6 - The Impact of Economic Factors on Business Function

Question 1

1. Inflation- definition

Answer 1

• Defined as a general and persistent rise in prices (deflation is the opposite).
• Every quarter (3 month period), the Australian Bureau of Statistics (ABS) calculates the ‘Consumer Price Index’ (CPI) based on a typical ‘basket’ of the goods and services purchased by a household. The CPI is compared to previous quarters.
• Inflation is identified when there is a rise in the CPI over three consecutive quarters. The inflation rate is the percentage change in the CPI from one quarter to the next. If inflation is rising (indicated by a rising CPI), consumers have to spend more to buy the same goods and services, i.e. purchasing power has fallen. Likewise, businesses must also pay more to purchase inputs in their production process.
• E.g. In September 2022, inflation reached a high of 7.3%. Grocery and petrol prices, in particular, skyrocketed. Consumers and businesses could buy less of each with their money.

Question 2

1. Inflation- Impact on business function

Answer 2

• If inflation is high (i.e. the value of money decreases and purchasing power falls):
  
  • Consumers can buy fewer goods and services with each unit of their currency.
  • Banks tend not to lend money. This is because the Reserve Bank of Australia (RBA) will likely increase interest rates to control the higher inflation. If banks gave out loans, many customers/businesses would be unable to repay their loans at higher interest rates, impacting the bank’s profit.
  • Impact on business: Without access to bank loans, businesses may not have the funds to expand or introduce new products.
  • Impact on consumers: Without access to bank loans, consumers may not have the funds to buy luxury products.
  • Businesses will have to pay more for supplies and possibly increase their prices. Businesses will find this problematic because as their costs are inflating, they still must offer competitive prices to encourage consumers to buy. Profit margins may be reduced.
  • Employees and unions may pressure businesses to increase wages in line with inflation, further increasing business expenses.
  • Businesses and consumers may change their market behaviour to use online shopping more to compare prices, and they may import less expensive goods/inputs.
  • Instead of substituting for less expensive brands, consumers may stop spending on luxury items altogether. This will negatively impact the sales of businesses that sell non-essential luxury items such as jewellery, travel, high fashion brands etc.

Question 3

2. Interest rates- definition

Answer 3

• An interest rate can be considered ‘the cost of borrowing money’. Interest is what a borrower pays a lender when they borrow their money, on top of the principal amount borrowed. Interest rates are generally expressed as a percentage of the total borrowed.
• For example, a business may borrow $10,000 over five years from a bank to purchase new equipment, for which the bank charges 7% interest per year. The business must pay this initial $10,000 (the principal) plus an additional $700 (7% interest) per year.
• The Reserve Bank of Australia (RBA) sets the official interest rate to keep inflation between 2-3%. Suppose the economy grows too quickly, causing inflation to increase rapidly. In that case, the RBA will raise the ‘cash rate’ (the national interest rate), slowing down economic activity. The cash rate set by the RBA then influences the interest rates charged by lenders, impacting the debt repayments businesses and consumers pay on their loans, mortgages and credit cards.

Question 4

2. Interest rates- impact on business function

Answer 4

If interest rates increase (i.e. the cost of borrowing increases):
□ Businesses’ debt repayments increase, leaving businesses with less to spend on business function and expansion. If, for example, a business relies on borrowed funds to expand operations or develop new products, an increase in interest rates may postpone these plans.
□ Businesses may delay plans to expand or introduce a new product due to the uncertainty of whether consumers will have the money to pay for these.
□ Higher interest rates thus decrease business activity.
□ Consumers’ debt repayments increase, reducing their disposable incomes as more of their income is spent repaying their debts, such as credit cards and mortgages.
- This will reduce their consumption, negatively impacting businesses’ sales. With interest rates higher, consumers may also prefer to save their money (rather than spend) in a bank account to earn higher interest.
- Businesses selling luxury, non-essential items are typically affected the most.

Question 5

3. Unemployment- definition

Answer 5

• The unemployed are people of working age who are without work, are available for work, and have taken specific steps to find work.

Question 6

3. Unemployment- Impact on business function

Answer 6

• Rising unemployment (higher levels of people unemployed):
  
  • Lower consumer spending as households have lower incomes/rely on welfare.
  • Consumer spending is focused on essential items, not luxury goods
  • Businesses, mainly those selling non-essentials/luxuries, may experience lower demand for their products and thus reduced profits.
  • Oversupply of available labour may result in lower pay levels - businesses can recruit and select workers from a larger pool, offering lower wages as individuals are desperate for work.
  • The cost structure of a business model may benefit in that it may not be necessary to increase wages as much due to the limited number of opportunities elsewhere in the labour market.
  • Specialised skills and experience are lost when people are sacked
  • Staff morale may be lower; employed workers feel threatened that they may lose their jobs.

Question 7

4. Availability of Skilled and Unskilled Labour - Definition

Answer 7

□ Skilled Labour: Skilled labour refers to workers who require certain training or skills to perform their duties effectively. Due to this additional training, skilled labour workers are typically paid more and have greater job responsibilities than unskilled labour.
□ Examples include electricians, administrative assistants, doctors and plumbers.
□ Unskilled Labour: Unskilled labour is a segment of the workforce associated with low skill levels. Unlike skilled labour, work in this category does not require much training or formal education. Due to the minimal training required, unskilled labour workers are typically paid less and have lower job responsibilities than skilled labour.
□ Examples include cashiers, grocery clerks and cleaners.
□ The availability of skilled and unskilled labour will rise and fall depending on economic growth (high economic growth results in less unemployment and greater shortages in skilled and unskilled labour, and vice versa).

Question 8

4. Availability of Skilled and Unskilled Labour - Impact on Business Function

Answer 8

• Low availability of skilled and unskilled labour (Labour Shortage):
  
  • Harder for businesses to employ more staff, so wages increase. Businesses will offer more than their competitors to secure skilled and unskilled employees.
  • Business function can be negatively affected if it is difficult to find skilled and unskilled staff to fill positions. Some businesses may need to restrict orders or days of operations if skilled and/or unskilled workers are in short supply. The scarcity of skilled and unskilled workers can hamper businesses’ growth opportunities as businesses cannot find the personnel they need to conduct their operations (making and selling).
  • Increased economic activity can cause a shortage of skilled workers, so unskilled workers may be used to fill job vacancies.
  • During a shortage, workers will earn higher wages and can spend more on luxury items such as travel, entertainment, electrical goods, and house renovations. Businesses selling these luxury items may experience higher sales from this segment of customers. This increased spending can lead to more jobs and profits.
• High availability of skilled and unskilled labour (Labour Surplus):
  
  • When the availability of skilled and unskilled labour is high (labour surplus), it is easier for businesses to employ more staff. So wages decrease because more people are looking for work and willing to take a lower pay rate to secure employment.
  • Both skilled and unskilled workers will apply for many jobs, and sometimes, a highly skilled worker will find work in a low-skilled job to obtain work. This impacts business function because it can make it easier to employ skilled people for less money, and businesses can offer more products or services.
  • If many migrants come to Australia looking for unskilled jobs, they are desperate for work and willing to get paid less. This means businesses will employ and pay them less, but Australians looking for unskilled jobs will not get the job as they expect to be paid more.