AB - The Business Organisation,

Stakeholders and the External Environment

Macroeconomic Factors

DEFINITIONS:

Macroeconomics is the study of the operating characteristics of national or international economy when examined
as a whole, rather than examining individual markets or components within that economy. Macroeconomics
examines how different parts of the economy interact together as part of the whole.

Macroeconomic policies are tools and mechanisms used by governments to achieve macroeconomic objectives
in the economy. These objectives are the objectives of the government for the domestic economy as a whole, or
could be the objectives of the international economy as agreed between the cooperating governments. Examples
of such objectives are:

● Full/high employment;

● Stable economic growth;

● Increasing living standards;

● Low inflation; and

● Sound national finances.

Note: The key challenge for governments is that these objectives will not necessarily at all times be achievable
together and could even be conflicting.

MACROECONOMIC DRIVERS:

Imagine that a government’s objective is to have sound national finances via a balanced budget which it achieves
by raising taxes by a certain level. Here, the overtaxing could result in a tendency for people not to spend in the
economy, thus lowering business activity and the opportunities for job creation. So the government’s task is to
carefully manage and incentivise what is called the Circular Flow of Income through an economy:

Aggregate demand and aggregate supply are other key macro drivers. The overall level of demand for business
products and services from individuals, businesses, and other consumers in an economy is known as aggregate
demand. The higher the demand, the better domestic businesses will do. However, imports lower aggregate
demand, because the purchase of imports results in money going to non-domestic businesses.

Aggregate supply is an economy’s total capacity to supply goods and services to that economy. When aggregate
supply is lower than aggregate demand, prices will increase. In response to this, businesses will increase their
output in order to take advantage of these higher prices and, therefore, aggregate supply will increase:

The following demand drivers may move the situation out of equilibrium:

A. Consumer confidence about the economy: This might push the price that the consumers are willing to
pay upwards, from P1 to P2, then driving the aggregate demand from D1 to D2. This response would
increase the supply to the economy and drive the overall level of activity upwards:
 Remember: The higher the overall level at which the demand and supply are in equilibrium, the higher the
overall level of national income.

B. The overall level of employment in an economy;

C. The overall level of domestic and international investment into the economy;

D. The overall propensity of the economy to save;

E. The level of interest rates, where lower rates encourage borrowing and, hence, spending and demand.

Note: Remember, that this is not all based on a 1 for 1 ratio, which is known as the multiplier effect. The multiplier
effect of different economic policies is an important component in making decisions about which to select in order
to maximise the benefit to an economy.

When there is an expansion of the aggregate demand and supply and, therefore, the national income, this is known
as economic growth. When there is a retraction, this is known as recession . These variations form part of what
is known as the business cycle. Governments attempt to design macroeconomic policies in order to avoid boom
and bust, whereby an economy experiences a boom followed by a decline. Governments instead wish to see
steady growth over time:

If there are large economic variations, businesses find it difficult to plan demand, which may result in problems
with investing in equipment. However, when growth is steady, confidence is higher and participants in the economy
can make spending and investment decisions with more confidence about the future.

When the business cycle is volatile and not operating smoothly, problems can arise in the economy, which can
have serious consequences for all participants in that economy:

● Individuals;
 ● Families; and ●
Busine
sses.

Lets now look at the most important issues which can arise from a volatile business cycle:

1. Unemployment: It arises in recessionary times when companies have to lay people off as a result of
shrinking demand for their products or services. Unemployment can also result as a result of less direct
reasons, such as growing imports, or because those who lose jobs in one industry are unable to find jobs
in another industry. This is known as frictional unemployment. Unemployment not only lowers the
standards of living of families, but also affects the demand for businesses who supply these families, and
state finances as well.

2. Inflation: Inflation can arise from many sources, such as increased demand from buyers or when firms
charge more as a result of higher costs. Inflation creates uncertainty about prices in the future, lowering
confidence in investment decisions made. Higher domestic prices may make imports look relatively
cheaper, resulting in more imports into an economy, which could damage domestic business, employment,
and government finances. Rising prices can also damage domestic purchasing power.

3. Stagnation: This is a period of very low growth in an economy over an extended period of time, ordinarily
accompanied by high unemployment. A key problem here is that growth is not sufficient to build
employment levels back in order to lower the unemployment rate. Stagnation also suppresses investment,
because firms do not invest expansion capital without the level of appropriate growth in the economy and
return on these investments being available. It also impacts consumer confidence as expectations are low
about the future prospects of the economy.

4. International Payments Disequilibrium: This occurs when the total payments into an economy differ
from the total payments out of that economy. Total payments comprise of:
a. The current account, being the flow of goods and services, income payments, etc. A large
component of the current account relates to goods and services, also known as the balance of
trade. A surplus or deficit on the current account can be problematic.
b. The capital account, being the flow of investment capital.

TYPES OF ECONOMIC POLICIES:

The main types of economic policies that governments or groups of governments are able to execute in the
management of the business cycle and achieving its macroeconomic objectives are:

1. Fiscal Policy: It relates to the spending, taxation, or borrowing activities of the government. Each of these
three main categories of activity is ordinarily managed via the government’s annual budget process:
 Expenditure Taxation Borrowing

- Deficit vs Surplus;
- Infrastructure; - Corporate;
- Targets;
- Public services; - Incomes;
- Funding gaps.
- Civil service; - Wealth;
- Police; - VAT/Sales Tax;
- Defence; Public - Incentives;
- policy; Social - Redistribution;
- good. - Public policy.

2. Monetary Policy: This policy relates to the management of the cost, availability, or supply of money in the
economy by the government. The core principle here is that money plays a critical role in the management
of macroeconomic objectives.
a. The cost of money can be determined by the management of interest rates in an economy. The
higher the interest rates, the more expensive money is. Lower interest rates cheapen the cost of
money, meaning that there is more borrowing which boosts aggregate demand.
b. The availability of money can be influenced by the imposition of a credit framework, setting
particular guidelines for lending institutions. The tighter these controls, the less money will be
available.
c. The supply of money can be influenced by the government by printing money or taking it out of
circulation. The bigger the money supply, the bigger the aggregate demand. A tighter money
supply will lower it.
Governments can also take other direct policy actions in pursuit of macroeconomic objectives:

● They can implement trade barriers;

● They can implement trade embargos; and
● They can implement foreign exchange management.

Note: Flexibility with these policies depends on the level of cooperation with other countries.

Fiscal and monetary policies have significant impacts on participants in the economy. For example, higher interest
rates will ordinarily mean higher loan repayments for those families with mortgages or companies with debt.

In some cases, it could put companies out of business. It could also mean a family may no longer be able to repay
a home loan. However, a state might take the view that it is the economy as a whole that matters and that high
inflation for the economy as a whole is too damaging to leave it unchecked.

Fiscal policies have a real impact at the participant level. A government’s decision to boost aggregate demand by
spending more money on infrastructure could boost jobs and lower unemployment raising the standards of living
for those families. Those families will have more income to spend boosting businesses and incentivising new ones
to open.