1.6 Government objectives and policies

1.6.1 Government spending

To provide public service

The main purpose of government expenditure is to provide essential resources to the public in order to benefit society.

These include:

  • Healthcare

  • Education

  • Security and Defense

  • Social welfare

  • Infrastructure

Taxation

Governments use taxation in order to fund spending such as on public services and infrastructure.

Types of Taxation:

  • Direct Taxes - Tax that is paid directly by the taxpayer to the government.

  • Indirect Taxes - Tax that is levied on a good or service rather than on an individual or company.

Constraints on public spending

Constraints on public spending are factors which prevent the government from increasing expenditure. This includes:

  • Limited tax revenue

  • National debt and deficit

  • Risk of inflation

  • Economic conditions

  • Politics

  • Environmental concerns

1.6.2 How governments can affect business activity

Infrastructure Provision

  • Improved transportation may reduce business costs

  • Improved communication systems may boost productivity as businesses, employees and suppliers can easily communicate.

  • Reliable energy will reduce the risk of production errors and allows businesses to operate more efficiently.

Legislation

  • Employment laws ensure employees receive fair wages and experience good working conditions.

  • Health and safety laws protect both employees and consumers, however, complying with these necessary measures may be costly for some businesses.

  • Environmental regulations may prevent businesses from operating in certain ways in order to reduce pollution or introduce sustainable practices.

  • Consumer protection laws ensure that businesses are honest with consumers, this builds trust and helps avoid legal issues.

Trade Policy

A trade policy is a government policy that affects the number of goods and services a country exports and imports. This includes tariffs, quotas, and membership in trade blocs.

Trading Blocs

Membership in trading blocs allows countries to trade with other member nations with fewer restrictions.

  • Trading blocs provide access to larger markets as businesses can trade more easily between other member countries.

  • Businesses can benefit from economies of scale by expanding in new markets.

  • Although trade blocs open markets, businesses will face more competition.

Tarrifs

Tariffs are taxes imposed on imported goods. Governments can use this revenue to protect domestic firms from foreign competition.

  • Tarrifs increase the cost of imports, therefore costs will increase for businesses.

  • Competitiveness may decrease as goods may cost more for exporters from countries with high tariffs.

1.6.3 The effect of interest rates on Businesses and Consumer spending

Definition: The interest rate represents the cost of borrowing money or the amount a saver receives in interest (the reward for saving).

Effect on businesses

When interest rates rise:

  • Increased cost of borrowing - Businesses must pay higher interest on loans, credit, and overdrafts.

  • Less investment - Businesses are less likely to invest in capital projects as the cost of financing is higher, and the potential returns are reduced.

  • Changes in profitability - Paying debt may become more expensive, therefore businesses may need to reduce costs or raise prices in order to remian profitable.

  • Reduced demand - Due to higher prices, consumer demand and therefore spending may decrease.

When interest rates fall:

  • Decreased cost of borrowing - Business may take out loans in order to innovate and expand.

  • More investment - Businesses can invest more and take growth opportunities as the cost of borrowing is lower.

  • Improved cash flow - Debt will be less expensive to pay off for businesses, therefore businesses may allocate resources more efficiently

  • Increased demand - Consumer spending and sales may increase due to an increased demand for goods and services.

Effect on consumer spending

When interest rates rise:

  • Increased cost of borrowing - Interest when borrowing money will rise, therefore there will be a decline in consumer loans, mortgages, and credit card spending.

  • Reduced disposable income - Conusumer spending will deacrease.

  • Reduced demand in the housing market - Mortgage rates will increase which makes buying homes more expensive.

  • Decreased consumer confidence - As borrowing is more expensive and disposable income is reduced, consumers may delay or reduce spending on non-essential items.

When interest rates fall:

  • Decreased cost of borrowing - Consumers will be inclined to take out loans and pay off debt due to the decreased cost of borrowing

  • Increased spending - Consumption will increase as consumers may choose to spend money instead of save.

  • Decreased saving - Consumers may choose not to save as the reward for saving is decreased.

  • Increased demand in the housing market - Purchasing homes may be more appealing due to lower mortgage rates.

  • Increased consumer confidence - Consumer confidence will increase as borrowing is cheaper and consumers may feel better about making large purchases and spending more.