11: The economic environment of business and finance Flashcards
Name the two economic environments that affect business?
The macroeconomic environment
- national influences
- global influences
The microeconomic environment
What is the macroeconomic environment?
compromises firstly the national economy and also global economy
encompasses the overall conditions of a country’s economy, including factors like inflation, unemployment, and interest rates, which businesses and investors must consider when making decisions
What is GDP and give some examples of those who purchase the output?
Gross Domestic Product: equals the amount of expenditure incurred by those who purchase the output
- consumers (households)
- government
- foreign buyers
The government has several functions within the national economy: (4)
- acts as the producer of certain goods
- acts as the purchaser of final goods
- invests by purchasing capital goods
- makes transfer payments from one section of the economy to the other
What is disposable income with respect to a consumer in the national economy?
Income avaliable to individuals after payment of personal taxes. It may be consumed or saved
Total spending or consumption by households is affected by which six influences?
- changes in disposable income
- changes in the distribution of wealth
- government policy
- development of new major products
- interest rates
- price expectations
The role of the saver in the national economy: Which three influences affect savings?
- Level of income
- Interest rates and the cost of credit (rising interest rates becomes more attractive to save)
- Long-term savings (these savings might be less likely to vary with income than demographic)
What is the business cycle/trade cycle?
The continual sequence of rapid growth in GDP, followed by a slowdown in growth and then a fall.
Growth then comes again, and when this has reached a peak, the cycle turns once more
What are the four main phases of the business cycle?
A. recession
B. depression
C. recovery
D. boom!
What happens in a recession?
- consumer demand falls
- investment projects undertaken but look unprofitable
- orders cut
- inventory levels reduced
- business failures occur
- business unable to sell their goods
- general price levels begin to fall
- economic outlook appears poor
What happens in a depression?
Absence of any stimulus for demand
What happens in a recovery?
- output, employment, income all begin to rise
- business expectations more optimistic
- investment more readily undertaken
- rising level of demand through increased production and hiring unemployed labour
- average price slowly rising
What happens in a boom!?
- capacity and labour will become fully used
- further rise in demand
- production increase
- business will be profitable
- expectations for the future appear optimistic
What is inflation?
An increase in price levels generally, and a decline in the purchasing power of money
What is deflation?
Falling prices generally, which is normally associated with low rates of growth and recession
Why is inflation an issue? (5)
Redistribution of wealth
- outstanding amounts ‘lose’ real value with inflation
Balance of payment effects
- exports become relatively expensive and imports cheap
Price signalling and ‘noise’
- influences allocation of resourcing in an economy
Wage bargaining
- wage demand increase with inflation
Consumer behaviour
- people may stockpile goods fearing price increase later
- causes shortages for other people
What are the two types of inflation and explain them
Demand pull inflation:
- price rises resulting from a persistent excess of DEMAND over supply
Cost push inflation:
- price rises resulting from an increase in COSTS of production
Name the two types of causes for demand-pull inflation:
Fiscal:
- increase in government spending or reduction in tax will raise demand in an economy
Credit:
- if levels of credit extended to customers increase, expenditure likely to rise
To achieve economic growth and control inflation, what two macroeconomic policies do the government use?
Influencing overall demand in the economy (aggregate demand) via
- monetary policy
- fiscal policy: policy on spending and taxation
What are the effects of a rise in interest rates?
- Companies will reduce inventory levels as the cost of having money tied up rises
- Households will reduce or postpone consumption in order to reduce borrowings
What is quantitative easing?
A form of expanisonary monetary policy which involves the central bank buying existing government bonds and corporate bonds as a way of adding liquidity to the financial system
A tool that has been used by many advanced economies, including the UK, to alleviate the treat of recessions
Quantitative easing works as follows: (3)
(a) Bank of England creates electronic cash and uses this to buy government and corporate bonds from banks
(b) The price of bonds rises leading to a fall in the yield of the bonds
(c) The low yields on bonds also reduces interest rates, which reduces the cost of borrowing by businesses
What is meant by fiscal policy?
The government’s policies on government spending, taxation and borrowing
What are some examples of supply-side, macroeconomic policies?
- more involvement in private sector
- reduction in taxes increases incentive to supply
- increasing flexibility in the labour market by curbing power of trade unions
- increasing competition through deregulation and privitisation of utilities
- abolition of exchange controls and allowing the free movement of capital (across borders without restriction)
What is a market mechanism?
The interaction of demand and supply for a particular item
What is a market?
A situation in which potential buyers and potential sellers of an item come together for the purchase of exchange
What is price theory?
concerned with how market prices for goods are arrived at
interaction of demand and supply
What is meant by demand?
The quantity of a good that potential purchasers would buy, or attempt to buy, if the price of the good were at a certain level
What factors determine demand within the control of the business? (Seven Ps)
Product
Price
Promotion
Place
People
Processes
Physical evidence
What factors determine demand outside the control of the business?
Price of subtitute goods
Price of complementary goods
Consumers’ income
Fashion and expectations
What are substitute goods?
goods that are alternatives to eachother so that an increase in demand for one is likely to cause a decrease in demand for the other
Switching demand from one good to another ‘rival’ good is substitution
What are some examples of substitute goods?
- rival brands of the same commodity (Pepsi and Coke)
- tea and coffee
- bus rides and car rides
- forms of entertainment
What are complement goods?
Complements are goods that tend to be bought together and used together, so that an increase in demand for one is likely to cause an increase in demand for the other
What are some examples of complements?
- cups and saucers
- holidays and travel insurance
- cards and components of raw material for manufacture
What is meant by income distribution?
Market demand for goods is influenced by the way in which the national income is shared among people
Countries with many rich and may poor might expect a relatively large demand for luxury cars and yachts
In opposite, there may be many middle-class households which there will be a high demand for foreign holidays and medium-sized cars
What is meant by fashion and explain the consequences of a ‘change in fashion’
A change in fashion will alter the demand for a product
We refer to such a change / shift in demand as a shift of the demand curve
What is meant by supply?
The quantity of a good that existing suppliers or would be suppliers would want to produce for the market at a given price
Explain the supply schedule and supply curve
A supply schedule and supply curve are constructed similarly to the demand curve
The quantity of suppliers, however, are willing to produce at different price levels
It is an upward sloping curve from left to right because greater quantities will be supplied at higher prices
What factors influence supply? (6)
- price
-prices of other goods - price of related goods
- cost of making the good
- changes in tech
- other factors (natural disaster, industrial distruption)
Explain the effective of time on supply and demand
Supply:
- changes in quantity of good often require laying off or hiring new staff, new inftrastructure, etc.
- these changes take time to implement
Demand:
- takes time for consumers to adjust to new buying patterns
- although, demand responds more rapidly to price changes than supply
What is meant by an equilibrium price?
The price of a good at which the volume demanded by customers and the volume businesses are willing to supply are the same
Adjustments in equilibrium:
Increase in consumer incomes
Prediction:
- rise in market price
- rise in quantity supplied
Adjustments in equilibrium:
Product becomes unfashionable
Prediction
- fall in market price
- fall in quantity supplied
Adjustments in equilibrium:
Improvements in production technology
Prediction
- fall in market price
- rise in quantity supplied
Adjustments in equilibrium:
Rise in factor costs
Prediction
- rise in market price
- fall in quantity supplied
Governments might introduce what regulatuions regarding price of goods due to supply and demand? (2)
Set a maximum price for a good
- suppliers cannot charge a higher price even if they wanted to
Set a minimum price for a good
- been attempted previously for oil in the world markets
What is elasticity in regard to supply and demand?
The extent of a change in demand and/or supply given a change in price
How is price elasticity of demand (PED) measured?
\frac{Proportional change in quantity} {Proportional change in price}
What is meant be elastic and inelastic demand?
Inelastic if absolute value < 1
- demanded changes by a smaller % than %change in price
Elastic if absolute value > 1
- demand changes by a larger % than %change in price
What is meant by perfectly inelastic demand, perfectly elastic demand, unit of elasticity of demand
Perflectly inelastic => PED = 0
Perfectly elastic => PED = \inf
Unit elasticity of demand => PED = 1
What is the significance of price elasticity of demand?
When demand is elastic, an increase in price will result in a fall in the quantity demanded such that the total expenditure will fall
Demand inelasticity >0 :
- increase in price will still result in a fall in quantity demanded but total expenditure will rise
Unit elasticity:
- expenditure remains constant
Factors influencing price elasticity of demand for a good
- Avaliability of substitutes
- The time horizon (adjusting buying habits)
- Competitor’s pricing
- Luxuries and neccessities
- % of income spent on a good
- Habit-forming goods
What is income elasticity for demand?
An indication of the responsiveness of demand to changes in household incomes
How is income elasticity calculated?
\frac{ % change in quantity demanded}{ % change in household incomes}
Describe and explain the changes in income elasticity of demand
Income elastic iff. income elasticity > 1
Income inelastic iff. income elasticity 0 < x < 1
Negatively income elastic if, in response to an increase in income, demand actually falls
These are inferior goods
What is meant by cross elasticity of demand?
A measure of the responsiveness of demand for one good to changes in the price of another good
How is cross elasticity of demand calculated?
\frac{ % change in quantity of A demanded}{ % change in the price of B}
What is meant by price elasticity of demand?
A measure of the responsiveness of supply to a change in price
How is price elasticity of supply (PES) calculated?
\frac{ % change in quantity supplied}{ % change in price}
What is a market structure?
A description of the number of buyers and sellers in a market for a particular good, and their relative bargaining power
Perfect competiton is characterised by the following:
- many small buyers and sellers which, individually, cannot influence market price
- no barriers to entry and exit
- perfect information such that production methods and cost structures identical
- identical products
- no collusion between buyers or sellers
A monopoly is characterised by:
- one supplier / dominant supplier
- many buyers
- barriers to entering industry (patents, unique talent, size domination)
Monopolistic competition is characterised by the following:
- many buyers and sellers
- some differentiation between products
- branding of products to achieve differentiation
- few barriers to entry
- significant advertising in many cases
- some (but not total) customer loyalty
EXAMPLES:
- pubs
- hairdressers
Oligopoly is characterised by the following:
- few large sellers but many small buyers
- product differentiation
- high degree of mututal interdependency
e.g. oil industry, (Shell, BP, Esso)
banking, (Lloyds BG, HSBC, Barclays)
washing powder (Procter and Gamble, Unilever)
Duopoly is characterised by the following:
- two dominant suppliers who between them control prices
- a temptation for the two suppliers to act in collusion (illegal breach of competition law)
What is market failure?
A situation in which a free-market mechanism fails to product the most efficient (optimum) allocation of resources
Market failure is caused by a number of factors: (4)
- market imperfection with one or few suppliers exerting market power
- externalities (indirect cost benefit to uninvolved third party)
- existence of public goods that are gained by third parties
- economies of scale
What is an externality?
The difference between private and the social costs, or benefits, arising from an activity.
Basically, a cost or benefit which the market mechanism fails to take into account because the market responds to purely private signals
