2.5.1 Economic Influences

Question 1

Definition: Economic influence

Answer 1

• Economic influence is when a business is affected in any way by economic factors e.g. inflation, exchange rates etc.

Question 2

What is inflation?

Answer 2

• The annual rate of inflation shows how much higher or lower prices are compared with the same month a year earlier. It indicates changes to our cost of living
• The inflation rate is the rise in the price of goods in the UK economy

Question 3

What is Consumer Price Index

Answer 3

• CPI looks at the prices of hundreds of things we commonly spend money on, including bread, cinema tickets and pints of beer - and tracks how these prices have changed over time.
• The inflation rates are expressed as percentages. If CPI is 3%, this means that on average, the price of products and services we buy is 3% higher than a year earlier

Question 4

How is Inflation measured by Consumer Price Index

Answer 4

• Consumer price inflation is the rate at which the prices of goods and services bought by households rise or fall
• Imagine a very large ‘shopping basket’ containing those goods and services bought by households, as the prices of the various items in the basket change over time, so does the total cost of the basket
• Movements in consumer price inflation (CPI) indices represent the changing cost of the shopping basket, this is how inflation is measured

Question 5

How is business affected by changes in inflation?

Answer 5

• As inflation rises so does the cost of products and services
• Cost of supplies, ingredients and raw materials will go up
• As costs go up due to inflation, business owners may need to increase their prices to maintain profitability
• Profit margins will be squeezed

Question 6

What are exchange rates?

Answer 6

• The exchange rate is the price of one currency in exchange for another
• You may have “changed” your money up for a holiday abroad, and you will have been charged commission to do so
• Currencies can change in value and this is due to the demand and supply of a currency

Question 7

What does Exchange rates - appreciation mean?

Answer 7

• Appreciation means that there is a rise in the £pound against other currencies means the £pound can buy MORE foreign currency
• This may also be called a high value or strong value of the pound
• Strong pound means that imports will be cheaper and exports will be dearer

Question 8

What does Exchange rates - depreciation mean?

Answer 8

• A fall in £pound is called depreciation
• UK decision to leave the EU meant that the £pound fell sharply against other currencies
• This is bad news for UK tourists as their money will be worth less abroad

Question 9

What is spiced?

Answer 9

Strong Pound Imports Cheaper Exports Dearer

• When the pound is strong UK businesses that import from abroad will have cheaper costs e.g. a restaurant that imports Italian wine will have lower import costs
• When the pound is strong businesses will find it harder to export UK made goods abroad as they will appear more expensive to other countries e.g. Raleigh bikes made in UK

Question 10

What is WPIDEC?

Answer 10

Weak Pound Imports Dearer Exports Cheaper

Question 11

How does Interest rates and the Bank of England correlate ?

Answer 11

• Interest rates means the cost of borrowing money
• The Bank of England is now responsible for deciding what the interest rate should be in the UK
• If the bank of England pushes up interest rates consumer and business spending will fall
• The bank of England will raise interest rates if inflation is high and lower them if inflation is not a problem within the economy
• Lower interest rates encourage economic growth and a fall in unemployment

Question 12

How does Interest rates – cost of borrowing correlate?

Answer 12

• If interest rates on a loan are low then consumers may borrow money to buy; a car, sofa, holiday etc. This will stimulate demand for these products and services
• If interest rates go up then consumers will not borrow and so will save instead of spending, this is bad news for UK businesses that sell products and services that are heavily financed e.g. cars

Question 13

How is business affected by changes in interest rates?

Answer 13

• If interest rates rise then the cost of borrowing will rise and this will mean that the cost of supplies for a business may increase
• A fall in interest rates means that the cost of lending falls which may lead to an increase in profits (costs less to borrow so less to pay back)

Question 14

What is taxation?

Answer 14

• The UK government requires its citizens and businesses to pay a variety of taxes
• These taxes are used to pay for; education in state schools, the armed forces, the 999 emergency services, the NHS and local councils to name a few
• If taxation increases then the costs of a business will also increase, which will reduce profitability

Question 15

How is business affected by changes in taxation?

Answer 15

• Lower taxes can result in more demand in the economy and lead to higher output and employment
• If taxes are high then UK businesses will have higher costs
• This makes them less competitive in a global marketplace
• It may also mean unemployment rates may rise as businesses have to lay off extra staff due to the reduction in demand

Question 16

What is UK taxation for small businesses

Answer 16

• UK taxes that sole traders must pay:
1. Income tax: taken off an employee’s or business owners’ salary.
2. VAT (only if they earn above £82,000) added to goods and services. A rise in VAT increases prices.
3. Business rates (but not if they work from home)
4. National insurance: contributions are payments made by both the employee and the employer. They pay for the cost of a state pension and the National Health Service. An increase in this tax raises a company’s costs and could result in inflation.

Question 17

What is UK taxation for larger businesses

Answer 17

• UK taxes for private limited companies (Ltds) and public limited companies (PLCs):
• Corporation tax at 20%
• VAT at 20%
• Business rates on business premises
• National Insurance contributions to employees
• These are all costs to a business and will have an impact on profitability

Question 18

What is excise duty?

Answer 18

Excise duty has to be paid by customers on products which are considered to have negative effects on society, in essence a sin tax e.g. fuel, tobacco, beer, wine and spirits
• If a UK business produces these goods they may see a reduction in demand

Question 19

What is government spending?

Answer 19

• Taxes that the government collects goes into a central pot – this is then spent on various things for the benefit of the UK society
• The person who makes the decisions about tax and how t spend it is the Chancellor of the Exchequer also known as the treasurer
• The budget, taxation and public spending is extremely complex but you only need to know how changes might affect UK business

Question 20

How is business affected by changes in government spending?

Answer 20

• If the government decides to cut government spending to reduce the deficit (amount it owes) this can have an impact on businesses which supply goods or services to public organisations e.g. the NHS
• Businesses affected for example in spending cuts may be care home providers, school builders

Question 21

What is the business cycle?

Answer 21

• As time has passed over the last 150 years economists have noticed that demand and output in the UK changes, it goes up and down in a cycle pattern
• This is called the business cycle.

Question 22

What is a boom?

Answer 22

• In boom times a country may enjoy a period of high consumer spending
• As consumers are spending there is an increased demand for goods and services
• This increase in demand means an increase in work, lower unemployment and higher wages
• This leads to more people in work able to buy more goods and services

Question 23

What is a recession?

Answer 23

• In times of recession countries experience falling levels of demand
• This means that consumers will demand less goods and services as they seek to save their money rather than spend – they worry about borrowing in case the interest rates go up
• Businesses will typically have to make redundancies to lower costs and will have lower profits as demand falls

Question 24

What is a slump?

Answer 24

• A slump is the bottom of the business cycle where consumer confidence and spending is at its lowest
• There is usually very little investment in businesses and high levels of unemployment as demand for goods and services falls to its lowest level

Question 25

What is a recovery?

Answer 25

• In the recovery phase of the cycle, demand levels for goods and services start to improve
• Unemployment will start to fall as businesses start to take on workers to meet new improving levels of demand
• Consumer confidence starts to return and consumers start to buy larger items again

Question 26

What is economic uncertainty

Answer 26

• A series of financial shocks since the recession in the UK in 2008 has meant that there has been macroeconomic uncertainly
• This means that with a risk of unemployment that consumers are delaying the purchase of goods
• This means that demand falls for goods and services
• As a result of uncertainty manufacturers are reluctant to expand and to grow which affects and reduces supply of goods and services