Effects of Government Policy (Cambridge (CIE) IGCSE Business): Revision Note

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

• 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

• 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

• 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

• 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