Business Finance Lessons Overview

Government Objectives

We can identify five main government objectives when discussing the economy. The economy refers to the activity of all businesses within a country and can be manipulated by the government. Indeed, the government's aims are:

1. Economic growth
2. Low and stable inflation
3. Low and stable unemployment
4. Balance of Payments stability
5. Income equality

These will now be explained individually

1. Economic Growth

Economic growth is an increase in the value of goods and services produced in a country over time. The value of goods and services is the total price of all goods/services multiplied by the total amount produced, in a time period. This is also known as Gross Domestic Product. Therefore, when our GDP increases, we get economic growth.

Reasons why economic growth is desirable

1. It indicates more jobs are available (so employment increases)
2. If there are more jobs then more people have an income, so spending rises, creating even more jobs
3. The government receives more tax revenue and spends less on benefits
4. It indicates a wider variety of goods and services available in the economy

2. Low and Stable Inflation

Inflation is the continuous increase in price levels in an economy in a certain time period. Governments like to have a target of 2-3% inflation in a year.

Reasons why low and stable inflation is desirable

1. If prices are rising too quickly, businesses may stop investing as they are worried about profits
2. If prices are rising quickly, profits may be harmed as supplies become more expensive
3. It is easy to predict future earnings and investments when inflation is low and steady
4. High inflation puts off investors, leaving companies with less money

3. Balance of Payments stability

The Balance of Payments are a record of all flows of money made from international trade for a country. It is broken down into three sections (the current account, the capital account and the financial account). The current account records the value of all exports - the value of all imports. If the value of exports is greater than the value of imports then there is a trade surplus but if the value of imports exceeds the value of exports then there is a trade deficit

Reasons why a stable Balance of Payments is desirable

1. If we run a trade deficit then money will be leaving the country, leading to less production and less jobs, so less economic growth
2. Trade deficits eventually have to be paid back, one way or the other.
3. A continuous trade surplus leaves companies reliant on other countries purchasing their products
4. A continuous trade surplus means most goods and services leave the country, leaving poor domestic choice

4. Income Equality

Income equality refers to the gap in earnings between the richest and poorest members of society. It can be measured in terms of income earned or as a percentage. It is usually achieved through a fair taxation system.

Reasons why a income equality is desirable

1. An unfair tax system leads to a large black market, which means less government revenue
2. High income inequality may mean a lot of unemployment and even immigration
3. High income inequality means that a large section of society are not spending money, leading to less jobs than the potential in a country
4. Poor tax systems mean the government is not getting the most it can in revenue

The Business Cycle

This attempts to show fluctuations in real GDP over time. Economists generally predict rising GDP over time (this is known as a trend , but sometimes we achieve above or below our estimated figures.

When GDP is increasing, we enter into a boom . During this period, jobs are increasing, people are spending money and money is entering the economy. This does not last forever though. The highest point during a recovery or boom is a peak .

After this, for various reasons, unemployment starts to rise and people begin to spend less money. As a result incomes fall and we enter a recession . A long recession may also be knnown as a slump . The bottom of a recession is known as a trough .

The distance between two peaks or two troughs is known as an economic cycle , hence the title trade cycle diagram .

Government tools

The government may use two types of tools to achieve its aims. These are known as Demand-side policies and Supply-side policies . Demand-side policies attempt to get or stop people spending in an economy, whilst supply side policies aim to encourage or reduce production. We can look at these further, below.

Demand-side Policies

These can be broken down into two types:

1. Fiscal Policies - This is the use of government spending or taxation.
2. Monetary Policies - This is changing interest rates. The interest rate is the price of saving or borrowing money. If you take $100 out of the bank you will have to pay back a percentage more than the $100 - this is the interest on borrowing. Similarly, banks offer interest on saving by promising to add a % to the money you put into a bank. The Central Bank sets the minimum interest rate

How fiscal policy affects business activity

How interest rates affects business activity

Supply-side Policies

These can be broken down into two types:

1. Interventionist - This is when the government gets actively involved in an economy to increase production
2. Market Policies - This is when the government retreats from the economy to let it naturally adjust

How taxes affects business activity

Taxes can either be direct (on income, profits or wealth) or indirect (on spending, like VAT, customs duties and excise duties).