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Government Policies on Business

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Government Policies on Business

There are two most important tools that governments use to regulate and boost economic growth: monetary policy and fiscal policy. What are they and what is the difference between them? Which objectives do they help the government to achieve? More importantly, how do they impact businesses and consumers? In this explanation, you will learn all about government policies and objectives.

Objectives of government policies on business

Economic government objectives are goals that a government wishes to achieve in the economic context.

In the UK, the HM Treasury is the ministry for economy and finance. Its main job is to implement economic policies and ensure sustainable economic growth throughout the UK. Specifically, the HM Treasury takes care of the country's public spending, financial services, tax system, and the delivery of infrastructure projects.

Its three main objectives are:

  • Manage public finances efficiently

  • Ensure a stable macroeconomic environment

  • Increase employment and productivity.1

In most economies around the world, there are four key government objectives:

  • Maintaining full employment

  • Ensuring price stability

  • Achieving economic growth

  • Having a balance of payments.

Let's examine each of these objectives further:

Government Policy Objectives: Economic growth

The first and also most important objective is achieving economic growth.

Economic growth is the increase in the value of national output, measured by the annual percentage of change in real GDP.


Government Policies on Business, UK GDP Growth Chart, StudySmarterFigure 1. UK GDP Growth in %, Macrotrends

Figure 1 depicts the growth of GDP levels in the UK over a ten-year period from 2010 to 2020. Before 2019, the figure was positive (above 0% growth rate). After 2019, there is a sharp decrease in the UK's GDP, causing the growth rate to drop below the 0% level. In 2020, the growth rate of UK GPD hit an all-time low at -9.79%, compared to 1.37% growth rate in 2019.2

Economic growth is important as it ensures better living conditions for citizens within an economy. Sustainable economic growth also contributes to a lower unemployment rate and higher tax revenues for public spending.

The government can stimulate economic growth through demand-side and supply-side policies:

  • Demand-side policies include fiscal policies, such as reducing tax and increasing public spending, and monetary policies such as lowering interest rates.

  • Supply-side policies include non-interventionist and interventionist policies. Non-interventionist policies emphasise the role of the market in economic growth and include policies such as tax cuts, free-market agreements, privatisation, and deregulation. Interventionist policies, on the other hand, give the government more control over economic activities. Some examples include increased funding for training, education, and infrastructure.

Demand-side policies aim to increase aggregate demand (national expenditure) whereas supply-side policies try to improve aggregate supply (national output) and productivity.

To learn more about these topics, take a look at our explanation How governments can affect business activity.

Government Policy Objectives: Employment and unemployment

Another main goal of the government is to reduce unemployment and provide more jobs for people in the economy.

Unemployment is the percentage of people in the workforce without a job. This does not include people who are unable to work or not willing to work.

Unemployment can be caused by a reduction in output or employee misconduct. Unemployment can put a strain on the economy as it reduces the living standards of unemployed people and limits their spending. This also puts businesses in a financial struggle as they make fewer sales.

Government Policies on Business, Chart showing the UK unemployment rate in 2021, StudySmarterFigure 2. UK unemployment rate, 2021, Office for National Statistics

Covid-19 is a global pandemic that has adversely affected the UK economy. Starting in 2019, the pandemic has resulted in a large portion of UK workers being made redundant, contributing to unemployment issues within the country.

Figure 2 illustrates the recovery of UK unemployment levels from the end of 2021 to October 2021. As can be seen from the chart, there was a steady reduction in the percentage of unemployed people in the UK during the given period, from just above 5% to around 4.2%.3 This can be attributed to the loosening of lockdown restrictions.

Full employment is the situation in which all of those people available to work in an economy are able to find a job at a living wage rate.

In reality, full employment is very unlikely to happen due to frictional unemployment, in which job seekers delay working in search of the best employment. Frictional unemployment isn't all bad, as it means people are looking for jobs that suit their skills. However, the desirable frictional unemployment rate is around 2-3%.

There are two ways for the government to reduce unemployment:

  • Increase aggregate demand: the government can enact fiscal policy (lower tax and increase public spending) to encourage consumption while providing more jobs in public services such as road building or bridge construction.

  • Provide subsidies or cut taxes: the government can inject funds into certain business sectors to encourage companies to hire more people, thus reducing the unemployment rate. Another solution is to reduce taxes so that businesses will have the incentive to hire new staff.

Government Policy Objectives: Inflation and price stability

The government also works hard to achieve price stability by keeping inflation at a low level.

Inflation is the general increase in the price of goods and services within an economy. It is measured by the consumer price index (CPI).

Consumer Price Index (CPI) is the percentage of change in the prices of an average basket of goods between a given year and the base year.

Generally, inflation reduces consumer purchasing power due to increased price levels. This means consumers are willing to spend their money, thus dropping the level of consumption. Businesses will make fewer sales as a result, which reduces production and the need for workers.

With that being said, a low inflation rate can benefit an economy, since it makes exported products cheaper and more competitive. In addition, firms are more likely to borrow money for investment and growth when the inflation rate is low.

To keep inflation at a low level, the government can introduce a contractionary monetary policy. Here, the central bank will reduce interest rates, which causes the cost of borrowing money to increase. As a result, consumers will be discouraged from borrowing and spending on goods and services. With lower consumption, price levels will drop and so will inflation.

To learn more, check out our explanation The effects of inflation on business.

Government Policy Objectives: Balance of payments

The final objective of the government is to maintain a satisfactory balance of payment.

Balance of payment is the value difference between a given country's exports and imports.

A balance of payment deficit happens when the value of imports exceeds the value of exports. A balance of payment surplus, on the other hand, occurs when the value of exports exceeds the value of imports.

Balance of payment deficit, as well as surplus, can stimulate economic growth in the short run. However, in the long run, a balance of payment deficit can lead to a huge national debt, as the government borrows money from other countries to pay for exports. Meanwhile, a balance of payment surplus can make the economy heavily dependent on exports and more vulnerable to global crises.

To deal with a balance of payment deficit, the government can enact supply-side policies to improve the competitiveness of exports and domestic goods.

Impact of government policies on business

To achieve the above-mentioned objectives, the government needs to adopt some tools for regulating economic activity. These tools are known as government policies. Two types of government policies are fiscal policy and monetary policy.

Impact of Government Policies: Fiscal policy

Fiscal policy involves the use of public spending and taxes to influence aggregate demand and economic development.

It is made up of two opposite policies: expansionary fiscal policy and contractionary fiscal policy.

Expansionary fiscal policy uses tax cuts and/or increased public spending to raise aggregate demand, whereas contractionary fiscal policy uses tax increases and/or reduced public spending to lower the aggregate demand. The former is adopted during the economic recession to encourage more economic activities, whereas the latter is used to fight inflation.

Another use of fiscal policy is to maintain a balanced budget in government.

A balanced budget is a situation where planned revenues are equal to planned expenditures. Accordingly, a budget surplus happens when revenue exceeds expenses, and a budget deficit happens when revenue is lower than expenses.

A budget deficit can result in growing debt as the government has to borrow money from other countries to pay for its expenses. To reduce a budget deficit, the government can adopt a contractionary fiscal policy. That is to raise taxes (revenues) and reduce public spending (expenses).

Impact of Government Policies: Monetary policy

Monetary policy is the use of interest rates to influence macroeconomic factors.

Similar to fiscal policy, monetary policy is made up of expansionary and contractionary monetary policy.

Expansionary monetary policy works by lowering the interest rate and increasing the money supply in the market. This lowers the cost of borrowing money and encourages people and firms to borrow more and spend what they borrow. As a result, consumer spending and investment will increase, contributing to a more robust economy.

Contractionary monetary policy, on the other hand, works by increasing the interest rate and reducing the money supply. Here, the consumers and businesses are discouraged from spending and investing, which causes the economy to slow down. Interest rates in monetary policy are regulated by the central bank.

Impact of Government Policies: Supply-side policies

Supply-side policies aim to increase aggregate supply (national output) and the level of productivity within an economy.

As mentioned earlier, supply-side policies can be split into interventionist supply-side policies and non-interventionist supply-side policies.

Interventionist supply-side policies include government provisions for private sector firms, education, training and infrastructure projects. Here, the government plays a central role in increasing the aggregate supply.

Non-interventionist supply-side policies use tax cuts, free-market agreements, privatisation or deregulation to regulate the supply of goods and services within an economy. Here, the market plays a central role instead of the government.

Privatisation is the case where the government sells a public sector to the private sector to increase efficiency.

Regulation is the imposition of government influence in a certain industry to stimulate competition within that industry.

A free trade agreement is a pact between two or more countries to remove trade barriers on each other’s imported and exported goods. The EU Single Market is a prime example of the free trade movement.

To conclude, there are two main tools for the government to regulate an economy and achieve economic objectives: monetary policy and fiscal policy. Both of them can be further divided into expansionary and contractionary policies.

Government policies are mainly the use of taxes, public spending, and interest rates to influence the level of consumer spending and demand on the market, which help to stimulate business activities or fight inflation. There are also supply-side policies that use interventionist and non-interventionist techniques to influence aggregate supply (national output).

Advantages of government policies on business

Government policies can have many positive impacts on business, such as:

  • Grant subsidies for a certain business sector to promote its growth

  • Impose tax exemptions on some goods or products to incentivise their production.

  • Create a stable political system to attract foreign investors.

  • Lower taxes or interest rates at specific times to encourage investment and spending

  • Set minimum wages which influence business costs.

Government policy constraints on business

On the other hand, government policy can put a constraint on business development. For example, excessive taxation can create extra costs for the business which affects its ability to invest in new developments.

The government can also influence the interest rate. A rise in the interest rate can increase the cost of borrowing, discouraging businesses from raising funds for growth and expansion. Increased interest rates also lead to less consumer spending and thus lower revenue for the business.

In a short term, the government may print excessive money, causing inflation and a rise in the prices of goods. This spells trouble for both businesses and consumers.

Government Policies on Business - Key takeaways

  • Economic government objectives are goals that a government wishes to achieve in the economic context.
  • There are four main government objectives:
    • Maintaining full employment
    • Ensuring price stability
    • Achieving economic growth
    • Having a balance of payments.
  • Tools that help the government to achieve its objectives are called government policies, including fiscal policies and monetary policies.
  • Fiscal policy involves the use of public spending and taxes to influence aggregate demand and economic development.
  • Monetary policy is the use of interest rates to influence macroeconomic factors.

  • Supply-side policies aim to increase aggregate supply (national output) and the level of productivity within an economy.

  • Government policies can stimulate business growth by granting subsidies, imposing tax exemptions, creating a stable political environment, and setting a suitable minimum wage.

  • Excessive taxation, increased interest rates, and excessive money supply can place a constant on business development.


SOURCES

1. 'HM Treasury', GOV.UK, 2022, gov.uk.

2. 'UK GDP Growth Rate 1961-2022', Macrotrends, 2022, macrotrends.net.

3. 'UK Unemployment Rate', Office for National Statistics, 2021, ons.gov.uk.

Frequently Asked Questions about Government Policies on Business

Tools that help the government to achieve its objectives are called government policies, including fiscal policies and monetary policies. 

Some examples of government policies 

  1. To keep inflation at a low level, the government can introduce a contractionary monetary policy. 
  2. To deal with a balance of payment deficit, the government can enact supply-side policies to improve the competitiveness of exports and domestic goods.  
  3.  The government can enact fiscal policy (lower tax and increase public spending) to encourage consumption while providing more jobs in public services such as road building or bridge construction.  


Government policies can have either positive or negative impacts on businesses.

Positive impacts:

  • Government policies can stimulate business growth by granting subsidies, imposing tax exemptions, creating a stable political environment, and setting a suitable minimum wage. 

Negative impacts:

  • Excessive taxation, increased interest rates, and excessive money supply can place a constant on business development. 

There are four key government objectives:


  • Maintaining full employment

  • Ensuring price stability

  • Achieving economic growth

  • Having a balance of payments.

Excessive taxation, increased interest rates, and excessive money supply can place a constant on business development. 

Final Government Policies on Business Quiz

Question

What is a government?

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Answer

A government is a group of people with the authority to run a state or a country.

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Question

What are the three main roles of a government in an economy?

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Answer

Reduce unemployment rate

Maintain a low rate of inflation

Achieve economic growth

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Question

What are the benefits of low inflation?

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Answer

High real wages which encourage people to spend more

Show question

Question

What are two main ways for a government to influence business activities?

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Answer

  • Introducing fiscal and monetary policies

  • Changing subsidies, tariffs or tax rates. 

Show question

Question

What is monetary policy?

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Answer

Monetary policy is a series of actions adopted by a government’s central bank to regulate the money supply and ensure economic stability.

Show question

Question

What is the difference between expansionary and contractionary monetary policy?

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Answer

Expansionary monetary policy lowers interest rates to encourage more consumer spending and boost economic growth


Contractionary monetary policy increases interest rates to slow down the supply of money and reduce inflation. 

Show question

Question

What is fiscal policy?

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Answer

Fiscal policy is the use of government spending and taxation to influence a country’s economy.

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Question

What does it mean to achieve business growth through expansionary fiscal policy?

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Answer

Increasing the aggregate demand and boosting the economy by reducing taxes. 

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Question

What does a contractionary fiscal policy mean?

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Answer

Increasing taxes to limit the supply of money and reduce inflation. 

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Question

What are subsidies? 

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Answer

Subsidies are the government funding to a business or an industry to promote a social good or make it more profitable. 

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Question

What is a tariff and its benefit̀?

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Answer

A tariff is a tax on imported goods. It aims to increase the competitiveness of domestic goods in the local market. 

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How do lower taxes affect business?

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Answer

Lower tax encourages consumers to spend more on goods and services, resulting in higher demand and business output. 

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Question

What are the five main types of taxes?

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Answer

  • Income tax

  • Value-added tax (VAT)

  • Corporation tax

  • National Insurance

  • Business rates 

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Question

What are sources for government spending?

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Answer

Direct taxes

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Question

How does a government spend its money?

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Answer

  • Transfer payment - welfare payments made through a social security system to support low-income individuals. 

  • Current spending - spending on state-provided goods and services such as salaries for people working in the public sector, education, defence. 

  • Capital spending - spending on public infrastructure such as roads, schools, hospitals, etc. 

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Question

What is the impact of increasing government spending on business?

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Answer

Lower investment

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What kind of business benefit from higher government spending?

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Answer

Businesses that provide services for the public sector. 

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Question

Name four economic objectives of a government!

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Answer

  • Maintaining full employment
  • Ensuring price stability
  • Achieving economic growth
  • Having a balance of payments

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Question

What is the measure for economic growth?

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Answer

The annual percentage of change in real GDP. (growth rate of GDP in %)

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Question

Which government policies are used to stimulate economic growth?

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Answer

  • Demand-side policies include fiscal policies such as reducing tax and increasing public spending and monetary policy such as lowering interest rates. 
  • Supply-side policies include non-interventionist and interventionist policies. 

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Question

What are interventionist and non-interventionist policies?

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Answer

  • Non-interventionist policies emphasise the role of the market in economic growth, including policies such as tax cuts, free-market agreements, privatisation, and deregulation. 

  • Interventionist policies give the government more control over economic activities. Some examples include increased funding for training, education, and infrastructure. 


Show question

Question

What is unemployment?

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Answer

Unemployment is the percentage of people in the workforce without a job. This does not include people who are unable to work or not willing to work. 

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What can be the cause of unemployment?

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Answer

A reduction in output

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What are the consequences of unemployment?

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Answer

Reduced living standard

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Is full employment realistic?

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Answer

In reality, full employment is very unlikely to happen due to frictional unemployment - the situation where people delay working in search of the best employment. 

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Question

What can the government do to reduce unemployment? 

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Answer

  • Increase aggregate demand through fiscal policy
  • Provide subsidies and cut taxes in labour-intensive industries

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Question

What is inflation?

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Answer

Inflation is the general increase in the price of goods and services within an economy.


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Why is high inflation bad for an economy?

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High inflation significant reduces consumer purchasing which lowers their consumption and business revenues. With lower revenues, businesses are less likely to make investments for growth and expansion. This can result in a declining economy. 

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Question

What policy helps the government to keep inflation low?

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Answer

a contractionary monetary policy - By reducing interest rates, the cost of borrowing money drops, causing people to borrow less money to spend on goods and services. As a result, price levels will drop, so will inflation. 

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What is the balance of payment?

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Balance of payment is the difference between exports and imports of a country. 

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What policy helps the government to reduce the balance of payment deficits?

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Supply-side policies - to improve the competitiveness of exports and domestic goods. 

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What is fiscal policy?

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Answer

Fiscal policy involves the use of public spending and taxes to influence aggregate demand and economic development. 

Show question

Question

Name two types of fiscal policy!

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Answer

  • Expansionary fiscal policy uses tax cuts and increased public spending to raise aggregate demand. 
  • Contractionary fiscal policy uses tax raises and reduced public spending to lower the aggregate demand. 

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Question

Define a balanced budget. 

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Answer

A balanced budget is a situation where the planned revenues are the same or exceed the planned expenditure. 

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Question

What kind of fiscal policy can help reduce budget deficit?

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Answer

To reduce budget deficits, the government can adopt a contractionary fiscal policy. That is to raise taxes (revenues) and reduce public spending (expenses). 

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What is used in monetary policy to influence the economy?

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Answer

Interest rates 

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What agency sets the interest rates in the monetary policy?

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The government

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What is the purpose of using supply-side policies?

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Answer

Supply-side policies aim to increase aggregate supply (national output) and the level of productivity within an economy. 

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Which supply-side policies give the government more control over economic activities?

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Answer

Interventionist supply-side policies such as policies to provide provision for private sector firms, education, training, and infrastructure. 

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Question

What is the definition of privatisation?

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Answer

Privatisation is the case where the government sells a public sector to the private sector to increase efficiency. 

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How do you define regulation?

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Answer

Regulation is the reduction of government influence in a certain industry to stimulate competition within that industry. 

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Question

Name an example of free trade agreement!

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Answer

EU free-trade agreement that allows the free flow of goods and services among EU countries. 

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What are business external factors?

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Business external factors are factors from outside that can affect a business's performance. 

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Question

What does PESTEC stand for?

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Answer

PESTEC stands for political, economic, social, technological, environmental, and competitive influence on business. 

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What is political influence on business?

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Answer

Political influence on business refers to new legislation being launched in a country that affects consumers, employees, and businesses' rights. 

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Question

Give some examples of business legislation!

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Answer

  • Anti-discrimination 
  • Intellectual property
  • Minimum wage
  • Health and safety 
  • Competiton 
  • Consumer protection

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Question

Name three type of business law!

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Answer

  • Consumer law
  • Employee law
  • Intellectual property law

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Question

What are some factors that can affect the economy?

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Answer

Tax rates

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Question

What is aggregate demand and how does it affect the economy?

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Answer

Aggregate demand is the total demand for goods and services within an economy (including consumer and government spending, investing, and exports minus imports). 


Higher aggregate demand indicates a more robust economy. However, too much demand for goods and services can result in higher prices for consumers or inflation.

Show question

Question

What is social influence on business?

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Answer

Social influence on business refers to changes in consumer tastes, behaviour or attitude that might affect business sales and revenues. 

Show question

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