Government Intervention to Help Businesses and Encourage Enterprise
→ Governments may intervene to create conditions that encourage businesses to start, invest, expand and employ workers.
Financial Support
→ Governments may provide grants, subsidies or low-interest loans to businesses.
→ Financial support can reduce the cost of starting or expanding a business.
→ This may encourage:
→ New business formation
→ Investment
→ Innovation
→ Employment
→ Expansion into new markets
Example:
→ A government provides a grant to small businesses adopting digital technology → cost of investment ↓ → more firms adopt technology → productivity may ↑.
Tax Incentives
→ Governments may reduce taxes or provide tax allowances for businesses that undertake particular activities.
Examples:
→ Investment in machinery
→ Research and development
→ Renewable energy
→ New business formation
→ Lower tax burden → after-tax profit ↑ → incentive to invest may ↑.
Support for Small Businesses
→ Governments may provide:
→ Business advice
→ Training
→ Finance schemes
→ Export assistance
→ Entrepreneurship programmes
→ Information about regulations and markets
→ These measures can reduce some of the difficulties faced by new and small businesses.
Infrastructure
→ Government investment in:
→ Roads
→ Railways
→ Ports
→ Airports
→ Electricity
→ Internet infrastructure
→ Better infrastructure → business costs may ↓ → productivity ↑ → businesses become more competitive.
Education and Training
→ Government investment in education and vocational training increases the skills available to businesses.
→ Skills ↑ → productivity ↑ → output per worker ↑ → business competitiveness ↑.
Enterprise and Entrepreneurship
→ Governments may encourage enterprise by:
→ Simplifying business registration
→ Reducing unnecessary regulations
→ Providing start-up finance
→ Offering entrepreneurship training
→ Protecting intellectual property
→ Supporting innovation
→ These policies can reduce the barriers to starting a business.
Government Intervention to Constrain Business Activity
→ Governments may restrict business activity when they believe unrestricted business activity could harm consumers, employees, other businesses or the environment.
Taxation
→ Governments may impose taxes on businesses or particular products.
→ Higher taxes → business costs ↑ or consumer prices ↑ → demand may ↓ → business activity may ↓.
→ Taxes can also be used to discourage activities that create negative externalities.
Regulation
→ Governments can establish rules concerning:
→ Employment
→ Health and safety
→ Environmental protection
→ Product quality
→ Advertising
→ Competition
→ Compliance can increase business costs but may protect wider social interests.
Competition Law
→ Governments may prohibit:
→ Cartels
→ Price fixing
→ Abuse of market power
→ Anti-competitive mergers
→ This prevents businesses from restricting competition and harming consumers.
Licensing
→ Some businesses may need government permission before operating.
Examples:
→ Financial services
→ Healthcare
→ Certain transport services
→ Businesses handling hazardous materials
→ Licensing can ensure minimum standards but may increase barriers to entry.
Environmental Controls
→ Governments may impose:
→ Pollution limits
→ Emission standards
→ Waste disposal rules
→ Environmental taxes
→ Requirements for environmental permits
→ Businesses may need to change production methods or invest in cleaner technology.
Government and Market Failure
Meaning of Market Failure
→ Market failure occurs when the operation of the market results in an inefficient allocation of resources.
→ The market may produce too much or too little of a good or service from society’s perspective.
→ Governments may intervene to improve resource allocation.
Externalities
→ An externality is a cost or benefit arising from production or consumption that affects third parties.
Negative externality:
→ Factory pollution → costs imposed on local residents → market price does not fully reflect the social cost.
→ Government may use:
→ Taxes
→ Regulations
→ Pollution limits
→ Emission permits
Positive externality:
→ Education → benefits to the individual and wider society.
→ Government may use:
→ Subsidies
→ Direct provision
→ Information campaigns
Public Goods
→ Public goods are non-excludable and non-rivalrous.
Examples:
→ Street lighting
→ National defence
→ Private businesses may be unwilling to provide sufficient quantities because of the free-rider problem.
→ Government may provide and finance these goods through taxation.
Merit and Demerit Goods
Merit goods
→ May be under-consumed because consumers underestimate their benefits.
Examples:
→ Education
→ Vaccinations
→ Government may subsidise, provide or promote them.
Demerit goods
→ May be over-consumed because consumers underestimate their harmful effects.
Examples:
→ Cigarettes
→ Excessive alcohol consumption
→ Government may tax, regulate or restrict their marketing.
Key Macroeconomic Objectives
Low Unemployment
→ Unemployment occurs when people who are willing and able to work and actively seeking employment cannot find jobs.
→ Governments generally aim for a low and sustainable level of unemployment.
→ Low unemployment means:
→ More people earning incomes
→ Consumer spending ↑
→ Production ↑
→ Tax revenue ↑
→ Government spending on unemployment benefits may ↓
→ Living standards may ↑
Impact on Businesses
→ Employment ↑ → household incomes ↑ → consumer spending ↑ → demand for businesses’ products ↑.
→ However, very low unemployment can create labour shortages.
→ Labour shortages → wages ↑ → business costs ↑.
Low Inflation
→ Inflation is a sustained increase in the general price level.
→ Governments generally aim for low and stable inflation rather than prices constantly rising at a high rate.
Why Businesses Are Affected
→ High inflation can cause:
→ Raw material costs ↑
→ Wage costs ↑
→ Transport costs ↑
→ Production costs ↑
→ Prices ↑
→ Uncertainty ↑
→ Businesses may find it more difficult to plan investment and pricing decisions.
Benefits of Low and Stable Inflation
→ Greater price stability
→ Easier financial planning
→ More predictable costs
→ Greater consumer confidence
→ Greater certainty for investment decisions
Economic Growth
→ Economic growth is an increase in the real output of an economy over time.
→ It is commonly measured using the percentage change in real GDP.
→ Economic growth can result from:
→ Higher productivity
→ More investment
→ Better technology
→ Larger or more skilled labour force
→ Improved infrastructure
Impact on Businesses
→ Economic growth ↑
→ Household incomes may ↑
→ Consumer spending ↑
→ Demand for goods and services ↑
→ Business sales and revenue may ↑
→ Businesses may expand production and employment.
→ Growth may also encourage:
→ Investment
→ New business formation
→ Expansion into new markets
Macroeconomic Performance and Business Activity
Economic Boom
→ Economic growth ↑
→ Consumer confidence ↑
→ Consumer spending ↑
→ Business sales ↑
→ Investment ↑
→ Employment ↑
→ Businesses may expand.
Possible Problem
→ Strong demand can create:
→ Labour shortages
→ Wage increases
→ Higher production costs
→ Inflationary pressure
Recession or Slow Growth
→ Economic activity ↓
→ Consumer confidence ↓
→ Consumer spending ↓
→ Business revenue ↓
→ Investment ↓
→ Businesses may reduce production and employment.
→ Businesses selling luxury or non-essential goods may be particularly affected when consumers reduce discretionary spending.
Unemployment and Business
Low Unemployment
→ More people employed → household incomes ↑ → consumer demand ↑ → business sales may ↑.
→ However:
→ Labour shortages → wages ↑ → recruitment costs ↑ → business costs ↑.
High Unemployment
→ Household incomes ↓
→ Consumer spending ↓
→ Demand for goods and services ↓
→ Business revenue may ↓
→ Businesses may reduce production and employment.
→ However, businesses may find workers easier and cheaper to recruit.
Inflation and Business
High Inflation
→ Input prices ↑
→ Production costs ↑
→ Businesses may increase prices
→ Consumer purchasing power ↓
→ Demand may ↓
→ Profit margins may be squeezed.
→ Businesses may also face difficulty deciding whether to increase prices because higher prices could reduce demand.
Low and Stable Inflation
→ Costs are more predictable
→ Pricing decisions become easier
→ Long-term planning becomes easier
→ Investment uncertainty may ↓.
Economic Growth and Business
→ Economic growth ↑
→ Disposable income may ↑
→ Consumer spending ↑
→ Demand ↑
→ Business revenue ↑
→ Profits may ↑
→ Investment ↑
→ Employment ↑
→ Further economic activity may be generated.
→ However, rapid growth can increase inflationary pressure and resource shortages.
Government Policies to Achieve Macroeconomic Objectives
Monetary Policy
→ Monetary policy uses interest rates, money supply and credit conditions to influence economic activity.
Lower Interest Rates
→ Interest rates ↓
→ Borrowing becomes cheaper
→ Consumer spending ↑
→ Business investment ↑
→ AD ↑
→ Output and employment may ↑.
Higher Interest Rates
→ Interest rates ↑
→ Borrowing becomes more expensive
→ Saving becomes relatively more attractive
→ Consumer spending ↓
→ Business investment ↓
→ AD ↓
→ Inflationary pressure may ↓.
Impact on Business Decisions
Lower interest rates may encourage businesses to:
→ Borrow
→ Invest in machinery
→ Expand capacity
→ Open new branches
Higher interest rates may cause businesses to:
→ Delay investment
→ Reduce borrowing
→ Reconsider expansion
→ Focus on cash flow
Fiscal Policy
→ Fiscal policy uses government spending and taxation to influence economic activity.
Expansionary Fiscal Policy
→ Government spending ↑ and/or taxes ↓
→ AD ↑
→ Output ↑
→ Employment ↑
→ Business sales may ↑.
→ Particularly useful when economic activity is weak.
Impact on Businesses
→ Demand ↑ → sales ↑ → revenue ↑ → profits may ↑ → investment may ↑.
Contractionary Fiscal Policy
→ Government spending ↓ and/or taxes ↑
→ AD ↓
→ Inflationary pressure ↓
→ Business demand may ↓.
Impact on Businesses
→ Sales ↓
→ Revenue ↓
→ Investment may ↓
→ Businesses may reduce employment or postpone expansion.
Supply-Side Policy
→ Supply-side policies aim to increase productivity and productive capacity.
Examples:
→ Education and training
→ Infrastructure investment
→ Support for research and development
→ Tax incentives for investment
→ Labour-market reforms
→ Increased competition
→ Reduced unnecessary barriers to business
Impact
→ Productivity ↑
→ Unit costs may ↓
→ Competitiveness ↑
→ Productive capacity ↑
→ Long-run economic growth ↑.
Impact on Businesses
→ Businesses may gain:
→ Better-skilled workers
→ Lower unit costs
→ Better infrastructure
→ Greater productivity
→ Greater competitiveness
→ More opportunities for expansion.
Exchange Rate Policy
→ An exchange rate affects the price of exports and imports.
→ Governments or central banks may influence the exchange rate in countries where they have the ability to do so.
Depreciation
→ Currency value ↓
→ Exports become relatively cheaper for foreign buyers
→ Imports become relatively expensive
→ Export demand may ↑
→ Import demand may ↓
→ Net exports may ↑
→ AD may ↑.
Impact on Businesses
Exporting businesses:
→ International competitiveness may ↑ → exports may ↑ → revenue may ↑.
Import-dependent businesses:
→ Imported raw materials and components become more expensive → costs ↑.
Appreciation
→ Currency value ↑
→ Exports become relatively more expensive
→ Imports become relatively cheaper
→ Export demand may ↓
→ Import demand may ↑.
Impact on Businesses
Exporting businesses:
→ International competitiveness may ↓ → exports may ↓.
Import-dependent businesses:
→ Imported raw materials and components become cheaper → costs may ↓.
Impact of Policy Changes on Business Decisions
Investment Decisions
→ Interest rates ↓ → cost of borrowing ↓ → investment becomes more attractive.
→ Corporate taxes ↓ → after-tax returns ↑ → investment may increase.
→ Economic growth ↑ → expected demand ↑ → businesses may invest more.
Pricing Decisions
→ Inflation ↑ → input costs ↑ → businesses may raise prices.
→ Currency depreciation → imported inputs become more expensive → businesses may raise prices or accept lower margins.
→ Strong competition during slow economic growth may limit the ability to increase prices.
Employment Decisions
→ Economic growth ↑ → demand ↑ → businesses may recruit more workers.
→ Minimum wage ↑ → labour costs ↑ → businesses may consider automation or changes in staffing.
→ Recession → demand ↓ → businesses may reduce recruitment or employment.
Location Decisions
→ Government infrastructure investment can make a location more attractive.
→ Tax incentives may encourage businesses to locate in particular regions.
→ High business taxes or costly regulations may discourage investment in a location.
Expansion Decisions
→ Strong economic growth + high consumer confidence
→ Expected demand ↑
→ Businesses may expand capacity.
→ High interest rates + weak demand
→ Borrowing costs ↑ + expected sales ↓
→ Businesses may postpone expansion.
How Macroeconomic Changes Affect Different Businesses
| Change | Likely impact on businesses |
|---|---|
| Economic growth ↑ | Demand and sales may ↑ |
| Economic growth ↓ | Demand and sales may ↓ |
| Unemployment ↓ | Consumer incomes ↑, but labour costs may ↑ |
| Unemployment ↑ | Consumer demand may ↓, but labour may be easier to recruit |
| Inflation ↑ | Input costs ↑ and pricing becomes difficult |
| Inflation ↓ | Cost pressures may ↓ |
| Interest rates ↑ | Borrowing and investment may ↓ |
| Interest rates ↓ | Borrowing and investment may ↑ |
| Currency depreciates | Exports become more competitive; imports cost more |
| Currency appreciates | Imports become cheaper; exports become less competitive |
| Government spending ↑ | Demand may ↑ |
| Business taxes ↑ | After-tax profit ↓ |
| Supply-side investment ↑ | Productivity and productive capacity may ↑ |
Applying Economic Factors to Business Decisions
→ Economic factors rarely affect all businesses in the same way.
→ The impact depends on:
→ Type of business
→ Target market
→ Price elasticity of demand
→ Dependence on imports
→ Dependence on exports
→ Labour intensity
→ Amount of borrowing
→ Stage of the business cycle
→ Level of competition
Example: Exporting Manufacturer
→ Currency depreciates → exports become relatively cheaper → foreign demand may ↑ → sales ↑ → production ↑ → employment ↑.
Example: Import-Dependent Retailer
→ Currency depreciates → imported products become more expensive → costs ↑ → profit margins ↓ → retailer may increase prices or find alternative suppliers.
Example: Interest-Rate-Sensitive Business
→ Interest rates ↑ → borrowing costs ↑ → investment becomes more expensive → expansion may be postponed.
Example: Consumer-Focused Business During Economic Growth
→ Economic growth ↑ → incomes ↑ → consumer confidence ↑ → demand ↑ → sales ↑ → business may expand.
→ The key to analysing economic factors is to trace the chain from the government policy or macroeconomic change to costs, demand, revenue, profit and finally the business decision.