Unit (65)

What external factors affect a business?1. Business decision will be influenced by many

factors within the business it self:2. Marketing – are consumers likely to buy this

new product? 3. Finance – are there enough funds within the

firm to produce the product? 4. Production – Does the firm have the

necessary technology to produce it? 5. Lab our – Do the workers have the right

skills?

Business and the economy

There are factors outside the business that could affect any business:

1- Legislation. There might be laws that affect the product. 2. Technology. The rate of change of technology may influence the type of good produced. 3. Political factors, A firm may delay a decision, until after a general election, because it is concerned a bout the effects of a new governments' policies. 4. Social factors, an increase in the amount of crime directed against businesses will affect firms differently. 5. Population. The size, age and the six distribution of the population can affect demand for a product. 6. The state of competition, A new competitor entering a market could lead to a reduction in the sales of existing firms. 7. Environmental factors. Increased consumer awareness has led many firms to re-evaluate their impact upon the environment. 8. Economic factors and economic system.

How a simple economy operates?- A useful tool for analyzing, how an economy works is the circular flow of income. - The circular flow shows how money flows around the economy. - Businesses buy land, lab our and capital from households. - Households receive rent, wages, interest and profiting return. - The money they earn is spent on goods and services produced by businesses. - So money or income flows from businesses to households and back again – a circular flow of income around the economy.

- The money earns by households, their income (y), is spent on goods and services (E), which are produced by businesses – their out put (O). - In the national accounts of economies, these are all defined, so that they are equal. Y= E = O

A more complex economy. - In practice, household will spend some money

(known as consumption) and save some as well. - Savings takes money out of the circular flow ( a

with drawl). - Businesses are not likely to spend all their revenue

on rent and wages. - They will also invest some in machinery and

equipment (an injection). Injections into the economy include: - Investments, spending on fixed capital, circulating

capital and work –in –progress. - Government spending (G) spending by government

on new schools. - Exports (X) goods and services sold abroad.

Withdrawals can be: 1. Savings (S) money saved by

households. 2. Taxation (T) money taken out of the

economy from businesses and households by government through taxation.

3. Imports (m) goods and services coming into the country and paid for by money leaving the circular flow to be paid to overseas producers.

How can we measure, how much money is flowing around the circular flow? The value of a country's economic activity is

shown as its gross national product. GNP can be measured by: 1. Income method, adding up all the income earned

by households (rent, wages, interest and profit). 2. Output method, adding up the value of all goods

and services produced by businesses. 3. Expenditure method, adding up the spending of

consumers © the investment of business (I) the expenditure of government (G) and the spending of people overseas on exports minus the spending of a country on imports from abroad (x-m). y = c + I + G + x – m . Whichever method is used, it will give the same. Gross domestic product (GDP), is GNP less net

earnings from property overseas.

Equilibrium: - If injections in any year are the

same as withdrawals the money flowing around the circular flow would remain the same. This is known equilibrium.

- If injections and withdrawals are not the same, the money flowing around the circular flow will change.

- If injections = withdrawals – income remains the same.

- If injections > withdrawals – income will rise, because more money is entering the economy than is leaving it.

- If injections < withdrawals – income will fall because more money is leaving the economy + han is entering it.

- Say an economy is in equilibrium, with 600 billion $ flowing around it, but 800 billion was needed for full employment.

- This gap of 200 billion $ known as deflationary gap.

- This means that there was unemployment in the economy.

- Keynesians argue that the government should fill any gap that exist by spending more + han it receives in taxes. This known as a budget deficit.

- Other economists suggest that the economy will be in equilibrium at full employment only if markets are allowed to operate freely.

Government objectives: - Governments have some common

economic objectives. 1- Control of inflation: - Governments usually set target rates at

which they want to keep inflation. - In practice the targets which governments

set themselves often depend upon the inflation rate from previous years.

- governments aim to achieve and inflation rate at or below the level of those of their com petites.

2- Full employment: - full employment occurs when all who want a

job have one at a given wage rate. - The level of unemployment in an economy can

be seen as an indicator of its success. - A falling rate may show an economy doing

well. 3- Economic growth: - It refers to the rise in economic activity or

gross national product. - Most governments Judge the performance of

an economy by the figure for growth. - A growing economy means that trading

conditions are favorable and there are new opportunities.

- There is another view that growth harms the environment.

4- The balance of payments and exchange rates: - Governments usually attempts to achieve

equilibrium or a surplus on the current account of the balance of payments.

- This means that the value of exports going out of a country is either the same as or greater than the value of imports coming into a country.

- At worst governments would aim to prevent a long term deficit.

- Deficit occurs when the value of imports exceeds the value of exports.

- The problem with a deficit is that, it must be financed either by borrowing form abroad or by running down savings.

- If the deficit persists then the country's debts will increase.

Government policy: - Governments have a range of policies, which they

can use to achieve their objectives. 1- Monetary policy: - It is designed to control the amount of money

flowing around the economy. The money supply. - It is mainly used to tackle inflation and balance of

payments problems. Tools of monetary policy: 1- Interest rate: - Raising interest rates may reduce the amount of

borrowing in the economy. - It makes borrowing more expensive. - The amount of money flowing around the system

will be reduced. - Interest rates can also affect the value of the pound

(see page No. 97).

2- The government can control the a mount of credit:

- It may set limits on the amount and type of lending banks can make.

3- The central bank can control the assets of banks and the amount of lending they can make by a variety of means.

Fiscal tools: - It aims to manage the level of total spending

in the economy. 1- Changes in government spending: - If the economy needs a boost, government

expenditure can be raised. - If the economy needs to be slowed down,

government expenditure can be lowered.

2- Changes in direct taxation: - Direct taxes are those which are levied

directly on individuals or businesses. - Income tax rates can be lowered in order to

encourage consumers to buy more goods and services.

- This should raise the level of aggregate demand.

3- changes in indirect taxation: - Indirect taxes are those which are levied on

goods or services (vat). - Governments raise indirect taxes as a part

of fiscal policy in order to raise the price of goods and services and discourage spending.

- Indirect taxes can be also used by governments as a means of raising revenue in order to finance spending plans.

- There is much debate as to wheat her it is individual businesses or consumers who have to pay for indirect taxes.

- If a government spends more than it receives from taxation and other sources, then it is said to have a budget deficit.

- This means that it has to borrow money from a variety of sources.

- Public sector borrowing requirement (PSBR)/ This is the amount of money borrowed the government over a period of time. (see page No. 98).

Supply side policies: - These policies allow the supply side of

the economy producers to operate more effectively.

- They aim to increase the amount of competition in markets.

- Examples of supply side policies would be:

1. Reducing income or corporation tax. 2. Cutting state benefits to encourage the

unemployed to return to work. 3. Privatizing nationalized industries to

open them up to competition from other businesses.

4. Supporting firms that provide training in order to create a more efficient and productive workforce.

5. Control of trade unions that may prevent wages from being flexible.

6. Removal of restrictions to employment, such as a maximum number of working hours in a week.

7. Reduction of the amount of red tape. 8. Reducing the national insurance

contributions of employees in order to reduce the cost of taking on new employees.

Exchange rate policy: - The exchange rate is the price of one

currency in relation to another. - Changes in exchange rates can affect

the economy and business within it. - Firms that export goods should gain

increased sales and possibly hire more workers, and at the same time the prices of imported goods will be higher.

- The overall effect will be uncertain. - The exchange rate not only affects

exports and imports it can also affect inflation.

Regional and urban policy: Regional policy aims to provide aid

to businesses in different parts of the economy. - It has been used to support

regions that have suffered from a decline in important industries.

- It may takes many forms, such as government spending on grants and loans.

- Urban policy has been designed to stimulate business mainly in inner – city areas.

- It has involved the reaction of enterprise zones throughout the country.

- Firms are encouraged to locate through incentives.

- It also encourages private sector investment.

Industrial policy: - It aims to support specific

industries and firms. - Incomes policy, It is designed to

control inflation, by imposing limits upon pay or price increases.

Policy disagreements: It was stated that economists have

different approaches to solving economic problems.

1-The operation of markets: - This approach favors the free

operation of markets. - Supporters of this believe that the

role of government should be limited to providing the - Wright environment for businesses to flourish.

- It suggests that market will achieve equilibrium.

- In a depressed area there are more workers wanting jobs than are available.

- This would put pressure on wages to fall.

As a result some workers don’t offer their - lab our to employers at this wage rate.

- This would occur until the lab our market returned to equilibrium.

- To the point where the demand for lab our was equal to the supply of lab our at a given wage.

Interventionists, argue that the operation of market economy results in a variety of problems, such as:

1. high levels of unemployment. 2. Inadequate merit goods (housing,

health, and education). 3. Lack of provision of some public

goods (defence). 4. Inequalities in income. Wages and unemployment: - Market supporters suggest that if

real wage are free to move up and down, the economy would always achieve full employment.

- Interventionists believe that in the 1930s depression, wage rates fell, this id because :

1. Lab our may be reluctant to move from one area to another.

2. Trade unions protect the real wage rates of their members.

3. Businesses may not reduce wages because of the dissatisfaction it may lead to.

4. Instead they argue that unemployment is caused by a lack of aggregate demand in the economy. (deflationary gap).

Inflation providing markets operate freely:

- The economy will achieve full employment according to market economists.

- An increase in output would only be possible if the technology changed.

- Monetarists, they argue that increases in the money supply over and above increases in output lead to inflation.

- Interventions, argue that inflation is caused by an excess of consumer demand in the economy as a shale or a rise in costs.

Government policy: - Market economists argue that

obstacles to the operation of markets should be removed by government.

- These occur on the supply side of the economy.

- Incentives to businesses to retrain workers may solve the lack of skills.

- The aim of supply side policies is to increase the level of output in the economy as a whole (Aggregate supply).

- Interventionists argue that government should attempt to solve problems of the market by suing government policies as follow.

1. Fiscal and regional policy to increase employment and growth.

2. Protection against foreign competition.

3. The use of prices and incomes policy to prevent wage costs rising.

4. Government ownership in particular sectors of the economy.