External Economic Influences on Business Activity

Economic Growth

The annual percentage increase in a country’s total level of output, known as Gross Domestic Product (\text{GDP}).

Real \text{GDP}

The value of total output of goods and services produced in an economy, adjusted for inflation.

Inflation

The rate at which consumer prices, on average, increase each year.

Unemployment

The state of being within the workforce but without a job, often measured as a percentage of the total working population.

Balance of Payments

A long-term objective to maintain a balance between the value of a country's imports and the value of its exports.

Exchange Rate Stability

A government objective to prevent uncontrolled and rapid swings in the external value of the national currency.

Macroeconomic Objectives

Targets set by governments for the whole economy, including growth, low inflation, low unemployment, and balance of payments.

Government Loan Guarantee Schemes

Schemes where the government guarantees a percentage of a bank loan repayment if a new enterprise or small business fails.

Business Start-up Support: Advice

Information and training provided through government industry departments and local colleges to help entrepreneurs.

Business Start-up Support: Workshops

The financing and construction of small workshops let to entrepreneurs at low rents, often in economically deprived areas.

Corporation Tax for Small Businesses

Lowering the rate of tax on profits for new and small businesses to allow them to retain more funds for expansion.

Government Subsidies

Financial assistance provided by the government to keep prices down or to stop loss-making businesses from failing.

Advantage of Subsidies: Unemployment

They help avoid rising unemployment by preventing business failure and keeping suppliers in business.

Disadvantage of Subsidies: Taxation

The government must raise taxes or cut other spending programmes to provide the financial support.

Disadvantage of Subsidies: Inefficiency

Subsidies can act as a disincentive for businesses to become more efficient, as they are protected from failure.

Market Failure

An inefficient allocation of resources where the free market fails to take all costs, such as environmental damage, into consideration.

Private Costs

The costs of land, capital, labour, and materials paid for by a business to produce a product.

External Costs

Consequences of production, such as pollution or noise, that are not paid for by the business but borne by society.

Market Failure: Over-production

Occurs when external costs are not included in the price; since the price is too low, consumer demand and production levels are too high.

Market Failure: Labour Training

Under-provision of training because businesses fear employees will be poached by competitors once they are qualified.

Monopoly

A market situation dominated by one supplier, where the business can restrict output and raise prices.

Correcting Market Failure: Pollution

Governments can impose fines on polluting businesses or set strict limits on allowable pollution levels.

Correcting Market Failure: Skill Shortages

Solutions include industrial organizations funding industry-wide training or the government paying for college courses through taxation.

Correcting Market Failure: Monopolies

Governments use competition laws to break down monopoly power or encourage new market entrants.

GDP Percentage Growth Example

Economic growth varies widely; for example, China averaged 8\% between 2009 and 2018, while Venezuela saw a recession of -25\%.

Benefits of Economic Growth: Living Standards

Real \text{GDP} growth raises average living standards if the population increases at a slower rate than output.

Benefits of Economic Growth: Public Sector

More resources can be devoted to health and education projects without reducing resources in other sectors.

Benefits of Economic Growth: Poverty

Absolute poverty can be reduced or eliminated if the benefits of growth are spread across the whole population.

Benefits of Economic Growth: Business Demand

Businesses typically experience rising demand for products, though this depends on the income elasticity of demand.

Potential Drawback of Rapid Growth

It can lead to worsened pollution, damage to health, and job losses due to the technological changes driving the growth.

Causes of Growth: Technological Change

Innovation and expansion of industrial capacity encouraged by business investment.

Causes of Growth: Economic Resources

Higher working populations or the discovery of new resources like oil and gas reserves.

Causes of Growth: Productivity

Achieving higher output per worker through a more highly skilled workforce and adoption of new technology.

The Business Cycle

The pattern of growth in an economy where it expands and contracts at different rates over time.

Business Cycle: Boom

A period of rapid growth, rising incomes, and high profits, often accompanied by rising inflation and worker shortages.

Business Cycle: Downturn / Recession

A period where real \text{GDP} growth slows or falls, leading to reduced consumer demand and lower business profits.

Technical Definition of Recession

Two consecutive quarters (six months) of falling real \text{GDP}, where growth is negative.

Business Cycle: Slump

A serious and prolonged recession where real \text{GDP} falls substantially and asset prices drop.

Business Cycle: Recovery

The phase where real \text{GDP} starts to increase again, often aided by corrective government action or increased export demand.

Recession Opportunity: Cheap Assets

Factories or equipment may be relatively cheap to buy, allowing businesses to invest in preparation for recovery.

Recession Opportunity: Inferior Goods

Demand for cheaper products with negative income elasticity of demand may increase as consumer incomes fall.

Recession Opportunity: Efficiency

The risk of job losses may encourage better relations between employers and employees, leading to improved efficiency.

Luxury Producers in a Boom

Businesses typically increase their range of goods, raise prices to increase profit margins, and increase output.

Luxury Producers in a Recession

They may offer credit terms and promotions, but often avoid price cuts to protect their long-term brand image.

Basic Goods Producers in a Boom

Sales are often not much affected, but businesses may add extra value through better packaging or ingredients.

Basic Goods Producers in a Recession

Businesses emphasize good value and low prices, and may extend their range to include more basic, affordable products.

Deflation

A situation where the value of money increases because the average level of prices is falling.

Venezuela Hyperinflation

An extreme case of inflation where prices rise so rapidly that local currency becomes virtually worthless, often requiring counting machines for cash.

Cost-Push Inflation

Inflation caused by rising costs of production, such as higher material prices or wage demands, forcing businesses to raise prices.

Demand-Pull Inflation

Inflation caused by high consumer demand exceeding the supply capacity of the economy, allowing businesses to raise prices for profit.

Benefit of Low Inflation: Debt

The real value of debt falls, making it easier for heavily indebted companies to repay loans.

Benefit of Low Inflation: Fixed Assets

The monetary value of land and buildings rises, which can make a business appear more financially secure.

Drawback of High Inflation: Cash Flow

Businesses may struggle to finance the higher costs of materials and supplies, leading to liquidity problems.

Drawback of High Inflation: Competitiveness

If one country's inflation is higher than its neighbors', its exports lose price competitiveness in global markets.

Drawback of High Inflation: Uncertainty

Difficulty in forecasting future prices and sales makes investment appraisal and long-term planning very difficult.

Negative Impact of Deflation: Demand

Consumers delay purchases hoping prices will fall further, which can lead to a recession.

Negative Impact of Deflation: Real Debt

Interest and loan repayments are made with money that has risen in value, increasing the real burden of debt.

CPI (Consumer Price Index) Target

The target inflation rate for many economies (like the UK and EU), typically set at 2.0\% per year.

Cyclical Unemployment

Unemployment caused by a lack of aggregate demand in the economy during the recession stage of the business cycle.

Structural Unemployment

Unemployment resulting from structural changes in the economy, where workers' skills no longer match existing job vacancies.

Frictional Unemployment

Temporary unemployment occurring when workers are between jobs or looking for their first job.

Cost of Unemployment: Social

Reduced output lowering living standards, increased social problems like crime, and the fiscal cost of supporting the unemployed.

Impact of Unemployment on Business: Recruitment

It becomes easier to recruit as a larger pool of applicants is available for every vacancy.

Impact of Unemployment on Business: Wages

Workers may accept lower pay increases due to fear of job loss, helping businesses control costs.

Monetary Policy

Government or central bank policy focused on managing the economy through changes in interest rates and the money supply.

Base Interest Rate

The rate set monthly by a central bank that influences all other interest rates in the economy.

Impact of Higher Interest Rates on Profits

Interest costs for businesses with high debt increase, directly reducing their net profits.

Impact of Higher Interest Rates on Consumer Demand

Borrowing becomes more expensive, reducing demand for luxury items often bought on credit, like cars and houses.

Fiscal Policy

Government decisions regarding total spending and tax rates, typically announced in an annual budget.

Budget Deficit

A situation where government spending exceeds tax revenue in a given year.

Budget Surplus

A situation where government tax revenue exceeds government spending in a given year.

Expansionary Fiscal Policy

Increasing government spending and/or reducing taxes to boost demand and reduce unemployment during a recession.

Contractionary (Deflationary) Fiscal Policy

Reducing government spending and/or increasing taxes to slow down an overheating economy and reduce inflation.

Direct Tax

Taxes levied on income or profits, such as income tax and corporation tax.

Indirect Tax

Taxes levied on spending, such as Value Added Tax (\text{VAT}) or excise duties on petrol.

Corporation Tax Impact

Increased rates reduce retained earnings, which decreases the internal finance available for business investment.

VAT Impact on Retail

Rising \text{VAT} increases the final price of products, potentially reducing demand depending on price elasticity.

Supply-side Policies

Government actions designed to improve the supply efficiency and global competitiveness of a country's industries.

Supply-side: Income Tax Cuts

Intended to increase the incentive for people to work harder, seek promotion, and start new businesses.

Supply-side: Labour Market Flexibility

Measures such as subsidies for training, funding for higher education, and encouraging skilled immigration to fill job gaps.

Supply-side: Infrastructure

Spending on roads, railways, and internet to improve the efficiency of transport and e-commerce.

Supply-side: Deregulation

Reducing 'red tape' and legal formalities to make it faster and easier for entrepreneurs to start a business.

Exchange Rate Determination

The price of a currency is determined by the interaction of demand (buyers of exports, tourists) and supply (buyers of imports) on the foreign exchange market.

Exchange Rate Depreciation

A fall in the external value of a currency in terms of another currency (e.g., 1 dollar falling from €2 to €1.50).

Exchange Rate Appreciation

An increase in the external value of a currency in terms of another currency (e.g., 1 dollar rising from €1.50 to €2).

Appreciation Winner: Importers

Domestic businesses buying foreign materials benefit because the domestic currency cost of those imports falls.

Appreciation Loser: Exporters

Businesses selling abroad suffer as their products become more expensive for foreign customers in their local currency terms.

Depreciation Winner: Exporters

Exporting firms can reduce prices in overseas markets, which should increase sales volume and business expansion.

Depreciation Loser: Importers

Manufacturers depending on imported materials face higher costs, which reduces their price competitiveness.

Common Currency (e.g., the Euro)

A single currency used by multiple countries, eliminating fluctuations and transaction costs between them.

Common Currency: Limitation

Individual member countries lose the power to set their own interest rates or use depreciation to boost competitiveness.

International Competitiveness: Non-Price Factors

Success factors other than price, including product design, quality, promotion, after-sales service, and employee training.

Income Elasticity of Demand & Growth

The extent to which demand for a product changes as consumer incomes rise during economic growth.

Hyperinflation

Extremely high and accelerating inflation that quickly erodes the real value of the local currency.

Discretionary Income

The amount of an individual's income available for spending after the essentials (like taxes and mortgages) have been paid.

Trade Receivables Management in Inflation

A strategy to reduce the time period for customers to pay so the business receives money before it loses significant real value.

Aggregate Demand

The total demand for goods and services within an economy at a given time.

Inward Investment

Investment from overseas businesses into the domestic economy, often encouraged by a common currency or stable economic environment.

Fixed Assets & Inflation

Items like land and buildings which typically appreciate in monetary value during inflationary periods.

The Engineering Employers Federation

An example of an industrial organisation mentioned that could facilitate industry-wide skills training to solve market failure.