2: ECONOMIC ENVIRONMENT FOR BUSINESS

1 Introduction
1.1 This is not an exam that will test economic theories. You only need to be aware of what a
government's general economic objectives are, and how this can impact on a business.

1.2 Government objectives for the economy are referred to as macroeconomic objectives or
targets. The three main targets are usually:
(a) Economic growth and high employment
(b) Low inflation
(c) Balance of payments stability

2 Key policies for achieving macroeconomic targets

Policy type Definition
Fiscal policy How much the Government decides to spend, and to raise as tax
revenue.
Monetary policy Control over the money supply and of interest rates.
Exchange rate policy Governments sometimes try to fix the exchange rate (fixed rate policy)
and sometimes they allow it to change in response to market forces (a
floating rate policy). If the value of the domestic currency is reduced it
makes imports more expensive and exports cheaper.

3 Target 1: Achieving economic growth/high

employment
Expansionary policies can be adopted in order to increase demand (spending) in the economy in
order to stimulate economic activity and create the need for new jobs.

Lecture example 1 Idea generation

Required
Identify the impact on a business of the policy changes outlined in the table below.

Policy Impact on a business's planning and decision making

Fiscal policy
 Boosting spending
 Cutting taxes
Monetary policy
 Increasing money supply
 Lower interest rates
Exchange rate policy
 Lower exchange rates

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4 Target 2: Achieving low inflation

Contractionary policies are usually required here. In order to keep inflation within acceptable
limits the policymakers must attempt to withdraw money from the economy.

Lecture example 2 Idea generation

Required
Identify the impact on a business of the policy changes outlined in the table below.

Policy Impact on a business's planning and decision making

Fiscal policy
 Cutting spending
 Raising taxes
Monetary policy
 Higher interest rates
Exchange rate policy
 Higher exchange rates

5 Target 3: Achieving balance of payments stability

5.1 It is very difficult for a country to spend more on imports than it earns from exports for a
sustained period of time. Where imports exceed exports this is often called a balance of
payments deficit, and governments will often take action to correct this situation using a
combination of expenditure switching and expenditure reduction policies.
Section 4–5

Lecture example 3 Idea generation

Required
Identify the impact on a business of the policy changes outlined in the table below.

Policy Impact on a business's planning and decision making

Fiscal policy
 Cutting spending
 Raising taxes
Monetary policy
 Higher interest rates
Exchange rate policy
 Lower exchange rates

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6 Other policies
6.1 Other policies include:
(a) Competition policy – eg preventing takeovers that are against the public interest,
because they create situations of monopoly (where a single firm is dominant) or
oligopoly (where a few powerful firms dominate the market) which can result in
consumers being exploited.
(b) Government assistance for business – grants may be available to attract firms to
invest in depressed areas.
(c) Green policies – the failure of the free market to recognise positive and negative
externalities (social costs and benefits) may lead to government action; this may
either threaten a business (eg tax on petrol) or create opportunities (eg subsidies for
loft insulation).
(d) Supply side policies – policies to improve efficiency and motivation eg privatisation.

Lecture example 4 Exam Standard Section A 2 marks

The following statements have been made in connection with macroeconomic policy.
(1) A contractionary fiscal policy involves in part the reduction of government spending.
(2) Businesses with variable rate debt are likely to see their interest expense increase in the
event of an expansionary monetary policy.
Required
Which of these statements is/are true?
A (1) only
B (2) only
C Both (1) and (2)
D Neither (1) nor (2)

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7 Chapter summary
Section Topic Summary
1 Introduction The three main economic objectives are: economic
growth and high employment, low inflation and
balance of payments stability.
2 Policies To achieve these objectives, governments use fiscal
policy, monetary policy, and exchange rate policy.
3 Achieving high This often requires stimulating the economy by
economic cutting taxes or interest rates.
growth
4 Achieving low This often requires the opposite ie raising taxes
inflation and interest rates.
5 Achieving This is often achieved by devaluing the exchange
balance of rate.
payments
stability
6 Other policies Competition
Government assistance for business
Green policies
Supply side policies

END OF CHAPTER
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