Chap 2 Economy and Business

Question 1

Business Cycles:

Answer 1

Business cycles are economy-wide periodic fluctuations in GDP, income, and employment

Question 2

. Leading Economic Indicators: (events signaling future)

Answer 2

These indicators are used to forecast at what stage economy will be in after some months.
These are used to assess whether a peak or trough will be reached in next 3 – 12 months.
 Index of business confidence/Stock Market Index.
 Manufacturers’ new orders
 New building permits for private housing
 Money supply

Question 3

. Leading Economic Indicators: (events signaling future)

Answer 3

These indicators are used to forecast at what stage economy will be in after some months.
These are used to assess whether a peak or trough will be reached in next 3 – 12 months.
 Index of business confidence/Stock Market Index.
 Manufacturers’ new orders
 New building permits for private housing
 Money supply

Question 4

. Leading Economic Indicators: (events signaling future)

Answer 4

These indicators are used to forecast at what stage economy will be in after some months.
These are used to assess whether a peak or trough will be reached in next 3 – 12 months.
 Index of business confidence/Stock Market Index.
 Manufacturers’ new orders
 New building permits for private housing
 Money supply

Question 5

Coincident Economic Indicators: (On going events)

Answer 5

These indicators are events that occur at the same time as peak or trough occurs. These are
used to assess whether an economy is in peak or trough.
 Number of people in employment
 Industrial production
 Personal incomes
 Manufacturing and trade sales

Question 6

Lagging Economic Indicators: (Events already happened)

Answer 6

These indicators occur 3 – 12 months after peak or trough.
 Consumer Price Index
 Rate of unemployment
 Interest rates
 Average income/Income per capita

Question 7

Changes in Economic Indicators and Some Common Business Responses:

Answer 7

refer notes

Question 8

Stock Market Index:

Answer 8

The stock market is considered most important leading indicators of economy. The performance of
a stock market is measured through stock market index.
Stock market index is the index of the market capitalization. Market capitalization is the market
value of a publicly traded company’s outstanding shares.

Question 9

Types of market index

Answer 9

 All Share Index: It represents market capitalization of all listed companies. It is calculated
on Full-Cap Method.
 KSE-100 index: It represents market capitalization of 100 companies with largest
capitalization. It is calculated on Free Float basis. It represents 85% of total market
capitalization.
 KSE-30 index: It represents market capitalization of 30 companies with largest
capitalization. It is calculated on Free Float basis.

Question 10

Types of market index

Answer 10

 All Share Index: It represents market capitalization of all listed companies. It is calculated
on Full-Cap Method.
 KSE-100 index: It represents market capitalization of 100 companies with largest
capitalization. It is calculated on Free Float basis. It represents 85% of total market
capitalization.
 KSE-30 index: It represents market capitalization of 30 companies with largest
capitalization. It is calculated on Free Float basis.

Question 11

Full-Cap and Free Float:

Answer 11

Full-Cap includes all of the shares issued by a company.
Free-float means those shares of a company which are readily available for trading at the Stock
Exchange.
It does not include shares held by controlling directors, sponsors, promoters, government and other
locked-in shares

Question 12

Stock Exchanges Indices and Business Decisions:

Answer 12

If stock exchange index is increasing, it means share prices are increasing and it is a good
time for company to issue shares.
 Many business hold shares as Cash Equivalents. A fall in share price may cause liquidity
problems for them.
 Share price is also an important factor in mergers and acquisitions

Question 13

Inflation

Answer 13

Inflation:
Inflation is a continuous or persistent increase in the general price level.
Inflation Rate (Annual %age) = (Price Level of Y1 – Price Level of Y0)/ Price Level of Y0 * 100
Suppose price level was 103 in 2016 and 106 in 2017. Then rate of inflation in 2017 is:
2.91% = (106 –103)/ 103 * 100

Question 14

Measures of Inflation:

Answer 14

Inflation can be measured from perspective of:
 Consumers (called Consumer Price Index i.e. CPI)
 Producers (called Producers Price Index i.e. CPI)
 Workers (called Wage-Price Spiral Inflation)

Question 15

Implications of Inflation:

Answer 15

Although some inflation is unavoidable (and keep producers motivated as prices of their produces
increase), however, a very high inflation can make economy stagnant or in recission.
Further, a high inflation can decrease value of loans because receivable will receive less and
payable will pay less in future.
People with fixed income (e.g. pensioners) will get poor, particularly if inflation rate increases
saving rate.

Question 16

Definition

Answer 16

Interest rates are the price of borrowing money. It is the amount charged by a lender to a borrower
on the amount borrowed.
Interest rates are expressed as a percentage of principal.

Question 17

Impact of Change in Interest Rate

Answer 17

Increase in interest rate affects economy in following ways:
1. Savings will be increased and borrowings will be decreased.
2. Consumption and investment in the economy will be decreased.
3. Disposable income of households (with loans and mortgages) will decrease.
Note: Impact of decrease in interest rate will be opposite.

Question 18

Impact of Change in Interest Rate

Answer 18

Increase in interest rate affects economy in following ways:
1. Savings will be increased and borrowings will be decreased.
2. Consumption and investment in the economy will be decreased.
3. Disposable income of households (with loans and mortgages) will decrease.
Note: Impact of decrease in interest rate will be opposite.

Question 18

Impact of Change in Interest Rate

Answer 18

Increase in interest rate affects economy in following ways:
1. Savings will be increased and borrowings will be decreased.
2. Consumption and investment in the economy will be decreased.
3. Disposable income of households (with loans and mortgages) will decrease.
Note: Impact of decrease in interest rate will be opposite.

Question 19

Unemployment:

Answer 19

Unemployment means being without employment and actively searching for work.

Question 20

Consequences of unemployment:

Answer 20

1. Loss of Output and National Income because of under-performance of economy. This will
   result in shortfall of tax collection, and current account.
2. Loss of Human Capital because of gradual decrease in skill and quality of performance of
   unemployed people.
3. Unemployed people slip into social evils e.g. depression, theft, robbery, personal suffering,
   suicide.
4. Burden on Govt. for Social Security Benefits

Question 21

Unemployment and business decisions:

Answer 21

High unemployment may affect businesses as follows:
 Demand for luxuries will decrease, but demand for cheaper goods will increase. Further,
demand of necessities of life will not change.
 Due to availability of workforce, business may hire new workers at lower rate.

Question 22

Fiscal Policy and it Use:

Answer 22

Fiscal policy is government policy on revenue (taxation), spending and government borrowing.
Govt. needs money to meet expenses for government employees, development expenditure, health,
education, defence etc.
Govt. also try to encourage investment by the private sector through tax incentives and subsidies.

Question 23

What is Balance of Payment:

Answer 23

Balance of Payment Account is a statement of all financial transactions of a country with rest of the
world over a period of time. Simply, it is the summary of imports and exports of a country.

Question 24

Surplus/Deficit in Balance of Payment:

Answer 24

If Exports > Imports  Surplus in Balance of Payment

If Exports < Imports  Deficit in Balance of Payment

Question 25

If there is a large trade deficit

Answer 25

 Govt. would ideally promote export e.g. textile and related value added products.
 Govt. would would also adopt a policy of trade restrictions e.g. quotas or tariffs on luxury
items such packaged food, chocolates or confectionary.

Question 26

Gross Domestic Product (GDP) or National Income:

Answer 26

“GDP is the aggregate market value of all goods and services produced within boundaries of a
country in a given period.”

Question 27

Components of GDP

Answer 27

GDP = C + I + G + (X – M)
C = Private/Domestic Consumption
I = Gross Private Investment/ Capital Formation
G = Government Spending
X – M = Net Exports

Question 28

Nominal GDP

Answer 28

Nominal GDP means measurements of GDP at current market prices (i.e. without adjustment for
inflation).

Question 29

Real GDP m

Answer 29

Real GDP means measurement of GDP at base/constant market prices (i.e. after adjustment for
inflation).
Real GDP= Nominal GDP / GDP Deflator (where GDP Deflator = 1 + Inflation Rate)
Real GDP is considered more accurate indicator of economic growth.