ECONOMIC ISSUES

What happens in the wider economy will affect businesses either directly or via
their customers. Some of these external changes will be due to factors such as
the business cycle, or as a result of government policy such as changes in
interest rates.
The Business/ Trade Cycle
An economy will not always go through an economic growth; there are often
years when the economy does not grow at all or when the value of Gross
Domestic Product (GDP) actually falls. There is usually a cycle, as shown
below.

What is a Business Cycle?

A business cycle is a cycle of fluctuations in the Gross Domestic Product (GDP)
around its long-term natural growth rate. It explains the expansion and
contraction in economic activity that an economy experiences over time.
A business cycle is completed when it goes through a single boom and a single
contraction in sequence. The time period to complete this sequence is called the
length of the business cycle.
 Stages of the Business Cycle
In the diagram above, the straight line in the middle is the steady growth line.
The business cycle moves about the line. Below is a more detailed description
of each stage in the business cycle:
Growth – this is when GDP is rising, unemployment is falling and there are
higher living standards in the country. Businesses will look to expand and
produce more and will earn high profits.
Boom – it is characterized by a period of rapid economic growth. It is the period
when GDP is at its highest and there is too much spending, causing inflation to
rapidly rise. Business costs will rise and firms will become worried about how
they are going to stay profitable in the near future.
Recession – this is a period of relatively stagnated economic growth. That is, it
is when GDP starts to fall due of high prices, as demand and spending falls.
Firms will cut back production to stay profitable and unemployment may rise as
a result.
Slump – this is when GDP is so low that prices start to fall (deflation) and
unemployment will reach very high levels. Many businesses will close down as
they cannot survive the very low demand level. The economy will suffer.
(When the government takes measures to increase demand and spending in the
economy to take it from a slump to growth, it is called as the ‘recovery’ period).
The cycle repeats.
What is Gross Domestic Product (GDP)?
Gross Domestic Product (GDP) is a way of measuring the size of the economy
or economic activity. It’s calculated by adding up the value of all the goods and
services produced in a country in one year.
Impact on business from changes in economic indicators (such as employment
levels, inflation and GDP)
 Changes in employment levels will affect the ability of the business to
recruit new employees and also the income of customers.
 Rising inflation may increase business costs, leading to higher product
prices. The effect of increasing inflation depends on the type of product
sold.
 An increase in GDP means the economy is growing. Increase sales, higher
income, but recruitment of employees hard.

Government Economic Objectives

Low inflation
Inflation is the increase in average prices of goods & services. Low Inflation on
the other hand is the low prices of goods & services so that people will buy
more money in the economy.
When there is rapid inflation the country faces the following problems:
 A fall in the value of money falls in real incomes.
 Wage price spiral.
 Fall in international competitiveness as prices will be high.
 Businesses may not want to expand and create jobs.
 Living standards will fall.
Low inflation rates will act as an incentive for firms to produce and encourage
them to expand.
Low Unemployment
When people want to and have the ability to work but cannot find job, then they
are said to be unemployed. Low Unemployment therefore is when a high
percent of people work so that they don’t rely on government funds.
Unemployment causes the following problem:
 The country's output will be lower if unemployed people don’t produce
goods and services.
 It involves an opportunity cost as the government has to pay greater
unemployment benefits, which could be used to improve education and
increase living standards.
 Increase in crime rate
 Reduction in government revenue especially from income tax.
Economic Growth
If an economy’s total output rises, it is said to be experiencing economic
growth.
GDP is the total value of goods and services produced in an economy.
Economic growth may cause employment to rise, increasing living standards
and reducing poverty. A fall in GDP can lead to:
 Unemployment
 Fall in average living standards as poverty rises
 Less investment

Balance of Payment
Balance of Payment is the difference between a country's imports and exports
balance out (BoP = Exports – Imports).
Exports are goods and services sold from one country to another.
Imports are goods and services bought by one country from another.
Governments will aim for an equal balance of payments, i.e exports equal
imports.
Higher imports than exports lead to a balance of payment deficit.
Higher exports than imports lead to a balance of payment surplus.

Problems of Balance of Payment Deficit:

 The government can run out of foreign currency reserves and will have to
borrow.
 The exchange rate depreciates – the price of our currency falls as
compared to the other currency.
Exchange Rate is the price of a currency in terms of another. For example, $1:
#1, 869
Exchange Rate depreciation is the fall in the value of a currency compared with
other currencies.

Government Economic Policies

FISCAL POLICY
Fiscal Policy is any changes by the government in tax rates or public sector
spending.

Spending by the Government

Government spending decisions can have a great impact on certain business
decisions. If the government decides to increase its spending:
 Increase subsidies and grants (to encourage businesses to set up in high-
unemployment areas).
 Increase in welfare benefits, meaning consumers will have a higher portion
of income to spend.
 Stimulation of economic growth.
If the government decides to decrease spending:
  Increased competition (mainly if privation is used)
 Disinflation (the reduction in the rate of inflation)
The government revenue is mainly source from taxes on individuals and
businesses.
What is Tax?
A tax is a mandatory or compulsory contributions levied on individuals or
corporations by a government entity.
There are two main types of taxes. They are direct taxes and indirect taxes.
A direct tax is a tax that is imposed on an individual’s income/wealth and an
organization’s profit. Income tax reduces consumer disposable income.
Indirect tax on the other hand is a tax levied on goods and services.
For examples; Expenditure taxes, e.g. VAT, Import tariffs/quotas to reduce
imports from abroad.

Import Tariffs is the tax on imported goods.

Import Quota is a physical limit on the quantity of a product to be imported.
Governments spending decisions include a tax measure according to the effect
they want to achieve.
Governments will reduce spending and increase tax rates to reduce inflation.
Governments will increase spending and decrease tax rates to stimulate
economic growth.

MONETARY POLICY
Monetary Policy is a change in interest rate by the government or the central
bank.
Governments will have a set of objectives they would like to achieve and
present them to the central bank, which will set the interest rate based on these
objectives.
If these objectives seek to increase the overall demand in the economy, the
central bank will lower interest rates, which will lead to -
 More consumers spending than borrowing.
 More risk of inflation (Decreases confidence consumers/Businesses have).
 There is less incentive for firms to invest/expand.
 Depreciation of the exchange rate (fall in value of the country’s currency)
will make for costlier imports.
If these objectives seek to decrease the overall demand in the economy, the
central bank will raise the interest rate; this will lead to -
 Less consumers spending than borrowing.
 Less risk of inflation (Increases confidence consumers/Businesses have).
 Increase incentives for firms to invest/expand.
 Appreciation of the exchange rate (Rise in value of the country’s currency)
will make for cheaper imports.

SUPPLY-SIDE POLICIES
Supply-Side Policies try to increase the competitiveness of industries in an
economy against those from other countries. They are policies to make the
economy more efficient and increase supply.
These supply policies focus on more long-term objectives, unlike
fiscal/monetary, which are more short-term and demand-focused. They have
three main categories:
 Encouraging Competition: through privatization/deregulations.
  Labour Market Reforms: through trade unions, minimum wage, and labour
legislations.
 Incentive-related Policies: through reduced tax rates and increased
subsidies.
How business might react to changes in economic policy
Government policy Possible business Problems with this
change decision decision
Increase income tax – Lower prices on existing Less profit will be made
this reduces the amount products to increase on each item sold (reduces
consumers have to spend demand gross profit margin)

Produce ‘cheaper’ The brand image of a

products to allow for product might be damaged
lower prices by using cheaper versions
of it
Increase tariffs on Focus more on the It might still be more
imports domestic market as profitable to export
locally produced goods Foreign materials and
now seem cheaper components might be of
higher quality
Switch from buying
imported materials and
components to locally
produced ones
Increase interest rates Reduce investment so Other companies might
future growth will be less still grow so market share
will be lost
Develop cheaper
products that consumers Depends on the product
will be better able to but could consumers start
afford to think that the quality
and brand image are
Sell assets for cash to lower?
 reduce existing loans The assets might be
needed for future
expansion
Increase government Switch marketing May be great competition
spending strategy to gain more if other businesses take
public-sector contracts same action
e.g. building or
equipping schools and
hospitals