Chapter 2: Economy and business perspective

Question 1

1 – Environment?

Answer 1

1 – Environment
▪ The environment of an organisation is a term that describes anything outside an organisation that
affects what it does or how it acts

Question 2

2 – Method of analysing environment?

Answer 2

2 – Method of analysing environment
▪ A famous method of analysing the environmental factors is known as ‘PESTEL’ and it is also known
as environmental scanning.
▪ PESTEL is an abbreviation of:
➢ P – Political factors
➢ E – Economic factors
➢ S – Social factors
➢ T – Technological factors
➢ E – Ecological factors (environmental factors)
➢ L – Legal factors

Question 3

3 – Significance of analysing the environment ?

Answer 3

3 – Significance of analysing the environment
1▪ Analysis and understanding the environmental factors, is important because:
- These factors can have a significant effect on organisation
- Can affect its activities and profitability
- Might affect the planning and other decision-making of the firm
2▪ Management should monitor developments in the environment, and should consider how
organisation should respond to that.

Question 4

2.1 – Defining the economic environment ?

Answer 4

▪ Economic environment refers to the external factors and the broader economic trends that can
impact a business

Question 5

2.2 – Types of economic environment ?

Answer 5

2.2 – Types of economic environment
(i) Microeconomic environment
(ii) Macroeconomic environment

Question 6

(i) Microeconomic environment?

Answer 6

▪ Microeconomic environment relates to a particular market place such as:
1- consumers behaviour,
2- market environment,
3- competition in the market and
4- demand and supply forces prevalent in that particular market place.

Question 7

(ii) Macroeconomic environment?

Answer 7

▪ Macroeconomic environment relates to broad economic factors that affect the entire economy and
all of its participants, including individual business.

Question 8

3.1 – Defining the economic cycle

Answer 8

▪ The economic cycle is a term used to describe how the national income of a country increases or
decreases from one year to the next.

Question 9

3.2 – Stages in economic cycle?

Answer 9

3.2 – Stages in economic cycle
1▪ When national income increases from one year to the next, there is economic growth.
2▪ When national income decreases from one year to the next, there is economic recession (or in
extreme cases, economic decline).
3▪ Specifically, economic cycle has four stages mentioned in the following diagram as:
(i) Boom (peak),
(ii) recession,
(iii) depression (trough) and
(iv) recovery
4▪ Government tries to achieve continued economic growth, but
5▪ if recession becomes unavoidable, policy is then aimed at making the recession as short and as
minor as possible.

Question 10

1 – Definition of economic indicators

Answer 10

.
▪ An economic indicator is a piece of economic information, usually of macroeconomic scale, that is
used by analysts to assess the overall health of an economy.

Question 11

Economic indicators may be classified into how many categories?

Answer 11

Economic indicators may be classified into following three categories
1Leading indicators
2Coincident indicators
3 Lagging indicators

Question 12

Leading indicators descripton?

Answer 12

Leading indicators tend to
change before the economy
starts to change and helps to
predict future changes in
economy.

Question 13

leading indicators examples?

Answer 13

1▪ Stock market returns
2▪ Money supply
3▪ Index of business confidence
4▪ New orders of manufacturers
5▪ New building permits for private

Question 14

Coincident
indicators description?

Answer 14

Coincident indicators are not so
useful for predicting the future
course of an economy but do
provide valuable insights into the
current or prevailing state of an
economy.

Question 15

Coincident
indicators examples?

Answer 15

1▪ Gross Domestic Product (GDP)
2▪ Number of people in employment
3▪ Industrial production
4▪ Personal incomes
5▪ Manufacturing and trade sales

Question 16

Lagging
indicators description?

Answer 16

Lagging indicators change only
after the change in economy has
already taken place.

Question 17

Lagging
indicators examples?

Answer 17

1▪ Level of inflation (consumer price
index)
2▪ Unemployment
3▪ Interest rates
4▪ Average income
5▪ Balance of trade or balance of
payments

Question 18

4.3 – Leading indicator - Stock market returns?

Answer 18

4.3.1 – Introduction
4.3.2 – Market capitalisation
4.3.3 – Stock exchange indices
(a) KSE – 100 Index
(b) All share Index
4.3.4 – Stock exchange indices and business decision

Question 19

4.3 – Leading indicator - Stock market returns
4.3.1 – Introduction?

Answer 19

4.3 – Leading indicator - Stock market returns
4.3.1 – Introduction
1▪ Stock market return is considered as one of the leading indicators.
2▪ Performance of a stock market is measured through stock market index such as:
a- KSE 100 index
b- KSE All share index
c- KMI All share index
d- KMI 30 share index
3▪ Stock market index is the index of the market capitalisation of a section of stock market.

Question 20

4.3 – Leading indicator - Stock market returns
4.3.2 – Market capitalisation?

Answer 20

4.3.2 – Market capitalisation
1▪ Market capitalization is the total market value of a publicly traded company’s outstanding shares:
Market capitalisation = Market value per share x number of outstanding shares
a- It reflects what investors are willing to pay for its stock.
b- It’s a tool used by investors to describe market and to compare return on investments.
c- It measures a company’s worth on the open market and its perceived future prospects.
2▪ Market capitalisation could be based on:
Methods Market capitalisation
Full-cap = Market value per share x number of all shares issued by company
Free-float = Market value per share x number of shares trading actively

Question 21

4.3 – Leading indicator - Stock market returns
4.3.3 – Stock exchange indices
(a) KSE – 100 Index
(b) All share Index

Answer 21

▪ Stock Exchange indices classify the companies in a specific category, sector or performance.
▪ Two major indices in Pakistan are as follows:
(a) KSE – 100 Index
1▪ This is the most recognized index of Pakistan Stock Exchange (PSX).
2▪ It includes the largest companies on the basis of market capitalization.
3▪ The index represents 85% of all the market capitalization of the exchange.
4▪ It is calculated using free float market capitalization methodology.
5▪ The KSE100 has a base value of 1,000 as of November, 1991.
(b) All share Index
▪ It consists of all listed companies on PSX based on Full Cap methodology

Question 22

4.3 – Leading indicator - Stock market returns
4.3.4 – Stock exchange indices and business decision?

Answer 22

4.3.4 – Stock exchange indices and business decision
1▪ Movements in stock market can impact a company in number of ways:
1- Rise and fall of share price values affects a company’s market capitalization
2- Businesses also consider stock performance in decisions related to issue of shares.
➢ If a stock is performing well, a company might be encouraged to issue more shares
because they will be able to raise more capital at a higher value.
3- Market value of a company is also an important factor when considering mergers and
acquisition.
4- Companies may hold shares as cash equivalents and value fall can lead to funding problem.
5- Increase in stocks’ value may generate interest for new products or businesses

Question 23

4.4 – Coincident indicator - Gross domestic product (GDP)
4.4.1 – Definition?

Answer 23

1▪ GDP is a monetary measure of the market value of all the final goods and services produced
within a country in a specific time period.
2▪ It can be expressed as the GDP per capita (i.e. head of population) to compare economies.
3▪ GDP per capita is often considered an indicator of a country’s standard of living, though it is not a
measure of personal income.

Question 24

4.4 – Coincident indicator - Gross domestic product (GDP)
4.4.2 – Computation of GDP?

Answer 24

4.4.2 – Computation of GDP
▪ Gross domestic product (GDP) = C + I + G + (X – M)
C = Amount of Consumption on goods and services
I = Amount spent on Investment in long-term assets
G = Amount of Government spending
X = Amount of Exports of goods and services
M = Amount of Imports of goods and services

Question 25

4.4 – Coincident indicator - Gross domestic product (GDP)
4.4.3 – Inclusions and exclusions in GDP?

Answer 25

4.4.3 – Inclusions and exclusions in GDP
1▪ GDP must include total output from all of the sectors of an economy:
(i) Primary sector (agriculture, mining etc.)
(ii) Secondary sector (manufacturing and construction); and
(iii) Tertiary sector (services)
2▪ GDP does not include services and products that are produced by nation in other countries

Question 26

4.4 – Coincident indicator - Gross domestic product (GDP)
4.4.4 – Real GDP vs Nominal GDP?

Answer 26

4.4.4 – Real GDP vs Nominal GDP
1▪ GDP for a particular year is measured by two ways:
(a) Nominal GDP is the value at current prices in a specific time period, this includes the impact
of inflation and is normally higher than the real GDP.
(b) Real GDP is an inflation adjusted value of GDP. It expresses the value of goods and services
produced in a country in a base year price.
2▪ Real GDP is an accurate indicator of economic growth.

Question 27

4.5 – Lagging indicators - Inflation
4.5.1 – Definition?

Answer 27

4.5.1 – Definition
▪ Inflation is the increase in price levels over time.?

Question 28

4.5 – Lagging indicators - Inflation
4.5.2 – Measurement of inflation?

Answer 28

4.5.2 – Measurement of inflation
▪ Rate of inflation is measured using one or more price indices or cost indices, such as:
(i) a Consumer Price Index (CPI) or
(ii) a Retail Price Index (RPI) or
(iii) an Index of Wages Costs.

Question 29

4.5 – Lagging indicators - Inflation
4.5.3 – Implication of inflation for Businesses?

Answer 29

4.5.3 – Implication of inflation for Businesses
▪ Businesses are affected by inflation because of:
➢ Inflationary spiral
➢ Inflationary expectations
(i) Inflationary spiral
In presence of inflation:
▪ Businesses have to pay more to suppliers in order to acquire resources such as materials and
labour; and
▪ Businesses have to pass on their extra costs to their customers by raising the prices of their own
goods and services.
▪ Individuals have to pay higher prices for purchasing goods and services, so they need more
money to pay for them. If they are in work, they might demand higher wages and salaries.
So, this ‘inflationary spiral’ can go on indefinitely.
(ii) Inflationary expectations
▪ Inflationary expectation refers to the rate of inflation that businesses and individuals expect in
future.
▪ Inflationary expectations affect demands for wage rises, and decisions by businesses to raise
their prices.
So, this inflationary expectation can also affect inflation rate**

Question 30

4.5 – Lagging indicators - Inflation
4.5.4 – Implications of high inflation for economy (national income)

Answer 30

Inflation has implications for national economy and economic growth
1▪ National income increases as a result of two factors:
(i) Increase in ‘real’ quantity of goods and services; and
(ii) Increases due to higher prices and costs.
2▪ It is possible that national income increases (due to inflation) but the real economy is in recession
(due to decrease in real quantities). For example
➢ Increase in national income from one year to next year is 3%
➢ Inflation rate is 5%
➢ Real economy is gone into recession and is lower by 2%.
3▪ Normally when the rate of inflation and inflationary expectation is high, the ‘real’ economy is likely
to stagnate or go into recession.
4▪ A government might think that some inflation is unavoidable
5▪ Rate of inflation and inflationary expectations should be kept under control, to give the ‘real
economy’ an opportunity to grow.

Question 31

4.5 – Lagging indicators - Inflation
4.5.5 – Social and economic implications of inflation?

Answer 31

4.5.5 – Social and economic implications of inflation
1▪ Inflation results in shift of economic wealth from savers/depositors/lenders to borrowers.
2▪ In times of inflations, borrower gains from fall in value of debt but lenders lose because value of
their savings falls.
3▪ For example, Individual is earning from saving a return of 3% after tax when inflation is 5%. So,
he is losing 2% in real terms in each year.
4▪ Another reduction in value of fixed incomes or income less than the rate of inflation of each year.
Richer might get more richer while the poor get poorer.

Question 32

4.6 – Lagging indicators - Unemployment
4.6.1 – Definition?

Answer 32

4.6.1 – Definition
▪ Unemployment means that there are not enough jobs for the people who want them. ?

Question 33

4.6 – Lagging indicators - Unemployment
4.6.2 – Causes of unemployment?

Answer 33

4.6.2 – Causes of unemployment
1▪ In economic recession and falling demand for goods and services, many firms will make some
employees redundant due to low profitability.
2▪ Sometimes unemployment is caused by shortage of skilled labour. Unemployment means that
there are not enough jobs for the people who want them.

Question 34

4.6 – Lagging indicators - Unemployment
4.6.3 – Managing shortage of skilled labour?

Answer 34

4.6.3 – Managing shortage of skilled labour
▪ Shortage of skilled labour can be managed through:
(i) Better standard of education
(ii) More training
(iii) Outsourcing to other countries where skilled labour is abundant.

Question 35

4.6 – Lagging indicators - Unemployment
4.6.4 – Implications of high levels of unemployment?

Answer 35

4.6.4 – Implications of high levels of unemployment
High levels of unemployment are un-welcome in an economy because:
1▪ individuals who want jobs cannot get them (and high unemployment is damaging to society and
the welfare of the people)
2▪ economic growth is less than it could be: if the unemployed individuals could be given work,
output in the economy would increase and there would be economic growth.

Question 36

4.6 – Lagging indicators - Unemployment
4.6.5 – Unemployment and business decisions?

Answer 36

4.6.5 – Unemployment and business decisions
1▪ Slow economic growth due to unemployment will directly affect businesses.
2▪ Many households will have less income which would result in lower sales
3▪ Demand for some cheaper products and services will increase
4▪ Demand of locally produced goods will increase so local companies might have to increase
production.
5▪ Businesses looking to recruit people may also be able to offer relatively lower pay and still attract
new staff.

Question 37

4.7 – Lagging indicators – Interest rate
4.7.1 – Definition of interest rate?

Answer 37

4.7.1 – Definition of interest rate
1▪ Interest rate is the:
- amount charged by lenders from borrowers on account of loan or
- amount received against money deposited in bank
2▪ Interest rate is expressed in annual percentages.

Question 38

4.7 – Lagging indicators – Interest rate
4.7.2 – Impacts of increase in interest rate?

Answer 38

1▪ It will discourage investment as it would be more difficult for companies to earn positive NPV on
projects because of high cost of capital.
2▪ It might encourage people to save, resulting in availability of more funds for investment.
3▪ Consumption would fall for a number of reasons:
a- High interest rates encourage people to save.
b- It would result in lower disposable income for borrowers.
c- It makes it more expensive to borrow, so less consumption.
4▪ Profitability of banking sector’s will increase (as their main business is lending)
5▪ Increase in interest rate would increase the cost of doing business which will make it less
competitive in international market, which is full of low-cost producers like Bangladesh etc.
6▪ Increased financing cost may hinder investment in expansion or upgradation technology etc

Question 39

4.7 – Lagging indicators – Interest rate
4.7.3 – Impacts of decrease in interest rate?

Answer 39

4.7.3 – Impacts of decrease in interest rate
▪ Impacts of decrease in interest rates would be opposite to impacts of increase in interest rates
such as:
- more investment,
- more consumption,
- less savings,
- higher disposable income and
- low cost of doing business

Question 40

4.8 – Lagging indicators – Balance of payments
4.8.1 – Definition of balance of payments?

Answer 40

▪ It measures the financial transactions made between
- consumers,
- businesses and
- the government in one country with others.

Question 41

4.8 – Lagging indicators – Balance of payments
4.8.2 – Computation of balance of payments?

Answer 41

4.8.2 – Computation of balance of payments
1▪ It is calculated by adding up the value of all the goods that are exported (i.e. sold to other
countries) and imported (i.e. bought from other countries).
2▪ It is made up by a combination, in a country, of:
- the current account
- the capital account
- official financing account
3▪ For any country, Surplus/deficit on trade = Net outflow or inflow of capital.

Question 42

4.8 – Lagging indicators – Balance of payments
4.8.3 – Importance of balance of payments?

Answer 42

4.8.3 – Importance of balance of payments
1▪ Balance of payments (BOP) data is an important indicator for:
a- investment managers,
b- government policymakers,
c- State bank,
d- businessmen, etc.
2▪ Businesses use BOP to examine market potential of a country, especially in the short term.
a- A country with a large trade deficit is not as likely to import much
b- Government may adopt a policy of trade restrictions, such as quotas or tariffs etc.
c- Government may promote industries focused on export
d- Government may also promote local manufacturing to avoid huge amounts on imports.