2.5 - External Influences

What can be used to analyse the external environment?

PESTLE analysis

What does PESTLE stand for?

Political Economic Social Technological Legal Ethical/environmental

Why must businesses consider the external environment in which they operate?

In order to make effective decisions

Do businesses have much control over the external environment?

Not likely, if any

Why do businesses need to monitor their environment constantly?

In order to react to any changes that occur

What will the most competitive businesses do about change?

Anticipate change, rather than react to it

What are economic influences a part of?

The external environment in which a business operates

Give examples of political factors in PESTLE analysis

Industry regulation Business policy & incentives

Give examples of economic factors in PESTLE analysis

Business cycle Interest rates Inflation Exchange rates Government spending & taxation

Give examples of technological factors in PESTLE analysis

Disruptive technologies Adoption of mobile tech New production processes Big data and dynamic pricing

Give examples of legal factors in PESTLE analysis

Employment law Minimum/living wage Health & Safety laws Environmental legislation

Give examples of social factors in PESTLE analysis

Demographic change Compact tastes & fashions Changing lifestyles

Give examples of ethical/environmental factors in PESTLE analysis

Sustainability Tax practices Ethical sourcing Pollution & carbon emissions

What is the business cycle?

The rate of change in the value of economic activity

What is the most common measure of the rate of change in the value of economic activity?

GDP - Gross Domestic Product

What is the level of demand in most markets influenced by?

The rate of economic growth

How do economies vary?

In terms of their 'normal' long-term growth rate

What will GDP vary depending on?

The stage of the business cycle

What does the business cycle describe?

The changes in GDP from one quarter to the next The traditional sequence of slump, recovery, boom and recession The regular patterns of 'ups and downs' in the economy

What is the traditional sequence of the business cycle?

Boom Recession Slump/depression Recovery

Describe the boom stage of the business cycle

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

Describe the recession stage of the business cycle

Falling levels of consumer spending and confidence means lower profits for business which start to cut back on investment Spare capacity increases Rising unemployment

Describe the slump/depression stage of the business cycle

Very weak consumer spending and business investment Many business failures Rapidly rising unemployment Prices may start falling

Describe the recovery stage of the business cycle

Things start to get better Consumers begin to increase spending Businesses feel a little more confident and start to invest again But it takes time for unemployment to stop growing

What causes the business cycle?

Changes in the level and value of business and consumer confidence Alternating periods of stocking (businesses increasing their stocks) and destocking (reducing the value of the stocks held) Changes in government policy which can induce a change in the economy

What is economic growth?

An increase in the level of economic activity or real gross domestic product Extent to which the volume of goods and services being produced increases over time

What is the best measure of whether a country is getting wealthier?

Real GDP is better than GDP measured in pure monetary value

How can real GDP be measured?

Total income of a country Total expenditure of the country Total level of output of the country

What is the level of economic growth affected by?

The availability and exploitation of valuable natural resources The availability of a well-educated and highly skilled workforce Increasing investment and new technology Government policy encouraging growth

What does the effect of economic growth on businesses depend on?

The rate of change of growth, reflected in the different stages of the business cycle

What are the effects of economic growth on businesses?

Sales Corporate profits Investment Employment Business strategy

How does economic growth affect sales of businesses?

With higher levels of real GDP, real incomes in the economy are higher, which should lead to higher retail sales

How does economic growth affect corporate profits of businesses?

Higher income leads to a greater demand for goods and services, this provides opportunities for higher profits Sales are likely to increase as well as the chance to increase the selling price due to the greater demand

How does economic growth affect investment of businesses?

Higher demand for goods and services means that firms are more likely to invest in expanding their operations Increasing demand is likely to be accompanied by rising share prices and higher profitability, which makes it easier to obtain the funds

How does economic growth affect employment of businesses?

Businesses seeking to expand production may initially choose to make their existing labour work harder They would then only recruit more workers once they are convinced the increase in demand for their production is sustainable

How does economic growth affect business strategy?

Expansion - rapid expansion is more easily achieved during this period as sales can be gained without having to steal sales from the competition New products - economic growth provides new opportunities for firms to update or extend their product range Generally, it provides favourable trading conditions and new opportunities

Why don't economic growth and increased wealth necessarily produce an increase in welfare?

It can have serious consequences for the environment e.g. pollution and congestion

What is an interest rate?

The reward for saving and the cost of borrowing expressed as a percentage of the money saved or borrowed

Give examples of how at any one time there are a variety of different interest rates operating within the external environment

Interest rates on savings in bank accounts Borrowing interest rates Mortgage interest rates Credit card interest rates and payday loans Interest rates on government and corporate bonds

What does the Bank of England use policy interest rates for?

To help regulate the economy and meet economic policy objectives

What might happen if interest rates start to fall?

Cost of servicing loans/debt is reduced - boosting spending power Consumer confidence should increase leading to more spending Effective disposable income rises - lower mortgage costs Business investments should be boosted e.g. prospect of rising demand Housing market effects - more demand and higher property prices Exchange rate and exports - cheaper currency will increase exports

What happens to demand for consumer and capital goods if the interest rate falls?

Increases

What happens to demand for consumer and capital goods if the interest rate rises?

Falls

Describe why the demand for consumer goods increases if the interest rate falls

Saving money is less attractive because less interest is received, meaning people prefer to spend rather than save, causing an increase in demand Also, variable rate mortgage and other loan repayments will fall, meaning more disposable income available

Describe why the demand for consumer goods decreases if the interest rate rises

Saving money is more attractive because more interest is received, meaning people prefer to save rather than spend, causing an decrease in demand Also, variable rate mortgage and other loan repayments will rise, meaning less disposable income available

Describe why the demand for capital goods increases if the interest rate falls

It is cheaper to purchase expensive capital equipment on credit, meaning firms might bring forward planned future investment or actually increase the level of investment, as the return on projects is more likely to exceed the interest payments

What happens when interest rates in the UK are high relative to interest rates in other countries?

It becomes more attractive to invest in UK banks, meaning foreign investment flows into the country in order to take advantage of the attractive rates Investment in a UK bank can only take place in sterling, so there is an increase in demand for pounds and the value of the pound rises

What is an exchange rate?

The price of one currency in terms of another currency

What determines the exchange rate?

The forces of demand and supply in the currency markets

What does it mean if the pond sterling appreciates?

The sterling value has become stronger or more expensive to buy

What does it mean if the pound sterling depreciates?

The sterling value has become weaker or cheaper to buy

What does the effect of changes in exchange rates on businesses depend on?

Whether they are businesses that: Export their goods to consumers in other countries Sell their goods in the UK Are competing against foreign imports Purchase imported fuel, raw materials and components to use in the production of their own goods

Describe SPICED

Strong pound, imports cheap, exports dear A rise in the value of the pound - cheaper for imports, demand for imports rises A rise in the value of the pound - less competitive export price, demand for exports falls

Describe WPIDEC

Weak pound, imports dear, exports cheap A fall in the value of the pound - more expensive for imports, demand for imports falls A fall in the value of the pound - more competitive export price, demand for exports rises

What 2 acronyms describe the impact of exchange rates on exporters and importers?

Rise in value = SPICED Fall in value = WPIDEC

Describe the full impact of an increase/appreciation in the exchange rate for a currency

May increase the price at which exports are sold abroad and reduces the price charged for imports in the UK This will affect revenue, competitiveness and profitability The extent to which the charging prices of exports and imports will affect export sales and the purchase of imports depends on the price elasticity of demand; despite this exchange rates aren't the only thing that affect demand for exports/imports

What will the strategies that a business may deploy in response to changes in exchange rates depend on?

Whether they are falling or rising What market the business is operating in

Describe the business strategy for a business that exports its goods to consumers in other countries for a rising exchange rate for the pound

It must understand how higher prices will affect sales - if sales are likely to fall as buyers switch to competing lower priced substitutes it may be better to accept a lower profit margin and reduce the price to take account of the appreciation of the exchange rate

What is difficult when exchange rates rise?

Staying competitive

What will most big businesses want if export markets are important to them?

A stable and low/weak exchange rate

What does the best strategy of responding to exchange rates depend on?

Price elasticity of demand for the product Cut prices if demand is elastic, do nothing if demand is inelastic

Describe why the demand for capital goods decreases if the interest rate rises

It is more expensive to purchase expensive capital equipment on credit, meaning firms won't bring forward planned future investment or actually decrease the level of investment, as the return on projects is less likely to exceed the interest payments

Describe the business strategy for a business that sells its goods in the UK in competition with foreign imports for a rising exchange rate for the pound

Added pressure to increase its efficiency as it may be facing competition from cheaper imported goods Increase investment in labour saving machinery and reducing the workforce Introduce new technologies and organisational strategies Increase marketing efforts as the company fights to maintain its competitiveness

Describe the business strategy for a business that imports raw material from abroad and exports the finished product for a rising exchange rate for the pound

Fall in demand could be offset through falling production costs where the business has an added incentive to reduce prices

Give an example of how price elasticity of demand is an important concept for any business where demand may be affected by changing exchange rates

Price elastic demand Stronger (higher) exchange rate will increase selling price for export customers e.g. they have to use more $ for each £ which is likely to result in greater reduction in quantity demanded and overall reduction export sales

Describe how the factors that determine effect of changing exchange rates on businesses would have a low effect on business

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

Describe how the factors that determine effect of changing exchange rates on businesses would have a high effect on business

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

What is inflation?

A sustained increase in the average price level of an economy

How is the rate of inflation measured?

By the annual percentage change in the level of prices as measured by the Consumer Price Index (CPI)

What is deflation?

A sustained fall in the general price level The rate of inflation becomes negative

What are the two main causes of inflation?

Too much demand - 'demand-pull inflation' Rising business costs - 'cost-push inflation'

Describe demand-pull inflation

Prices rise because there is excess demand in the economy Excess demand in the economy or a market is associated with the boom phase of the business cycle Businesses respond to high demand by raising prices to increase their profit margins

Describe cost-push inflation

Increase in the costs of production that forces firms to increase their prices in order to protect their profit margins The main causes are external shocks, a depreciation in the exchange rate and faster growth in wages and salaries Firms raise prices to protect their profit margins - better able to do this when market demand is price inelastic 'Wages often follow prices' A rise in inflation can lead to rising inflationary expectations

What are the main costs and consequences of inflation?

Money loses its value and people lose confidence in money as the value of savings is reduced Inflation can get out of control - prices increases lead to higher wage demands as people try to maintain their living standards, this is known as wage-price spiral Consumers and businesses on fixed incomes and employees in poor bargaining positions lose out because their real income falls Inflation can favour borrowers at the expense of savers because inflation erodes the real value of existing debts Inflation can disrupt business planning and lead to lower capital investment Inflation is a possible cause of higher unemployment in the long term because of a lack of competitiveness Rising inflation is associated with higher interest rates which reduces economic growth and can lead to a recession

What should a business consider when evaluating which strategies to undertake when dealing with inflation?

How high or low the inflation rate is Whether demand for the product is elastic or inelastic Nature of the business and the products it offers - a luxury product with a high status and popular brand where price isn't a major factor in determining demand may be able to continue to raise prices during a period of high inflation, however businesses selling products in highly competitive markets where price competition is of crucial importance are unlikely to be able to push up prices unless all business are doing so within that market

What does price elasticity of demand refer to?

The responsiveness of demand to changes in price When demand is elastic, a price rise leads to a more than proportionate fall off in quantity demand When demand is inelastic, a price rise leads to a less than proportionate fall off in quantity demand

How does price elasticity of demand affect how much a business will be impacted by inflation?

Businesses with products that have inelastic price elasticity of demand will be less affected by a rise in inflation

How can some businesses absorb price increases?

By becoming more efficient

What does economic policy involve?

Efforts by the government to control the economy in order to achieve its objectives

What are key economic objectives that most governments try to achieve?

Encouraging economic growth Controlling and reducing inflation Maintaining a satisfactory level of unemployment Achieving a satisfactory balance of payments (exports - imports) Maintaining a stable exchange rate

What is the major problem facing governments with the economic policy?

The degree of trade-off between the objectives as they cannot all be fully achieved

What is macroeconomic policy?

Governments attempt to influence the level of demand in the economy as a whole This is done primarily through monetary policy and fiscal policy, the choice depending on priorities of the government

What does fiscal policy involve?

The use of government spending, taxation and borrowing to affect the level and growth of economic activity

What do governments use taxes to do?

Raise revenue to finance government spending Manage aggregate demand to help meet the government's macroeconomic objectives Change the distribution of income and wealth Address market failure and environmental targets

What are the 2 main kinds of taxation?

Direct and indirect

What is direct taxation levied on?

Income, wealth and profit E.g. Income Tax, National Insurance Contributions, Corporation Tax and Capital Gains Tax

What is indirect taxation levied on?

Spending by consumers on goods and services E.g. VAT and excise duties on fuel, alcohol, car tax and betting tax

What are the 3 main areas of government spending?

Transfer Payments Current Spending Capital Spending

Describe what Transfer Payments are

Welfare payments made to benefit recipients such as the state pension and the Jobseeker's Allowance

Describe what Current Spending is

Spending on state-provided goods and services such as education and health

Describe what Capital Spending is

Infrastructural spending such as spending on new roads, hospitals, motorways and prisons

Why is government spending so significant?

Provide welfare support for low income households/unemployed Redistributes income within society e.g. to reduce the scale of relative poverty Tool to manage aggregate demand (GDP) as part of macroeconomic policy

What is the difference between monetary and fiscal policy?

Monetary policy is using the rate of interest to influence the level of spending and demand in the economy whereas fiscal policy is using taxation and government expenditure to influence the economy

How do taxes differ from interest?

Taxes can't be charged as often as interest rates but can be used to target certain products or affect certain types of behaviour more specifically, as different taxes can be charged in different ways e.g. income tax, VAT, duty paid on alcohol and tobacco and the sugar tax

What is the impact of monetary/fiscal policies during a recession?

Growth can be encouraged by allowing demand to increase by keeping interest rates down, reducing taxes and increasing government expenditure By increasing government expenditure through an increase in spending on health, roads or education there may be an increase in jobs and construction/supply of private sector goods which benefits the economy

What is the impact of monetary/fiscal policies during a boom?

Symptoms of 'overheating' may start to appear, such as high inflation and shortages of skilled labour The government is faced with accelerating inflation and rising demand for imported goods and services, therefore will want to reduce the rate at which demand is increasing It will restrict consumer and government spending through increasing interest rates and taxes and reducing government expenditure

How is the government responsible for spending in the public sector?

It provides a range of services such as education, defence, welfare benefits, transport and healthcare

What is the effect of changes in government expenditure on businesses?

To control inflation the government could cut back on its own spending which would reduce the income of businesses involved in education, health and road building so these businesses may have to make some people redundant which may have the effect of reducing demand, therefore helping to keep prices from rising The government could increase the amount it spends and this will have the effect of reducing unemployment as construction companies, schools, hospitals employ more staff

What is economic uncertainty?

The inability to predict exactly what will happen in the economic environment in the future

What is the effect of economic uncertainty on the business environment?

The inability to predict exactly what will happen in the economic environment in the future can affect the actions of individuals and businesses as uncertainty makes decision making more difficult, reduces business confidence and presents businesses with some unexpected events which they have to deal with