CHAPTER 3-ECONOMIC ENVIRONMENT.ppt

CHAPTER 3-ECONOMIC ENVIRONMENT.ppt

• 1.
  ECONOMIC ENVIRONMENT ECONOMIC SYSTEMS THECONCEPT OF RESOURCE SCARCITY From a societal point of view the existence of economic scarcity poses three serious problems concerning the use of resources: 1 What to use the available resources for? That is, what goods and services should be produced (or not produced) with the resources (sometimes described as the ‘guns v. butter’ argument)? 2 How best to use those resources? For example, in what combinations, using what techniques and what methods? 3 How best to distribute the goods and services produced with them? That is, who gets what, how much and on what basis?
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  ECONOMIC SYSTEMS The centrallyplanned economy In this type of economic system – associated with the post-Second World War socialist economies of eastern Europe, China, Cuba and elsewhere – most of the key decisions on production are taken by a central planning authority, normally the state and its agencies. Under this arrangement, the state typically: • owns and/or controls the main economic resources; • establishes priorities in the use of those resources; • sets output targets for businesses which are largely under state ownership and/or control; • directs resources in an effort to achieve these predetermined targets; and • seeks to co-ordinate production in such a way as to ensure consistency between output and input demands. The main features of this economic system include: • The state decides on what goods and services should be produced in an economy. • The government makes decisions on how the goods will be produced. • The state controls the prices of goods services
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  ECONOMIC SYSTEMS • Advantagesof a planned economy • There is usually a fairer distribution of goods and services, since it is done by the state. • Only desirable and harmless products will be produced in an economy. • Prices of goods and services are usually fair and affordable to the masses. • There is high production of social goods and services, e.g. school, hospitals etc • There is no competition between companies in which resources are wasted. • Effective long term strategies can be formulated taking into account the needs of the whole society. • Disadvantages of the planned economy • There are limitations on personal freedom and control over resource allocation. • Due to the absence of competition, the quality of goods and services is poor. • There are inefficiencies in production and distribution of goods and services due to bureaucratic tendencies of the government. • Companies are not free to produce goods and services they want and consumers are not free to buy goods according to their choices
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  ECONOMIC SYSTEMS • Freemarket economy • This is an economic system which has the following characteristics: • Individuals and private firms control the economy by deciding goods and services that should be produced and how the goods will be produced. • There are no price controls and therefore individuals can charge any price they feel / want. • There is private ownership of property. • The prices of goods and services are determined by the market forces of demand and supply which are ruling on the market. • The allocation of goods and services is done by the market forces of demand and supply. • Advantages of free market economic system • High production of goods and services due to the availability of incentives such as profits. • There is production and consumption freedom, that is producers are free to produce what they want and consumers buy what they prefer. • Efficiency in allocation of resources because such allocations are done by the market forces of demand and supply. • Due the availability of competition, the quality of goods and services is high.
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  ECONOMIC SYSTEMS Disadvantages ofthe free market system i. Some vital services cannot be provided by the private enterprise. ii. Some undesirable and harmful products can be produced. iii. There is inequitable distribution of goods and services (uneven distribution). iv. Only rich people can afford to buy the best products on the market because they might be very expensive. v. There is low production of social services, such as roads, schools etc because the private sector will aim at maximising their profits. vi. In a free market many resources can be wasted due to high failure rate of new businesses because a lot of money can be spent on setting up the new business.
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  ECONOMIC SYSTEMS The mixedeconomy • The disadvantages of the free market system listed above indicate the need of government intervention in the workings of the economy. As such, a mixed economy is blended by the state and the private enterprise. • In the private sector, individuals decide on what goods and services should be produced, how they should be produced and the allocation of goods and services is done by the forces of demand and supply. • In the public sector, the government controls on what goods and services should be produced and how the goods and services should be allocated. • Examples of mixed economies are USA, United Kingdom, Malawi, and Japan. • Advantages of mixed economy • There is high production of goods and services because there are incentives such as profits, in the private sector than in a planned economy. • Prices are usually affordable to the masses because they are set up by the government than in a free market economy where prices are determined by the market forces of demand and supply. • Production reflects the wishes of consumers as goods and services being produced are the ones being demanded on the market as compared to a planned economy where the state decides on what should be produced. • The system is flexible in the way that it responds to different conditions of demand and supply as compared to a command /planned economy. • Resources can be allocated more equitably because the government will attempt to produce and distribute products in areas where there inefficiencies than in a free market economy.
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  ECONOMIC FACTORS 1. Inflationis usually defined as an upward and persistent movement in the general level of prices over a given period of time; it can also be characterised as a fall in the value of money. For governments of all political complexions reducing such movements to a minimum is seen as a primary economic objective 2.Reducing unemployment • In most democratic states the goal of ‘full employment’ is no longer part of the political agenda; instead government pronouncements on employment tend to focus on job creation and maintenance and on developing the skills appropriate to future demands. The consensus seems to be that in technologically advanced market-based economies some unemployment is inevitable and that the basic aim should be to reduce unemployment to a level which is both politically and socially acceptable.
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  ECONOMIC FACTORS A stableexchange rate • On the whole, governments and businesses involved in international trade tend to prefer exchange rates to remain relatively stable, because of the greater degree of certainty this brings to the trading environment; it also tends to make overseas investors more confident that their funds are likely to hold their value. To this extent, schemes which seek to fix exchange rates within predetermined levels (e.g. the ERM), or which encourage the use of a common currency (e.g. the ‘euro’), tend to have the support of the business community, which prefers predictability to uncertainty where trading conditions are concerned.
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  ECONOMIC FACTORS 3. Fiscalpolicy  Involves the use of changes in government spending and taxation to influence the level and composition of aggregate demand in the economy and, given the amounts involved, this clearly has important implications for business.  Reductions in taxation and/or increases in government spending will inject additional income into the economy and will, via the multiplier effect, increase the demand for goods and services, with favourable consequences for business.  Reductions in government spending and/or increases in taxation will have the opposite effect, depressing business prospects and probably discouraging investment and causing a rise in unemployment.
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  ECONOMIC FACTORS To Businesses: Apart from their overall impact on aggregate demand, fiscal changes can be used to achieve specific objectives, some of which will be of direct or indirect benefit to the business community. Reductions in taxes on company profits and/or increases in tax allowances for investment in capital equipment can be used to encourage business to increase investment spending, hence boosting the income of firms producing industrial products and causing some additional spending on consumption.  Similarly, increased government spending targeted at firms involved in exporting, or at the creation of new business, will encourage increased business activity and additionally may lead to more output and employment in the economy.
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  ECONOMIC FACTORS 4. MonetaryPolicy • Monetary policy seeks to influence monetary variables such as the money supply or rates of interest in order to regulate the economy. While the supply of money and interest rates (i.e. the cost of borrowing) are interrelated, it is convenient to consider them separately. • Interest rates As far as changes in interest rates are concerned, these clearly have implications for business activity, as circular flow analysis demonstrates. Lower interest rates not only encourage firms to invest as the cost of borrowing falls, but also encourage consumption as disposable incomes rise (predominantly through the mortgage effect) and as the cost of loans and overdrafts decreases. Such increased consumption tends to be an added spur to investment, particularly if inflation rates (and, therefore ‘real’ interest rates) are low and this can help to boost the economy in the short term, as well as improving the supply side in the longer term.
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  ECONOMIC FACTORS  Raisinginterest rates tends to have the opposite effect – causing a fall in consumption as mortgages and other prices rise, and deferring investment because of the additional cost of borrowing and the decline in business confidence as consumer spending falls. If interest rates remain persistently high, the encouragement given to savers and the discouragement given to borrowers and spenders may help to generate a recession, characterised by falling output, income, spending and employment and by increasing business failure.  Changes in the money stock (especially credit) affect the capacity of individuals and firms to borrow and, therefore, to spend. Increases in money supply are generally related to increases in spending and this tends to be good for business prospects, particularly if interest rates are falling as the money supply rises.  Restrictions on monetary growth normally work in the opposite direction, especially if such restrictions help to generate increases in interest rates which feed through to both consumption and investment, both of which will tend to decline.