6.

1 Economic issues
Objectives

A01 Understand the meaning of Business Cycle

A02 Be able to assess the impact on businesses of changes
in employment levels, inflation and Gross Domestic
Product
A03 Be able to evaluate how businesses will respond to
changes in government policy
Key terms

Business cycle
Growth
Boom
Recession
Slump
Gross domestic product (GDP)
Price stability
Unemployment
What is meant by the business/trade
cycle?
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.
What are the 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 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.
What are the effects of a 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
Achieve price stability

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.
What are the 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.
Reduce 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.
What are the 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.
Reduce income equality/achieve
effective income redistribution

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 and
become more developed.
What will be the effects of income
inequality?

unequal distribution of goods and services - the poor

cannot buy as many goods as the rich - poor living
standards will arise.
What are the government economic
policies?

Government can influence the economic conditions in a

country by taking a variety of policies.
Fiscal policies

Fiscal policy is a government policy which adjusts

government spending and taxation to influence the
economy. It is the budgetary policy, because it manages
the government expenditure and revenue. Government
aims for a balance budget and tries to achieve it using
fiscal policy.
What fiscal policies can a government
use?

Increasing government spending and reducing taxes

will encourage more production and increase
employment, driving up GDP growth. This is because
government spending creates employment and increases
economic activity in the economy and lower taxes means
people have more money to consume and firms have to
pay lesser tax on their profits. On the other hand, reducing
government spending and increasing taxes will discourage
production and consumption, and unemployment and GDP
will fall.
Monetary policies

Monetary policy is a government policy that adjusts the

interest rate and foreign exchange rates to influence the
demand and supply of money in the economy, and thus
demand and supply. It is usually conducted by the
country’s central bank and usually used to maintain price
stability, low unemployment and economic growth.
What monetary policy can a government
use?

Increasing interest rates will discourage

investments and consumption, causing employment
and GDP to fall (as the cost of borrowing-interest on
loans – has increased, and people prefer to earn more
interest by saving rather than spend). Similarly, reducing
interest rates will boost investment, consumption,
employment, and thus GDP.
Supply-side policies

both the fiscal and monetary policies directly affect

demand, but the policies that influence supply are very
different
What supply-side policies can a
government use?
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.
Government policies and business
decisions