

Impact of depreciation of exchange rate on international trade
Demand for:

·         exports rise

·         imports fall

E.g. if dollar/sterling falls from £1=$1.50 to £1=$1.20

·        Impact on export

A British firm selling goods worth £70,000 to an American firm receiving payments of ($70,000 x $1.50) = $1, 05,000 @ original exchange rate. After the exchange rate falls, dollar price of goods also falls to ($70,000 x $1.20) = $84,000.

Hence, demand for UK exports rise as they become cheaper now.

·        Impact on import

A British firm buying goods worth £90,000 from an American firm paying ($90,000 / $1.50) = $60,000 @ original exchange rate. After the exchange rate falls, dollar price of goods rises to ($90,000 / $1.20) = $75,000.

Hence, demand for UK imports fall as they become expensive now.

N.B.  “A better government builds a better nation”