6.

1 – Government Economic Policies

and Objectives
This topic is detailed in our Economics section. Please do
refer to it for a better understanding.
Economic Objectives
Here, we’ll look at the different economic objectives a government might have
and how their absence/negligence will affect the economy as well as
businesses.

 Maintain low inflation: inflation is the increase in average

prices of goods and services over time. (Note that, inflation, in the
real world, always exists. It is natural for prices to increase as the
years go by. In the case there is a fall in the price level, it is called
a deflation) Maintaining a low inflation will help the economy to
develop and grow better.
Effects of high inflation:
 As cost of living will have risen and peoples’ real
incomes (the value of income) will have fallen (when prices
increase and incomes haven’t, the income will buy lesser goods
and services- the purchasing power will fall).
 Prices of domestic goods will rise as opposed to foreign
goods in the market. The country’s exports will become less
competitive in the international market. Domestic workers may
lose their jobs if their products and firms don’t do well.
 When prices rise, demand will fall and all costs will rise
(as wages, material costs, overheads will all rise)- causing
profits to fall. Thus, they will be unwilling to expand and
produce more in the future.
 The living standards (quality of life) in the country may
fall when costs of living rise.
 Low unemployment: unemployment exists when people who
are willing and able to work cannot find a job. A low
unemployment means high output, incomes, living standards etc.
Effects of high unemployment:
 Unemployed people do not produce anything and so, the
total output/GDP in the country will fall. This will in turn, lead to
a fall in economic growth.
  Unemployed people receive no incomes, thus income
inequality can rise in the economy and living standards will fall.
It also means that businesses will face low demand due to low
incomes.
 The government pays out unemployment benefits to the
unemployed and this will rise during high unemployment and
government will not enough money left over to spend on other
services like education and health.
 Economic growth: economic growth occurs when a country’s
Gross Domestic Product (GDP) increase i.e. more goods and
services are produced than in the previous year. This will increase
the country’s incomes and achieve greater living standards.
Effects of reducing GDP (recession):
 As output falls, fewer workers will be needed by firms, so
unemployment will rise
 As goods and services that can be consumed by the
people falls, the standard of living in the economy will also fall
 Balance of Payments: this records the difference between a
country’s exports (goods and services sold from the country to
another) and imports (goods and services bought in by the
country from another country). The exports and imports needs to
equal each other, thus balanced.
Effect of a disequilibrium in the balance of payments:
 If the imports of a country exceed its exports, it will
cause depreciation in the exchange rate– the value of the
country’s currency will fall against other foreign currencies (this
will be explained in detail here).
 If the exports exceed the imports it indicates that the
country is selling more goods than it is consuming- the country
itself doesn’t benefit from any high output consumption.
 Income equality: the difference/gap between the incomes of
rich and poor people should narrow down for income equality to
improve. Improved income equality will ensure better living
standards and help the economy to grow faster become more
developed.
Effects of poor income equality:
 Inequal distribution of goods and services- the poor
cannot buy as many goods as the rich- poor living standards
will arise.
The Business/ Trade Cycle
An economy will not always go through an economic growth; there is usually a
cycle, as shown below.

Growth– 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– 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– 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– 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.

Government Economic Policies

Government can influence the economic conditions in a country by taking a
variety of policies.
 FISCAL POLICY
Using taxes and government spending to influence the demand conditions in
the economy.
 GOVERNMENT SPENDING
Governments can change their spending on education, health,
defence, law and order, transport and communications
infrastructure etc. to influence demand. Higher spending on these
services can boost demand in the economy as jobs and GDP
increase. Reducing government spending will reduce demand.
 TAXES
 Direct Taxes are paid directly from incomes. There are
different types of direct taxes.
 Income tax: paid from an individual’s income.
Disposable income is the income left after deducting income
tax from it. When income tax rise, there is little disposable
income to spend on goods and services, firms will face lower
demand and sales and will cut production, increasing
unemployment. Lower income taxes will encourage more
spending and thus higher production.
 Corporation Tax: tax paid on a company’s profits.
When the corporation tax rate is increased, businesses will
have lower profits left over to put back into the business and
will thus find it hard to expand and produce more. It will also
cause shareholders/owners to receive lower
dividends/returns for their investments. This will discourage
people from investing in businesses and economic growth
could slow down. Reducing corporation tax will encourage
more production and investment.
 Indirect Taxes are added to the prices of goods and
services and it is paid while purchasing the good or service.
Some examples are:
 GST/VAT: these are included in the price of goods
and services. Increasing these indirect taxes will increase
the prices of goods and services and reduce demand and in
turn profits. Reducing these taxes will increase demand.
 Import tariffs and quotas: an import tariff is a tax
on imported goods and services; an import quota is the
physical limit to the quantity of a product that can be
imported into a country. Increasing tariffs will reduce
demand for foreign products and imposing quotas will mean
 there are lesser foreign goods in the market to be sold and
so demand is reduced.

MONETARY POLICY
Using interest rates (as well as money supply and the exchange rate) to
influence the demand conditions in the economy.
The interest rate is the cost of borrowing money. When a person
borrows money from a bank, he has to pay an interest (monthly or annually)
calculated on the amount he borrowed. Interest can also be earned by
depositing money in the bank.
A higher interest rate will thus discourage borrowing (as more interest will
have to be paid to the bank) and encourage saving (people will get more
interest from saving) – thus, investing and spending will fall respectively-
demand in the economy will fall. A lower interest rate will increase demand.
From a business’ point of view, a higher interest rate means more interest has
to be paid on existing loans, reducing profits; as well as suffer low demand
levels. They may have to delay expansion plans that involve borrowing from
the bank. A lower interest rate will be more favourable to a
business.

SUPPLY-SIDE POLICIES
Both the fiscal and monetary policies directly affect demand, but the policies
that influence supply are very different. It can include:
 Privatisation: selling government organizations to private
individuals- this will increase efficiency and productivity that
increase supply as well encourage competitors to enter and
further increase supply.
 Improve training and education: governments can spend
more on schools, colleges and training centres so that people in
the economy can become better skilled and knowledgeable,
helping increasing productivity.
 Increased competition: by acting against monopolies (firms
that restrict competitors to enter that industry/having full
dominance in the market- refer xxx for more details) and reducing
government rules and regulations (often termed ‘deregulation’),
the competitive environment can be improved and thus become
more productive.

*EXAM TIP: Remember that economic conditions and policies are all
interconnected; one change will lead to an effect which will lead to another
effect and so on, like a chain reaction in many different ways. In your exams,
you should take care to explain those effects that are relevant and appropriate
to the business or economy in the question*
How might businesses react to policy changes? It will depend varying on how
much impact the policy change will have on the particular
business/industry/economy. Here are a few examples:

6.2 – Environmental and Ethical Issues

Business’ Impact on the Environment
Social responsibility is when a business decision benefits stakeholders
other than shareholders i.e. workers, community, suppliers, banks etc.
This is very important when coming to environmental issues. Businesses can
pollute the air by releasing smoke and poisonous gases, pollute water bodies around it by
releasing waste and chemicals into them, damage the natural beauty of a place and so on.
WHY BUSINESSES WANT TO BE WHY BUSINESSES DO NOT WANT
ENVIRONMENT- FRIENDLY TO BE ENVIRONMENT-FRIENDLY
It is expensive to reduce and
Sense of social responsibility that recycle waste for the business. It
comes from the fact that their means that expensive machinery
activities are contributing to global and skilled labour will be required
warming and pollution by the business – reducing profits.
Using up scarce non-renewable Firms will have to increase prices
resources (such as rainforest wood to compensate for the expensive
and coal) will raise their prices in environment-friendly methods
the future, so businesses won’t use used in production- higher prices
them now mean lower demand.
Consumers are becoming socially- High prices can make firms less
aware and are willing to buy only competitive in the market and they
environment friendly products. could lose sales
Governments, environmental
organisations, even the community
could take action against the Businesses claim that it is the
business if they do serious damage government’s duty to clean up
to the environment pollution

Externalities
A business’ decisions and actions can have significant effects on its
stakeholders. These effects are termed ‘externalities’. Externalities can be
categorized into six groups given below and we’ll take examples from a
scenario where a business builds a new production factory.

Private Costs: costs paid for by the business for an activity.

Examples: costs of building the factory , hiring extra employees, purchasing
new machinery, running a production unit etc.
Private Benefits: gains for the business resulting from an activity.
Example: the extra money made from the sale of the produced goods etc.
External Costs: costs paid for by the rest of the society (other than the
business) as a result of the business’ activity.
Examples: machinery noise, air pollution that leads to health problems among
near residents, loss of land (it could have been a farm land before) etc.
External Benefits: gains enjoyed by the rest of the society as a result of a
business activity.
Example: new jobs created for residents, government will get more tax from
the business, other firms may move into the area to support the firm-helping
develop the region, new roads might be built that can be enjoyed by residents
etc.
Social Costs = Private Costs + External Costs
Social Benefits = Private Benefits + External Benefits
Governments use the cost-benefit-analysis (CBA) to decide whether to
proceed with a scheme or not and businesses have also adopted it. In CBA,
the government weighs up all the social costs and benefits that will arise if the
scheme is put into effect and give them all monetary values (this is not easy-
what is the value of losing natural beauty?). They will only allow the scheme to
proceed if the social benefits exceed the social costs, if the costs exceed the
benefits, it is not allowed to proceed.
Sustainable Development
Sustainable development is development that does not put at risk
the living standards of future generations. It means trying to
achieve economic growth in a way that does not harm future generations. Few
examples of a sustainable development are:
 using renewable energy- so that resources are conserved for
the future
 recycle waste
 use fewer resources
 develop new environment-friendly products and processes-
reduce health and climatic problems for future generations
Environmental Pressures
Pressure groups are organisations/groups of people who change
business (and government) decisions. If a business is seen to
behave in a socially irresponsible way, they can conduct consumer boycotts
(encourage consumers to stop buying their products) and take other actions.
They are often very powerful because they have public support and media
coverage and are well-financed and equipped by the public. If a pressure
group is powerful it can result in a bad reputation for the business that can
 affect it in future endeavors, so the business will give in to the pressure
groups’ demands. Example: Greenpeace
The government can also pass laws that can restrict business
decisions such as not permitting factories to locate in places of natural beauty.
There can also be penalties set in place that will penalize firms that
excessively pollute. Pollution permits are licenses to pollute up to a
certain limit. These are very expensive to acquire, so firms will try to avoid
buying the pollution permit and will have to reduce pollution levels to do so.
Firms that pollute less can sell their pollution permits to more polluting firms to
earn money. Taxes can also be levied on polluting goods and services.
Ethical Decisions
Ethical decisions are based on a moral code. It means ‘doing the right
thing’. Businesses could be faced with decisions regarding, for example,
employment of children, taking or offering bribes, associate with
people/organisations with a bad reputation etc. In these cases, even if they
are legal, they need to take a decision that they feel is right.
Taking ethical/’right’ decisions can make the business’ products popular
among customers, encourage the government to favour them in any future
disputes/demands and avoid pressure group threats. However, these can end
up being expensive as the business will lose out on using cheaper unethical
opportunities.

6.3 – Business and the

International Ecoonmy
Globalization
Globalization is a term used to describe the increases in worldwide
trade and movement of people and capital between
countries. The same goods and services are sold across the globe;
workers are finding it easier to find work by going abroad for work; money is
sent from and to countries everywhere.
Some reasons how globalization has occurred are:
 Increasing number of free trade agreements– these are
agreements between countries that allows them to import and
export goods and services with no tariffs or quotas.
 Improved and cheaper transport (water, land, air) and
communications (internet) infrastructure
 Developing and emerging countries such as China and
India are becoming rapidly industrialized and so can export large
volumes of goods and services. This has caused an increase in the
output and opportunities in international trade, allowing for
globalisation
Advantages of globalisation

 Allows businesses to start selling in new foreign

markets, increasing sales and profits
 Can open factories and production units in other countries,
possibly at a cheaper rate (cheaper materials and labour can
be available in other countries)
 Import products from other countries and sell it to customers in
the domestic market- this could be more profitable and producing
and selling the good themselves
 Import materials and components for production from foreign
countries at a cheaper rate.
Disadvantages of globalisation

 Increasing imports into country from foreign competitors- now

that foreign firms can compete in other countries, it puts up much
competition for domestic firms. If these domestic firms cannot
compete with the foreign goods’ cheap prices and high
quality, they may be forced to close down operations.
 Increasing investment by multinationals in home country- this
could further add to competition in the domestic market (although
small local firms can become suppliers to the large multinational
firms)
 Employees may leave domestic firms if they don’t pay
as well as the foreign multinationals in the country-
businesses will have to increase pay and conditions to recruit and
retain employees.
When looking at an economy’s point of view, globalisation brings
consumers more choice and lower prices and forces domestic
firms to be more efficient (in order to remain competitive). However,
competition from foreign producers can force domestic firms to close down
and jobs will be lost.
 Protectionism
Protectionism refers to when governments protect domestic firms
from foreign competition using trade barriers such as tariffs and
quotas; i.e. the opposite of free trade.
Import quota is a restriction on the quantity of goods that can be imported
into the country.
Tariffs are taxes on imports.
Imposing these two measures will reduce the number of foreign
goods in the domestic market and make them expensive to
buy, respectively. This will reduce the competitiveness of the foreign goods
and make it easy for domestic firms to produce and sell their goods. However,
it reduces free trade and globalisation.
Free trade supporters say that it is better to allow consumers to buy imported
goods and domestic firms should produce and export goods and services that
they have a competitive advantage in. In this way, living standards across the
globe will improve.

Multinationals
Multinational businesses are firms with operations
(production/service) in more than one country. Also known as
transnational businesses. Examples: Shell, McDonald’s, Nissan etc.
Why do firms become multinationals?

 To produce goods with lower costs– cheaper material and

labour may be available in other countries
 To extract raw materials for production, available in a few
other countries. For example: crude oil in the Middle East
 To produce goods nearer to the markets to avoid transport
costs.
 To avoid trade barriers on imports. If they produce the
goods in foreign countries, the firms will not have to pay import
tariffs or be faced with a quota restriction
 To expand into different markets and spread their risks
 To remain competitive with rival firms which may also be
expanding abroad
Advantages to a country of a multinational setting up in their country:
 More jobs created by multinationals
 Increases GDP of the country
 The technology that the multinational brings in can bring in
new ideas and methods into the country
 As more goods are being produced in the country, the
imports will be reduced and some output can even be
exported
 Multinationals will also pay taxes, thereby increasing the
government’s tax revenue
 More product choice for consumers
Disadvantages to a country of a multinational setting up in their country:

 The jobs created are often for unskilled tasks. The more
skilled jobs will be done by workers that come from the firm’s
home country. The unskilled workers may also be exploited with
very low wages and unhygienic working conditions.
 Since multinationals benefit from economies of scale, local
firms may be forced out of business, unable to survive the
competition
 Multinationals can use up the scarce, non-renewable
resources in the country
 Repatriation of profit can occur. The profits earned by the
multinational could be sent back to their home country and the
government will not be able to levy tax on it.
 As multinationals are large, they can influence the
government and economy. They could threaten the
government that they will close down and make workers
unemployed if they are not given financial grants and so on.

Exchange Rates
The exchange rate is the price of one currency in terms of another
currency.
For example, €1=$1.2. To buy one euro, you’ll need 1.2 dollars. The
demand and supply of the currencies determine their
exchange rate. In the above example, if the €’s demand was greater than
the $’s, or if the supply of € reduced more than the $, then the €’s price in
terms of $ will increase. It could now be €1= $1.5. Each € now buys more $.
A currency appreciates when its value rises. The example above
is an appreciation of the Euro. A European exporting firm will find an
appreciation disadvantageous as their American consumers will now have to
pay more $ to buy a €1 good (exports become expensive). Their
competitiveness has reduced. A European importing firm will find an
appreciation of benefit. They can buy American products for lesser Euros
(imports become cheaper).
A currency depreciates when its value falls. In the example
above, the Dollar depreciated. An American exporting firm will find a
depreciation advantageous as their European consumers will now have to pay
less € to buy a $1 good (exports become cheaper). Their
competitiveness has increased. An American importing firm will find an
depreciation disadvantageous. They will have to buy European products for
more dollars (imports become expensive).
In summary, an appreciations is good for importers, bad for
exporters; a depreciation is good for exporters, bad for
importers; given that the goods are price elastic (if the price didn’t matter
much to consumers, sales and revenue would not be affected by price- so no
worries for producers).