Chapter 7 - Economical Influences on Business Activity

govt assistance for entrepreneurs

- offering loan guarantee schemes

- providing info, advice and training schemes for entrepreneurs thru college and govt industry departments

- financing building of small workshops which are lent to entrepreneurs and small businesses at low rent

- reducing paperwork and legal formalities to set up new business

- cutting rate of profits tax for new and small businesses

govt assistance for all businesses

- subsidies to keep prices down

- subsidies to stop loss-making businesses failing and protect employment

- grants to relocate to areas with high unemployment

- financial support for consumers to buy products that will increase national output

advantages of subsidies

- avoid rising unemployment due to business failure

- avoiding business failure keeps suppliers in business

- if a business fails, consumer may switch to imported products, making balance of payments worse

disadvantages of subsidies

- govt has to raise taxes or cut other spending programmes in order to provide subsidies

- act as a disincentive to businesses to become more efficient

- consumers buy subsidised products at lower prices so spend less on unsubsidised products, distorting the market

market failure definition

when markets fail to achieve the most efficient allocation of resources, resulting in over or under production of certain goods and services

examples of market failure

- external costs (doesn't include external cost of production in price)

- labour training (not much investment in training due to poaching)

- monopoly

external costs definition

the costs of an economic activity that are not paid by the producer or consumer, but by rest of society

external costs - pollution from manufacturing process

- consumers forced to buy environmentally damaging products if no alternatives

- govt. and local authorities forced to take issue seriously by voters and pressure groups

- workers worried about health effects of pollution and job security if business is closed down

- business may take action to reduce external costs if bad publicity leads to damaging reputation and sales

- govt can impose fines on polluting businesses or impose strict limits on pollution levels

labour training - inadequate provision of skills training

- customers may receive poor bad customer services

- govt will worry about international competition of industry

- shareholders may see future profits fall as output will be below potential

- industrial organisations can get members to pay industry-wide training

- govt could pay for more training courses at college funded from general tax

monopoly producers - restricting of output to keep prices high

- consumers affected by lack of choice, restricted supplies, and high prices

- monopolies may not invest to develop new goods due to lack of competition

- govt is worried as prices are high and competition is low

- consumers could use internet for consumer goods

- govts use competition laws

macroeconomic objectives definition

goals a govt is aiming to achieve for the whole economy

macroeconomic objectives include

- economic growth

- low price inflation

- low rate of unemployment

- long-term balance of payments between value of imports and value of exports

- exchange rate stability

economic growth definition

increase in a country's productive potential, measured by an increase in its real GDP

gross domestic product (GDP) definition

total value of goods and services produced in a country in one year

real GDP definition

GDP data adjusted for inflation

inflation definition

increase in average price level of goods and services resulting in a fall in value of money

unemployment definition

members of working population are able and willing to work but cannot find a job

imports definition

goods and serviced purchased from other countries

exports definition

goods and services sold to consumers/businesses in other countries

exchange rate definition

price of currency in terms of another

economic growth

- means that country is getting richer

- measured by increases in GDP

- negative economic growth or recession is when GDP falls

benefits of economic growth

- real gdp growth raises average living standards if population growth is slow

- higher output levels results from increased employment, meaning that consumer incomes increase and unemployment is reduced

- more resources can be allocated to desirable public sector projects

- absolute poverty can be reduced or even eliminated

- businesses should experience rising demand for products

- higher gdp makes more resources available for govt thru greater income tax and reduced spending on social benefits

recession definition

decline in real GDP of two or more quarters

causes of economic growth

- technological changes and expansion of industrial capacity

- increases in economic resources

- increases in productivity

business investment definition

expenditure by businesses on capital equipment, new technology and research and development

labour productivity definition

average output per employee in given time period

business cycle definition

regular swings in output, measured by real GDP, that occur in most economies. varying from boom conditions to recession

4 stages of business cycle

1. boom

2. recession

3. slump

4. growth

boom

- period of very fast economic growth with rising incomes and profits

- inflation increases due to high demand

- shortages of key skilled workers

- high inflation makes economys goods uncompetitive

- business confidence falls as profits hit by high costs

- interest rates usually increased to reduce inflation

recession

- falling demand and higher interest rates

- real gdp slows and may even start to fall

- incomes and consumer demand fall

- some business make record losses and some may even fail

slump

- very serious and prolonged recession

- real gdp falls substantially and product and asset prices fall

growth

- all downturns turn to recovery

- one effect of lower product prices is to increase competitiveness of country's exports and demand for them starts to increase

impact of economic growth on producers of luxury goods

- increase range of goods and services

- raise prices to increase profit margins

- promote exclusivity and style

- increase output

impact of recession on producers of luxury goods

- may not reduce prices for fear of damaging long-term image

- offer credit terms to improve affordability

- offer promotions

- widen product range with lower-priced models

impact of economic growth on producers of basic goods and services

- add extra value to product

- make brand image more exclusive

- do nothing as sales not much affected anyways

impact of recession on producers of basic goods and services

- lower prices

- offer promotions

- do nothing as sales not much affected anyways

impact of economic growth on producers of inferior goods and services

- attempt to move product upmarket

- add extra value to product

- extend product range to include more exclusive or better designed products

impact of recession on producers of inferior goods and services

- promote good value and low prices

- offer consumer special promotions

- increase range of distribution outlets

consequences of recession

- as output falls, fewer workers are needed

- unemployment increases and incomes fall

- demand for products falls further

- govt tax revenue falls

- businesses creating luxury items experience reduced demand, creating spare capacity

opportunities of recession

- capital assets may be relatively cheap and businesses could invest in hopes for economic recovery

- demand for inferior goods could actually increase

- risk for entrenchment and job losses may encourage improved relations between employer and employee, leading to increased efficiency

- decisions to close factories and offices could reduce business costs significantly

deflation definition

a fall in the average price level of goods and services

hyperinflation definition

very high and accelerating inflation, which quickly erode real value of local currency

causes of inflation

- cost-push (prices rise because businesses are forced to increase them when their costs are rising)

- demand-pull (businesses raise prices to take advantage of high consumer demand and make extra profit)

cost push causes

- lower exchange rate pushing up prices of imported values

- world demand for materials pushing up prices

- higher wage demands from workers, in response to inflation in previous year

demand pull causes

- if prices are not raised, inventories could run out, leaving unsatisfied demand

- businesses earn even higher profit margins

benefits of low inflation on business decisions

- cost increase can be passed onto consumers more easily

- real value of debts owed by companies will fall

- value of fixed assets owned by business could rise

- since inventories are bought in advance then sold later, there is an increased profit margin from effect of inflation

drawbacks of high inflation on business decisions

- employees will demand big wage increases to maintain real value of their incomes

- consumers may become more price sensitive and look for bargains

- rapid inflation lead to higher rates of interest

- cash flow problems

- businesses reluctant to offer extended credit periods

- consumers may stock-pile some items and cut back on non-essential items

- if inflation is higher in one country, then business in that country will lose competitiveness in overseas market

high inflation adds to uncertainty about future and business decisions might include:

- cutting back on investment spending

- cutting profit margins and limiting prices to stay as competitive as possible

- reducing borrowing to make interest payments more manageable

- reducing labour costs

- reducing time period for customers to pay

why most businesses wouldn't benefit from deflation

- consumers might delay purchases in hopes that prices will fall further

- businesses with long-term debts make interest payments and loan repayments with money that has risen in value since original loan was taken out

- as prices fall, future profitability of new investment projects appear doubtful

- inventories of materials and finished goods fall in value

working population definition

all those in population of working age who are willing and able to work

cyclical unemployment definition

caused by low demand for goods and services during a period of slow economic growth or recession

structural unemployment definition

caused by decline in important industries, leading to significant job losses in one sector

frictional unemployment definition

when workers lose or leave jobs taking a substantial period of time to find alternative employment

cyclical unemployment

businesses need fewer workers as they are producing fewer goods and services meaning that workers who are made unemployed will have lower incomes and there are fewer overtime opportunities for employees and they all spend less

structural unemployment

happens because of structural changes in the economy, which radically changes the demand for labour most likely due to:

- consumer tastes and expenditure patterns change

- workers can be replaced by tech

- heavy manufacturing industries in most western economies have declined

frictional unemployment

- if labour turnover rates increase in economy as a whole, then level of frictional unemployment will also increase

costs of unemployment

- output of economy is lower than it could be, reducing living standards

- cost of supporting unemployed workers and family is paid from general taxation

- may lead to social problems such as crime

- reduces demand for goods and services

- reduced income

- longer the period of unemployment, the more difficult it is to find work

impact of unemployment on business activity

- reduced income levels will reduce demand for most products

- easier to recruit new employees

- workers may accept lower pay increases as they are afraid of losing their job

- govt grants and subsidies may be available to encourage job creation

monetary policy definition

decisions about levels of interest rates and supply of money in economy

monetary policy

- mainly concerned with changes in interest rates which are determined by base interest rate set each month by central banks

- occurs when economy is experiencing inflation in growth phase

- if inflation is low and forecasted to remain below govt targets, central bank could reduce interest rates

- reduction in interest rate is more likely if economic growth is low and there is danger of unemployment rise

high interest rate impacts

- increase interest costs and reduce profits for businesses that have very high debts

- reduce borrowing by consumers, which reduces demand for goods bought on credit

- often lead to an appreciation of the country's exchange rate

fiscal policy definition

decisions about govt expenditure, tax rates and govt borrowing

fiscal policy

- govt raises tax revenues to pay for major expenditure programmes like social security, health service, education, defence and law and order

- main tax revenues come from income tax, value added tax, corporation tax and excise duties

budget deficit

value of govt spending exceeds tax revenue

budget surplus

value of tax revenue exceeds value of govt spending

fiscal policy circumstances

1. recession = raised govt spending and lower tax rates = increase in aggregate demand = increase in output and employment

- leads to budget deficit and is described as expansionary

2. boom = reduce govt spending and raise tax rates = reduction in aggregate demand = reductions in output, employment and inflation

- leads to budget surplus and termed as contractionary or deflationary

impacts on stakeholders of fiscal policy

- raising direct taxes (income and profits tax)

~ consumers disposable incomes fall so demand falls

~ impact on businesses depends on elasticity of demand

~ businesses retained earnings reducing finance for investment

- raise indirect taxes on spending (value added tax)

~ retail prices of taxed products increase and impact on demand depends on price elasticity

- reducing govt spending

~ businesses selling products directly to govt experience reduction in demand

impacts on stakeholders of monetary policy

1. increase interest rates

- highly indebted businesses have to increase payments, worsening cash flows

- businesses less likely to borrow to finance further investment

- consumers less likely to buy goods on credits

- demand for houses falls as mortgage interest costs rise

- may encourage overseas capital to flow into country

- appreciation of exchange rate is likely

supply side policies definition

govt measures that aim to improve competitiveness of markets and economy

supply side policies

- reducing rates of income tax which can encourage enterprise and increase incentive to work

- reducing rates of corporation tax which increase retained earnings and encourage investment

- increasing labour market flexibility and labour productivity

- spending on infrastructure projects

- making it easier to start businesses

exchange rate policy definition

rate is determined by supply of and demand for a country's currency

factors for demand for currency

- foreign buyers of domestic goods and services

- foreign tourists spending money in the country

- foreign investors buying currency to take advantages

factors for supply of currency

- domestic businesses buying foreign imports

- domestic population travelling abroad

- domestic investors wanting to obtain foreign currency

exchange rate depreciation definition

- a fall in the external value of currency as measured by its exchange rate against other countries

- if the supply of currency is greater than the demand, the price of currency falls

exchange rate appreciation definition

- a rise in the external value of currency as measured by its exchange rate against other countries

- if demand of currency is greater than supply, the price of currency rises

exchange rate appreciation

1. domestic businesses that gain

- importers of foreign raw materials and components, and manufactured goods (domestic currency cost of these imports will fall)

- lower import prices help reduce rate of inflation

2. domestic firms that lose

- exporters of goods and services to foreign markets

- businesses that sell goods and services to domestic markets and have foreign competition

exchange rate depreciation

1. domestic businesses that gain

- exporters who can reduce prices in overseas markets

- businesses that sell in domestic markets will experience less price competition from importers

2. domestic businesses that lose

- manufacturers who depend heavily on imported supplies of materials, components or energy sources

- retailers who purchase foreign supplies, especially if there are domestic substitutes

exchange rate policy summary

most govts want to keep the exchange rate of their currency stable which reduces the risky and destablishing effects of large appreciations and depreciations however there are exceptions in which the govt may allow or encourage:

- depreciation in order to increase competitiveness of domestic industries

- depreciation in order to cancel out loss of competition caused by high inflation although this will add to inflationary pressures

- appreciation in order to increase living standards

common currency definition

a currency that is used by more than one country

eurozone definition

countries in the european union that all use the euro currency

limitations of common currency

- central bank for each country loses its power to control interest rates

- may eventually lead to common tax policies throughout the currency zone

- each govt cannot allow a depreciation of its own country's currency to increase competitiveness

benefits of common currency

- eliminates currency fluctuations between member countries

- no fluctuating prices of imported materials and components

- no fluctuations in export prices

- no uncertainty over profits earned from trading or investing in other member countries

- reduces costs for businesses trading with member countries as there are no conversions meaning no commission payments to banks

- encourages inward investment from businesses in non-member countries that want to gain access to common currency market

international competitiveness: non price factors

- product design and innovation

- quality of construction and reliability

- effective promotion and extensive distribution of products

- after-sales service

- investment in trained employees and modern technology