1. Unit 6: Changing the business environment
Business Activity
Unit 6: Changing the business environment

2. Learning outcomes
To understand the need for government intervention in business activity
To develop knowledge of the role of the government in influencing business decisions
To appreciate the impacts of tax and interest rates

3. Introduction
Governments influence business and the economy through taxation and public spending. Governments are responsible for controlling the amount of money in circulation and and stimulating economic growth.

4. Business in context
See worksheet

5. Why does the government want to influence business and the economy?
Governments try to influence the economy of a country for several reasons:
To ensure that essential goods and services are produced and made available to those sections of the community who need them
To prohibit or control the production of goods and services considered undesirable or harmful
To regulate the activities of suppliers and protect the interests of consumers
To help disadvantaged sections of the community through taxation and welfare
To help suppliers through grants and subsidies and improved trading conditions
To encourage economic growth

6. Why does the government want to influence business and the economy?
Governments influence the economy through fiscal policies, concerned with government income and public expenditure, and monetary policies, concerned with the amount of money in circulation, and stimulating demand home and abroad.
Fiscal policies – government economic policies based on taxation and public expenditure
Public expenditure – government spending on public services and payments such as payments
Monetary policies – policies aimed at influencing business and the economy by controlling the money supply

7. How does the government get its money?
The most important source of income for a government is taxation. There are three main types of taxes that affect business and the economy.
Taxes on income, known as direct taxes. They reduce the amount a person keeps out of his or her earnings to spend as they wish.
Taxes on expenditure, including purchase taxes such as sales tax or value-added tax (VAT) which are added to the price of most goods and services (these are known as indirect taxes).
Taxes on business such as taxes on making profits made by a company.
Indirect taxes – taxes paid to the government through an intermediary: for example, VAT is added to the price of most goods and collected from customers by the business selling the products; the business then pays the VAT collected in a period the the government

8. What does the government spend its money on?

9. How does a government spend its money?
Governments use the money they receive from taxation to:
Provide or purchase goods and services for the benefits of society
Purchase or construct hospitals, schools, roads, public libraries etc.
Subsidise the production of goods and services by business
Make transfer payments such as taking the income tax from the employed people to provide benefits to the unemployed
If the government spends more than it receives, it must borrow enough money to make up the difference.

10. Specific forms of tax
India – an agriculture tax is levied on income from plantations and certain state governments have a luxury tax on specified goods
Saudi Arabia – has no value-added tax or estate tax
United Kingdom – national insurance contributions made by employees and employers to pay for the cost of a state pension and national health service

11. Fat tax
Obesity seems to becoming a bigger concern for the UK government as the number of overweight people in the UK rises and causes knock effects on health and work. The government are now considering placing a ‘fat tax’ on takeaways. Burger bars, kebab houses and fish and chip shops would be forced to pay the £1,000 before being allowed to open their doors to the public..
Back in 2004, the Government floated the idea of a fat tax on unhealthy foods. However research by the Institute for Fiscal Studies warned that a fat tax on consumers would have a disproportionate effect on the poor.

12. How do changes in taxation affect businesses?
Changes taxation affect businesses in various ways.
Increasing income tax may lead to reduced demand for goods and services, reduced levels of production and possible redundancies. Reducing income tax may have an opposite affect.
Increasing indirect taxes would lead to an increase in prices. Businesses must decide whether to pass any increase onto customers, risking a fall in demand, or to absorb the cost and have reduced profits.
Increasing levels of taxes on business has the effect of increasing costs and reducing profits forcing business to cut costs in other areas such as employment or to pass on the cost to the customers.

13. Activity 6.1
Find out the present forms and rates of direct and indirect taxes such as income tax, taxes on purchases (such as VAT), business taxes and excise duty in your country.
Were these increased in the last budget, and if so by how much?
If you were responsible for setting the levels of taxation and government expenditure for the next year, which rates would you change? Give reasons for your answer.
Excise Duty In the UK tax levied* on certain goods. These are levied partly to raise government revenue, and rates are often higher on items which have an adverse effect on public health, public order or the environment. For example, tax is levied on Petrol, Tabacco and Alcohol in the UK.
*Levied-impose tax

14. Activity 6.2
Find out how the government of your country spends its money. What are the main categories of government expenditure?
Create a table showing the percentage of the total government expenditure against each category.
Construct a pie chart from your table
Do you think the government should change the way it spends its income, spending more on some categories and less on others? Explain your reasons.

15. Activity 6.3
The government has decided to increase spending on the road network throughout the country. To do this it needs to raise an additional $1 billion.
Suggest how the government might raise this money.
Explain the effect of the government’s actions on the country’s business and economy.

16. Monetary policies
The money supply is the amount of money that is available for people and businesses to spend. It doesn’t just include cash but also the amount you can borrow too.
Borrowing money allows consumers to buy more goods and services. This leads to an increase in demand and possible inflation (a general increase in the level of prices)

17. Monetary policies
If there is a price increase on goods and services (inflation) some consumers will be unable or unwilling to afford the higher prices. Therefore demands for goods and services will fall causing businesses to produce less and perhaps make employees redundant.

18. The global credit crisis 2008/09
Money supply is a crucial part of the government’s strategy for the economy.
In 2008/09 there was a global economic crisis where many banks sought to take out more risky loans to ensure large profits. One bank collapsed forcing a sharp rise in the cost of credit and banks stopped lending to each other meaning businesses and individuals could not borrow money easily.

19. The global credit crisis 2008/09
Governments were forced into extreme measures including nationalising several banks or investing large sums of money to support them.
Emergency policies were put in place and interest rates were cut to stop the world financial system collapsing.
Governments from around the world realised they would have to implement stricter rules and regulations to prevent this from happening again.

20. How money supply is controlled
Money supply is controlled through interest rates.
When customers borrow money from a bank they will be charged interest on the amount they borrow. If the rates are low, then customers are likely to borrow money. However, if the rates are high, borrowers may think again.

21. How do changes in interest rates affect business?
An increase leads to reduction in borrowing because it will cost the company more to borrow the same amount of money therefore unwilling or unable to invest in new facilities to increase production.
A decrease in interest rates leads to an increase in borrowing. Companies are able to borrow to expand and demand increases as customers borrow.

22. Interest rates and Sharia law
In Islam, Sharia law does not allow ‘riba’ – the paying or receiving of interest for profit.
According to Sharia, giving a loan is seen as doing good towards those in need.
However, some profit may be gained through a financial contract involving shared risk taking meaning if it the risks go bad the lender also has to pay.

23. Activity 6.4
Find out some rates of interest charged on loans by banks and building societies or other financial institutions.
Are the interest rates charged to the borrowers different from the rate of interest paid to savers?
Suggest reasons for any differences.
How much more would someone have to pay on a loan of £18500 if the interest rate was increased by 0.75%?
Explain the effects that an interest rate increase of 0.75% might have on inflation, production and employment.
If Sharia law applies in your country, what other ways of financing business are there?

24. Economic growth
The total value of goods and services produced in a country is called its Gross Domestic Product (GDP).
Since one of the objectives of a government is to improve the standard of living, the country must try to increase its GDP.
In order to do this, the government must stimulate, or increase, demand for the goods and services produced by the country.
Demand for goods and services come from within the country as well as abroad.
Increasing GDP may also have an effect of reducing unemployment as businesses will need more staff to meet demand.

25. Stimulating demand at home
People will only buy goods and services if they have enough money and can afford to buy them. Demand from within the country producing goods and services can be stimulated by:
Redistributing income through transfer payments to ensure all sections of society can buy the goods and services they need
Maintaining a low level of unemployment so that people can work to earn money to buy goods and services
Keeping inflation low so that people’s income cover the cost of goods and services and to ensure the cost of products are not higher abroad

26. Stimulating demand from abroad
The main methods of stimulating demand from abroad are:
Encouraging international trade by providing marketing assistance and subsidies to businesses that sells goods and services abroad
Maintaining a competitive exchange rate between currencies, so that goods sold abroad is attractive to foreign consumers

27. Tip
Make sure you understand what happens when interest or tax rate change. If rates rise, what does this mean for businesses and consumers? Could you explain it?

28. Factors affecting demand
Unemployment
International trade
Income distribution
Demand
Inflation
Exchange rates

29. Key terms
Direct taxes – taxes paid directly to the government, for example by employees from income, or by businesses from their profits
Gross Domestic Product (GDP) – the total value of goods and services produced by a country
Indirect taxes – taxes paid to the government through an intermediary: for example, VAT is added to the price of most goods and collected from customers by the business selling the products; the business then pays the VAT collected in a period the the government
Inflation – a general increase in the level of prices
Monetary policies – policies aimed at influencing business and the economy by controlling the money supply
Money supply – the amount of money in the economy
Fiscal policies – government economic policies based on taxation and public expenditure
Public expenditure – government spending on public services and payments such as payments

30. Summary
The government influence the economy in order to gain control of unemployment, inflation and economic growth.
One way the government does this is through fiscal policies, which are based on levels of taxation and public expenditure.
Monetary policies are designed to influence the economy and business by controlling the money supply.
Borrowing increases money supply.
The amount of people are willing to borrow can be controlled through changes to interest rates.
Economic growth occurs when a country’s Gross Domestic Product (GDP) grows in response to increased demand from within the country or abroad.

31. Exemplar exam question
See worksheet.