A LEVEL Business
External Economic influences on
business behaviour
DO NOW- 5 min
Read the ase extract on page 98.
Write the topic ´ External Economic influences on business
behaviour.
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Objectives
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Describe the economic objectives of governments
Explain the nature and causes of economic growth and its impact on
business strategies
Analyse the business cycle and its impact on business strategies
Recognise and analyse the different causes of unemployment
Analyse the different causes of inflation and deflation and assess the
impact of the changing value of money on business strategy
Describe the policy measures that may be taken by governments to
pursue their economic objectives
Analyse the possible impact on business strategies of changes in tax rates,
interest rates and exchange rates
Analyse the significance of income elasticity of demand to business
decisions
Key terms to explain
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Economic growth
Recession
GDP
Business Cycle
Income elasticity of
demand
■ inflation
■ Fiscal policy
■ Monetary policy
■ Unemployment
■ Cyclical
unemployment
■ Structural
unemployment
■ frictional
unemployment
■ Exchange rate
■ Appreciation
■ Depreciation
Introduction
The state of a country’s economy – and by this is meant the
rate of economic growth, the rate of price inflation, the
unemployment level and the exchange rate – can contribute
directly to the success or failure of businesses. If business
expansion goes ahead just before a long economic recession,
then the additional cost of borrowing can destroy a business
as it will probably not be able to increase its sales. However,
the ability to spot and exploit a gap in a fast-growing
economy can lead to high profits. It is, therefore, misleading
to think just of ‘economic constraints’ on business activity as
the country's economic performance can just be easily
‘enable’ a business to take advantage of great new
opportunities.
Economic objectives of governments
All governments set targets for the whole economy and these are referred
to as ‘macro-economic’ objectives. These are likely to include,
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Economic growth – the annual percentage increase in a country’s total
level of output (known as gross domestic product or GDP)
A low target rate of price inflation – the rate at which consumer prices, on
average, increase each year
Low rate of unemployment
Exchange rate stability – the government will try to prevent wild swings in
the external value of the currency in terms of its price compared with
other currencies
Wealth and income transfers to reduce inequalities – some governments,
but necessarily all, attempt to reduce extreme inequalities of personal
income and wealth, usually by using the tax system
Economic growth – a definition and why it
is considered desirable
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Gross Domestic Product (GDP) is the total value of goods and services
produced in a country in one year – real GDP has been adjusted for
inflation
Economic growth is an increase in a country’s productive potential
measured by an increase in its real GDP
Economic is important to a country for several reasons,
Higher real GDP increases the quantity of goods and services available
for consumers and this increases living standards
Higher levels of output often lead to increased employment, which will
consumer incomes
Businesses should experience rising demand for their products,
although this will depend on income elasticity of demand for their
products
External economic influences
A beginners guide to GDP
https://www.youtube.com/watch?v=9sQHuILeU9
A
Factors to economic growth
Solo- individual task- in your book list the
factors that lead to economic growth
The business cycle
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The business cycle is 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
The business cycle
The business cycle
The business cycle
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A boom is a period of very fast economic growth with rising
incomes and profits. However, a boom often sows the seeds of its
destruction. Inflation rises due to a very high demand for goods and
services, and shortages of key skilled workers leads to high wage
increases.
The business cycle
The business cycle
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A downturn or recession is the effect of falling demand. Read GDP
growth slows (downturn) and may even start to fall (recession).
Incomes and consumer demand fall and profits are much reduced –
some firms will record losses and some will go out of business.
The business cycle
The business cycle
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A slump is a where GDP falls substantially and house and asset
prices fall. This is much more likely to occur if the governments fails
to take corrective economic action.
The business cycle
The business cycle
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Recovery and growth occurs when real GDP starts to increase
again. This is either because corrective government action starts to
take effect or the rate of inflation falls so that the country’s
products become competitive once more and demand for them
starts to increase.
Recession.
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What is a recession?
Is a recession a good or a bad thing?
Is it always bad to have a recession?
How does it occur?
How do businesses adapt and
respond to period of economic
growth and period of recession?
Is a recession all bad?
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A recession is a period of six months or more of declining GDP
How business strategy could adapt to either economic growth or recession
Type of producer
Period of economic
growth
Producers of luxury
• Increase the range of
goods and services – e.g.
goods and services
• Raise prices to
cars
increase profits
Period of recession
• May not reduce prices for fear
of damaging long-term image
• Offer promotions
Producers of normal
• Do nothing – sales not • Lower prices
goods and services – e.g.
much affected anyway • Promotions
tinned food
Producers of inferior
• Attempt to move
goods and services – e.g.
product upmarket
very cheap clothing
• Promote good value and low
prices
• Increase range of distribution
outlets
Progress check
Business cycle
Missing words
The business (or t__________) cycle is the tendency in free
______________ economies for demand and output to move up and
down in a wave-like motion. Between 1946 and 1981, this cycle lasted
for about five years, in other words from the peak to the
____________ was about two and a half years and the upturn lasted
for about the same time. Fortunately, because the underlying
__________ in demand was moving ahead quite rapidly, the upturns
were sharp and the downturns quite minor. Since 1980/81, the length
of the upturns has increased, though the downturns have been severe.
The key to the business cycle is to know that it is real, but not
predictable.
trend, trade, peak, market, developing
Business cycle
What happens in which phase of the cycle?
Match 2 characteristics to each phase.
Phase of the Cycle
Ans
Characteristics
Characteristics
1. Slump
A. Rising wage and price
inflation
W. Many new business startups
2. Upturn
B. Business investment
low, but not falling
X. Interest rates falling
3. Boom
C. Firms may be building
up stock levels
Y. High unemployment
4.
Recession/downturn
D. Import levels are
starting to decline
Z. Growth, but no sign of
inflation yet
Businesses in recession
Fill in the gaps
A recession can be defined as two consecutive quarters of
_____________ growth in GDP (Gross Domestic Product). During
a recession consumers tend toward saving rather than spending
as they fear more difficult times ahead. This lack of spending
means demand for most products __________ . Therefore
unless firms can find ways either to cut ________ or find, new
innovative ways of increasing demand, __________ also fall. In a
recession, cash __________ becomes especially important, as a
business can survive for many months without profit, but cannot
survive for a month without cash.
falls, costs, flow, profits, negative
Businesses in recession
State whether each statement is true or false:
■Demand for
all products falls during a recession.
■A recession occurs when house prices fall.
■Consumers tend to become more price sensitive during a
recession.
■Launching new brands, products or services may be even riskier
during difficult economic times
Response to Economic Downturn
Missing words
When there is a downturn in the economy, consumer spending falls
and firms tend to suffer from a fall in
_______________. Quickly a firm must decide on a new strategy
suited to this situation. It can respond positively or negatively. If
managers see a serious threat to the firm’s __________________ they
are likely to respond negatively, by ____________ cutbacks and
cutting ____________. Positive responses would include ways to
improve competitiveness for example, increasing advertising spending,
finding more creative ways to market and distribute the product and
____________________ the product from competitors.
prices, staff, demand, differentiating, survival
Income elasticity of demand
Virtually all businesses will have greater opportunities for increased
sales, profits and expansion during periods of economic growth.
However the impact of growth and the rising consumer incomes
that accompany it will not be evenly felt, however. It depends
upon the income elasticity of demand for a product.
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Income elasticity of demand measures the responsiveness of
demand for a product after a change in consumer incomes.
Income elasticity of demand =
% change in demand for a product
% change in consumer incomes
Income elasticity of demand
1. Normal goods
The income elasticity for normal goods is positive and
between 0 and 1. This means that, when consumer incomes
rise, the demand for these goods may well also increase, but
by a smaller proportion. These tend to be essential or
necessity goods, which will be brought in roughly the same
quantities by consumers no matter what their incomes.
Examples include basic foods and pharmaceutical goods.
Income elasticity of demand
2. Luxury goods
The income elasticity associated with luxury goods is positive
and greater than 1. This means that, when consumer
incomes rise, the demand for these goods will rise by an
even greater proportion. This is because consumers may
already be purchasing sufficient quantities of normal goods.
Thus, when their disposable incomes rise, they are able to
spend these increases on more unusual non-necessity items,
such as holidays, leisure activities and consumer durables.
Income elasticity of demand
3. Inferior goods
The income elasticity for these products is negative. This
means that demand for these products will decline following
an increase in consumer incomes, but will rise when
consumer incomes are reduced. Examples of these goods
and services could include:
◻ Second-hand goods, such as furniture
◻ ‘economy’ own-brand food products
◻ Poorer cuts of meats
◻ Weekend breaks in own country rather than long holidays
abroad
Inflation and deflation – changes in the
value of money
Inflation is an increase in the average price level of
goods and services. It results in a fall in the value of
money.
■ Deflation is a fall in the average price level of goods
and services.
■ Demand pull inflation- caused by too much demand
on limited supply of goods. Businesses tend to
increase prices
■ Cost push inflation- Caused by increased production
costs. Businesses will have to increase SP to avoid
loss
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What causes inflation?
Essentially, it is accepted that prices rise either
because businesses are forced to increase them,
since their costs are rising (cost-push inflation), or
businesses take advantage of high consumer
demand to make extra profits by raising prices
(demand-pull inflation).
Demand pull vs Cost push inflation
Demand pull inflation- caused by too much demand for
a product. Businesses may increase prices to
generate more income, depending on the price
elasticity of demand
Cost push inflation:- caused by increased costs of
production. Business may be forced to increase
prices to avoid losses
The impact of inflation on business strategy
Inflation can have a number of benefits for business if the
rate is quite low including,
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Cost increases can be passed on to consumers more easily if
there is a general increase in prices
However, high rates of inflation, say above 5-6% per year, can
have very serious drawbacks for business including,
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Employees will become much more concerned about the real
value of their incomes. Higher wage demands are likely and
there could be an increase in industrial disputes.
The impact of deflation on business strategy
Deflation would not actually benefit most businesses
because,
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Consumers would delay making important purchases, hoping
that prices would fall further. This would cause a reduction in
demand, which could lead to a recession.
Holdings of stocks of materials and finished goods will be
falling in value. Businesses will hold as few stocks as possible.
This will also reduce orders for supplies from other
businesses.
Unemployment – definitions
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Unemployment exists when members of the working
population are willing and able to work, but are
unable to find a job
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The working population are all those in the
population of working age who are willing and able
to work
Unemployment – causes
1.
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2.
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3.
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Cyclical unemployment
Cyclical unemployment is unemployment resulting from low
demand for goods and services in the economy during a period of
slow economic growth or a recession
Structural unemployment
Structural unemployment is unemployment caused by the decline
in important industries, leading to a significant job losses in one
sector of industry
Frictional unemployment
Frictional unemployment is unemployment resulting from
workers losing or leaving their jobs and taking a substantial period
of time to find alternative employment
Unemployment – costs to businesses
Unemployment tends to effect businesses negatively
because,
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Unemployment reduces demand for goods and services by
reducing their incomes of those looking for work
Reduced demand from consumers for luxury and normal
goods and services will lower the revenues and profits for
these types of businesses
Gov’t may increase taxes on businesses to try and pay
welfare benefits - grants
Unemployed workers lose skills and reduced the quality of
labour force.
Unemployment – benefits to businesses
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Employed workers will not risk losing jobs
Reduced wages, or business may choose not to increase
wages at all.
Businesses may attract skilled labour from regions that face
high unemployment rates.
Progress check B
Unemployment
Missing words
Unemployment refers to people who are able and willing to work but
unable to get a job. Governments are concerned if the unemployment
level _______________, partly because it results in
_________________ tax revenue and _________________ costs in
social benefits. Additionally, if more people are unemployed,
consumer spending is likely to _____________ as those people have
less disposable ______________. This will cause a greater loss of
government income. In the 2009 recession many analysts were
concerned about how the government would cope with its very poor
financial position.
income, increasing, falling, rises, fall
Unemployment
True or false?
■An
increase in the level of unemployment is likely to have a
negative net effect on a country.
■Some businesses will benefit from increased levels of
unemployment
■In times of recession unemployment is likely to fall
■Immigration always leads to increased unemployment among
the home workforce
■Unemployment only falls when economic growth exceeds the
rate of increase in productivity
How do Governments control and impact
the economy and business in a country?
Governments can use:
FISCAL POLICIES
MONETARY POLICIES
EXCHANGE RATE FLACTUATIONS
Government macro-economic policy
These are policies that are designed to impact on the
whole economy – or the ‘macro-economy’. They mainly
operate by influencing the level of total or aggregate
demand in the economy. This level of demand then
works through to determine the value of output of
goods and services (GDP) and, as a consequence, the
level of employment.
Government macro-economic policy
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Fiscal policy
Fiscal policy is concerned with decisions about government
expenditure, tax rates and government borrowing. These
operate largely through the government’s annual budget
decisions.
In many countries, the government is responsible for spending
(and raising in taxes) up to 40% of the GDP. The major
expenditure programmes include social security, health service,
education, defence and law and order. The government raises
finance to pay for these schemes through taxation, and the main
tax revenues come from taxation, and the main tax revenues
come from income tax, value added tax, corporation tax and
excise duties.
Government macro-economic policy
Government macro-economic policy
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Monetary policy
Monetary policy is concerned with decisions about the rate of
interest and the supply of money in the economy.
Monetary policy is mainly concerned with changes in interest
rates, which are determined by the base interest rate set each
month by central banks, e.g. the Bank of England (UK) and the
European Central Bank – ECB (Eurozone).
Government policy, economic efficiency
and business competitiveness
Government policies that aim to increase industrial competitiveness
are often refereed to as supply-side policies because they aim to
improve the supply efficiency of the economy. Three examples of
policies that could have this effect are,
1.
Low rates of income tax
It is argued that, if workers and managers are forced to pay high rates
of tax on any increase in income, then they will not be motivated 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 after tax do not justify the risks involved.
So, reducing rates of income tax is a supply-side policy.
Government policy, economic efficiency
and business competitiveness
2.
Low rate of corporation tax
This is a tax on the net profits of limited companies after interest.
High rates of this tax will leave fewer funds for reinvestment in
businesses and will discourage new investments and new projects.
This lack of investment will reduce the competitiveness of businesses.
3.
Increasing labour market flexibility and labour productivity
Labour is, of course, a key economic resource. Most governments
want to use polices that will increase the skills and efficiency of the
country’s workforce and encourage workers to demonstrate a strong
incentive to work.
Progress check C
Exchange rates
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The exchange rate is the price of once currency in terms of
another
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An exchange rate depreciation is a fall in the external value
of a currency as measured by its exchange rate against other
currencies, e.g. if $1 falls in value from R20 to R15, the value
of the dollar has depreciated in value. (The value of rand has
appreciated in value.)
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An exchange rate appreciation is a rise in the external value
of a currency as measured by its exchange rate against other
currencies, e.g. if $1 rises from R15 to R20, the value of the
dollar has appreciated. (The value of rand has depreciated)
Exchange rates
As with any price on a free market, exchange rates are
determined by the forces of supply and demand.
Factors that determine the demand for and supply of a
currency
Demand for the currency
Supply of the currency
• Foreign buyers of a country’s
domestic goods and services
• Domestic businesses buying
foreign imports
• Foreign tourists spending
money in the country
• Domestic population travelling
abroad
• Foreign investors
• Domestic investors abroad
Exchange rates fluctuations
When demand for a currency exceeds supply, its value will rise. This is
called an appreciation because one unit of the currency will buy more
units of other currencies.
Appreciation of a currency – winners
The domestic firms that gain from an appreciation of the country’s
currency are,
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Prices of exports increase- importers of foreign raw materials and
components for whom the domestic currency cost of these imports will
be falling – this increases their competitiveness
Importers of foreign manufactured goods, who are able to import the
product more cheaply in terms of domestic currency
Exchange rates fluctuations
When demand for a currency exceeds supply. Its value will rise. This is
called an appreciation because one unit of the currency will buy more
units of other currencies.
Appreciation of a currency – losers
The domestic firms that lose from an appreciation of the country’s
currency are,
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Exporters of goods and services to foreign markets – these will become
more expensive to foreign buyers
Businesses that sell goods and services to the domestic market and have
foreign competitors – as appreciation makes imports cheaper, it will
make domestic producers less competitive in their own market
Exchange rates fluctuations
Impact of HK dollar appreciation from US$8.60 to US$10. 00 to HK$1
Importer
Exporter
Places an order for US$86,000 worth of Has a contract to supply HK$50,000
components from US supplier
worth of goods to a US customer
At the old exchange rate, this would
cost HK$10,000
At the old exchange rate these goods
would be sold for US$430,000
At the new exchange rate, this would
cost HK$8,600
At the new rate, these would be sold
for US$500,000
The importer’s costs have fallen and
The exporter’s products are now less
this makes the domestic business more competitive on the US market – export
competitive
orders are likely to be lost
Other businesses that are currently
buying domestic components will now
be encouraged to buy US ones.
Sales are also likely to be lost in the
home market since firms may be able
import more cheaply from the US.
Exchange rates fluctuations
When supply for a currency exceeds demand, its value will fall. This is
called a depreciation because one unit of the currency will less more
units of other currencies.
Depreciation of a currency – winners
The domestic firms that gain from a depreciation of the country’s
currency are,
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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
Exchange rates fluctuations
When supply for a currency exceeds demand, its value will fall. This is
called a depreciation because one unit of the currency will less more
units of other currencies.
Depreciation of a currency – losers
The domestic firms that lose from a depreciation of the country’s
currency are,
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Manufacturers who depend heavily on imported supplies of materials,
components or energy sources – these costs will rise and will reduce
competitiveness
Retailers that purchase foreign supplies, especially if there are close
domestic substitutes – the prices of these imports will rise and the
retailers may be forced to find domestic suppliers of similar quality
goods
Progress Check D
Exchange rates
Missing words
The exchange rate measures the value of one currency compared to another.
When the RAND increases in value, each RAND can buy more of any foreign
currency. For example, if the RAND was worth $15 but then increased in
value by 10%, each RAND could now buy ___________ $s. This would mean
that ___________ RANDS would be needed to buy any US import, i.e.
imports to the SA become ________________. Therefore the SA demand for
US imports would __________. When the value of the RAND increases, this
makes SA exports more __________________ and therefore demand for
exports is likely to _________________ . To sum it up, a higher RAND makes
SA goods ____________ competitive internationally; a weaker RAND makes
SA goods ___________ competitive internationally.
fewer, more, fall, less, more, cheaper, expensive, rise
Exchange rates
True or false?
■The
value of a currency rises with inflation
■The Japanese currency is called the Wan
■If the pound depreciates, this will make UK exports cheaper for
foreign importers
■Increasing interest rates tends to strengthen the value of the
domestic currency
A2 External influences on business
behaviour: Multiple Choice
What is real GDP?
a a measure of an economy’s rate of inflation
b the total value of exports less imports of an economy
c the total value of goods and services produced in an economy
in one year, adjusted for inflation
d the value of household consumption in an economy in one
year
A2 External influences on business
behaviour: Multiple Choice
Which of the following is not a factor that leads to economic
growth?
a technological progress
b an increase in the working population
c an increase in investment
d an increase in the rate of inflation
A2 External influences on business
behaviour: Multiple Choice
What is an economic recession?
a two successive quarters of declining real GDP
b the recovery phase of the business cycle
c two successive quarters in which inflation is falling
d any time period in which GDP declines
A2 External influences on business
behaviour: Multiple Choice
During a recession, which of the following businesses is least
likely to see a drop in its sales?
a a business selling inferior goods
b a business selling luxury goods
c a business selling goods which have a high income elasticity
d a business selling normal goods
A2 External influences on business
behaviour: Multiple Choice
What is inflation?
a a period of time during which the purchasing power of money
increases
b a fall in the average price level of goods and services
c a fall in the purchasing power of money
d the value of output of the economy
A2 External influences on business
behaviour: Multiple Choice
Which of the following is an example of cost−push inflation?
a an increase in demand in the economy causing an increase in
prices
b an increase in the price of imported commodities due to a
reduction in world supply
c an increase in the real value of the output of an economy
d a reduction in interest rates
A2 External influences on business
behaviour: Multiple Choice
When is an economy most likely to suffer from demand–pull
inflation?
a during an economic recession
b when there is a rise in the value of a country’s exchange rate
c when interest rates rise
d during an economic boom
A2 External influences on business
behaviour: Multiple Choice
What is the cause of cyclical unemployment?
a workers being between jobs
b a low level of aggregate demand
c technological progress
d a shift in demand causing a decline in important industries
A2 External influences on business
behaviour: Multiple Choice
The following data relate to the Indian economy:
Year
Consumer price inflation
(percentage annual change)
2002
4.3
2003
3.8
2004
3.8
2005
4.2
2006
6.2
2007
6.4
Which of the following statements about inflation in India is true?
a Prices fell between 2002 and 2003.
b Between 2002 and 2007 prices rose by 28.7% in total.
c Consumer prices have been volatile.
d Consumer prices have risen each year during the period.
A2 External influences on business
behaviour: Multiple Choice
In 2018, there was a depreciation of the UK’s currency (sterling)
against that of the euro (used in the eurozone countries in the
European Union). Which of the following is a consequence of that
depreciation?
a UK exporters will become more price competitive in eurozone
countries.
b UK importers will pay less for goods and services imported from the
Eurozone.
c There will be a reduction in inflationary pressure in the UK economy.
d Tourists from the UK visiting countries in the eurozone will benefit
from the increased spending power of sterling.
A2 External influences on business
behaviour: Multiple Choice
Which of the following is an example of a contractionary fiscal
policy?
a an increase in interest rates
b a reduction in interest rates
c an increase in income tax
d an increase in government spending
A2 External influences on business
behaviour: Multiple Choice
Monetary policy is concerned with:
a decisions about government spending and taxation in the
economy
b decisions about interest rates and the supply of money in the
economy
c decisions about government spending alone
d decisions about interest rates alone.
A2 External influences on business
behaviour: Multiple Choice
A government wishing to reduce inflation within the economy
would be advised to:
a increase government spending
b reduce taxation
c increase the supply of money
d increase interest rates.
A2 External influences on business
behaviour: Multiple Choice
A reduction in interest rates is most likely to lead to which of the
following economic outcomes?
a an increase in consumer spending
b an increase in unemployment
c an increase in the value of the exchange rate
d a reduction in the rate of inflation
Other Economic issues
Taxation on products VAT
Subsidies and incentives
Training of youth/workforce