Macroeconomic Objectives and their impact on Business Activity

Economics

1. Start with an introduction that briefly describes the key macroeconomic objectives of a country such as the UK and the business you have chosen to illustrate their impact. (LO1)

The Key Macroeconomic Objectives of the UK are:

Sustained Growth

This is growth that does not negatively affect the poor, workers and the environment. It is economic growth that is just and fair and improves the likelihood of such growth in the future.

Low Inflation

This means that the continuous rise in the general price level, i.e. in the prices of all goods and services, drops to such a low level that it no longer influences the decisions of consumers and producers.

High Level of Employment

A situation in which all available labour resources are being used in the most economically efficient way. Full employment embodies the highest amount of skilled and unskilled labour that could be employed within an economy at any given time.

The business I have chosen to illustrate the impact of UK macroeconomic objectives is ASDA.

ASDA Stores Ltd is a British chain which retails food, clothing, toys and general merchandise. It also has a mobile telephone network, . I feel that ASDA is more than appropriate enough for me to illustrate the impact of key macroeconomics objectives of the UK as it provides a variety of different services and doesn’t just focus on one area such as selling food.

2. Explain the different causes of price rises and analyse their impact on your chosen business. (LO 1)

Cost Push Inflation

This type of inflation is caused by costs rising for firms – which are in turn passed on to consumers in the form of higher prices. Very importantly, this type of inflation can occur irrespective of the state of the economy. ie AD might be fairly weak, and there could even be relatively high unemployment, cost –push inflation is still possible. A good example of this would be due to oil prices rising.

Costs can rise for several reasons:

1. Higher wage costs. This is where wages rise by more than any productivity gains inflating unit costs of production. Strong trade unions in the past have been blamed for forcing up wages that have not be warranted by productivity gains – in turn triggering cost – push inflationary pressure.

2. Imported good prices could rise. A trigger for this is often the exchange rate. If sterling depreciates it causes the price of imported goods to rise, and this in turn can lead to higher imported good prices feeding in to UK retail prices. This is especially likely due to the UK’s deindustrialization, making the UK very heavily reliant on many imported goods ( in effect making the UK fairly price inelastic ).

3. Taxation increases can be cost – push in nature if they are levied on firms or on goods. Increasing excise duties on petrol for instance is likely to result in prices rising, contributing to higher inflation.

Demand pull inflation

This type of inflation is caused by excess aggregate demand, exceeding aggregate supply. Too much demand is chasing too few goods. This can occur when the growth in aggregate demand is so strong, that aggregate supply cannot respond quickly enough resulting in prices getting bidded up. Surges in aggregate demand can lead to greater inflationary pressures, supply simply cannot respond quickly enough.

Pricing Power Inflation

This type of inflation occurs when the business houses and industries decide to increase the price of their respective goods and services to increase their profit margins. A point noteworthy is pricing power inflation does not occur at the time of and economic depression, or when there is a downturn in the economy.

Sectoral Inflation

This is the fourth major type of inflation. The sectoral inflation takes place when there is an increase in the price of the goods and services produced by a certain sector of industries. For instance, an increase in the cost of crude oil would directly affect all the other sectors, which are directly related to the oil industry. The ever increasing price of fuel has become an important issue related to the economy all over the world especially in the UK right now, diesel is now on average over £1.30 a litre! An example I could use is that of the aviation industry. When the price of oil increases, the ticket fares would also go up. This would lead to a widespread inflation throughout the economy, even though it had originated in one basic sector. If this situation occurs when there is a in the economy, there would be layoffs and it would adversely affect the work force and the economy in turn.

Impact On My Chosen Business, ASDA

If inflation was to rise then ASDA would earn more money as prices would increase however, people would have less money to spend unless their wages increased inline with inflation. ASDA would also have to pay their suppliers more and spend more on fuel costs, this means even though they can earn more they are also losing money because of the add on effects of inflation.

ASDA might also experience its staff demanding a higher wage to try and maintain their standard of living. Higher wages over and above any gains in labour productivity causes an increase in unit labour costs. Also, the actual time and cost of negotiating this, and making the necessary administrative changes can be quite high and whilst managers are negotiating, they aren’t doing anything else.

Cost-push inflation usually leads to a slower growth of company profits which can then feed through into business investment decisions.

I think another relevant point to add that will affect ASDA is that if the UK has higher inflation than competitor countries then UK prices gradually rise above imported prices. More imports are bought, so demand leaks out of the country and leaves UK businesses such as ASDA in a weak position. This could be devastating for ASDA. The same effect occurs with UK export businesses. The eventual effect may be a fall in the pound which puts prices back where they were, but leaves UK consumers worse off because they can buy fewer imports than before.

Yet another impact of inflation that would affect ASDA is that consumers could find it more attractive to save more and spend less. They will find it more expensive to borrow money for spending. Most consumers also have mortgages. The repayments become more expensive so their disposable income falls and they spend less. Overall, spending in the economy falls. Consumers will spend less in ASDA which is a big impact on the company!

To briefly conclude this question, inflation affects ASDA in much the same way as changes in tax would. So if the changes ...

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To briefly conclude this question, inflation affects ASDA in much the same way as changes in tax would. So if the changes in interest rates went down so may the prices. The lower the rate of inflation, the better it is for businesses, as it means that people can spend more and the prices of the products will be affordable. If the rate of inflation was high, people will be spending less, as their income will be less. This will also lead to the increase of the prices of goods.

3. Explain the types of unemployment and assess their impact on your chosen business. (LO1)

Cyclical Unemployment

Cyclical unemployment is usually related to the national output of a country, this is because when national output is high, the work force is also high meaning that cyclical unemployment is low, and vice versa. Cyclical unemployment is usually described as the result of businesses not having enough demand for labour to employ all those who are looking for work.

Getting laid off due to a recession is the classic case of Cyclical Unemployment. This is why the unemployment rate is a key economic indicator.

Structural Unemployment

The defines as:

"An unemployment that comes from there being an absence of demand for the workers that are available."

Structural unemployment occurs because a difference between the types of workers wanted by employers and the kinds of workers looking for that job. The differences may be caused by inadequacy in skills, location, or personal characteristics. An example of this type of unemployment is if a robot dismisses a welder or if a nuclear engineer is simply no longer needed in a lab, these workers become unemployed. This type of unemployment is called because the arrangement of the job is incompatible with the skills offered by the worker.

Frictional Unemployment:

The defines as:

"Frictional unemployment is unemployment that comes from people moving between jobs, careers, and locations."

This basically means that people who are not working and are simply between jobs. This maybe the result of changes in the technical conditions of work, being hired elsewhere or simply relocating etc. They are not actively searching for a job, but instead they are waiting to begin their next job. In general, frictional unemployment is partial and temporary.

Seasonal Unemployment

This type of unemployment occurs when industries have a slow season, such as construction and other outdoor work in winter. It also arises at the end of the school year, when large numbers of students and graduates look for work. Santa Claus has a tendency to only be in demand for a short period of the year, and the rest of the year would be classified as seasonally unemployed. Seasonal unemployment tends to take place in certain industries. Industries that suffer particularly are:

Hotel catering
Tourism
Santa Claus

Classical or Real Wage Unemployment:

Classical unemployment is the result of the real wage rate being maintained at an unrealistically high level. This might occur because a Trade Union has insisted on a certain wage, even though this wage is not really realistic. In this case, firms will be inclined to employ less people because the marginal cost of labour will be too high. It will also become cheaper in real terms to switch to more capital intensive methods of production, requiring less labour.

ANALYSIS OF EFFECTS OF UNEMPLOYMENT ON MY CHOSEN BUSINESS

Cyclical unemployment may force ASDA to make extra marketing effort, this is due to falling sales. ASDA will also be intensely conscious of competition as customers may seem very price sensitive. There may be cuts in output, few job opportunities, falling level of investment and ASDA may also make a loss.

I think the main impact of Structural Unemployment is that ASDA could create many new potential employees as people are let go from jobs that can now be done quicker and cheaper by machines. However, using machines instead of people is more profitable for a firm because if there is an invention of some new machinery, employing it will have a more capital intensive method of production, this could benefit ASDA. An example could be that some kind of machinery that mimics a forklift but does not need a driver is created. This could save ASDA money as the machinery will do the job at a much lower cost rather than having to employ and pay a person to do the same job which will be to move pallets around the warehouse. Technology has made a massive leap and has enabled companies to produce more with the same or less employees.

I think Frictional Unemployment could potentially have a big impact on ASDA. This is due to the fact that many people are always found to be in the process of moving from one job to another in order to improve their income. This is caused by the fact that it takes time for employers and workers to find an appropriate match. Job seekers tend to spend time on finding the best possible job rather than take the first one available and employers take their time to interview several candidates to find the best fit. This costs money. So, ASDA could lose staff as employees pass through their job at ASDA onto something else. However, frictional unemployment could also attract people to work for the company as they leave their previous job and come to work for ASDA and decide to stay put because they have found a job that suits their needs.

Seasonal Unemployment is not a major issue for ASDA as all of their workers are employed for a specific role that they can carry out all year round like stacking shelves or serving customers. ASDA can however benefit from seasonal unemployment. To give an example, the construction industry unemployment levels rise in the winter due to bad weather which means workers cannot do their jobs. This means they might search for another job to tide them over until they can successfully return to their jobs. ASDA recruits temporary workers to help with the Christmas season so could therefore benefit from the seasonal unemployment caused by another industry by recruiting the unemployed to work for them over the Christmas period.

As a result of classical unemployment ASDA may be inclined to employ less people because the marginal cost of labour will be too high. It will also become cheaper in real terms to switch to more capital intensive methods of production, requiring less labour. This may affect ASDA’S profits.

4. Identify the meaning and measurement of economic growth and give examples of how this might affect your chosen business. (LO1)

The definition of economic growth is an increase in Real GDP (gross domestic product), which is usually calculated annually. Therefore in order to calculate economic growth, GDP, which is the total value of production in an economy, needs to be calculated. There are three ways of doing this,

The Expenditure Method:

Adding up all of the expenditure on outputs over a period of time, usually a year. It is necessary to add expenditure to exports and deduct expenditure on imports. (This is because the sale of exports represents UK output and creates incomes in the UK, whereas the expenditure on imports is spending on goods and services made abroad and creates incomes for people overseas). It is also necessary to deduct indirect taxes and add subsidies (a payment made by the government to consumers or producers that reduces the market price of a good or service), in order to get a value which corresponds to the incomes generated in the production of the output. Inflation needs to be removed in order to identify real changes.

The Income Method:

Adding up everyone’s income. It is important to include only payments received in return for providing a good or a service. It is often difficult to distinguish between ‘productive work’ e.g factory work, and ‘unproductive work’ e.g. housework, and whether their incomes should be included. The problem with this method is people do not always officially declare all of their income, so there can sometimes be a difference between income and expenditure. This is known as the ‘black economy.’ Transfer payments, which are transfers of income from taxpayers to groups of individuals for welfare benefits, pensions, and unemployment, are not included because they are simply transferred from one group of people to another without the recipients adding to production.

The Output Method:

Adding together the output of all firms, and estimating the total value of what is produced in a year. When using this method it is important to avoid counting the same output twice, e.g. if the value of cars sold by car manufacturers is added to the value of the output of tyre firms, double counting will occur. Also the prices consumers pay for final goods and services are inflated by indirect taxes, and deflated by subsidies. So it is necessary to count only the value added by each firm. Value added is the increase in the value of goods as a result of the production process. It is calculated by deducting the cost of the input goods used in the production, from the sales revenue received by the firm. It is equal to the payments made to the factors of production in return for producing the good or service. This is related to the distinction between final goods and intermediate goods. Final goods are goods purchased by the user, either consumer goods purchased by households or capital goods purchased by firms, e.g. cars. Intermediate goods are partly finished goods which form inputs to use in another firm’s production process, e.g. tyres.

There are small discrepancies between the values of GDP using each method, and so in the UK the official measurement used by the government is an average of all three methods.

EFFECTS ON ASDA OF ECONOMIC GROWTH

A rise in GDP makes more income available to people who then tend to spend more, leading to higher sales and more profits for ASDA. However, growth also leads to higher competition in the long run. As the economy expands, higher demand levels could lead more firms into the market, trying to fulfil the consumers' needs. The inflation leads to less goods being bought at higher prices. As ASDA’s cost of goods increases, they attempt to pass on this increase to the consumers. However, it is often not possible to pass on the entire amount to the consumer, hence resulting in possible cuts to ASDA’s profits.

5. Explain the structure of the Balance of Payments Accounts and assess the significance of surpluses or deficits. (LO1)

The Balance of Payments (BOP) is the record of the transactions of the residents of a country with the rest of the world. The BOP is split into two accounts. The current account describes the transactions in goods, services and transfers. The capital account covers transactions in assets. One of the main macroeconomic objectives of most economies is to run a small current account surplus. I will now explain why.

It is considered to be a bad sign to have a current account deficit. For example a current account deficit may be the result of a low saving rate, which results in a high current consumption leading to lower future consumption, implying that future generations bear the burden of low national saving. Other possible causes of a current account deficit include a declining comparative advantage, high propensity to buy imported goods, high dividend payments as a result of foreign investment in the domestic country, lack of productive capacity of domestic firms, falling surplus in an important resource or a high propensity to buy imported goods and services. Clearly these causes are all undesirable, and so an economy should aim for a current account surplus. However, a large persistent current account surplus is undesirable.

One disadvantage of a current account surplus is that one country’s surplus is another’s deficit. The BOP for the world must balance, so all the countries cannot run surpluses simultaneously. If countries with persistently large surpluses do not try to reduce them, then deficit countries will not be able to reduce their deficits. Deficit countries may then resort to import controls, from which all countries will suffer. A large persistent surplus is highly likely to lead to domestic inflation. A surplus on the BOP tends to increase the money supply, causing the country’s currency to be in short supply on the foreign exchange markets, leading to a rise in the exchange rate. To prevent the exchange rate rising, the government must sell their own currency and buy other currencies, which are then added to the reserves.

An economy should aim for only a small surplus on the current account of the BOP.

Devaluation is one possible way of achieving this BOP objective. It’s an expenditure switching policy. Given the nominal prices in two countries a devaluation reduces the relative price of exports from the devaluing country and increases the relative price of imported goods in the devaluing country. The idea is that a devaluation will cause the demand for imports to decrease and the demand for exports to increase. The hope is that as a result the balance of trade will improve, making current account deficits smaller and surpluses greater.

6. Analyse and evaluate Government policies designed to achieve the Macroeconomic objectives you have described in task 1. These should include:

Monetary Policy
Fiscal Policy
Exchange rate Policy
Supply side policy

Make sure you include recent Government Policies and their impact on your chosen business. (LO2)

Monetary policy plays an important role in controlling inflation. The main tool of monetary policy, short-term interest rates, is manipulated with the specific aim of achieving an inflation target. The interest rate is therefore an important way in which monetary policy is used to control inflation.

A contraction in the real money supply is another way in which monetary policy can be used to control inflation. A contraction of the money supply has the effect of shifting the aggregate demand curve to the left, since there is less money available for consumers to spend. This is therefore a way of reducing demand-pull inflation.

Monetary policy therefore has an important role to play in the control of inflation. There are, nevertheless, other methods of control which are used. Fiscal policy, for example, can be used. During periods when the economy is experiencing demand-pull inflation, the government can increase direct taxes, resulting in a fall in households' disposable income. This will reduce consumer spending, which will cause a fall in aggregate demand. The government can also cut its own spending, which will cause a fall in aggregate demand of which government expenditure is a component. Since excessive growth of aggregate demand is the cause of demand-pull inflation, fiscal policy can be used to curb inflation.

There are, however, problems associated with such demand management policies. The first is that they are largely impractical since there is a time lag involved before a tax comes into effect. It is therefore very difficult for the government to be able to quickly implement a tax, for example, to reduce inflation. In addition, such budget manipulation would mean that health care and other public goods would suffer a budget cut whenever the government wished to curb inflationary pressures.

Fiscal policy is nevertheless often used in conjunction with monetary policy. For example, during periods of inflationary pressure, interest rates may be increased and increases in government spending may be frozen. Such policies then complement one another and drastic fiscal measures are not needed. In addition, during periods of economic growth and inflationary pressures, tax revenues automatically increase (through increases in employment) and government spending is reduced (due to fewer transfer payments). Fiscal policy, therefore, automatically helps to reduce inflation. Despite this, however, the automatic stabiliser on its own is not enough to keep inflation at bay and monetary policy remains central to the control of inflation.

Supply side reforms are long term policies partly aimed at controlling inflation. If a greater output can be produced at a lower cost per unit (i.e. if productivity is increased), then the economy can achieve sustained economic growth without inflation. Hence, an increase in aggregate supply is often the key long term objective of government economic policy. The benefits of an outward shift in the short-run aggregate supply curve are both an increase in real national income and a fall in the average price level.

Productivity gains help to control unit labour costs, which are an important cause of cost-push inflation, and so put less pressure on producers to raise their prices. Supply side policies designed to improve productivity may include education and training schemes.

Supply side policies are therefore an important way of controlling inflation, but they are, like fiscal policy, used in conjunction with monetary policy. Supply-side policies on their own are unlikely to keep inflation at bay.

Monetary policy is therefore an important tool in controlling inflation. Other policies are also used, however, such as fiscal policy and supply side policies, but these on their own are usually problematic, often giving rise to policy conflicts. Supply side policies are important ongoing measures which help to reduce the price level, particularly through controlling cost-push inflation. Monetary policy, however, is currently the main method of controlling demand-pull inflation.

Demand-side policies

Other than supply side policies the government could pursue demand side policies to reduce the rate of unemployment.

To cure involuntary unemployment, the government can stimulate demand to provide more jobs, this can be done via demand side policies; there are two main policies which are all aimed at boosting aggregate demand. These are:

Monetary Policy – controlling the supply of money and interest rates.
Fiscal Policy – government spending

The government can use traditional macro-economic policies to increase AD and therefore generate a higher level of national income and employment. Reflationary policies can help to ease the effects of an economic recession.

The government could also make use of regional policies to encourage inflows of foreign investment form multinational companies particularly to those areas and regions where unemployment is constantly above the national average.

The government could give employment subsidies for businesses that take on the long term unemployed to create an incentive for firms to increase the size of their workforce. Employment subsidies may also be available for overseas firms locating in the poorer regions of the UK.

Increased Spending on Education and Training

Investment in education by the government has the potential to raise the total stock of skills within the work force and improve the employment prospects of thousands of unemployed workers.

Government spending on education and training has improved workers human capital. Employees become better quality workers and therefore their productivity improves.

In 2007 Gordon Brown promised to increase spending on education by 5% each year for the next three years in his budget, boosting funding from £60bn to £74bn by 2010. The investment meant that when Labour came to power in 1997, the amount of money spent on each school pupil rose from £2,500 to £6,600.

There was also help in the budget for 16 and 17-year-olds that commit themselves to developing new skills and sign up to activity and learning agreements. Gordon Brown promised that the government would pay these estimated 50,000 students a training wage and at the same time, any small business that commits itself to train an employee in basic skills would receive £2,000 or £3,000.

Improved training, especially for those who lose their job in an old industry has improved the occupational mobility of workers in the economy. This has helped to reduce the problem of structural unemployment.

Exchange Rate

A change in exchange rate affects aggregate demand. If a government wants to raise aggregate demand to reduce deflationary gap, it may try to reduce the exchange rate. This reduction would increase the price competitiveness of products and therefore increase exports and reduce imports. If the fall in the exchange rate increases demand for products, it’s likely that employment and output will rise in the short run. However, by increasing demand for products and raising import prices may lead to inflationary pressures.

7. Conclude this assignment by recommending policies that the current Government should continue or introduce to encourage future economic growth. (LO2)

I believe that the current government should continue to use the monetary policy and fiscal policy. Monetary and fiscal policies are what helps keep the nations economy stable. The policies are used to prevent long periods where there is high unemployment, inflation, and prices, along with low wages and investment. I will now go into detail about each of the policies which will show why they are of vital use to the government in encouraging future economic growth.

Fiscal policy involves the use of government spending, taxation and borrowing to influence both the pattern of economic activity and also the level and growth of aggregate demand, output and employment. Changes in fiscal policy affect both aggregate demand and aggregate supply.

Monetary policy is the attempt to control macroeconomic variables in an economy through the use of interest rates.

Fiscal policy is the attempt to influence the level of economic activity through changing taxation and government spending.

The objectives of the government are:

Low inflation
Strong economic growth, but, not inflationary growth
Reduce unemployment
Avoid large deficit on current account balance of payments

In the UK, Monetary policy has been given to the Bank of England. Therefore, the Bank of England has independence in setting interest rates. The government only set the inflation target of 2% inflation.

If the MPC predict inflation will rise above the inflation target then they will increase interest rates. Higher interest rates reduce demand and prevent the economy expanding too fast.

Fiscal policy is not used so much in modern economies, but, in theory can be used to prevent recessions or prevent inflation.

If inflation is a problem the government can increase tax rates and cut spending. This will reduce aggregate demand, and therefore, reduce inflationary pressure.

In a recession, the government can increase AD, by increasing government spending and cutting taxes. Lower taxes increase disposable income. This helps increase economic growth and reduces unemployment.

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