Edexcel_AS_Business_Year_1_Companion_Edition_1

Business Cycle

Boom

• High levels of consumer spending, business confidence, profits, and investment.

• Prices and costs tend to rise faster.

• Unemployment tends to be low.

Recession

• Falling levels of consumer spending and confidence lead to lower profits for businesses, resulting in reduced investment.

• Increased spare capacity and rising unemployment.

Slump / Depression

• Very weak consumer spending and business investment.

• Many business failures.

• Rapidly rising unemployment.

• Prices may start falling.

Recovery

• Economic conditions begin to improve.

• Increased consumer spending.

• Businesses regain confidence and begin investing again.

• Unemployment continues to grow before stabilizing.

Causes of the Business Cycle

• Changes in business and consumer confidence.

• Periods of stocking and de-stocking by businesses.

• Variations in consumer spending and business investment.

• Changes in government policy impacting the economy.

• An interest rate is the reward for saving and the cost of borrowing, expressed as a percentage of the money saved or borrowed.

• Different types of interest rates:

  • Savings account interest rates.

  • Borrowing interest rates.

  • Mortgage interest rates.

  • Credit card interest rates and payday loans.

  • Interest rates on government and corporate bonds.

• The Bank of England uses policy interest rates to help regulate the economy and achieve economic objectives.

• The Bank of England Base Rate has been low and stable for several years.

Interest Rates

• An interest rate is the reward for saving and the cost of borrowing, expressed as a percentage of the money saved or borrowed.

• Different types of interest rates:

  • Savings account interest rates.

  • Borrowing interest rates.

  • Mortgage interest rates.

  • Credit card interest rates and payday loans.

  • Interest rates on government and corporate bonds.

• The Bank of England uses policy interest rates to help regulate the economy and achieve economic objectives.

• The Bank of England Base Rate has been low and stable for several years.

Possible Effects of Rising Interest Rates

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• Cost of servicing loans/debt is reduced - This can boost consumer spending power.

• Increase in consumer confidence - Higher confidence levels may lead to increased spending.

• Effective disposable income rises - Lower mortgage costs contribute to an increase in disposable income.

• Boost in business investment - The prospect of rising demand can encourage businesses to invest more.

• Effects on the housing market - Increased demand can lead to higher property prices.

Exchange Rates

• An exchange rate is the price of one currency expressed in terms of another currency.

• Determined by the forces of demand and supply in currency markets.

• Reflects the amount of currency consumers and businesses want to buy (demand) and sell (supply).

• Determines how much of one currency must be given up to buy a specific amount of another currency.

Example

• £/$ exchange rate example:

  • May: £1 = $1.60, €1.15

  • September: £1 = $1.45, €1.05

• The value of £1 fell against the US dollar and the Euro from May to September.

• The pound weakened against the dollar, meaning it takes less dollars to buy £1.

Factors Affecting Business due to Exchange Rate Changes

• Low Effect on Business:

  • No export sales; all turnover in the domestic (UK) market.

  • All business activities located in the UK.

  • Raw materials and supplies bought in the UK.

  • Demand predominantly from domestic customers.

  • Demand is price inelastic.

• High Effect on Business:

  • Significant export sales, possibly in many currencies.

  • Overseas operations, earning profits in foreign currency.

  • Significant purchases from overseas suppliers.

  • Substantial demand from overseas visitors to the UK.

  • Demand is price elastic.

Price Elasticity of Demand

• Price elasticity of demand is a crucial concept for businesses affected by changing exchange rates.

• When demand is price elastic:

  • A stronger exchange rate increases selling prices for export customers.

  • Leads to a greater reduction in the quantity demanded and an overall decline in export sales.

Effects on Businesses of Changing Economic Variables

Economic influences can present significant opportunities and threats to business activities. Businesses need to anticipate and respond to changing economic variables in order to maximize their chance of success.

Key Economic Variables to Consider:

Changes in Inflation

• Definition: Inflation is the general rise in prices in an economy over time.

• Consumer Price Index (CPI): Measures monthly changes in the prices of a range of goods and services, comparing these changes to earlier periods to calculate the rate of inflation.

• UK Government Focus: Targets a 2% inflation rate and tasks the Bank of England to take steps to maintain this (e.g., raising the interest rate).

• Recent Trends: After several decades of low inflation, the UK has recently experienced rapidly increasing levels of inflation.

Problems Caused by Inflation:

1. Increased Costs:

   • Workers often demand higher wages to compensate for the increase in the cost of living.

   • Suppliers increase the cost of raw materials and components.

   • Utilities (e.g., electricity) become more expensive.

   • Higher repayments on loans due to rising interest rates.

2. Consumers Change Spending Habits:

   • Inflation deters consumers from making significant purchases.

   • May reduce demand for lower-priced wants (e.g., cinema tickets).

   • Purchasing on credit becomes more expensive.

3. International Competitiveness:

   • Higher domestic inflation rates can make UK businesses less competitive.

   • Imports from overseas may become cheaper than domestic goods, leading to a loss of sales for UK businesses.

4. Uncertainty:

   • Lack of predictability in prices can lead to businesses focusing on survival until stability returns.

   • Spending and contract decisions are likely to be delayed due to uncertainty.

Changes in Taxation and Government Spending

Governments impose direct and indirect taxes on businesses and households.

Types of Taxes:

• Direct Taxes: Levied on income (e.g., Income Tax, Corporation Tax).

• Indirect Taxes: Levied on spending (e.g., Value Added Tax - VAT).

The Impact of an Increase in Taxation:

Impact on:

Revenue

• Revenue may fall for many businesses.

• Increased income tax reduces the disposable income of customers, leading to a fall in demand for products.

• Increased VAT makes products more expensive, causing customers to switch to alternative products.

Costs

• Operating costs will rise due to increased taxes such as VAT and National Insurance contributions.

• Higher costs may be offset by charging higher prices.

• Higher prices may lead to lower sales, resulting in a fall in profit.

• Import costs increase when customs duties are raised.

Business Decisions

• Business spending and investment may be affected by increases in Corporation Tax as less profit is retained for future expenses and expansion plans.

• Operational decisions may be influenced by increases in business rates and employment-related taxes.

• Businesses might forego improvements or relocations and could reduce workforce size due to increased costs.

• Some businesses may take measures to avoid higher taxes (e.g., moving to low-tax locations or changing production methods to reduce the use of highly-taxed components).

Government Spending:

• Increased government spending is usually funded by either tax increases or public sector borrowing.

• Increased investment spending (e.g., on infrastructure) can encourage business investment and lead to economic growth.

• Increased public sector spending can lead to improvements in public health and education levels, which can boost productivity.

Recent Trends in the UK:

• The UK government has increasingly focused on reducing government spending.

  • Infrastructure projects have been scaled back or canceled, exemplified by the reduced scale of the planned HS2 rail line connecting London to Northern cities.

  • Businesses in cities like Leeds and Manchester are unlikely to benefit from improved transport links, affecting access to markets and workers.

  • Spending on key services such as health and education has decreased, and public sector wage rises have been limited.

  • Ongoing strike action across the public sector has led to increased employee absence levels, making it difficult for businesses to function effectively.