2.5.1 Economic Influences

Question 1

Business cycle

Answer 1

When an economy moves from boom to recession over time.

Question 2

Boom

Answer 2

When an economy is growing rapidly.

• High levels of consumer spending –> Sales revenue and profits will be high.
• High levels of business confidence and investment as capacity utilisation is high and consumer demand is increasing.
• Prices and costs also tend to rise faster as inflation is high and unemployment is low putting upward pressure on wages.

Question 3

Recession

Answer 3

Two consecutive quarters of negative economic growth.

• Falling levels of consumer spending means lower sales revenue and profits.
• Falling levels of confidence means business investment will be low, as capacity utilisation is low and consumer demand is falling.
• Costs might start to decrease as inflation is low, and unemployment is high putting downward pressure on wages.

Question 4

Slump/depression

Answer 4

• Low consumer spending so sales revenue and profits will be low.
• Investment is very unlikely and businesses may have to cut capacity.
• Many business failures.
• Rapidly rising unemployment.
• Prices may start falling.
• Businesses have to cut costs to survive.

Question 5

Recovery

Answer 5

• Consumers begin to increase spending so sales revenue and profits start to increase.
• Costs will not yet be rising and unemployment is still high so there is no upwards pressure on wages.
• Business investment and confidence may start to increase, but businesses will still be cautious.

Question 6

Interest rates

Answer 6

The price of borrowing and the reward for saving.

Question 7

Base rate

Answer 7

The interest rate set by the Bank of England for lending to other banks.
Sets base rate it thinks enables it to meet inflation targets.
Lenders commonly charge interest on borrowing at a higher rate.

Question 8

Impact of increasing interest rates on consumers

Answer 8

• Save money to increase its wealth.
• Won’t take out long term loans due to higher repayment costs.
• Unlikely to change buying habits of generic products.
• Reduces disposable income.
• May have more value in savings/pensions.

Question 9

Impact of increasing interest rates on businesses

Answer 9

• Costs will increase due to higher repayment costs.
• Investment decisions - invest abroad or where interest rates are lower.
• Affect consumer spending decisions.

Question 10

Businesses affected more by interest rate changes

Answer 10

1) Luxury products.
2) Those involved in overseas trade - higher interest rates make products more expensive abroad.
3) Products bought on credit.

Question 11

Two methods to control demand for goods/services

Answer 11

• Monetary policy (Bank of England): Control demand by increasing/decreasing interest rates.
• Fiscal policy (Government): Control demand by increasing/decreasing taxes and government spending.

Question 12

Exchange rate

Answer 12

The price of one currency expressed in terms of another.

Question 13

Strong pound

Answer 13

Imports, cheaper.
Exports, dearer.

Question 14

Weak pound

Answer 14

Imports, dearer.
Exports, cheaper.

Question 15

Inflation

Answer 15

A persistent rise in the aggregate price level of an economy (fall in purchasing power of money).

• Demand falls, people spend less.
• Currency looses its value (depreciation).
• Wages rise.
• Depreciation is the opposite.

Question 16

How is the rate of inflation calculated?

Answer 16

% change in consumer price index.
1. Basket of 650-700 typical goods.
2. Prices checked monthly.
3. Weighted by % income spent.
4. Index created showing average prices each month.

Question 17

Positive impact of high inflation on businesses

Answer 17

+ Industry wide price rises enables revenue to grow.
+ Makes using debt as a source of finance cheaper - debtors pay back with money worth less than what it was originally.
+ May be caused by higher consumer demand in the economy, for a short period of time before costs start to rise this could increase profit margins.

Question 18

Negative impact of high inflation on businesses

Answer 18

• Cost of raw materials rise so prices increase.
• Some businesses have long contracts and fixed prices, businesses cannot increase prices.
• Higher interest rates - reduces economic growth and can lead to a recession.

Question 19

Direct taxation

Answer 19

Tax on income or profits.

Income tax, corporation tax, business rates, national insurance.

Question 20

Indirect taxation

Answer 20

Tax on goods/services.

VAT, Excise duty

Question 21

The impact of taxation on businesses

Answer 21

• Cut in income tax —> Increases disposable income —> Increases demand.
• Cut in indirect tax —> Lower costs —> Lower prices —> Increases demand.
• Cut in corporation tax —> Higher ‘post tax’ profits —> Adds to business capital spending or investment.
• Cut in tax on interest from saving —> Increases disposable income —> Increases demand.

Question 22

Government spending

Answer 22

Money spent by the public sector on the acquisition of goods and the provision of services such as education, healthcare, social protection and defence.

Question 23

Employment

Answer 23

The number of people in work.

Question 24

Unemployment

Answer 24

When someone is willing and able to work but unable to find a job.

Question 25

Benefits and drawbacks of high unemployment

Answer 25

+ Larger poole of labour to choose from.
+ Low wage growth.
+ Demand for inferior goods rises.
+ Lower staff turnover.

• People will spend less on income elastic goods.
• Low morale and uncertainty in the workforce.
• Social problems e.g. shoplifting may rise.

Question 26

Benefits and drawbacks of low unemployment

Answer 26

+ More income to spend on goods/services.
+ Higher morale/motivation.

• Upward pressure on wages.
• Higher staff turnover.
• Harder to recruit.