3.7.5 Analysing the external environment to assess opportunities and threats: economic change

Question 1

List some economic factors

Answer 1

GDP
Taxation
Exchange rates
Inflation
Fiscal and monetary policy
More open trade v protectionism

Question 2

What is Gross Domestic Products (GDP)?

Answer 2

a measure of economic activity (the total value of a countries output) over a given period of time, usually provided as quarterly or annual figures

Question 3

What is the difference between GDP and real GDP?

Answer 3

The difference between GDP and real GDP is that on its own, GDP is nominal, whereas real means that the effect of inflation has been removed

Question 4

What is direct tax?

Answer 4

Direct taxation is levied on income, wealth and profit

Question 5

What is indirect tax?

Answer 5

An indirect tax is charged on producers of goods and services and is paid by the consumer indirectly.

Question 6

What is corporation tax?

Answer 6

This is a form on direct taxation, which is a tax on the trading profits made by a business over the course of their financial year as well as any profit from investments and disposal of assets

Question 7

What is value added tax?

Answer 7

This is a form of indirect taxation, collected by businesses for the government. It is a tax placed on the sale of goods and services in the UK – it is a type of ‘consumption tax’

Question 8

What does the business cycle look like?

Answer 8

Question 9

What are the causes of the business cycle?

Answer 9

• Changes in business confidence
• Periods of inventory building and then de-building (usually due to seasons factors such as Christmas or Halloween; or due to expansion of the firm)
• Irregular patterns of expenditure on consumer durables
• Confidence in the banking sector

Question 10

What are injections?

Answer 10

Investment
Government expenditure
Exports

Question 11

What are withdrawals?

Answer 11

Savings
Taxes
Imports

Question 12

What is a boom?

Answer 12

high levels of consumer spending, business confidence, profits and investment. Prices and costs also tend to rise faster. Unemployment tends to be low as growth in the economy creates new jobs

Question 13

What is a recession?

Answer 13

falling levels of consumer spending and confidence mean lower profits for businesses – which start to cut back on investment. Spare capacity increases + rising unemployment as businesses cut back and reduce stocks

Question 14

What is a slump?

Answer 14

a prolonged period of declining GDP - very weak consumer spending and business investment; many business failures; rapidly rising unemployment; prices may start falling (deflation)

Question 15

What is a recovery?

Answer 15

things start to get better; consumers begin to increase spending; businesses feel a little more confident and start to invest again and build stocks; but it takes time for unemployment to stop growing

Question 16

What is exchange rates?

Answer 16

the rate between two distinct countries

Question 17

What is currency demand?

Answer 17

demand from currency comes from a need to purchase the currency of a particular economy

Question 18

What do sources of demand include?

Answer 18

Exports of goods
Exports of services
Inflows of foreign investment
Speculative demand
Official buying of sterling by the Bank of England

Question 19

What is currency supply?

Answer 19

supply of currency comes from economic agents needing to demand overseas currency in exchange for their own

Question 20

What do sources of demand include?

Answer 20

Imports of goods
Imports of services
Outflows of foreign investment
Speculative selling
Official selling of sterling by the Bank of England

Question 21

Explain free floating exchange rates

Answer 21

Rate determined purely by market demand and supply
No government intervention
Current finds its own value
Means that businesses need to be concerned about how the ER may change when international sales and imports of materials occur
For large transactions, firms may need to use the futures market
If the pound is weak, it is good for exporters but bad for importers

Question 22

Explain managed exchange rates

Answer 22

Government may seek to influence the market value of the currency
Intervention is done by the Bank of England
Uses stocks of gold and other foreign currencies
May change short term interest to manage the external value of the pound
Increasingly difficult to manage the exchange rate fine the size and power of the FOREX market
Provides stability for businesses but means they neither benefit nor lose out

Question 23

Explain fully fixed exchange rates

Answer 23

Central target for the exchange rate (currency peg)
No fluctuations permitted
Occasional revaluation or devaluation when economic fundamentals demand one
Central bank intervention to maintain the currency
Illegal to trade away from the currency peg
Eurozone countries ‘locked’ their exchange rates together from 1999-2002 before the introduction of the euro

Question 24

What is inflation?

Answer 24

A sustained rise in the general price level

Question 25

What is Consumer Price Index?

Answer 25

The main measure of inflation for the UK
The Government has set the Bank of England a target for inflation (using the CPI) of 2%
The aim of this target is to achieve a sustained period of low and stable inflation

Question 26

Explain demand pull inflation

Answer 26

High inflation can be caused by too much demand (more than the economy can supply). It happens when there’s an increase in disposable income so people buy more and companies can’t supply goods quickly enough and increase their prices. This is demand-pull inflation. Excess demand when the economy is near its full capacity is called overheating. Demand-pull inflation can actually make profit margins go up.
Businesses can put up prices in response to high demand without their costs going up by as much.

Question 27

Explain cost push inflation

Answer 27

Rises in inflation can be due to rising costs pushing up prices - this is cost-push inflation.
Wage rises can make prices go up - especially if productivity isn’t rising. Cost-push inflation can make profit margins go down if businesses decide not to put up their prices.

Question 28

What are the effects of inflation on consumers?

Answer 28

As prices rise (inflation) money loses its value and people lose confidence in money as the value of savings is reduced
Inflation can get out of control – price increases lead to higher wage demands as people try to maintain their living standards
Consumers on fixed incomes (e.g. pensioners) lose out because the their real incomes fall

Question 29

What are the positive effects of inflation on businesses?

Answer 29

• Industry-wide price rises enable revenues to grow
• Growing revenues + constant gross margin = higher gross profit
• Makes using debt as a source of finance cheaper in real term

Question 30

What are the negative effects of inflation on businesses?

Answer 30

• If costs are rising due to inflation, a business may not be able to pass them onto customers (PED)
• Inflation can disrupt business planning and lead to lower investment
• Rising inflation is associated with higher interest rates - this reduces economic growth and can lead to a recession

Question 31

What are expansionary fiscal policies?

Answer 31

this means that they are aiming to increase economic activity by borrowing more than the government gets in tax and using it to inspire growth

Question 32

What are contractionary fiscal policies?

Answer 32

This means they are aiming to decrease economic activity by spending less than the government gets in tax and using it to slow down economic growth

Question 33

What are neutral fiscal policies?

Answer 33

this means they are trying to balance the books and spend what it taxes

Question 34

Explain monetary policy

Answer 34

This refers to the availability of money, credit, and the price of credit
In the UK, it is done through the Bank of England and the Monetary Policy Committee (MPC)
Every month, the MPC meets to look at the state of the economy, and the governments policy to set the interest rate

Question 35

What is quantitative easing?

Answer 35

a tool that central banks use to inject digital money directly into the economy should it be weak or failing – create digital money and use it to buy government debt in the form of bonds

Question 36

List supply side policies used to try and improve the supply of goods and services

Answer 36

• Privatisation
• Nationalisation
• Deregulation
• Freeing up labour laws
• Incentives to work
• Immigration
• Education and training
• Transport infrastructure

Question 37

What is protectionism

Question 38

Explain protectionism

Answer 38

This involves any attempt by a country to to impose restrictions on the open trade in goods and services
The main aim of protectionism is to cushion domestic businesses and industries from overseas competition and prevent the outcome resulting solely from the interplay of free market forces of supply and demand

Question 39

What is open trade?

Answer 39

This involves the removal or reduction of barriers to international trade

Question 40

What are the main forms of protectionism?

Answer 40

• Tariffs
• Quotas
• Export subsidies
• Domestic subsidies

Question 41

What are tariffs?

Answer 41

these are a tax or duty that raises the price of imported products and causes a contraction in domestic demand and an expansion in domestic supply

Question 42

What are quotas?

Answer 42

these are quantitative (volume) limits on the level of imports allowed or a limit to the value of imports permitted into a country in a given time period. Quotas do not normally bring in any immediate tax revenue for the government although if they cause domestic production and incomes to expand, there will be a beneficial impact on taxes paid.

Question 43

What are export subsidies?

Answer 43

this is a payment to encourage domestic production by lowering their costs (loans can be used to fund the dumping of products in overseas markets)

Question 44

What are domestic subsidies?

Answer 44

these involve government help (state aid) for domestic businesses facing financial problems

Question 45

Why do governments implement protectionism?

Answer 45

Develops new trade advantages
Improves the balance of trade
Response to dumping
Employment protection
Desire to increase government revenue

Question 46

What is globalisation?

Answer 46

The process through which an increasingly free flow of ideas, people, goods, services, and capital leads to the integration of economies and societies
The main driver of globalisation are businesses as multinationals was to increase sales, profit, and shareholder value; and the government wants to encourage domestics firms to expand further

Question 47

List the things that globalisation involves

Answer 47

An expansion of trade in goods and services between countries
And increase in FDI by multinational countries (MNC)
The development of global brands
Shifts in production
Increased levels in labour migration
The entry of countries into the global trading system

Question 48

What are the drivers of globalisation?

Answer 48

Rising living standards
Less protectionism
Lower transport costs
Digital communication
Diverging consumer cultures
Market liberalisation

Question 49

What are the advantages of globalisation?

Answer 49

• Opportunities for trade and investment overseas
• Access to cheaper goods and services
• Lifted millions out of poverty
• More intense competition
• Bigger export markets (economies of scale)
• Opportunities to live, study, and travel overseas

Question 50

What are the disadvantages of globalisation?

Answer 50

• Increased unemployment for firms that lose demand to lower cost competition
• Rising income and wealth inequality
• Surge of inward migration of labour has brought economic and social tensions
• National governments gave less control
• Globalisation of brands means there is a loss of cultural diversity
• Environmental damage

Question 51

What are the features of less developed economies?

Answer 51

• Low incomes and levels of productivity in terms of labour and capital
• Often endowed with rich natural resources
• Higher dependency of export incomes from primary commodities/low export diversification
• Much of the population works in agriculture and lives in rural areas
• Limited support provided
• Distant from technological frontiers
• Relatively fast growth of population and a younger average age
• Rapid urbanisation and large scale rural-urban migration
• Weaknesses in infrastructure such as telecommunications, transport, ports, water, and sanitation
• Higher tariffs and other import controls

Question 52

Explain the potential business opportunities from emerging economies

Answer 52

• They tend to have relatively high rates of economic growth compared with more mature developed economies like the UK, US, Japan and Europe.
• Many emerging economies have seen the rapid growth of a “middle class” with rising disposable incomes that might simulate demand for the products of businesses located in developed economies.
• Emerging economies may be a suitable location for international operations - either as a location for production and/or to sell into the domestic market

Question 53

Explain the potential business challenges from emerging economies

Answer 53

Many domestic businesses based in emerging economies are now actively pursuing expansion into developed economies
Doing business in emerging economies is not straightforward – an increased risk of intellectual property theft, restrictions on the methods of doing business and competitive challenges from established domestic businesses are threats that need to be overcome