Unit 1.5 External Environment Introduction ► This chapter assesses the importance of external influences on business performance and decision-making. ► Businesses depend for their survival on understanding and responding to external factors that are beyond their control. ► Many of the factors are ‘constraints’ because they may limit the nature of decisions that business managers can take. Introduction ► The legal requirements imposed by governments, on environmental pollution for example, are one of the most obvious constraining influences on business activity. However, external influences can also create opportunities and enable a business to become even more successful – introducing new technology in advance of rival firms is one example. Internal Factors ►Are the constraints and opportunities (facing a business in the attempt to achieve its aims and objectives) within a firm’s own control Internal Factors (Constraints) ► Example: Finance – most firms lack sufficient sources of finance People – poor working relations, poor communications can harm a firm’s ability to achieve its objectives Marketing – firms might not have attractive marketing campaigns as their rivals Production – firm may lack the resources or expertise External Factors (Constraints) ►Are those issues which either restrict or aid the performance of a business but are beyond its control. PEST ANALYSIS ► PEST = Political, Economic, Social and Technological opportunities and threats of the external environment within which businesses operate ► These factors affect all businesses in the economy and are beyond the control of any individual organization ► Mainly used at the start of a strategy review process PEST analysis issues ► POLITICAL Government legislation (employment law, consumer protection rights, copyright, trademark regulations) define the boundaries within which businesses can operate ► ECONOMIC Inflation, unemployment, economic growth and international trade Consumer and business confidence also affect the level of economic activity PEST analysis issues ► SOCIAL Social, cultural and demographic changes can also present opportunities and threats ► TECHNOLOGICAL Advances in technology and work processes (such as the microchip revolution or the introduction of just-in-time stock control system) have improved the efficiency of businesses Variations of PEST ►STEP – more optimistic name ►PESTLE analysis Legal and Environmental ►STEEPLE Ethical opportunities and threats Steps to carry out a PEST analysis ►Brainstorm external factors likely to affect the business ►Discuss these factors to decide which ones are most likely to have a significant impact on the business and hence its strategy ►Summarize the information in a PEST analysis template to further the development of business strategy PEST Analysis ► http://www.youtube.com/watch?feature=player_embedded&v=eGLFVj s1Zak#t=194 PEST Analysis is useful for four main reasons: ► It helps you to spot business or personal opportunities, and it gives you advanced warning of significant threats. ► It reveals the direction of change within your business environment. This helps you shape what you're doing, so that you work with change, rather than against it. ► It helps you avoid starting projects that are likely to fail, for reasons beyond your control. ► It can help you break free of unconscious assumptions when you enter a new country, region, or market; because it helps you develop an objective view of this new environment. A simplified example of a PEST analysis which examines some of the opportunities and threats of foreign businesses operating in India PEST analysis of multinationals operating in India ► POLITICAL Political reform in India will encourage better trade relations with other nations. Legislation is less stringent than in developed nations, thereby placing fewer constraints on business activity. Regarded as less politically stable compared with many other countries in the region. Poor enforcement of patents and copyrights might discourage technology transfer to India. PEST analysis of multinationals operating in India ► ECONOMIC Huge growth potential in financial markets. Significant economic growth and rising disposable incomes (spending power) in India. Improved infrastructures and market opportunities in Mumbai and New Delhi. Relatively low costs of production (average wage rates are still very low). Infrastructure and economic stability are less attractive than in other countries such as China. The vast majority of the Indian population is still very poor. PEST analysis of multinationals operating in India ► Social Potential market of over 1.2 billion people (the second most populous country in the world and expected to overtake China as the most populated nation by 2050). Well-educated English-speaking workforce. Large yet increasing discrepancies in income and wealth distribution. Language barriers in rural cities and/or a clash of national cultures. PEST analysis of multinationals operating in India ► Technological Growing number of technologically aware population (huge opportunities for firms providing products such as mobile phones, personal computers and internet services). Technologies are easily copied due to a lack of appropriate legislation. Key advantage of PEST analysis ► Simple to use ► If the overall opportunities of a decision outweigh the threats, then a business is likely to pursue that option ► The analysis helps managers to be thorough and logical in their analysis of the external opportunities and threats faced by the business ► PEST promotes a proactive and forward thinking rather than static views based on gut feelings Social and Cultural Opportunities and Threats ► The attitude of society towards a wide range of different issues (business ethics, social welfare, women, religion or animals) will affect what good and services are provided in the economy. ► Demographic changes in developed nations, such as a more educated and flexible workforce alongside an aging population, have affected recruitment practices, marketing strategies and the products provided by businesses. Review question 1.5.1 Page 68 Comment on how the demographic changes below may present both opportunities and threats to a business: 1. 2. 3. 4. Growing number of self-employed people. Increasing number of single parent families. Parents choosing to have fewer children and at a later stage in their lives. More people graduating with university degrees. Growing number of self-employed people Increasing number of single parent families Parents choosing to have fewer children and at a later stage in their lives More people graduating with university degrees Technological Opportunities and Threats ► Technology has affected all aspects of business functions ► Internet affected: Human resources in recruitment process Marketing (e-commerce – trading in internet) Finance – annual reports online Operations Management – access to benchmarking data Technological Opportunities and Threats ►Internet presents opportunities for businesses: Speed of access to information Reducing language and cultural barriers Reduced cost of production Technological Opportunities and Threats ►Internet presents threats for businesses: Price transparency – customers can easily compare the prices of different businesses without leaving their home or office Online crime – hackers, online banking and credit card fraud Higher cost of production – maintenance and training costs Reduced productivity – access personal email and social networking during working hours Technological Opportunities and Threats ► Other opportunities: New working practices – working from home, video conferencing, e-commerce, advertising in the internet Increased productivity and efficiency gains – use of robots / machines, automation Quicker product development time – CAD/CAM allowed businesses to produce prototypes quickly and cost-efficiently Technological Opportunities and Threats ► Other opportunities: New products and new markets – technology is a source of innovation and brings about new products in the market The creation of jobs – increased need for maintenance and technical support Technological Opportunities and Threats ► Other Threats: Technology is not always reliable or secure It can be costly Shorter product life cycle Automation has led to job losses in primary and secondary sector industries Technological Opportunities and Threats ► Factors to consider when adopting or implementing technology in the workplace: Costs Benefits Human relations Recruitment and training Review question 1.5.2 NINTENDO AND APPLE Page 70 Nintendo’s Wii games console and Apple’s iPod are huge hits with customers. Nintendo’s games console appeals to new market segment such as women and the elderly. Demand is high in Asia, Europe and the USA helping Nintendo to outsell its two nearest rivals, the Xbox 360 and PlayStation 3. In April 2007, announced the sale of its 100 millionth iPod, making it the most successful music player in history. Some 300 million iPods were bought within the first ten years of its launch. Explain how the technological environment can present opportunities for hi-tech firms such as Nintendo and Apple. The technological environment can present a host of opportunities for hitech firms which include: ► The ability to produce more sophisticated consoles, games and other gadgets (such as the iPod) to appeal to a larger and wider market ► Quicker product development times; essentially in fast-paced industries where products may have a short product life cycle The technological environment can present a host of opportunities for hitech firms which include: ► Marketing opportunities are enhanced with the use of improved technology, e.g. purchasing music online through iTunes ► Any other relevant factor that is explained Rubric ► 3-4 marks: there is good explanation of how the technological environment can provide opportunities to organizations. Examples are used and there is relevant application to hi-tech firms. ► 1-2 marks: a vague answer that lacks detail and / or depth. There may be little, if any, application. Award 1 mark for a list of factors. Economic Opportunities and Threats ► Economic environment refers to the largescale economic factors affecting a nation as a whole, such as the condition of foreign trade and the levels of business and consumer confidence. ► Government’s 4 key macro-economic goals: Controlled inflation Economic growth Reduced unemployment Healthy international trade balance Economic Opportunities and Threats ► Controlled rate of inflation Inflation is the continual rise in the general level of prices in the economy Causes of inflation: ►Demand Pull Inflation – caused by excessive aggregate demand in the economy ►Cost Push Inflation – caused by higher cost production leading to a rise in prices so that firms can maintain their profit margins Introduction to inflation ► http://www.youtube.com/watch?v=7rpvxZp hZZc Gold Standard ► http://www.youtube.com/watch?v=LdyHso5 iSZI Definitions ► INFLATION is a sustained increase in the AVERAGE PRICE LEVEL of goods and services in a nation. ► DEFLATION occurs when the AVERAGE PRICE LEVEL of goods and services decreases over time. ► KEY WORDS in the definition is the AVERAGE since inflation does not measure changes in relative prices of particular goods. Inflation ► INFLATION Causes the value of money to decrease Makes money less valuable Reduces purchasing power Encourages households and firms to spend now rather than postponing spending until the future when prices are higher Demand-pull and Cost-push Inflation ► http://www.youtube.com/watch?v=XU33RPl EioU GDP ► http://www.youtube.com/watch?v=yUiU_xR PwMc DEMAND-PULL INFLATION LRAS PL SRAS P1 P0 AD1 AD0 Y0 Y1 YFE Real GDP DEMAND-PULL INFLATION LRAS PL SRAS PE P1 P0 ADE AD1 AD0 Y0 Y1 YFE Real GDP DEMAND-PULL INFLATION LRAS PL SRAS P2 PE P1 AD2 P0 ADE AD1 AD0 Y0 Y1 YFE Y2 Real GDP DEMAND-PULL INFLATION LRAS PL SRAS P3 P2 PE AD3 P1 AD2 P0 ADE AD1 AD0 Y0 Y1 YFE Y2 Y3 Real GDP COST-PUSH INFLATION LRAS SRAS2 PL SRAS1 P1 PE AD Y1 YFE Real GDP + Aggregate Demand Chapter 12 + Macroeconomic Objectives Economic Growth A steady rate of increase of national output Employment A low level of unemployment Price Stability A low and stable rate of inflation External Stability A favorable balance of payments position Income Distribution An equitable distribution of income + Aggregate Demand and Supply Introduction http://www.youtube.com/watch?v=hTWPrWmPJS0&list=PLF2 A3693D8481F442 + Aggregate Demand Is the total demand for the goods and services of a nation at a given price level and at a given period of time. Is the total demand for a nation’s goods and services from domestic households, firms, the government and foreigners. + Components of AD 1) Consumption (C) – includes the durable and nondurable goods and services purchased by private individuals and households 2) Investment (I) – refers to spending by firms and households 3) Government spending (G) – spending on government purchases, which includes salaries for workers as well as capital goods spending 4) Net Exports (X-M) – count all exports as an inflow and thus an increase in GDP while subtracting imports as an outflow and a decrease in GDP. AD = C + I + G + (X – M) Average Price Level P1 P2 AD 0 Y1 Y2 National Output (real GDP) + AD slopes downwards for 3 different reasons The Net Export Effect As price level falls in a particular country, goods and services produced in that country become more attractive to foreign consumers. The Wealth Effect High price levels reduce the purchasing power The Interest Rate Effect High interest rates, quantity demanded decreases + Determinants of AD or shifts in the AD curve A change in the price level leads to a movement along a nation’s AD curve and a change in the national output demanded. AD will shift if any of its four components changes. Each components has its own determinants that may cause it to increase or decrease. + What causes changes in CONSUMPTION? Changes in INCOME Income is the most significant determinant of consumption As income rise people have more money to spend on goods and services, so consumption increases Growing economy => national income rising => increase in consumption => increase in aggregate demand + What causes changes in CONSUMPTION? Changes in INTEREST RATES Rise in interest rates (price of borrowed money) will likely lead to less borrowing => consumption will fall => fall in AD Rise in interest rates makes saving more attractive; people would prefer to put extra money in the bank to earn money A fall in interest rates will lead to an increase in consumption, ceteris paribus, as it becomes more attractive to borrow money to spend on durable goods and services. + What causes changes in CONSUMPTION? Changes in WEALTH Income is the money that people earn. Wealth is made up of the assets the people own. 2 factors that can change the level of wealth: 1. Change in house prices 2. Change in the value of stocks and shares + What causes changes in CONSUMPTION? HOUSEHOLD INDEBTEDNESS Household debt is the amount of money owed by a household to lenders In the short run, an increase in consumer debt allows households to increase consumption at each level of household income. In the long run, debts must be paid back, which is only achieved through reduction in future consumption. + What causes changes in CONSUMPTION? Changes in EXPECTATIONS/CONSUMER CONFIDENCE If people are optimistic about their economic future then they are likely to spend more now High consumer confidence is likely to lead to increased consumption Economists regularly measure consumer confidence and put the information together in the form of a “consumer confidence index” or “consumer sentiment index” What causes changes in CONSUMPTION? 1. Changes in INCOME 2. Changes in INTEREST RATES 3. + Changes in WEALTH 4. Changes in EXPECTATIONS/CONSUMER CONFIDENCE 5. HOUSEHOLD INDEBTEDNESS + What causes changes in INVESTMENT? INTEREST RATES If interest rates are high, then firms may prefer to put their retained profits in the bank to earn higher returns on savings rather than use them to invest Decrease in interest rates will decrease the incentive to save decrease the cost of borrowing likely to lead to an increase in borrowing likely to result in an increase in the level of investment + What causes changes in INVESTMENT? Changes in the level of NATIONAL INCOME Increase in national income leads to an increase in consumption This will encourage firms to invest in new plant and equipment to meet the increase in demand Investment accelerates when national income rises + What causes changes in INVESTMENT? BUSINESS CONFIDENCE/EXPECTATIONS Future prices Technology Business taxes Inventories Degree of excess capacity What causes changes in INVESTMENT? 1. INTEREST RATES 2. NATIONAL INCOME + BUSINESS CONFIDENCE/EXPECTA TIONS 3. What causes changes in GOVERNMENT SPENDING? • • Government spending will rise: 1. Government made commitment to financially support a given industry + • 2. Government to correct market failure • 3. A new education or health policy might require increased public spending on schools or hospitals + What causes changes in NET EXPORTS? INCOMES ABROAD Household income in trading nations is a major determinant of a nation’s net exports Ex. U.S. and Canada (trading partners) As income in the U.S. fall, Canada’s exports fell + What causes changes in NET EXPORTS? TASTES AND PREFERENCES OF CONSUMERS Once a country’s producers have developed a strong reputation in the global marketplace, that country can count on steady demand from abroad for its output Demand abroad is an important objective of government and multinational corporations + What causes changes in NET EXPORTS? EXCHANGE RATES Weak currency is likely to contribute to a country’s net exports Weaker currency makes the output cheaper to consumers abroad Weaker currency makes foreign products less desirable to domestic consumers & may lead to growth in domestic household consumption + What causes changes in NET EXPORTS? PROTECTIONISM Government actions and policies that restrict or restrain international trade, often done with the intent of protecting local businesses and jobs from foreign competition. Typical methods of protectionism are import tariffs, quotas, subsidies or tax cuts to local businesses and direct state intervention. What causes changes in NET EXPORTS? • 1. INCOMES ABROAD • 2. TASTES AND PREFERENCES OF + CONSUMERS • 3. EXCHANGE RATES • 4. PROTECTIONISM + Aggregate Supply + Aggregate Supply (AS) Is the total amount of goods and services that all the firms in all the industries in a country will produce at every price level in a given period of time + Aggregate Supply (AS) AS curve illustrates the relationship between the average price level in a nation and the total output of the nation’s producers. + Aggregate Supply (AS) There are 2 competing theories on the possible response of a nation’s producers to changes in the price level, depending on how prices and wages in an economy change following a change in AD. + Keynesian vs. Neo-classical + Fear the boom and bust http://www.youtube.com/watch?v=d0nERTFo-Sk + Keynesian Curve • When price level rises from P1 to P2, producers are responsive to the higher price • Increase their ouput from Y1 to Yfe (fullemployment output) • AS is relatively elastic when the nation is producing relatively low level of ouput + Neo-classical curve • A change in the average price level of the nation’s goods from P1 to P2 has no effect on the level of output • Regardless of price level, nation’s producers will always produce at the level of output at which all the nation’s resources are fully employed + Full Employment (FE) national output Yfe refers to nation’s full employment level of output It is the level of output of goods and services achieved when a nation is producing at or near its potential by employing all available land, labor and capital A nation achieving Yfe is producing either on or near its PPC, enjoy a low rate of unemployment and a stable price level (economy could be considered strong and healthy) + Full Employment (FE) national output LRAS curve is vertical at the full employment level of output SRAS curve slopes upward (highly elastic below full employment and becomes highly inelastic beyond full employment output) + SRAS • At low levels of aggregate output, the curve is fairly flat. • As the economy approaches capacity, the curve becomes nearly vertical. • At capacity, the curve is vertical. Short-run + Short-run is defined as the period of time when the prices of the factors of production do not change The period of time over which the level of wages in a nation are fixed. Also known as “fixed wage” period. + SRAS is horizontal at levels of output below full employment PL LR AS SR AS • Equilibrium => AD = AS PE AD1 YFE Real + SRAS is horizontal at levels of output below full employment PL LR AS PE SR AS • At YFE, the nation experiences very low unemployment, stable prices (meaning low inflation), nation’s resources are being used efficiently and near their full capacity towards the production of G&S AD1 YFE Real + SRAS is horizontal at levels of output below full employment LR AS PL SR AS • A fall in AD, small decrease in price level, large decrease in output P P E1 AD2 Y1 YFE Real AD1 + SRAS is horizontal at levels of output below full employment LR AS PL SR AS P P E1 AD1 AD2 Y1 YFE Real • At Y1, decrease in AD caused by a decrease in any of the components of AD, causes a fall in price level (from PE to P1) • As PL falls, firms respond by reducing output and laying off workers • In the SR, the decrease in the PL is proportionally smaller than the decrease in the equilibrium output + SRAS is horizontal at levels of output below full employment LR AS PL P P E1 P2 SR AS AD1 AD2 Y2 Y1 YFE AD3 Real • At Y2, as AD continues to decrease, firms must reduce employment and output • Reduce in AD caused the PL and output to decrease • Due to elasticity below employment level, decline in output is proportionally greater than the decline in the PL + SRAS is horizontal at levels of output below full employment LR AS PL SR AS PE P1 P2 AD1 AD3 Y2 Y1 YFE AD2 Real • At Y2, as AD continues to decrease, firms must reduce employment and output • Reduce in AD caused the PL and output to decrease • Due to elasticity below employment level, decline in output is proportionally greater than the decline in the PL + Short – Run: Level of output below full employment The decline in the short-run equilibrium output and employment resulting from a fall in AD is explained by the fact that in the short run, wages and prices are downwardly inflexible. Firms find it difficult or impossible to adjust workers’ wages due to several rigidities that exist in many countries’ labor markets. + Labor market rigidities that make wages inflexible in the SR: Worker contracts Minimum wage laws Wage agreements with labor unions Government regulations + In the SR: C, I, G, (X-M) AD YFE Employment + Shifts in Aggregate Supply + Causes of an increase in SRAS Lower resource costs (ex. oil, minerals and other raw materials) Improvement in the productivity of land or capital Reduction in the minimum wage Government subsidies to producers Investment tax credits (encouraging firms to invest in capital) Reduction in trade union power Better infrastructure Better educated or more skilled workforce Strong currency + Causes of a decrease in SRAS Increase in resource costs (oil shocks, energy shortages, higher food prices) Increase in trade union power Increase in the minimum wage Higher business taxes Weaker currency (makes imported raw materials more expensive) + In Summary Understanding the interactions of AD and AS in a nation’s economy helps governments, households and firms to respond better to fluctuations in the level of economic activity, and gives all stakeholders involved the ability to understand the appropriate responses to periods of macroeconomic uncertainty or prosperity. Review question 1.5.3 Zimbabwe’s inflation problems Page 71 Zimbabwe suffered immensely from the impacts of hyperinflation for almost a decade, with annual rates reaching 231,000,000 percent in July 2008. This meant that prices of goods and services in the country were more than doubling each week! Back in June 2006, the country’s Reserve Bank had issued new bank denomination – the 100,000 Zimbabwean dollar note (less than $1 at the time). However, by January 2009 the government had launched the 100 trillion Zimbabwean dollar banknote (ZWD 100,000,000,000,000)! It is estimated that 10.5 million Zimbabwean (around 80% of the population) live below the poverty line. The Zimbabwean dollar was eventually abandoned in favor of the US dollar as the nation’s official currency. Economists warned that the problem would continue to be a major issue unless the government dealt with the root causes of inflation. Outline 3 factors that could have caused inflation in Zimbabwe ► Cost-push inflation Caused by soaring food prices COST-PUSH INFLATION LRAS SRAS2 PL SRAS1 P1 PE AD Y1 YFE Real GDP Outline 3 factors that could have caused inflation in Zimbabwe ► Cost-push inflation Caused by soaring food prices ► Zimbabwean government printing more money, thereby raising the money supply and reducing its value Depreciation: Supply increase Price of USD in terms of EUR EUR SUSD SUSD 1 .749 .66 DUSD O Qe Q1 Q of USD Appreciation: Supply decrease Price of USD in terms of EUR EUR SUSD SUSD 1 .80 .749 DUSD O Q1 Qe Q of USD Appreciation: Demand increase Price of USD in terms of EUR EUR SUSD .80 .749 DUSD 1 DUSD O Qe Q1 Q of USD Depreciation: Demand decrease Price of USD in terms of EUR EUR SUSD .749 .66 DUSD 1 O Q1 Qe DUSD Q of USD Outline 3 factors that could have caused inflation in Zimbabwe ► Cost-push inflation Caused by soaring food prices ► Zimbabwean government printing more money, thereby raising the money supply and reducing its value ► Demand pull inflation Citizens getting large pay raises (due to increasing cost of living), thereby creating pentup demand and higher prices DEMAND-PULL INFLATION LRAS PL SRAS P1 P0 AD1 AD0 Y0 Y1 YFE Real GDP Evaluate the impact of uncontrollable inflation on the Zimbabwean economy ► Reduces the international competitiveness of the economy This will make it more difficult for Zimbabwe to sell its exports, thereby hindering the country’s economic growth ► The level of national output is likely to decline due to soaring costs of production This will have detrimental effects on the employment level in the economy Evaluate the impact of uncontrollable inflation on the Zimbabwean economy ► Investment (including foreign direct investment) is likely to decline as business confidence levels fall This will hamper future levels of economic activity in Zimbabwe ► Standards of living is likely to fall Causing further social and economic problems for the poverty-ridden country UNEMPLOYMENT Economic Opportunities and Threats ►A high level of employment / reducing the rate of unemployment: Types of unemployment (pg. 72) Policies to tackle the problems of unemployment: ►Demand Side Policies - increase the level of AD ►Expansionary Fiscal Policies - reduce taxes/increase government spending ►Expansionary Monetary Policies - reduce level of interest rates ►Supply-side Policies - increase the level of AS UNEMPLOYMENT http://www.youtube.com/watch?v=_CdT u1pk06w&list=PLF2A3693D8481F442 TYPES OF UNEMPLOYMENT http://www.youtube.com/watch?v=ZckA N1KYB5I&list=PLF2A3693D8481F442 Meaning of unemployment UNEMPLOYMENT Is the condition of someone of working age (16-64) who is willing and able to work, actively seeking employment, but unable to find a job. Unemployment rate (UR) calculations: UR = number of unemployed x 100 labor force Unemployment rate is the percentage of the total labor force in a nation that is unemployed. Labor Force It’s the sum of EMPLOYED and UNEMPLOYED persons aged 16-64 (age range may vary from nation to nation) Persons who are neither employed nor seeking employment are not in the labor force Retired persons Students Those taking care of children or other family members Others who are neither working nor seeking work Labor force participation rate (LFPR) Is the proportion of the working-age population that is either unemployed or employed. (Ratio of the number of people in the labor force to the entire working-age population of a nation.) LFPR = labor force x 100 working age population Labor force participation rate (LFPR) LFPR If = labor force x 100 working age population the LFPR drops, it may be because people have chosen to give up searching for jobs or they have decided to retire early or go back to school. Labor force participation rate (LFPR) LFPR A = labor force x 100 working age population decline in LFPR can cause the unemployment rate to understate the true number of people out of work in a nation. Examples of people who are part of the labor force and who are not part of the labor force A part-time retail sales clerk who is also going to college Part of the labor force because she is employed A stay-at-home mother NOT part of the labor force because she is not employed nor seeking employment A college graduate who volunteers in a community center NOT part of the labor force because although he is working, he is not formally employed nor is he seeking employment A full-time nurse Part of the labor force because he is employed A factory worker whose plant closed and who is applying for jobs at other firms Part of the labor force because he is unemployed A discouraged worker who has been looking for a job for 18 months but has given up the job search NOT part of the labor force because he is no longer seeking employment An engineer who goes back to school to earn a teaching degree NOT part of the labor force because he is not currently seeking employment A recent college graduate interviewing at different companies for her first job Part of the labor force because she is unemployed Consequences of unemployment Individual consequences of unemployment Decreased household income and purchasing power Increased levels of psychological and physical illness, including stress and depression Consequences of unemployment Social consequences of unemployment Downward employed Increased pressure on wages for the poverty and crime Transformation of traditional societies Economic consequences of unemployment 1. Lower level of AD Unemployment lowers household’s disposable income Reduces consumption Reduces level of demand and output in the nation as a whole Leads to more unemployment Can pull the economy into a recession Economic consequences of unemployment 2. Under-utilization of the nation’s resource Unemployment means a nation is not fully utilizing its productive resources Nation with high unemployment is producing within its PPC at a level below that which is most beneficial to an economy Economic consequences of unemployment 3. Brain-drain Skilled workers choosing to leave the country with high unemployment if job opportunities are abundant elsewhere This further leads to a fall in the production possibilities of the nation with high unemployment Economic consequences of unemployment 4. A turn towards protectionism and isolationist policies Rise of protective tariffs and quotas or increased government spending on subsidies for domestic producers Such policies lead to a misallocation of society’s scarce resources and in the long run will make the nation less competitive in global markets Economic consequences of unemployment 5. Increased budget deficits High unemployment reduces tax revenues flowing to a government while increasing public expenditures on financial support for the unemployed Result in decrease government spending on public goods (infrastructures, education, defense, healthcare) or an increase in government borrowing to finance its budget deficit Economic consequences of unemployment (T/F) Higher level of AD FALSE Lower level of AD Economic consequences of unemployment (T/F) Over-utilization of the nation’s resources FALSE Under-utilization of the nation’s resources Economic consequences of unemployment (T/F) Brain-dead FALSE Brain-drain Economic consequences of unemployment (T/F) A turn towards protectionism and isolationist policies True Economic consequences of unemployment (T/F) Decreased budget deficits FALSE Increased budget deficits Types of unemployment Frictional unemployment Seasonal unemployment Technological unemployment Regional unemployment Structural unemployment Cyclical unemployment Frictional Unemployment: Occurs when people change jobs as there is usually a time lag between leaving a job and finding or starting another. As this is temporary, there is relatively little social hardship. It is always present in the economy. Seasonal Unemployment: Is caused by seasonal changes in demand for a product e.g. beach resorts tend to suffer from a lack of tourists during the winter months. Technological Unemployment: Results in people losing their jobs due to the introduction of laborsaving (capital intensive) technologies, which can cause mass-scale unemployment. Regional Unemployment: Refers to the different unemployment rates that exist in different areas of a country. Remote rural areas tend to have higher levels of unemployment than busy urban business districts. Structural Unemployment: Occurs when the demand for products produced in a particular industry continually falls. The industry therefore suffers from structural and long-term changes. Cyclical (demand-deficient) Unemployment: Is caused by a lack of aggregate demand in the economy. It is the most severe type of unemployment as it tends to affect each and every industry (caused by a recession). Types of Unemployment Description: People who are in between jobs or looking for their first job Types of Unemployment Description: People who are in between jobs or looking for their first job Frictional Unemployment Types of Unemployment Description: Workers unable to find work because a reduction in private and public spending reduces AD. Types of Unemployment Description: Workers unable to find work because a reduction in private and public spending reduces AD. Cyclical Unemployment (Demand-Deficient) Types of Unemployment Description: Workers who need to seek other work between seasons. Types of Unemployment Description: Workers who need to seek other work between seasons. Seasonal Unemployment Types of Unemployment Description: Workers unable to find work because their skills do not match those demanded by firms. Types of Unemployment Description: Workers unable to find work because their skills do not match those demanded by firms. Structural Unemployment Types of Unemployment Description: People losing their jobs due to the introduction of labor-saving technologies. Types of Unemployment Description: People losing their jobs due to the introduction of labor-saving technologies. Technological Unemployment Types of Unemployment Description: Refers to the different unemployment rates that exist in different areas of a country. Types of Unemployment Description: Refers to the different unemployment rates that exist in different areas of a country. Regional Unemployment 3 TYPES OF MACROECONOMIC TOOLS • Fiscal Policy • Monetary Policy • Supply-side Policy 3 TYPES OF MACROECONOMIC TOOLS • Fiscal Policy • Government’s use of taxes and spending to influence the overall level of AD in the economy • Monetary Policy • Is the process by which the monetary authority of a country controls the supply of money • Supply-side Policy • Combination of government-led and free market policies designed to increase the productive capacity of the country FISCAL POLICY • http://www.youtube.com/watch?v=1qhJPqyJRo8 DEFINITION OF FISCAL POLICY • Is a government’s manipulation of TAXES and EXPENDITURES with the goal of increasing or decreasing the level of aggregate demand (AD) in an economy. • Government spending can have powerful effects on the economic activity in a nation • Taxation can change the level of consumption and investment • Either aimed at reducing AD to reduce inflation or increasing AD to reduce unemployment, FP is used regularly by government to manage the overall level of economic activity of a nation EXPANSIONARY FISCAL POLICY • Is a decrease in taxes and/or an increase in government spending aimed at increasing the level of aggregate demand to close a recessionary gap and move an economy towards its full-employment level of output This will reduce unemployment Move the economy towards full-employment level of output during a recession Expansionary Fiscal Policy LRAS SRAS1 Price level AD1 P2 P1 AD2 Y1 YFE Real gross domestic product Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 9172 CONTRACTIONARY FISCAL POLICY • Is an increase in taxes and/or an decrease in government spending aimed at decreasing the level of aggregate demand to close an inflationary gap and moving the economy to its full-employment level of output and price level stability Reduces inflation Slow down the economy Contractionary Fiscal Policy Price level LRAS SRAS1 P1 P2 AD1 AD2 YFE Y1 Real gross domestic product Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 9174 Intro to Money Market Macroeconomics policymakers have 2 general tools to manage the level of aggregate demand Fiscal Policy – changing the levels of taxes and government spending Monetary Policy – changing the supply of money available in a nation Carried out by the central bank of each country Note the difference between central bank and commercial bank Central bank vs. Commercial bank Commercial banks are financial institutions whose main functions are to hold deposits for their customers (consumers and firms) to make loans to their customers to transfer funds by check & electronically from one bank to another to buy government bonds Role of Central Banks Central bank Is the monetary authority of a country, which performs the functions of issuing currency, managing the money supply, and controlling interest rates 2 largest economies European Union – The European Central Bank (ECB) United States – US Federal Reserve (the Fed) Independent from politics Head and governors are appointed by politicians to fixed terms Central Bank’s Responsibilities Banker to the government Banker to commercial banks Regulator of commercial banks Conduct Monetary Policy Central Bank’s Responsibilities Banker to the government Holds the government’s cash/deposits Receives payments for the gov’t and makes payments for the gov’t Manages the government’s borrowing by selling bonds to commercial banks and the public Acts as an adviser to the gov’t on financial and banking matters Central Bank’s Responsibilities Banker to commercial banks Holds deposits for commercial banks Loans to commercial banks in times of need Note: central bank does not act as a banker to consumers and firms Central Bank’s Responsibilities Regulator of commercial banks Central bank regulates and supervises commercial banks, making sure they operate with appropriate levels of cash & according to rules that ensure the safety of the financial system This is a very important function, because the funds that commercial banks use to make loans are the savings and other deposits that consumers and firms deposit with commercial banks Central Bank’s Responsibilities Conduct Monetary Policy CB is responsible for monetary policy, based on changes in the supply of money or the rate of interest Usually responsible for the determination of exchange rates because of the close relationship between interest rates and exchange rates Economic Opportunities and Threats ► Economic Growth: Increase in a country’s economic activity over time Measured in terms of Gross Domestic Product (GDP) – change in total output of the economy per year See the trade cycle (pg. 72) ECONOMIC GROWTH IN THE BUSINESS CYCLE Recession • Defined as 2 consecutive quarters of declining national output • If the economy contracts over a six-month period, it is classified as a recession • Impacts consumer and market confidence and will cause less economic activity • Fewer workers required to produce because less output is demanded • Raises fear of unemployment • Policy makers will intervene to help the economy Trough • Lowest point of a recession • Nobody knows exactly when this is reached • Economy, hopefully, will enter a recovery period quickly (recovery – increase in GDP) Expansion • Economy grow beyond its previous level of output Peak • Highest point of output before a recession ECONOMIC GROWTH Improved efficiency in the production process (better use of existing resources) Enhancing the quality of factors of production which requires investment in: Capital Goods – developing an economy’s infrastructure to aid economic activity and competitiveness Education and Training – better educated and trained workforce becomes a more productive and internationally competitive labor force Health Technology – advances helps to ensure workers are healthy and therefore more productive; also prevents workers having to take time off work or retire early due to illness ECONOMIC GROWTH Increased in the quantity of resources Discovering new sources of raw materials Changes in the labor force Changes in demography – a fall in the birth rate in developed economies has led to an aging population and a smaller workforce. Conversely, a ‘baby boom’ will lead to a larger workforce in the next couple of decades. Changes in participation rates – gov’t. policies (such as lower rates of income tax or reduced welfare payments) can boost the participation rate. Changes in net migration – This refers to the difference between IMMIGRATION (the number of people entering a country for work purposes) and EMIGRATION (those leaving a country). If the net migration figure is positive, then the size of the workforce will increase, thereby helping to raise the productive capacity of the economy. BARRIERS TO ECONOMIC GROWTH Lack of infrastructure (transport and communications networks) Countries without basic electricity, road networks, schools, hospitals and housing will find it difficult to prosper Lack the technical knowledge and skilled labor force Essential resources for generating sustainable economic growth Rapid population growth High net birth rate will tend to find that there are too many ‘mouths’ to feed High foreign debt repayments Highly indebted poor countries are obliged to repay their huge interest-bearing loans, with little left for domestic investment and growth Economic Opportunities and Threats ► An improvement in the balance of payments: BoP is a record of a country’s money inflows and outflows, per time period It records export earnings and import expenditures BOP ► Components: ►Current account ►Capital account ►Financial account ► To correct an imbalance on the BOP, governments often attempt to alter their exchange rates, which will have a direct effect on businesses. Exchange Rate ► The exchange rate measures the value of one currency in terms of foreign currencies. ► Appreciation – higher exchange rate means that export prices will be relatively higher, thereby reducing the exporter’s price competitiveness. ► Depreciation – lower exchange rate means that domestic firms that import raw materials and components will suffer from having to pay higher prices, thereby raising their costs. Depreciation: Supply increase Price of USD in terms of EUR EUR SUSD SUSD 1 .749 .66 DUSD O Qe Q1 Q of USD Appreciation: Supply decrease Price of USD in terms of EUR EUR SUSD SUSD 1 .80 .749 DUSD O Q1 Qe Q of USD Appreciation: Demand increase Price of USD in terms of EUR EUR SUSD .80 .749 DUSD 1 DUSD O Qe Q1 Q of USD Depreciation: Demand decrease Price of USD in terms of EUR EUR SUSD .749 .66 DUSD 1 O Q1 Qe DUSD Q of USD Consequences of continual & large fluctuations in the foreign exchange ► Can create difficulties for businesses Business planning and forecasting become very complex and impractical ►Businesses may not be able to accurately forecast export sales or costs of imported materials due to exchange rate volatility ►International trade deals could be postponed until the business can benefit from more favorable movements in the exchange rate ► Governments can set up international trade barriers to correct any disparity in its BOP or to protect their domestic industries. Protectionism ► Gov’t. policy used to safeguard domestic businesses from foreign competitors. TARIFFS – tax placed on imported products, raising their price QUOTAS – quantitative limits on the volume or value of imports SUBSIDIES – payments made by a gov’t. to domestic firms as a form of financial aid to reduce the cost of production of domestic firms EMBARGOS – physical bans on international trade with a certain country TECHNOLOGICAL & SAFETY STANDARDS – strict administration and compliance costs in meeting industrial and health & safety regulations imposed on imports Review question 1.5.4 Text handout K&Q sell jeans in the UK. They buy their jeans from an American supplier and import 10,000 pairs of jeans per month for a cost of $30 each. K&Q then sell these to their customers at a price of 30 GBP each. Use the various exchange rates to complete the table below for K&Q Jeans. Exchange Rate UK 1 = $1.00 UK 1 = $2.00 UK 1 = $1.50 UK 1 = $2.50 UK 1 = $0.75 Purchase Cost ($) Purchase Cost (GBP) Sales Revenue (GBP) Profit or Loss (GBP) Use the various exchange rates to complete the table below for K&Q Jeans. Exchange Rate Purchase Cost ($) Purchase Cost (UK) Sales Revenue (UK) Profit or Loss (UK) UK 1 = $1.00 300,000 300,000 300,000 0 UK 1 = $2.00 300,000 150,000 300,000 150,000 UK 1 = $1.50 300,000 200,000 300,000 100,000 UK 1 = $2.50 300,000 120,000 300,000 180,000 UK 1 = $0.75 300,000 400,000 300,000 -100,000 Comment on the relationship between changes in the exchange rate and the level of profits. ► There is a positive relationship between the exchange rate and the level of profits for K&Q Jeans. ► For example, when the exchange rate (for sterling) rises from $1 to $2, the profit rises from zero (break-even) to 150,000 GBP since K&Q Jeans are able to purchase from their US supplier at a lower rate. By engaging in international trade, explain two other costs that K&Q Jeans might incur. ► Possible answers with full explanation: Tariffs imposed on the import of US jeans Transportation costs for the jeans being shipped in from the USA Insurance for the stock being transported from overseas Examine how a high exchange rate can be both an opportunity and a threat to a business such as K&Q Jeans. ►A high exchange rate can create an opportunity for K&Q Jeans because the costs of importing its stocks of jeans will fall K&Q will be able to purchase the same quantity of stock for a lower cost K&Q profit margin will increase Examine how a high exchange rate can be both an opportunity and a threat to a business such as K&Q Jeans. ►A stronger currency can also present threats If the business exports its products Price of jeans sold overseas will automatically increase K&Q’s exports will become less competitive Environmental Opportunities and Threats ► External cost of production or negative externalities – costs incurred by a third party in a business transaction (cost borne by society or the environment rather than by the buyer or seller) Samples of external costs: ►Passive smoking ►Air pollution ►Noise pollution ►Packaging waste ►Global warming Environmental Opportunities and Threats ► Public concerns and changes in social attitudes about the environment have meant that businesses are increasingly reviewing their operations Firms that do not respect the environment face ruining their reputation and long-term profitability If compliance cost are too high, then firms may choose not to become more environmentally friendly Environmental Opportunities and Threats ► Changes in weather Torrential rain or flooding will affect large number of businesses Indian Ocean Tsunami (SE Asia 2004); Hurricane Katrina (USA 2005); snow & icy conditions across Europe (12/2010); floods in Australia (2011) caused major havoc to businesses Extreme weather condition in Russia reduced its GDP by over 1 percent in 2010 Japan’s 9.0 earthquake (2011) cost the nation over $15bn Some business might be able to exploit changes in the season Environmental Opportunities and Threats ► Health scares and epidemics SARS 2003 and bird flu (2006) in SE Asia caused turmoil in the region with many businesses collapsing Mad cow disease (late 1990s), foot and mouth disease (2001) and swine flu (2009) had similar effects in Europe Political Opportunities and Threats ►A government is said to adopt a laissez-faire (don’t interfere) approach to managing the economy if it does not intervene significantly in business activity; this should stimulate healthy competition and efficiency ► Government intervention takes place and can present opportunities and threats to businesses in the economy ► Fiscal and Monetary Policies Fiscal Policy ► Uses taxation and government expenditure ► 2 forms: Deflationary (contractionary) fiscal policy – higher taxes and/or decrease in gov’t. expenditures Expansionary fiscal policy – decrease in taxes and/or increase in gov’t. expenditures Direct Taxes Taxes imposed on people’s income or wealth and on firm’s profit Taxes that are paid directly to the government by those on whom they are imposed Example: Income tax and Corporation tax Unavoidable because individuals and firms have to declare their full income Indirect Taxes Taxes paid by households through an intermediary such as a retail store The intermediary then pays the government Possibly avoidable – you can choose not to buy the goods and services Types of Taxation Systems Proportional Tax Regressive Tax Progressive Tax Proportional Tax A tax for which the percentage remains constant as income increases Many countries are now promoting the idea of proportional direct taxes or flat taxes The same percentage tax is paid at all levels of income Regressive Tax Tax that decreases in percentage as income increases Such a tax places a larger burden on lower income household than it does on higher income earners since a greater percentage of a poor household’s income is used to pay the tax than a rich household’s Most indirect taxes are regressive Regressive Tax Income of buyer $ Amount of tax paid $ % of income taxed 10,000 100 1% 50,000 100 0.2% 100,000 100 0.1% The higher-income consumer pays the same amount of tax as the lower-income consumer Although they appear to be equitable since everyone pays the same percentage of the price of the goods they consume, placing a larger burden on those whose ability to pay is lower and a smaller burden on the higher-income earners whose ability to pay is greater Regressive taxes may be a good source of government revenue and might discourage the consumption of demerit goods but they can worsen income inequality Progressive Tax This is a tax for which the percentage paid in tax increases as income increases Is the most equitable of the 3 types of taxes a government collects Lower income households not only pay less tax, but they pay a smaller percentage of their income in tax as well This is a hypothetical example where there are 4 tax brackets Taxable Income ($) % to be paid as tax 0 – 10,000 0 10,001 – 25,000 30% 25,001 – 50,000 40% 50,001 and higher 50% Progressive Tax If someone earns $56,000 they will pay the following tax: For the first $10,000 = 0 For the next $15,000 = 4.5k (15k x .30) For the next $25,000 = 10k (25k x .40) For the next $6,000 = 3k (6k x .50) In total they would pay = 17,500 On average they would be paying 31% tax (17,500 / 56,000) Progressive Taxation Exercise How much tax would they pay and what is their average tax rate if they earned: a) $7,000 b) $14,000 c) $28,000 d) $77,000 Taxable Income ($) % to be paid as tax 0 – 10,000 0 10,001 – 25,000 30% 25,001 – 50,000 40% 50,001 and higher 50% Common examples of taxes Income tax Corporate tax Sales taxes Capital gains tax Inheritance tax Excise duties Customs duties Stamp duty Monetary Policy ► Designed to control the amount of spending and investment in an economy by altering interest rates to affect the money supply and exchange rates. ► Interest rates refers to the price of money, both in terms of the price of borrowing money and the return for saving money in a bank account. ► If the economy is growing fast (overheating), the gov’t. or central bank is like to raise interest rates to combat the effects of inflation. 4 reasons businesses are charged varying ‘RATES’ of interest RISK – the greater the risk of a business defaulting on a lone, the higher the interest rate ► ADMINISTRATION COSTS – the higher the admin. costs involved in lending money to a business, the higher the interest rate. ► TIME – the longer the period of a loan, the higher the real interest rate tends to be due to opportunity cost of money being lent out ► EXPECTATIONS – if the economy is expected to do well, the it is likely interest rates will rise to dampen the effect of inflation. ► Interest Rates and Exchange Rates ► Positive correlation – an increase in interest rates tends to stimulate demand for its currency since foreign investors are attracted by better returns on their saving. ► Increase int. rates and appreciation of currency cause the price of exports to be relatively higher and likely to reduce the demand for exports; can be damaging for domestic businesses in the long run. Legal Opportunity & Threats ► The gov’t. imposes rules, regulations and laws to ensure that the general public is protected from the negative aspects of business activity. ► Common legislation affecting businesses include: Consumer protection legislation Employee protection legislation Competition legislation Social and environmental protection Ethical Opportunities and Threats ► Business ethics are the moral principles that are, or should be, considered in business decision making. ► Benefits of being socially responsible: They attract and retain good quality workers They attract new customers and retain existing ones It generates good publicity and public relations SWOT Analysis ► SWOT = strengths, weaknesses, opportunities and threats ► Is a frequently used decision-making tool ► We will discuss this topic next (unit 1.6)