A Level Business, Chapter9, external economic influences on business behaviour

Causes of structural unemployment

Changes in consumer tastes and expenditure patterns, possibly resulting from higher incomes. Workers in some industries may find the demand for their services declining Improvement in technology

income elasticity of demand formula

% change in demand for a product / % change in consumer incomes

2 ways higher interest rates affects business

1 Increases interest costs and reduces profits for business that have very high debts. 2 Reduces consumer borrowing and this reduces demand for goods bought on credit, e.g. houses, cars, washing machines.

Deflation

A fall in the average price level of goods and services

Recession

A period of 6 months or more of declining real GDP.

Boom

A period of very fast economic growth with rising income and profits, A Boom also sows the seeds of its destruction

Slump

A very serious and prolonged downturn can lead to a slump where real GDP falls substantially and house and asset prices fall

Recovery and growth

All downturns eventually lead to a recovery when real GDP starts to increase again

economic growth

An increase in a country's productive potential measured by an increase in its real GDP

Is a recession always bad?

As output falls - fewer workers needed (unemployment) and tax revenues fall. Firms also notice reduced demand.

Four stages are (biz cycle):

Boom, Downturn or recession, Slump, Recovery and growth.

advantages of not joining a common currency

By not joining the common currency, the central bank could keep its status as the interest-setting authority. Replacing the currency with a common currency will eventually lead to common tax policies throughout the currency zone, which reduce the independence of each government to control its own tax rates.

Advantages of recession

Capital assets, such as land and property and even other businesses, may be relatively cheap and firms could invest in expectation of an economic recovery. Demand for 'inferior' goods could actually increase. The risk of retrenchment and job losses may encourage improved relations between employers and employees, leading to increased efficiency.

How is inflation measured?

Consumer Price Index (CPI)

Why would businesses not benefit from deflation?

Consumers would delay making important purchases, hoping that prices would fall further. As prices fall, the future profitability of new projects appears doubtful

The impact of inflation

Cost increases can be passed on to consumers more easily if there is a general increase in prices, The real value of debts owed by companies will fall, Since inventories are bought in advance and then sold later, there is an increased profit margin from the e ect of inflation.

What causes inflation

Cost push Demand pull

Government policies towards unemployment

Cyclical - The government attempts to manage the economy so as to avoid substantial swings in the business cycle, which lead eventually to recessions. Also to maintain a competitive rate. Structural- It will provide education and training programmes for workers who do not have the required skills. Government choose not to prevent economic changes.

Economic objectives of governments include

Economic growth- annual increase in a countrys GDP, Low price inflation - the rate at which consumer prices increase each year, Low unemployment rate, Long term balance of payments between imports and exports, Exchange rate stability - prevent wild swings.

High rates of inflation drawbacks for businesses

Employees will become much more concerned about the real value of their incomes, Consumers are likely to become much more price sensitive Rapid inflation will often lead to higher rates of interest. Cash flow problems

business investment

Expenditure by businesses on capital equipment, new technology and research and development.

economic growth is important because

Higher real GDP increases average living standards if the population increases at a slower rate, Higher levels of output often lead to increased employment which will increase consumer income, More resources can be devoted to the public sector, Poverty can be reduced.

winners when a currency depreciates

Home-based exporters, who can now reduce their prices in overseas markets - this should increase the value of their exports and lead to an expansion of the business. Businesses that sell in the domestic market will experience less price competition from importers - prices of imported goods and services are likely to rise on the domestic market.

Forecasting for the future is much less reliable

If inflation is higher in one country than in other countries, then businesses will lose competitiveness in overseas markets. Businesses that sell goods on credit will be reluctant to o er extended credit periods - the repayments by creditors will be with money that is losing value rapidly. Consumers may stockpile some items and cut back on non- essential items of spending

Inflation and deflation changes in the value of money

If one dollar buys fewer goods this year than it did last year, then the value of money has fallen and this must have been caused by inflation. If one dollar buys more goods this year than it did last year, then the value of money has increased. It must have been caused by deflation.

low rates of income tax

If workers and managers are forced to pay high rates of tax on any increase in income, then they could lose motivation to work hard and to gain promotion. Also, high rates of income tax will discourage entrepreneurs from setting up new businesses as they will consider that the rewards a er tax do not justify the risks involved

winners when a currency appreciates

Importers of foreign raw materials and components, for whom the domestic currency cost of these imports will be falling - this increases their competitiveness. importers are able to import cheaply

The factors that lead to economic growth

Increases in output resulting from technological changes and expansion of industrial capacity (achieved by innovation and investment), Increases in economic resources, such as a higher working population or discovery of a new resource (more use of resources = higher GDP) Increase in productivity

Cost push

Lower exchange rate World demand for materials like oil Higher wage demands

losers when a currency depreciates

Manufacturers who depend heavily on imported supplies of materials, components or energy sources - these costs will rise and will reduce competitiveness.

income elasticity can be described for 3 classes of goods?

Normal goods- necessary goods, income elasticity is positive between 0 and 1. These are basic goods that everyone needs. pharmaceutical etc luxury goods- income elasticity is positive and greater than 1. when incomes rise demand rises proportionally. this is disposable income like holidays etc inferior goods- income elasticity is negative, meaning that demand drops because of an increase in consumer incomes. second hand goods (furniture), poor cut meats etc.

Top tip

Rapid economic growth is not always beneficial to everyone.

Costs of Unemployment

The cost of supporting unemployed workers and their families is substantial and is paid for out of general taxation. May lead to social issues like crimes. May lead to reduced demand for goods and services.

Downturn or recession

The effects of falling demand and higher interest rates starts to bite. Real GDP growth slows and may even start to fall

Business cycle

The regular swings in economic activity, measured by real GDP, that occur in most economies, varying from boom conditions (high demand and rapid growth) to recession when total national output declines.

Gross Domestic Product (GDP)

The total value of goods and services produced in a country in one year- real GDP has been adjusted for inflation.

Top tip on unemployment

Unemployment is a cost to society and a personal cost to the individuals affected by it. Businesses may be able to negotiate lower wages or lower wage rises, however, during periods of high inflation. But would this be seen as exploiting the workforce?

market failure: monopoly producers

When a market is dominated by one firm, a monopoly is said to exist. e business will be interested in making pro ts as high as possible. e easiest way of achieving this will be to restrict output and raise prices. As the monopolist is able to prevent competitors from entering the market, this strategy will lead to under-provision of goods and services compared with what consumers would really like.

Demand pull

When consumer demand in the economy is rising, usually during an economic boom, producers and retailers will realise that existing stocks can be sold at higher prices. If they do not raise prices, stocks could be sold out, leaving unsatisfied demand.

exchange rate fluctuations

When demand for a currency exceeds supply, its value will rise.

Drawbacks of floating rates, but benefits of joining a common currency

When firms are planning to purchase goods from abroad it is di icult to make cost comparisons because suppliers from di erent countries will be using di erent currencies and these may change from one month to another. a lot of currency conversions. businesses may need to relocate to avoid currency costs.

market failure: labour training

Will firms pay for the training of staff when there is a real danger that, once quali ed, they could be 'poached' by other businesses that have not paid for the training? e answer is that many rms will not make su cient provision for training. is means that the country has a shortage of skilled workers and professional staff , which will reduce economic growth. In this case there is under-provision of training

Inflation adds uncertainty

Will prices continue to rise? Will the rate of inflation go up again? Will the government be forced to take strong corrective action, which could reduce business profitability?

Exchange rate depreciation

a fall in the external valueof a currency as measured by its exchange rate against other currencies. If $1 falls in value from €2 to €1.5, the value of the dollar has depreciated in value.

Exchange rate appreciation

a rise in the external value of a currency as measured by its exchange rate against other currencies. If $1 rises from €1.5 to €1.8, the value of the dollar has appreciated.

Working population

all those in the population of working age who are willing and able to work.

Inflation

an increase in the average price level of goods and services - it results in a fall in the value of money

contractionary fiscal policy

boom->reduce gov spending/raise tax->reductions in aggregate demand-> reduce output, employment and inflation

international competitiveness - non price factors

product design and innovation (iPhone), quality of product (Japanese cars) effective promotion and extensive distribution (like McDonalds) after sales service (guarantees etc)

fiscal policy

concerned with decisions about government expenditure, tax rates and government borrowing - these operate largely through the government's annual budget decisions.

external costs

costs of an economic activity that are not paid for by the producer or consumer, but by the rest of society.

During a period of rapid inflation, businesses focus on?

cutting back on investment spending ■ cutting profit margins to limit their own price rises to stay as competitive as possible ■ reducing borrowing to levels at which the interest payments are manageable ■ reducing time period for customers (trade receivables) to pay ■ reducing labour costs.

increasing labour market flexibility and labour productivity

policies uses by Govs to increase skill and efficiency: Subsidies for worker training programmes, Low rates of income tax to encourage workers, Restricting welfare benefits to those in genuine need.

losers when a currency appreciates

exporters can't cope with the high exchange rate and may need to locate overseas, domestic producers lose competition due to imports being cheaper

Imports

goods and services purchased from other countries

Exports

goods and services sold to consumers and business in other countries.

monetary policy

is concerned with decisions about the rate of interest and the supply of money in the economy.

low rate of corporation tax

is is a tax on the operating pro ts of limited companies a er interest

income elasticity of demand

measuresthe responsiveness of demand for a product a er a change in consumer incomes.

macro-economic policies

policies designed to impact the whole economy

expansionary fiscal policy

recession->raise gov spending/lower tax->increase in aggregate demand->increase in output and employment

how can Govs intervene to help small and large businesses

subsidies to help keep down prices ■ subsidies to stop a loss-making business failing ■ grants to locate to particular regions ■ financial support for consumers to buy products - e.g. houses - that will increase demand.

government budget surplus

taxation revenue exceeds the value of government spending.

If inflation is low

the central bank may decide to reduce interest rates - especially if economic growth is slowing down and there is a danger that unemployment might rise.

Exchange rate

the price of one currency in terms of another

government budget deficit

the value of government spending exceeds revenue from taxation.

Balance of payments

this account records the value of trade in goods and services between one country and the rest of the world. A deficit means that the value of goods and services imported exceeds the value of goods and services exported.

Unemployment

this exists when members of the working population are willing and able to work, but are unable to find a job.

Structural unemployment

unemployment caused by the decline in important industries, leading to significant job losses in one sector of industry.

cyclical unemployment

unemployment resulting from low demand for goods and services in the economy during a period of slow economic growth or a recession.

frictional unemployment

unemployment resulting from workers losing or leaving jobs and taking a substantial period of time to find alternative employment.

market failure

when markets fail to achieve the most efficient allocation of resources and there is under- or overproduction of certain goods or services.

If the balance of payments has a serious deficit

■ a fall or depreciation in the value of its currency's exchange rate ■ a decline in the country's reserves of foreign currency ■ an unwillingness of foreign investors to put money into the economy

Factors that cause unemployment

■ cyclical unemployment ■ structural unemployment ■ frictional unemployment.