Effects of Government Policy

Introduction to government policy

Introduction to government policy

• Most governments pursue similar objectives for their national economies

1. Positive economic growth

• Positive economic growth is the increase in the value of goods and services produced per head of population over a period of time

• The standard of living of the population is likely to increase with GDP growth

  • As output is rising, more workers are needed, and high levels of employment are achieved

  • Households can afford to buy more goods and services as most people become richer

  • Business owners expand their business as people have more money to spend on their products and revenue rises

2. Low levels of inflation

• Inflation refers to a general increase in prices and fall in the purchasing value of money over time

  • Both the UK and US governments set their Central Bank an inflation target of 2%

  • Central Banks have a range of tools they can use to achieve this target, such as base rates and quantitative easing

3. Low levels of unemployment

• Unemployment refers to the number of people without a job who are actively seeking and available for work

  • Low unemployment increases national output, improves workers’ living standards and reduces government spending on welfare benefits

4. A healthy balance of payments

• The balance of payments is the relationship between the value of imports and exports over a period of time

• Exports bring foreign currency in to an economy, whilst imports lead to currency flowing out of it

  • If a balance of payments deficit occurs

    • The country could run out of foreign currency and it may have to resort to expensive borrowing from abroad

    • The exchange rate (the price of one country’s currency against another) is likely to fall

Effects of changes in taxes

Effects of changes in taxes

• Government decisions on taxation, spending, and interest rates have a major impact on businesses. These policies affect both costs and customer demand, and businesses must adapt their strategies to survive and grow

Effect on business profits

• Higher business taxes (e.g. corporation tax):

  • Reduces the share of profit a business keeps

    • There is less money available for reinvestment, expansion, or dividends

  • Why? Because more of the profit is paid to the government

• Lower business taxes:

  • Increases retained profit

    • Businesses can invest more or reward shareholders

  • Why? Because the business gives less of its earnings to the government

Effect on people’s income

• Higher income tax:

  • Consumers keep less of their wages

    • There is less disposable income, and demand for goods and services falls

  • Why? Because more of people’s pay goes straight to the government

• Lower income tax:

  • Consumers keep more of their wages

    • There is more disposable income, and spending rises, especially on non-essential goods

  • Why? Because less is deducted from their earnings, leaving more to spend

Effects of changes in government spending

Effects of changes in government spending

• Increased government spending:

  • Creates new demand for goods and services, for example, contracts for construction firms

    • It also improves infrastructure like roads, education, and healthcare, which helps businesses operate more efficiently

  • Why? Because the government is injecting money into the economy, creating jobs and income that flow to businesses

• Reduced government spending (austerity):

  • Leads to fewer contracts for firms and lower consumer spending

    • Public services may weaken, which can harm the workforce or raise costs for firms

  • Why? Because less government money is being spent, which slows down the economy

Business responses to changes in government spending

Effects of changes in interest rates

Effects of changes in interest rates

• The interest rate is the cost of borrowing money and the reward for saving

Higher interest rates

• Businesses face higher costs on loans, so they are less likely to borrow for growth

• Consumers also pay more on credit cards or mortgages, so they have less disposable income and reduce spending

• Why? Because interest is the price of borrowing money, and when it rises, both businesses and households borrow less

Implications of rising interest rates

Lower interest rates

• Borrowing becomes cheaper, so businesses are more likely to invest and expand

• Consumers also borrow and spend more, which increases demand

• Why? Because lower interest makes loans and credit more affordable, encouraging spending

Business responses to changes in taxes and interest rates

Business responses to changes in taxes and interest rates

• Businesses need to respond appropriately to changes in government policy

  • Long- and short-term consequences of decisions needs to be balanced

  • The responses of different stakeholder groups should be carefully considered

  • Individual business circumstances may mean that even the closest of competitors respond in different ways

Typical business responses