Factors Determining Economic Activity

Factors Determining Economic Activity & Economic Systems

Factors Influencing Economic Growth

• Key Idea: A country's ability to grow its economy is influenced by various characteristics and resources.
• Demand-Side Factors:
  • Examples: Consumer spending, investment, government expenditure.
  • Impact: Affect the demand for goods and services.
• Supply-Side Factors:
  • Examples: Productive capacity, natural resources, skilled workforce.
  • Impact: Affect the ability to produce goods and services.
• General Idea: Both demand and supply-side factors determine a country's economic potential.

Economic Systems: How Resources are Allocated

Economic systems are the methods countries use to solve the fundamental economic problem of what, how much, how, and for whom to produce.

1. State-Controlled (Planned/Command) Economies

• Definition: The government decides what to produce, how to produce it, and how it is distributed.
• Key Feature: Central planning replaces market forces.
• Example: The Soviet Union (historical).
• Perceived Advantages:
  • Lower levels of inequality and unemployment.
  • Common good prioritised over profit.
• Disadvantages:
  • Potential for large inequalities.
  • Excessive bureaucracy and lack of flexibility.
  • Reduced individual choice.
  • Tendency for inefficiency

2. Market Economies

• Definition: Supply and demand determine resource allocation.
• Key Feature: Businesses produce goods and services to meet consumer demand.
• How it Works:
  • Market-Clearing Price: Price at which supply and demand are balanced.
  • Oversupply: Prices fall, some producers leave.
  • Undersupply: Prices rise, new producers enter.
  • Markets exist for goods, services, capital, labor (wages), and money (interest rates).
• Competition:
  • Businesses compete for customers.
  • Individuals compete for jobs.
  • Scarce resources command high prices.
  • Unsuccessful businesses may fail and those with limited skills may need to seek alternative career paths.

3. Mixed Economies

• Definition: Combination of market economy with some state control.
• Key Feature: Governments provide welfare and essential services.
• Government Role:
  • Provides a safety net for vulnerable people.
  • Funds areas like defence, education, healthcare, transport, and police.
• Government Funding:
  • Direct taxes (from wages and companies).
  • Indirect taxes (sales tax, fuel, alcohol, etc.).
  • Borrowing in capital markets.

4. Open Economies

• Definition: Few barriers to trade or controls over foreign exchange.
• Key Feature: Encourages free trade with other countries.
• Trade Tensions:
  • Disputes arise when countries believe others have unfair trade policies.
  • Retaliatory actions may include sanctions and tariffs.
  • Protectionism: When a country prevents free trade to protect its domestic market.
• Role of WTO:
  • World Trade Organization promotes free trade between economies.
  • Arbitrates trade disputes.
• Trade Agreements:
  • Many regional and bilateral trade agreements go beyond WTO commitments to increase trade and boost economic growth.

In Summary

A country's economic success is determined by a combination of factors influencing production and demand. The economic system adopted dictates how resources are used and can range from state-controlled to market-driven. Most economies operate as a mix of both, and international trade plays an important role. Open economies promote free trade, with bodies like the WTO resolving disputes and promoting economic growth.

Implications of Fiscal & Monetary Policy for Business

Fiscal Policy Implications for Business

Planning

• Key Idea: Fiscal policy impacts aggregate demand, which businesses must consider for planning.
• How it Affects Planning:
  • Businesses need to adjust output, employment, and investment plans based on government spending and taxation decisions.
  • Stable government policy makes planning easier.
• Uncertainty: Changes in fiscal policy can create uncertainty for businesses, making long-term planning challenging.

Cost

• Key Idea: Fiscal policy directly impacts business costs.
• Taxation Effects:
  • Direct Taxes: Employer national insurance contributions increase labor costs.
  • Indirect Taxes: VAT increases can either be:
    • Absorbed by the firm, reducing profit margins.
    • Passed on to consumers, potentially reducing sales.
• Impact: Fiscal policy changes affect the final cost of products and services.

Monetary Policy Implications for Business

Monetary Policy Overview

• Definition: Regulation of the economy through control of the monetary system.
• Tools:
  • Money supply.
  • Interest rates.
  • Credit availability conditions.
• General Goal: To manage the level of spending and inflation.

The Money Supply

• Key Idea: Money supply influences spending, output, and prices.
• Government Tools:
  • Credit Squeeze: Restricting credit lending to control spending and reduce inflation.
  • Reserve Requirements: Imposing minimum cash reserves on banks.

Interest Rates

• Key Idea: Interest rates are the "price" of money and borrowing costs.
• Expected Impact of Higher Interest Rates:
  • Discourage spending and borrowing.
  • Encourage saving.
  • Increase mortgage payments, reducing disposable income.
  • Deter corporate investment due to higher borrowing costs.
  • Lower business confidence due to reduced expected returns.
• Counter Effects of Higher Interest Rates:
  • Increase savings income, potentially increasing consumer spending.
  • Increase demand for higher wages to offset mortgage payment increases.
  • Attract capital inflows, leading to currency appreciation (making imports cheaper).
  • Lead to lower demand, causing higher unemployment and lower tax revenue for the government
  • Result in less investment which leads to poorer prospects for future growth.

In Summary

• Fiscal Policy: Impacts business planning through changes in demand and costs. Businesses must stay informed on changes to government spending and tax rates to plan effectively.
• Monetary Policy: Influences the economy through money supply and interest rates, affecting borrowing costs, investment, and overall economic activity.
• Complexities: The effects of both fiscal and monetary policy are not always straightforward and can have both intended and unintended consequences. Businesses need to consider a range of factors in order to make sensible plans.