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Unit (65)
Business and the economy
What external factors affect a business?
1. Business decision will be influenced by many
factors within the business it self:
2. Marketing – are consumers likely to buy this
new product?
3. Finance – are there enough funds within the
firm to produce the product?
4. Production – Does the firm have the
necessary technology to produce it?
5. Lab our – Do the workers have the right
skills?
There are factors outside the business that could affect
any business:
1- Legislation. There might be laws that affect the product.
2. Technology. The rate of change of technology may
influence the type of good produced.
3. Political factors, A firm may delay a decision, until after a
general election, because it is concerned a bout the effects
of a new governments' policies.
4. Social factors, an increase in the amount of crime directed
against businesses will affect firms differently.
5. Population. The size, age and the six distribution of the
population can affect demand for a product.
6. The state of competition, A new competitor entering a
market could lead to a reduction in the sales of existing
firms.
7. Environmental factors. Increased consumer awareness
has led many firms to re-evaluate their impact upon the
environment.
8. Economic factors and economic system.
How a simple economy operates?
- A useful tool for analyzing, how an
economy works is the circular flow of
income.
- The circular flow shows how money
flows around the economy.
- Businesses buy land, lab our and capital
from households.
- Households receive rent, wages, interest
and profiting return.
- The money they earn is spent on goods
and services produced by businesses.
- So money or income flows from
businesses to households and back again
– a circular flow of income around the
- The money earns by households,
their income (y), is spent on goods
and services (E), which are produced
by businesses – their out put (O).
- In the national accounts of
economies, these are all defined, so
that they are equal. Y= E = O
A more complex economy.
- In practice, household will spend some money
(known as consumption) and save some as well.
- Savings takes money out of the circular flow ( a
with drawl).
- Businesses are not likely to spend all their revenue
on rent and wages.
- They will also invest some in machinery and
equipment (an injection).
Injections into the economy include:
- Investments, spending on fixed capital, circulating
capital and work –in –progress.
- Government spending (G) spending by government
on new schools.
- Exports (X) goods and services sold abroad.
Withdrawals can be:
1. Savings (S) money saved by
households.
2. Taxation (T) money taken out of the
economy from businesses and
households by government through
taxation.
3. Imports (m) goods and services
coming into the country and paid for
by money leaving the circular flow to
be paid to overseas producers.
How can we measure, how much money is flowing
around the circular flow?
The value of a country's economic activity is
shown as its gross national product.
GNP can be measured by:
1. Income method, adding up all the income earned
by households (rent, wages, interest and profit).
2. Output method, adding up the value of all goods
and services produced by businesses.
3. Expenditure method, adding up the spending of
consumers © the investment of business (I) the
expenditure of government (G) and the spending
of people overseas on exports minus the spending
of a country on imports from abroad (x-m).
y=c+I+G+x–m.
Whichever method is used, it will give the same.
Gross domestic product (GDP), is GNP less net
earnings from property overseas.
Equilibrium:
- If injections in any year are the
same as withdrawals the money
flowing around the circular flow
would remain the same. This is
known equilibrium.
- If injections and withdrawals are not
the same, the money flowing
around the circular flow will
change.
- If injections = withdrawals – income
remains the same.
- If injections > withdrawals – income
- If injections < withdrawals – income will fall
because more money is leaving the
economy + han is entering it.
- Say an economy is in equilibrium, with 600
billion $ flowing around it, but 800 billion
was needed for full employment.
- This gap of 200 billion $ known as
deflationary gap.
- This means that there was unemployment in
the economy.
- Keynesians argue that the government
should fill any gap that exist by spending
more + han it receives in taxes. This known
as a budget deficit.
- Other economists suggest that the economy
will be in equilibrium at full employment
Government objectives:
- Governments have some common
economic objectives.
1- Control of inflation:
- Governments usually set target rates at
which they want to keep inflation.
- In practice the targets which governments
set themselves often depend upon the
inflation rate from previous years.
- governments aim to achieve and inflation
rate at or below the level of those of their
com petites.
2- Full employment:
- full employment occurs when all who want a
job have one at a given wage rate.
- The level of unemployment in an economy can
be seen as an indicator of its success.
- A falling rate may show an economy doing well.
3- Economic growth:
- It refers to the rise in economic activity or
gross national product.
- Most governments Judge the performance of
an economy by the figure for growth.
- A growing economy means that trading
conditions are favorable and there are new
opportunities.
- There is another view that growth harms the
environment.
4- The balance of payments and exchange rates:
- Governments usually attempts to achieve
equilibrium or a surplus on the current account of
the balance of payments.
- This means that the value of exports going out of a
country is either the same as or greater than the
value of imports coming into a country.
- At worst governments would aim to prevent a long
term deficit.
- Deficit occurs when the value of imports exceeds
the value of exports.
- The problem with a deficit is that, it must be
financed either by borrowing form abroad or by
running down savings.
- If the deficit persists then the country's debts will
increase.
Government policy:
- Governments have a range of policies, which they
can use to achieve their objectives.
1- Monetary policy:
- It is designed to control the amount of money
flowing around the economy. The money supply.
- It is mainly used to tackle inflation and balance of
payments problems.
Tools of monetary policy:
1- Interest rate:
- Raising interest rates may reduce the amount of
borrowing in the economy.
- It makes borrowing more expensive.
- The amount of money flowing around the system
will be reduced.
- Interest rates can also affect the value of the pound
(see page No. 97).
2- The government can control the a mount
of credit:
- It may set limits on the amount and type of
lending banks can make.
3- The central bank can control the assets of
banks and the amount of lending they can
make by a variety of means.
Fiscal tools:
- It aims to manage the level of total
spending in the economy.
1- Changes in government spending:
- If the economy needs a boost, government
expenditure can be raised.
- If the economy needs to be slowed down,
government expenditure can be lowered.
2- Changes in direct taxation:
- Direct taxes are those which are levied
directly on individuals or businesses.
- Income tax rates can be lowered in order to
encourage consumers to buy more goods
and services.
- This should raise the level of aggregate
demand.
3- changes in indirect taxation:
- Indirect taxes are those which are levied on
goods or services (vat).
- Governments raise indirect taxes as a part
of fiscal policy in order to raise the price of
goods and services and discourage
spending.
- Indirect taxes can be also used by
governments as a means of raising
revenue in order to finance spending
plans.
- There is much debate as to wheat her it
is individual businesses or consumers
who have to pay for indirect taxes.
- If a government spends more than it
receives from taxation and other
sources, then it is said to have a budget
deficit.
- This means that it has to borrow money
from a variety of sources.
- Public sector borrowing requirement
(PSBR)/ This is the amount of money
Supply side policies:
- These policies allow the supply side of
the economy producers to operate
more effectively.
- They aim to increase the amount of
competition in markets.
- Examples of supply side policies
would be:
1. Reducing income or corporation tax.
2. Cutting state benefits to encourage the
unemployed to return to work.
3. Privatizing nationalized industries to
open them up to competition from other
businesses.
4. Supporting firms that provide training in
order to create a more efficient and
productive workforce.
5. Control of trade unions that may
prevent wages from being flexible.
6. Removal of restrictions to employment,
such as a maximum number of working
hours in a week.
7. Reduction of the amount of red tape.
8. Reducing the national insurance
contributions of employees in order to
reduce the cost of taking on new
employees.
Exchange rate policy:
- The exchange rate is the price of one
currency in relation to another.
- Changes in exchange rates can affect
the economy and business within it.
- Firms that export goods should gain
increased sales and possibly hire
more workers, and at the same time
the prices of imported goods will be
higher.
- The overall effect will be uncertain.
- The exchange rate not only affects
exports and imports it can also affect
inflation.
Regional and urban policy:
Regional policy aims to provide aid
to businesses in different parts of
the economy.
- It has been used to support
regions that have suffered from a
decline in important industries.
- It may takes many forms, such as
government spending on grants
and loans.
- Urban policy has been designed
to stimulate business mainly in
inner – city areas.
- It has involved the reaction of
enterprise zones throughout the
country.
- Firms are encouraged to locate
through incentives.
- It also encourages private sector
investment.
Industrial policy:
- It aims to support specific
industries and firms.
- Incomes policy, It is designed to
control inflation, by imposing limits
upon pay or price increases.
Policy disagreements:
It was stated that economists have
different approaches to solving
economic problems.
1-The operation of markets:
- This approach favors the free
operation of markets.
- Supporters of this believe that the
role of government should be
limited to providing the - Wright
environment for businesses to
flourish.
- It suggests that market will
achieve equilibrium.
- In a depressed area there are more
- This would put pressure on
wages to fall.
As a result some workers don’t
offer their - lab our to
employers at this wage rate.
- This would occur until the lab
our
market
returned
to
equilibrium.
- To the point where the demand
for lab our was equal to the
supply of lab our at a given
wage.
Interventionists, argue that the
operation of market economy
results in a variety of problems,
such as:
1. high levels of unemployment.
2. Inadequate merit goods (housing,
health, and education).
3. Lack of provision of some public
goods (defence).
4. Inequalities in income.
Wages and unemployment:
- Market supporters suggest that if
real wage are free to move up and
down, the economy would always
achieve full employment.
1. Lab our may be reluctant to
move from one area to
another.
2. Trade unions protect the real
wage rates of their members.
3. Businesses may not reduce
wages
because
of
the
dissatisfaction it may lead to.
4. Instead they argue that
unemployment is caused by a
lack of aggregate demand in
the economy. (deflationary
gap).
Inflation
providing
markets
operate freely:
- The economy will achieve full
employment
according
to
market economists.
- An increase in output would
only be possible if the
technology changed.
- Monetarists, they argue that
increases in the money supply
over and above increases in
output lead to inflation.
- Interventions, argue that
Government policy:
- Market economists argue that
obstacles to the operation of
markets should be removed by
government.
- These occur on the supply side of
the economy.
- Incentives to businesses to retrain
workers may solve the lack of
skills.
- The aim of supply side policies is to
increase the level of output in the
economy as a whole (Aggregate
supply).
Interventionists
argue
that
1. Fiscal and regional policy to
increase
employment
and
growth.
2. Protection against foreign
competition.
3. The use of prices and
incomes policy to prevent
wage costs rising.
4. Government ownership in
particular sectors of the
economy.