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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.
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