Theme 1 Flashcards
Scarcity
- Insufficient resources to supply everyone’s needs and wants.
Opportunity Cost
- Cost of an opportunity that has been forgone when a choice is made.
Business Objectives
- A goal or target that the business wishes to reach
- Allows businesses to measure their progress
Examples:
- Profit Maximisation
- Sales Maximisation
- Survival
- Market Share
- Cost Efficiency
- Employee Welfare
- Customer Satisfaction
- Social Objectives (CSR)
Stakeholders
Someone who has an interest or concern or is affected by the operations and objectives of a business.
Possible stakeholders include:
– Employees - want high wages and good working condition
– Shareholders - want high profits so they get high dividends
– Consumers - want high quality goods with low prices
- Managers - want high salaries and bonuses and other personal benefits
– The Government - want to earn corporation tax from the business’s profits
– Suppliers - want businesses to stay successful so they still have customers
- Different stakeholders have different objectives depending on how the business will affect them, this leads to conflicting objectives.
Corporate Social Responsibility (CSR)
- Refers to the companies taking responsibility for their impact on the local area and beyond society, even including the environment
- CSR can be shown by making decisions that benefits all stakeholders or takes them all into account (rather than just shareholders).
- Treating customers, employees, local community and suppliers well.
- Examples of this would be avoiding polluting activities and contributing positively to lives in the local community.
Business Ethics
- Goes beyond CSR
- A moral code of ethics that a business follows e.g not investing in countries which have human rights issues.
- Being moral despite the finance (cost) e.g. The Body Shop does not use ingredients tested on animals.
Entrepreneur
- Someone who has a business idea and develops it. They take the risk and the profits that come with success and the losses that come with failure
- Entrepreneurs organise the factors of production in order to set up and create an enterprise
- They also make decisions to operate, expand and develop a business.
- To add value by selling the output by more than the cost of the input.
- Be innovative.
Innovation
- Developing a product which is an improvement on an existing one or is changed/altered to fit a new market.
- They also use creative destruction which involves organising factors of production to create and set up an enterprise.
- Creativity leads to new ideas, inventions, and products which means that consumers switch to these newer products whilst the old ones become outdated.
- Creative destruction is linked to technological change which allows new developments to be made in products.
Non-Financial Motives
o Ethical stance and social entrepreneurship - this means that they might be motivated by their want to make an impact in the world and perhaps increase others standard of living. They may also wish to leave a personal legacy behind.
o Independence and working from home - being an entrepreneur allows people to have flexibility in their lives and have more freedom in their lives which can be very important. It can also allow people to have a more consistent home life.
Factors of Production
- capital, enterprise, land and labour
Division of Labour
Employees are organised so that they specialise in one part of the production process
- Specialisation is when each worker is given a specific task in the production process.
- It makes individual workers more productive as they improve at the task they are given and are able to excel at this task.
- Output increases due to higher worker productivity which causes the firms costs to lower and then they can offer lower prices to customers.
- Then they can either reinvest and expand the branches or pay higher dividends to shareholders.
Interest Rates
- the percentage rate charged on a loan and paid on savings (price charged for borrowing money)
- Cost of borrowing, Reward for saving
Rising Interest Rates
o When interest rates go up, it means that for consumers who have a variable mortgage, their monthly repayments will increase, reducing their disposable income. They will cut back on luxury or unnecessary goods. Also house prices fall.
o It also discourages borrowers as the interest paid back on the loans becomes quite expensive, and it becomes riskier to take out a loan as it is harder to pay back. This is detrimental to small businesses trying to start up as they may not be able to pay back the lender.
o The positives of rising interest rates are for the savers. They will get more money from their savings’ as increasing interest rates encourage saving.
o The overall impact of this will be reduced economic growth due to lower consumer demand and lower inflation as prices will go down and consequently the value of money will increase. It will also cause a fall in investment.
Falling Interest Rates
o When interest rates fall, it causes monthly mortgage payments to be lower and consumers will have a higher disposable income, meaning that they are more likely to spend more, especially large purchases like cars or holidays. This increases net consumer spending and therefore there is higher consumption.
o On the other hand, savers are discouraged, as they gain less from their savings and are now more likely to go out and spend what they would have saved, on large purchases such as cars or holidays.
o Larger businesses will see an increase in sales and are also more likely to take out loans in order to expand, as low interest rates encourage businesses to invest, expand and create jobs with their raised profits.
o Overall, lower interest rates increase inflation but also cause increased economic growth as well as increased consumption causing a higher GDP.
Unemployment
The number of people able and willing to work but no table to find a paid job.
Employment
Being financially active
Underemployment
- When people who want to work full time can only find part time work, or people who work in a job that doesn’t use all their skills
- For example someone with a law degree that works in Tesco
High Rates of unemployment
- With higher rates of unemployment, there is a larger supply of labour to employ from. This also means that as people are more desperate for jobs, it means the firms can pay lower wages.
- Also with high levels of unemployment, it means there is less consumer spending due to consumers having less disposable income leading to firms losing profits.
- With lower rates of unemployment, there is pressure on firms from employees to get higher wages.
Problems of unemployment
o It is an opportunity cost (the alternative being employment)
o There is a loss of output, growth and income.
o Retraining for the unemployed to find a job is very expensive.
o Negative multiplier effects - the loss of jobs in one area can lead to less spending and cause others to also lose out.
o Social costs as rising unemployment is linked to social deprivation,
o Fiscal costs as the government earns less tax revenue as people are earning less.
Rising unemployment on firms
Less overall spending as consumers have less disposable income to buy goods with.
Less demand due to less spending, so they have less output, so they don’t need as many workers causing unemployment to continue to rise.
There is a larger supply of labour, so wages will fall as people are willing to work for less (not competitive wages). This means costs decrease and therefore profit margins increase.
It will cost firms money to retrain unskilled workers which can be expensive causing costs to increase.
Businesses that sell cheaper goods/inferior goods, will see a rise in sales.
Falling unemployment on firms
More overall spending as more consumers have disposable income to buy goods with.
As demand rises, output will also have to increase therefore workers will either get more hours or more jobs will be created, continuing the fall in unemployment.
Lower supply of workers means that businesses need to pay higher wages to workers (competitive wages) in order to gain new workers.
As the firm’s profits increase, they will be able to pay higher wages to the workers, increasing their disposable income.
Businesses that sell luxury/superior goods, will see a rise in sales.
Inflation
A rise in the average price level of goods and services
-GOV target is 2%
Deflation
when there is no inflation and average price level is decreasing
Disinflation
A reduction in the rate of inflation
How is inflation measured
- uses a weighted average of price changes over a range of 700 goods and services (based on a basket of goods a typical family would buy)
- Starts with a base year of 100, the following years the % change is compared to the base year.
CPI: the headline rate and is the one used to measure general inflation, but it excludes certain items.
RPI: this also includes house costs such as mortgage repayments, council tax as well as petrol costs.
Demand Pull Inflation
– This is caused by a rise in aggregate demand (overall demand) that is slower that the increase in aggregate supply.
– This is when consumers compete to buy limited amounts of goods and services causing the prices to be driven.
This can be known as “too much money chasing too few goods”.
Cost Push Inflation
– Prices have been pushed up due to increases in any of the factors of production and when companies are already running at maximum.
– To maintain their profit margins, companies will pass on their higher prices to their customers.
– This may also cause them to attempt to cut costs or search for cheaper suppliers if that is where the increased price has come from.
Exchange Rates
the price of one currency expressed in terms of another
Causes of change in exchange rates
- Due to demand and supply (market forces) which causes a floating exchange rate (constant fluctuations).
- The more the currency is demanded, the more the price of it rises and vice versa.
Appreciation
When one currency rises in value against another. E.g. The pound becomes stronger or buys more dollars
Depreciation
When one currency falls in value against another. E.g. The pound becomes weaker or buys less dollars
How are interest Rates and Exchange Rates linked?
Interest rates and exchange rates are linked, as changing interest rates changes demand for certain currencies as it draws more or less foreign investors who take advantage of changing interest rates.
Effects of exchange rate on businesses
- Causes uncertainty as if money is not exchanged before exchange rates change, it causes the profit margins to change completely.
- They cannot be certain of their revenue for their exports.
- Thousands of pounds can be lost if the exchange rate changes.
- Businesses that export will want a depreciating/weaker pound as it will make them more competitive in foreign markets.
- Businesses that import will want an appreciating/stronger pound as their costs will fall and they can reduce prices and make more profit.
(Both above points are summarised in the acronym below)
SPICED
Stronger Pound Imports Cheaper Exports Dearer
Direct Taxation
tax which is charged on earnings, such as corporation tax or income tax
Indirect Taxation
Tax which is charged on things other than income or profits, for example VAT, car tax, insurance tax and others
Government expenditure needs to be paid for, most of the money for which comes from tax revenue. The remainder for this comes from borrowing from other countries and/or the Bank of England.
Corporation Tax
A tax on the profits that a business makes
Effects on businesses
- Direct taxation is charged (levied) on earnings. A change in the rate of income tax will affect the amount of disposable income that consumers have. An increase in taxation will reduce demand for most goods and services (apart from essentials).
- Indirect taxation such as VAT will cause prices of many goods and services which reduces consumer spending.
- Decreases in corporation tax allow businesses to keep more of their profits, which encourage them to invest it for future growth.
- Too high a corporation tax may deter foreign companies from basing in the UK.
Demand
the quantity of a good or service that people are willing and able to buy at a given price, at a given time.
Factors that affect demand
o Substitutes are goods that can be consumed in place of another, if the price of the original good goes up then sales of the substitute will rise, shifting the demand curve to the right.
o Complements are products that will usually be consumed together, if a good increases in price, then its complement will have the demand curve move to the left and vice versa.
o Tastes/fashions and how they change. Preferences for a certain good over time will cause demand for that good to change can move the demand curve: to the right with an increase in demand and vice versa.
o Advertising is meant to cause people to buy more and is intended to shift the demand curve to the right, which works similarly to branding which works by reinforcing and increasing knowledge of the brand.
Supply
the amount of a good or service that producers are willing and able to provide, at a given price, at a given time.
Factors that affect supply
o Changes in the cost of raw materials, which increase the costs of production and shifts the supply curve upwards and to the left. This is because as profits decrease, suppliers are less willing to make products as it is less profitable.
o Changes in the wages paid to staff also add to the costs of production which also moves the supply curve to the left.
o Changes in the climatic conditions which affect the production of the goods/services can reduce or increase supplies depending on the weather conditions causing les raw materials to be available etc.
o Subsidies are payments made to a producer by the government in order to encourage production as it lowers their cost of production and makes them more willing and able to produce more.
Limitations of Supply and Demand Diagrams
o Diagrams only show what happens in certain markets e.g. in competitive markets where there are many buyers.
o It assumes that when making economic decisions, that business have complete knowledge whereas in real life this is often not the case.
o Some markets/products do not reduce in demand if the prices increase e.g. designer clothes/ticket prices.
o There is an assumption that if price falls, demand increases which is not always the case in real life.
o Brand loyalty is a factor which is not taken into account.
o Supply curves assume that as prices rise, suppliers will produce more which is not always the case as suppliers may not have sufficient resources to do so.
o Consumers are not always rational e.g. despite the fact that products are cheaper after Christmas, consumers still buy before Christmas when prices are high.
Price Mechanism
an economic model that helps to explain the allocation of resources between different possible uses.
Consumer Sovereignty
the power of consumers to determine what is produced as it their needs and wants control the output of suppliers.
Market Share
the percentage of a market’s total sales that a particular business has.
Market Research
gathering and interpreting of information about customer needs and preferences. Process of gathering data to understand current and future needs and the market
Two types of market research
Primary is research that has not been carried out before which is first-hand information e.g. questionnaire/ survey, focus group, observation and test marketing.
Secondary research is that which has been previously carried out by a third party such as the government or an organisation. Sources of this include the library, the internet and newspapers.
Qualitative data – market research that gives results based on feelings and opinions.
Quantitative data – market research that gives numerical results and can be analysed statistically
Limitations of Market Research
- Some markets change very quickly (dynamic markets) making market research invalid. These markets are often product-oriented as they don’t do market research and focus on making and developing the product.
- Smaller samples of research may be biased as they may not be representative of the population.
- Can be expensive so smaller businesses cannot afford to carry it out.
- Especially difficult to research foreign markets.
- Sometimes product decisions may be taken by managers who have not understood/factored in the results of market research (reduces impact of market research.
Market Segmentation
dividing a broad market into subsets of similar consumers, by needs, interests, or purchasing behaviour.
Market Mapping
shows all the positions a product can based upon two dimensions which are important for consumers.
Competitive Advantage
any feature of a business that allows it to compete effectively with rival products as the have an ‘edge’ over competitors.]
Product Differentiation
designing and making the product/service so it is different from competitors’ products.
Adding Value
creating worth or additional value to a product over its’ cost of production.
Pricing Strategy
The way In which a business decide on the price of a product
Examples of Pricing
Cost plus: add a profit margin to the cost of production
Competitive pricing: taking the market price (based off competitors)
Premium pricing: high prices for status brands.
Market penetration: low prices used initially to gain market share
Collateral
something pledged as security for repayment of a loan, to be forfeited in the event of a default.
Risk
the possibility that events will not turn out as expected (uncertainty) e.g. lower than expected sales. It also includes the probability of damage, loss or injury happening.
Credit
a contractual agreement in which a borrower receives money and agrees to repay the lender at some date in the future with interest.
Internal/External Finance
Internal = money that is sourced from inside the business.
External = money that comes from outside the business
Bank Loan
The use of someone else’s money which involves repayment and payment of interest.
Greater certainty of funding provided terms of loan are complied with.
Lower interest rates than overdraft.
Appropriate method of financing fixed costs.
Requires security (collateral).
Interest is paid on full amount withstanding not amount used.
Regular repayments must be made regardless of cash flow.
Total interest can be high if loan is paid over long period of time
Hard to get for smaller businesses
Overdraft
Facility that allows borrowing of up to a certain limit.
Flexible/ useful way of dealing with cash flow problems
Interest paid only on amount used
Relatively easy to obtain/arrange.
Interest rates usually higher than for loans. Short-term so unsuited for large amounts. Banks can demand payment at any time. Interest rate varies with change in base rate
Retained Profit
Profit collected from years of business
No interest to pay, No loss of control
Profits could be earning interest for the company
Loss of security – less funds to help if in trouble
Trade Credit
Time allowed by a supplier before a business must make payment for goods provided.
No interest
Effectively ‘free’ finance
Commonly available
Helps with cash flow
Limited amounts provided and is short term
Delaying payment for too long will lead to withdrawn credit
Can also lead to extra fees
Suppliers can commence insolvency proceedings (take you to court)
Venture Capital
Investment provided in turn for a proportion of shares/ profits
Immediate cash injection (given in exchange for shares)
Does not require repayment
Can also receive advice
Loss of control through the selling of shares
Requires a dividend to be paid
Share Capital
The money retained from selling shares to investors
Immediate cash injection
Does not require repayments
Loss of control as shares are sold
Need to pay dividends
Leasing
Long term rental agreement that allows businesses to use assets without having to pay upfront
Maintenance is often included and new models regularly updated
Much lower outlay on equipment
More expensive in long term
Cannot own the item
Regular monthly payments must be made
Private Costs
costs internal to a business (raw materials, equipment etc.) and the price/income given up by consumers – people involved in transactions.
Private Benefits
sales revenue for the firm and the pleasure/ease gained for consumer through the product
Externalities
the cost or benefit of an economic action that affects a third party not involved in the transaction
Social Cost
the total cost to society (private cost + negative externality)
Market Failure
The inefficient allocation of resources
Purpose of Government Intervention
- Reducing impact of external costs such as pollution.
- Ensuring that under-produced products are available to all.
- Ensuring that over-consumed products such as tobacco are discouraged and prevented.
- Reduce anti-competitive behaviour to ensure fair prices for the consumer.
Types of Gov intervention
- Legislation
- Regulation
- Subsidies
- Voluntary agreements
- Indirect taxation (green tax)
- Tradable permits
Legislation
Can ban/restrict bad practices
Expected standards are clear
Consequences are known
Difficult to enforce, expensive
Regulation
Used to set environmental standards and then monitor and control activity e.g. quota or minimum standards.
The UK Environmental agency can inspect, fine and prosecute.
It is costly and difficult to enforce.
Subsidies
Government grants for under-consumed ‘beneficial’ goods e.g. solar panels.
Makes them cheaper and increases demand.
Reduces demand for energy from non-renewable sources (which contain externalities.)
Costs government funds
Total Revenue Formula
Total Revenue = price x quantity sold
Average Revenue Formula
Average Revenue = total revenue/quantity sold
Percentage Change Formula
% change = (final value – initial value)/initial value
Contribution
Contribution is the profit made on each product, it does not consider fixed costs. Fixed costs do not vary with output, so they are simply subtracted from total contribution. This gives the firm’s total profit or loss.
Contribution Formula
Contribution = Selling Price - Variable Cost Per Unit
Total Contribution = contribution x units sold
Break Even
The break even point is the point where the firms costs are covered.
Break-even point (units) = fixed costs / contribution per unit
Break -even point (money) = sales price per unit x breakeven point in units
Margin of Safety
The margin of safety is the point between the actual level of output and the break-even level of output.
Limitations of Break-Even
- The selling price per unit is constant and does not change with quantity produced
- The variable cost per unit is the same
- Fixed costs do not change with output
- Everything produced is sold
Gross Profit
Gross Profit = total sales revenue - cost of goods sold
Gross Profit Margin = gross profit/sales
Cash Flow
the movement of money in and out of a business
Cash Flow Forecast
A cash flow forecast can predict future cash flow over a period of time. It estimates when cash will leave and enter the bank account. It helps estimate the net balance at the end of each period of time e.g. month.
A cash flow forecast can be used to identify where the majority of business spending goes to and whether they are spending more than they can afford.
