Economic Influences

AS Edexcel New Specification 2015 Business

By Mrs Hilton for

From the specification

a) The effect on businesses of changes in: inflation (the rate of inflation, the CPI)

exchange rates (appreciation, depreciation)

interest rates

taxation and government spending

the business cycle

b) The effect of economic uncertainty on the business environment

Guidance from Edexcel

Lesson Objectives

• To be able to discuss the effect on business of changes in inflation, interest rates etc.

• To be able to discuss the effect of economic uncertainly on the business environment

• To be able to answer sample exam questions based on the topic area

Starter

• Do you have a savings account? Why do you save? Do you think that UK citizens saving is good or bad for the economy?

• Have a look at current savings account rates here

INFLATION

What is inflation?

• Inflation explained by Declan Curry video from BBC here

• Bank of England video on inflation here • Causes of inflation here does it matter?

here • Inflation is a sustained rise in the

general price level. • The inflation rate is the percentage by

which the general price level is increasing.

• A fall in the rate of inflation from 6% to 3% still means average prices are rising but at a slower rate.

• A fall in the general price level is known as deflation

Inflation videos from bbc

UK Rate of inflation

• Find out the current rate of inflation here

• BBC article inflation explained here

• Try an interactive quiz on inflation here

• BBC article and video – cake maker notices that prices keep going up here

• Inflation price rises hidden in smaller packaging, video here

Inflation

• Inflation is a rise in the price of goods and services we buy • The annual rate of inflation shows how much higher or lower prices

are compared with the same month a year earlier. It indicates changes to our cost of living

• So if the inflation rate is 3% in January, for example, prices are 3% higher than they were 12 months earlier. Or, to look at it another way, we need to spend 3% more to buy the same things

• We compare this to the annual change recorded in the previous month to get an idea of whether price rises are getting bigger or smaller

• If the annual rate has risen from 3% to 4% from one month to the next, prices are rising at a faster rate

• Bank of England ideal is 2%

Consequences of changes in inflation on business

• What impact will a change in inflation rates have on the cost of supplies?

• As inflation rises so does the cost of products and services

• Cost of supplies, ingredients and raw materials will go up

• Suppliers likely to be also within UK so will also be suffering from a rise in prices

• Business owners may need to increase their prices to maintain profitability

• Profit margins will be squeezed

• What impact will a change in inflation rates have on labour wages?

• As inflation rises then this lowers the real wage rate, increases the demand for labour and lowers unemployment

• As inflation lowers this raises the real wages, reduces the demand for labour and increases unemployment

Consequences of changes in inflation on business

PDF of this poster here from the Bank of England

EXCHANGE RATES (APPRECIATION, DEPRECIATION)

Exchange rates - introduction

• The exchange rate is the price of one currency in exchange for another

• You may have “changed” your money up for a holiday abroad, and you will have been charged commission to do so

• Currencies can change in value and this is due to the demand and supply of a currency

Look up how much £1 is worth in other currencies, keep track of it for a term and see how it fluctuates

here

Find out why a strong pound is good news for

holidaymakers here

Exchange rates - appreciation

• A rise in the £ pound against other currencies means the £ pound can buy MORE foreign currency

• This may also be called a high value or strong value of the pound.

• Find out how appreciation impacts firms in the UK here

Strong pound good news for holidaymakers

July 2015

figures full

article here

Exchange rates - depreciation

• A fall in the £pound against other currencies means the £pound will buy less foreign currency than before

• This may be known as a weak pound or a low pound value

Exchange rates – the link with interest rates

• The change in interest rates can lead to a change in exchange rates

• As interest rates fall then there is less saving and investment in UK less demand for £pound and so the value of the £pound will fall or depreciate

• As interest rates rise then exchange rates rise, see a BBC article here

Consequences of changes in exchange rates on business

• What impact will a change in exchange rates have on the cost of supplies? It depends if they were purchased from abroad. If our pound increased (or appreciates) against another currency this will make imported supplies cheaper:

• Strong • Pound • Imports • Cheaper • Exports • Dearer

Strong

Pound

Imports

Cheaper

Exports

Dearer

INTEREST RATES

UK interest rate

• This is the cost of borrowing money.

• If the bank of England pushes up interest rates consumer and business spending will fall.

Watch the video from the Bank of England on the

relationship between interest

rates and the inflation rates here

Interest rates

• The Bank of England is now responsible for deciding what the interest rate should be in the UK.

• It will raise interest rates if inflation is high and lower them if inflation is not a problem within the economy.

• Lower interest rates encourage economic growth and a fall in unemployment.

• Current rate is 0.5% is this good for consumers? here

Changes to interest rates – effect on business

• What is the impact on the cost of borrowing to business?

• If interest rates rise then the cost of borrowing will rise and this will mean that the cost of supplies for a business may increase

• A fall in interest rates means that the cost of servicing debt falls which may lead to an increase in profits (costs less to borrow so less to pay back)

TAXATION AND GOVERNMENT SPENDING

Government spending and taxation • The government can

change the way businesses work and influence the economy either by passing laws, or by changing its own spending or taxes. For example:

• Extra government spending or lower taxes can result in more demand in the economy and lead to higher output and employment.

• Governments can pass legislation protecting consumers and workers or restricting where businesses can build new premises.

Watch George Osbourne’s Spending review 2015 animation here

Government and taxation

• The main types of tax include: • Income tax taken off an employee's

salary. This results in less money to spend in the shops.

• Value added tax (VAT) added to goods and services. A rise in VAT increases prices.

• Corporation tax is a tax on company profits. A rise in this tax means companies keep less of their profits leading to less company investment and the possible loss of jobs.

• National Insurance contributions are payments made by both the employee and the employer. They pay for the cost of a state pension and the National Health Service. An increase in this tax raises a company's costs and could result in inflation.

Website here for larger version – by the Guardian, also compare with previous year here

Implications of government decisions on business

• Governments can control the rate of interest and the amount of money circulating in an economy.

• Government can also affect the amount of borrowing or credit available from financial institutions like banks.

• This is called MONETARY policy and they manipulate these variables to achieve their political party’s objectives

• The rate of interest is the price of money and the key instrument of monetary policy

Government policy continued

• The government may change the way that it spends and this may effect business

• The government may change the tax that it charges in the UK and this may effect business

• There are consequences for business of unemployment and inflation

• Business will be effected by changes in the exchange rate

• Changes in economic indicators such as unemployment will have a knock on effect to business (such as demand or larger pool of applicants for vacancies )

Changes in taxation – effect on business

• If the % of VAT goes up a business will have to pass this cost on to the consumer so if makes goods more expensive to buy

• The alternative is that the business absorbs this extra costs and the price of the goods remain the same to the customer – therefore lowering profit margins

• Video on the VAT rate rise when it went from 17.5% to 20% here

THE BUSINESS CYCLE

The Economic Cycle

‘Fluctuations in the level of economic activity around its productive potential over a period of time’

The Economic Cycle

Recession

Boom

Slump

Recovery

Time

GDP

The Impact on Businesses

Boom High Prices High Wages

High Consumer Spending

Time

The Impact on Businesses

Time

Recession Businesses look for other

markets Investments Fall

Low Profits Redundancies

The Impact on Businesses

Time

Slump More redundancies

Consistent high unemployment

Low Consumer Spending Shops/Factories Close

The Impact on Businesses

Time

Recovery Increased production

Wages rise Unemployment declines

Consumers start to spend more

Slump Question • What is a slump?

• Identify three effects that are likely to occur to

a small business in the event of a slump

Boom Question • What is a boom?

• Identify three effects that are likely to occur to

a small business in the event of a Boom

Recession Question • What is a recession?

• Identify three effects that are likely to occur to

a small business in the event of a recession

Recovery question • What is a recovery?

• Identify three effects that are likely to occur to

a small business in the event of a recovery

Types of goods • In a recession consumers will change their

buying habits (a pattern of demand changes as income changes) if I gave you £500 now you would buy different things than if I gave you £5

• There are; – Normal goods – as income increases so does

demand – Inferior goods – as income increases demand

decreases e.g. Bread, as incomes rise consumers switch to more expensive food. Margarine as incomes rise consumers switch to butter. Bus transport – as incomes rise consumers switch to their own car

– Luxury goods – as income rises consumers may substitute items for these types of goods. In times of recession consumer demand drops

You decide….

• Bus travel

• Cigarettes

• Designer clothes

• Fine wines

• Fresh vegetables

• Frozen vegetables

• Fruit juice

• Instant coffee

• International air travel

• Luxury chocolates

• Margarine

• Stilton

• Private education

• Private health care

• Stringy cheese

• Rail travel

• Shampoo

• Tinned meat

• Value “own-brand” bread

UNCERTAINTY

Uncertainty and spending decisions

• As uncertainty about future economic conditions changes over time it can affect spending decisions.

• If one company is taken over by another, the employees may feel more uncertain about whether next year’s pay will be higher or lower than currently.

• Or businesses may become more unsure about the level of next year’s orders if there is a change of government in one of their export markets.

• Households faced with uncertainty may save more rather than spend. • Consumers may delay the purchase of a large item such as a car or house,

these industries feel effects of shock and uncertainty the most • Companies may decide to delay an investment decision with a “wait and

see” policy to see if the project is viable

How a business may protect itself from

uncertainty

• A business may be involved in import and export and be affected by fluctuations in the exchange rate.

• This could cause huge problems for the business if there are a lot of fluctuations – see diagram euro to £ changes over just 90 days

• foreign exchange can be bought and sold in advance – what is known as the ‘forward’ market

How a business may protect itself from uncertainty

• A business may worry about fluctuating interest rates and so may take out a long term loan at a FIXED rate of interest.

• So payments stay the same and the business knows its fixed costs each month will not change.

Sample question 1

• 4 mark question

• Case on next slide

2 marks for

context Inflation – impact on fishing company?

What costs does a fishing company have that might rise with inflation?

Answer question 1

Sample question 2

• 12 mark question • Answer will require an evaluation – is an appreaciati0on of £

important to Benson’s yes or no, do not sit on the fence. Either is right if you back it up with evidence from the case study

Answer question 2

How to level a 12 mark question

Sample question 3

• 14 mark question – 7 marks for each “way”

• Case on next slide

• Knowledge 1, Application 2, Analysis 1, Evaluation 3 for each “way”

https://www.leski.com/

Level Mark Possible answer

1 1 e.g. uncertainty brings a variety of risks and that businesses want to try and reduce

uncertainty

e.g. May identify ways to reduce uncertainty including risk spreading,

diversification, market research/forecasting, R&D, collaboration, Use of

macroeconomic indicators, market orientation, mergers, contingency planning,

forward exchange rate (hedging) 2 2-3 e.g. Uncertainty can be reduced in the travel industry by risk spreading,

diversification, market research/forecasting, R&D, collaboration and contingency

planning, macroeconomic indicators, market orientation.

Some travel companies may carry out market research in order to find out customer

views and new improve current holidays.

Travel companies may monitor macroeconomic indicators such as consumer

confidence and GDP in order to predict future trends. 3 4-5 e.g. Travel businesses are also affected by external factors such as exchange rates

and PED. Some external factors such as the weather cannot be predicted or planned

for. E.g. 9/11, Tsunami, the recent volcano ash cloud and even with planning,

exogenous events such as these cannot be foreseen.

4 6-7 e.g. Market Research can identify broad trends and gaps in the market which can

help a travel business plan for the future. Market research is not always accurate

and cannot fully predict the future.

R&D can help keep ahead of competitors especially in a dynamic market. It is also

very costly and many products fail to reach the market.

Macroeconomic indicators can

only record what has already happened and even with time series analysis can only

give pointers on future trends and market events.

Sample question 4

• 4 mark question

• Case on next slide

2 marks for

context

Answer question 4

Series of videos

• Don’t just sit passive through the videos, make notes, pause them to review the information and ask if you have any questions…

Revision Video

Another video

Bonus video

Glossary

• Interest rates; cost of borrowing, the price of money • Inflation rates; rise in cost of goods and services to buy (persistent

increase in costs) • Unemployment rates; rise in numbers not in employment • Tax; monies demanded from the government so they have money to

spend elsewhere like the NHS and on roads and education • Exchange rate; the rate at which one currency can buy another £1 = $1.67 • Boom; period when an economy is growing strongly and is operating

around its productive potential (pp) • Recession; A period when growth or output become negative (for two

successive quarters 6 months) • Recovery; the movement back from when the economy is operating

below its pp to a point where it is at its PP • Slump; A period where there is a particularly deep and long fall in output