STUDY UNIT TWENTY

LEGAL, ECONOMIC, AND REGULATORY ISSUES

20.1 CONTRACTS

1. Contract Law

2. Agreement

3. Consideration

4. Capacity

5. Legality

6. Written Contracts

20.2 ECONOMIC MEASURES

1. Measuring the Gross Domestic Product

2. Business Cycles

3. Economic Indicators

4. Inflation and Consumer Price Index

5. Unemployment

6. Monetary Policy

20.3 INTERNATIONAL TRADE

1. Comparative Advantage

2. Trade Barriers

a. According to classical economics, individuals (as a whole) are best off under free
trade. However, governments often establish policies designed to interfere in the workings of the
marketplace (Protectionism)
Tariffs
Import quotas
Domestic content
rules
Voluntary export
restrictions
A trigger price
mechanism
Antidumping rules
Exchange controls
Export subsidies
Special tax benefits

b. Advocates of trade barriers advance three basic arguments in favor of protectionism:

1) Reducing imports protects domestic jobs.
2) Certain industries are essential to national security.
3) Industries need protection in the early stages of development

20.4 CURRENCY EXCHANGE RATES AND MARKETS

1. Buying in a Foreign Market
2. Fixed Exchange Rates
3. Floating (Flexible) Exchange Rates
a. The following factors affect currency exchange rates:
1) Relative income levels – Citizens with higher incomes look for new
consumption opportunities in other countries, driving up the demand for those
currencies.
a) Thus, as incomes rise in one country, the prices of foreign currencies rise
as well, and the local currency will depreciate.
2) Relative interest rates – When the interest rates in a given country rise relative
to those of other countries, more investors purchase the high-interest country’s
currency to make investments, driving up the demand for this currency.
a) Thus, as interest rates increase in one country, the prices of the local
currency rise as well, and the local currency will appreciate.
3) Relative inflation rates – When the rate of inflation in a given country rises
relative to the rates of other countries, the products of that country become
relatively expensive and the demand for that country’s currency falls.
a) Thus, as a result of inflation in a foreign country, the domestic currency has
appreciated with respect to the currency of the foreign country with higher
inflation.
b) The difference between the countries’ inflation rates is approximately equal
to the change in the currency exchange rate between the two countries.
4. Spot and Forward Exchange Rates
5. Mitigating Exchange Rate Risk

20.5 METHODS OF TAXATION

1. Tax Uses
Government finances its expenditures by taxation
individuals should pay tax based on the benefits received from the services

2. Tax Rate Structures

Progressive Higher income persons pay a higher percentage of their income in taxes
Proportional At all levels of income, the percentage paid in taxes is constant (flat tax on
income)
Regressive As income increases, the percentage paid in taxes decreases (sales, payroll,
property, or excise taxes)

3. Tax Rates
average tax rate the total tax liability/ the amount of taxable income
effective tax rate the total tax liability/ total economic income
(includes amounts that do not have tax consequences)
4. Direct vs. Indirect
Direct taxes imposed upon the taxpayer and paid directly to the government,( personal
income tax)
Indirect taxes levied against others and therefore only indirectly on the individual taxpayer,
(corporate income taxes)

5. Tax Credits
6. Incidence of Taxation
7. International Tax Considerations
a. Multinational corporations frequently derive income from several countries
b. To avoid double taxation: two or more countries may adopt treaties to coordinate or
synchronize the effects of their taxing statutes
c. some countries tax worldwide income (from whatever source derived) of a domestic
corporation. Double taxation is avoided by allowing a credit for income tax paid to foreign
countries or by treaty provisions

8. Value-Added Tax (VAT)

.
a. The amount of value added is the difference between sales and purchases
b. The consumer ultimately bears the tax through higher prices.
c. The VAT is based on consumption, people in the lower income groups spend a greater
proportion of their income on this type of tax. Thus, the VAT is regressive
d. The VAT requires all businesses to pay taxes, regardless of income
e. The VAT tax is not a useful tool for fiscal policy purposes.

20.6 REGULATION OF BUSINESS

1. Agencies and Commissions
a. An administrative agency is any public officer or body that makes rules and renders
decisions.
1) An agency or commission may regulate a specific industry or one area affecting all industries
2) Agencies and commissions may have the functions of investigation, enforcement, rule
making, and adjudication. They do not impose criminal sanctions.
3) They must act within the authority granted by the enabling statutes.

2. Economic Regulation
a. Such regulation usually affects prices and service to the public and is ordinarily industry-
specific.
3. Social Regulation
a. This type of regulation has broader objectives and more extensive effects (workplace and
product safety, pollution, and fair employment practices. It applies to most industries)
1) Social regulation has been criticized on the grounds that:
(a) is costly (b) contributes to overregulation
(c) may inhibit innovation (d) increases inflation
(e) may place a disproportionate burden on small entities, thereby having an anticompetitive
effect
(f) regulators are perceived to have little concern for the relation of marginal benefits and
marginal costs
4. Securities Law
a. One purpose is to provide complete and fair disclosure to potential investors in an
initial issuance of securities
Disclosure a filing with a government agency
Exemptions transactions by a person not an issuer, underwriter, or dealer
Civil liability parties associated with a filing that contains a misstatement or omission of a
material fact
Antifraud liability selling a security using a communication containing an untrue statement, or
an omission, of a material fact

b. Other purposes are to regulate trading of securities after initial issuance, provide
adequate information to investors, and prevent insiders from unfairly using nonpublic
information
5. Antitrust Law
a. Competition controls private economic power, increases output, and lowers prices.
It promotes the following:

1) Efficient allocation of resources (resulting in lower prices)

2) Greater choice by consumers
3) Greater business opportunities
4) Fairness in economic behavior
5) Avoidance of concentrated political power resulting from economic power

b. Restraints of trade in domestic or foreign commerce may be prohibited.

1) But only unreasonable restraints may be illegal.

2) Some restraints may be automatically treated as violations
 Price fixing is usually the most prosecuted violation

c. Other antitrust laws may prohibit the acquisition of shares or assets of another entity if
the effect may be to substantially lessen competition or to create a monopoly
1) The following are other actions that may be prohibited by antitrust laws:
a) Tying or tie-in sales Sales in which a buyer must take other products to buy the first product
b) Exclusive dealing a requirement by the seller that a buyer not deal with the seller’s
competitors
c) Price discrimination Sellers may not be allowed to grant, and buyers may not induce,
unfair discounts and other preferences. However, price discrimination
may be justified by cost savings or the need to meet competition
2) Interlocking directorates also could be prohibited even if the entities ceased to be
competitors

d. Unfair methods of competition and unfair or deceptive acts in commerce, including

false or misleading advertising, are antitrust violations in some countries

6. Consumer Protection
a. A government agency may help to maintain the safety of drugs, food, cosmetics, etc.,
and also may enforce laws requiring the labeling of hazardous substances.
1) New drugs may be required to be thoroughly tested before they are marketed.
But the premarket review is usually based upon research supplied by the manufacturers
 b. Other consumer protection laws may
1. Prohibit deceptive packaging and labeling
2. Give consumers the right to obtain the information reported by credit agencies
3. Protect the public from unreasonable risk of injury from consumer products. They may
emphasize safety standards for new products
4. Prohibit discrimination in providing credit a) Provide consumers with rights in contesting
billing errors
b) Prohibit mailing of unsolicited credit cards
c) Limit a consumer’s liability for unauthorized
use of lost or stolen credit cards.
5. Regulate written warranties on consumer products
6. Prohibit abuses of consumers’ rights by collection agencies
7. Require disclosure of the terms and conditions of consumer credit

7. Environmental Protection
a. An agency may be created to centralize environmental control functions of the
national government.
(1) Air quality
(2) Water quality
(3) Hazardous waste