AS Business Theme 2 - Economic Influences

Nota:

• • The sequence of slump, recovery, boom and recession. • The regular pattern of "ups and downs" in the economy • Measured by changes in GDP from one quarter to the next

1. GDP

   Nota:

   • • Measure of the value of output (activity) in the economy. • Value used to assess changes in economic growth
2. Demand

   Nota:

   • How much of a good or service a consumer wants - and is able to pay for For a business, demand turns into revenue (sales)
3. Boom

   Nota:

   • High levels of consumer spending, business confidence, profits and investment. Prices and costs also tend to rise faster. Unemployment tends to be low
4. Recession

   Nota:

   • Falling levels of consumer spending and confidence mean lower profits for businesses - which start to cut back on investment. Spare capacity increases + rising unemployment
5. Recovery

   Nota:

   • Things start to get better; consumers begin to increase spending; businesses feel a little more confident and start to invest again; but it takes time for unemployment to stop growing
6. Slump/Depression

   Nota:

   • Very weak consumer spending and business investment; many business failures; rapidly rising unemployment; prices may start falling
7. Main Causes

   Nota:

   • • Changes in the level of business and consumer confidence • Alternating periods of stocking and de-stocking • Changes in the value of consumer spending and business investment • Changes in government policy which can induce a change in the economy

Nota:

• Real incomes measure the amount of disposable income available to consumers (e.g. households and individuals)

1. Key factors
   1. Employment levels
   2. Wage growth
   3. Price inflation
   4. Interest rates
   5. Govt. Tax Policy

Nota:

• An interest rate is the reward for saving and the cost of borrowing expressed as a percentage of the money saved or borrowed

1. Currently 0.25% in the UK
2. Bank of England set the interest rate
3. What happens when it falls
   1. Cost of servicing loans/debt is reduced - boosting spending power
   2. Consumer confidence should increase leading to more spending
   3. Effective disposable income rises - lower mortgage costs
   4. Business investment should be boosted e.g. prospect of rising demand
   5. Housing market effects - more demand and higher property prices
   6. Exchange rate and exports - cheaper currency will increase exports
4. What happens when it rises

   Nota:

   • • Bank of England raises interest rates • Cost of borrowing rises • Main effect will be through via mortgages (higher mortgage payments reduce household income) • Repayments on other debts (e.g. credit cards & personal loans) will also increase • Possible slowdown in housing market • Contraction in retail credit • Higher taxes might also cause currency (pound) to get stronger • Makes UK exports more expensive in overseas markets

Nota:

• An exchange rate is the price of one currency expressed in the terms of another currency. The exchange rate determines how much of one currency has to be given up in order to buy a specific amount of another currency

1. Current Exchange Rates
   1. £1 = $1.26
   2. £1 = €1.16
2. Floating exchange rate

   Nota:

   • Currency is market determined.
   1. Appreciation

      Nota:

      • Value of the pound increasing compared against other exchange rates
   2. Depreciation

      Nota:

      • Value of the pound decreasing compared with other exchange rates
3. SPICED

   Nota:

   • Stronger Pound Imports Cheaper Exports Dearer: A stronger pound makes it cheaper to pay for imports, but exports will seem more expensive to overseas customers
4. Factors
   1. Low effect on business

      Nota:

      • No export sales - turnover all in domestic (UK) market All business activities located in UK Raw materials and other supplies bought in UK Demand predominantly from domestic (UK) customers Demand is price inelastic Higher costs can be passed on to customers to maintain margin
   2. High effect on business

      Nota:

      • Significant export sales, perhaps in many currencies Overseas operations, earning profits in foreign currencySignificant purchases from overseas suppliers Substantial demand from overseas visitors to UK Demand is price elastic Higher costs usually have to be absorbed via a lower margin

Nota:

• PESTLE analysis provides a useful way to analyse the overall external environment.

1. Political
   1. Competition policy
   2. Industry regulation
   3. Government spending & Tax policies
   4. Business policy & incentives
2. Economic
   1. Interest rates
   2. Consumer spending & income
   3. Exchange rates
   4. Business Cycle (GDP)
3. Social
   1. Demographic (population) change
   2. Changing lifestyles
   3. Consumer tastes/fashions
   4. Impact of pressure groups
4. Technological
   1. Disruptive technologies
   2. Adoption of mobile tech
   3. New production processes
   4. Big data and dynamic pricing
5. Legal
   1. Employment law
   2. Minimum/Living Wage
   3. Health/Safety laws
   4. Environmental legislation
6. Ethical/Environmental
   1. Sustainability
   2. Tax practises
   3. Ethical sourcing (supply chain)
   4. Pollution & Carbon emissions

Nota:

• Sustained increase in the average price level of an economy

1. How is it measured?

   Nota:

   • The rate of inflation is measured by the annual percentage change in the level of prices as measured by the consumer price index A sustained fall in the general price is called deflation - in this situation, the rate of inflation becomes negative
2. Consumer Price Index (CPI)

   Nota:

   • Main measure of inflation in the UK Government has set the Bank of England a target for inflation of 2% The aim of this target is to achieve a sustained period of low and stable inflation
3. Main causes
   1. Demand Pull

      Nota:

      • Occurs when there is excess aggregate (total across economy) demand Businesses respond by raising prices to increase their profit margins Associated with the boom phase of the business cycle.
      1. A depreciation of the exchange rate
      2. A reduction in direct or indirect taxation
      3. Rising consumer confidence
      4. Faster rates of economic growth in other countries
   2. Cost Push

      Nota:

      • Occurs when costs of production are increasing
      1. Causes

         Nota:

         • External shocks (e.g. overall price fluctuations) A depreciation in the exchange rate Acceleration in wages
      2. What happens?

         Nota:

         • Firms raise prices to protect their profit margins - better able to do this when market demand is price inelastic. Wages often follow prices A rise in inflation can lead to rising inflationary expectations
4. Costs and Consequences

   Nota:

   • Money loses its value and people lose confidence in money as the value of savings is reduced Inflation can get out of control (wage-price spiral) Consumers and businesses on fixed incomes lose out because their real incomes falls.
   • Inflation can favour borrowers at the expense of savers (erodes real value of existing debts) Can disrupt business planning and lead to lower capital investment Possible cause of higher unemployment in the long term due to lack of competitiveness Rising inflation associated with higher interest rates - reduce economic growth + can lead to a recession

1. Fiscal Policy

   Nota:

   • Involves the use of government spending, taxation and borrowing to affect the level and growth of aggregate demand, output and jobs
2. Why does the Government Tax?
   1. Raise revenue

      Nota:

      • To finance government spending
   2. Managing aggregate demand
   3. Changing the distribution of income and wealth
   4. Market failure and environmental targets
3. Current VAT = 20%
4. Direct taxes

   Nota:

   • Based on income, wealth and profit Include Income tax, National insurance contributions, Corporation tax (tax on businesses) and Capital gains tax
5. Indirect taxes

   Nota:

   • Based on spending by consumers on goods and services Include VAT and excise duties (taxes to improve health)
6. Government spending
   1. Takes up around 40% of annual GDP
   2. Transfer payments
   3. Current spending
   4. Capital spending
   5. WHY?

      Nota:

      • Direct government provision of public goods and merit goods Provides welfare support for low income households/unemployed Redistributes income within society (reduce scale of relative poverty) Can be used to manage aggregate demand (GDP) as part of a macroeconomic policy
   6. Definitions
      1. Aggregate = total demand in economy
      2. Macroeconomic = whole economy