(PAPER 3) 2.5.1 economic influences* Flashcards
inflation definition
a sustained increase in the cost of living or the general price level
causes of inflation
> demand-pull inflation = too much demand for goods and services, usually because of an increase in consumer incomes- business cannot supply fast enough so prices are increased
cost-push inflation = when rising cost, such as employee wages, push prices up.
Exchange rate definition
the value of one currency expressed in terms of another
Appreciation definition
a rise in the value of a currency
E.g. if £1changed from being worth $1.20 to $1.60 it has strengthened cause you can buy 0.40 more dollars with every pound
Appreciation makes UK exports more expensive abroad = bad for UK exports cause their prices are less competitive- means that UK exports may need to reduce their prices which will affect their profits.
An increase in the exchange rate is good for UK importers because imports become cheaper= more profit for every imported item sold in UK
Depreciation definition
A fall in the value of a currency
If the pound becomes weaker this is known as depreciation.
E.g. if £1 changed from being $1.60 to $1.20 it has weekend cause you can buy 0.40 dollars less with every pound.
UK exports become cheaper when the exchange rate decreases- good for UK exporters cause their products become more competitively priced abroad and so may be cheaper than other similar products in other countries- could increase demand or the exporter could increase their price in pounds which will increase profitability but won’t increase demand.
UK imports are damaged by a weaker exchange rate because their imported stock costs more- firms could react by increasing their prices but could lead to a fall in demand. These businesses are therefore likely to do nothing and make less profit on each sale of an imported item
Example of calculating differences in currencies
Q. How much will it cost a French business to buy goods from a British business which costs £400000 if £1=€1.25?
A. £400000 x 1.25= £500000
Q. How much will it cost a British business in pounds to buy $300000 of goods from a US business if £1=$1.50
300000/1.50= £200000
Tips for answering exchange rate math questions
when the money signs are different (£ €) you TIMES BUT if the money signs are the same (£ £) you DIVIDE
SPICED WPIDEC
Strong Pound Imports Cheaper Exports Dearer
Weak Pound Imports Dearer Exports Cheaper
Effects to a British exporter to the EU if the pound appreciates in value
makes them less competitive- costs American businesses more to buy our goods- gonna buy less from us
Effects to a British importer if the pound depreciates in value
makes them less competitive- weaker pound means we can buy fewer dollars
Effects to a British importer if the pound appreciates in value
makes them more competitive- imports are cheaper because our pound is stronger
Effects to a British exporter to the US if the pound depreciates in value
makes them more competitive- Americans want to buy from us because their currency is stronger compared to ours
Effective strategies for business to make them more competitive
if the pound appreciates in value, they should buy domestically e.g. Instead of buying oranges form Spain, buy from England- cheaper to import goods
REMEMBER…
a fall in the rate of inflation is not the same as a fall in prices, which is known as
deflation.
Deflation is usually associated with a fall in demand- when prices are falling, consumers may delay spending because they think they can make purchases in the future at lower prices. For a fall in prices, inflation needs to be a negative number. Deflation is rare in the UK.
The consumer price index
Inflation is measured by the consumer price index- which is produced by the government each month
- it uses index numbers to track changes in the average cost of a “basket” of around 700 goods and services that an average household would regularly buy. This relates back to the starting time of the index, the base year which is given in index numbers of 100.
Practice question- exchange rate.
How much will it cost a french business to buy goods from a British business which costs £400,000 if £1 = €1.25
The cost of the french business in euros: £400,000 x 1.25 = €500000
the effect on a business from changes in inflation
high inflation:
inflation that is too high is bad and unsustainable for the economy. it unsettles customers—-> they generally react by saving their money to make up savings to their previous real value. This is because steady inflation erodes the spending power of money. As far as businesses are concerned,
this means that borrowing and lending money becomes an opportunity and a problem. If inflation is
100 per cent per annum, the real value of money borrowed a year ago is halved in one year.
two causes of inflation
DEMAND-PULL INFLATION: when there is too much demand for goods and services usually because of the increase in consumer incomes. because businesses cannot supply these goods and services quickly enough, prices are forced up
COST-PUSH INFLATION: when rising costs, such as employee wages, push prices up
2 reasons why high and/or fluctuating inflation is damaging to a business
- UK exports become more expensive
2. premium products may become too expensive so consumers swap to cheaper alternatives
deflation definition
a fall in the general price level over a period of time
how is inflation measured
consumer price index - measured through a basket of goods
what happens if the exchange rate depreciates
price of exports: DECREASES
demand for exports: INCREASES
price of imports: INCREASES
demand for imports: DECREASE
what happens if the exchange rate appreciates
price of exports: INCREASES
demand for exports: DECREASE
price of imports: DECREASE
demand for imports: INCREASES
Interest rate definition
the cost of borrowing or the reward of saving
effects of rising interest rates on a business
- cost of borrowing becomes too high so firms stop investing
- consumers will tend too save, rather than spend, reducing demand
why might changes in interest rates have an effect on investment by a business
a business that uses loan capital to grow will have to pay more interest thus making it less likely that they want to invest
difference between direct and indirect tax
direct- taken directly from income
e.g. income tax, corporation tax
indirect- taken from spending on goods and services
e.g. VAT, income tax
2 effects on businesses of changes in government expenditure
- less demand for goods and services if direct taxes rise
2. higher corporation tax means less profit left for investment
what does the business cycle represent
represents the fluctuation in a countries gross domestic product
main features of a business cycle
y= real GDP x= time
process= expansion, peak recession, trough expansion, peak, recession, trough…
describe what happens in each stage of the business cycle
- BOOM- economy performing well, high consumption of g&s, business may not be able too keep up with demand, unemployment low, possible inflation
- RECESSION- consumer income start to fall, fall in demand, stock may pile up, possible financial problems
- SLUMP- GDP at a low, interest rates likely to fall, business may have to adapt with cheaper products
- RECOVERY- businesses encouraged to expand as consumer confidence increases, new employment opportunities- inc consumer incomes
2 effects of uncertainty on the business environment
- makes forecasting really difficult, therefore PESTLE AND SWOT are very important
- business failure
economy definition
all activity related to the production, consumption and trade of goods and services in an area