Unit 7 - Economic Change Flashcards
The economy
The state of a country/region in terms of the production and consumption of goods and services and the supply of money
Gross domestic product (GDP)
A measure of economic activity; the total value of a country’s output over a period of time usually in annually/ quarterly figures
The business cycle
The regular pattern of ups and downs in demand and output within an economy or GDP over time
Peak / boom
- GDP is growing fast
- unemployment is likely to be low and spending and disposable incomes high
- full capacity/ firms will increase their investment
Downturn/ recession
- The economy is slowing down
- unemployment rising
- consumer and investment spending slowing
- inflationary pressure falling
Slump
- rate of growth of GDP may be close to zero or negative
- unemployment high
- inflation low
- firms reluctant to invest and spare capacity
Recovery / expansion
- rate of growth of GDP picks up
- consumers start to regain confidence and spend more
- unemployment begins to fall
How to survive during a recession
- strong balance sheet
- sufficient liquidity
- low gearing
- diversify the product range
Strategic decisions of recovery
- discounts of promotions to capture market share
- partnerships / mergers
- capacity expansion
Functional decisions of recovery
- inventory management (meet sales and avoid excess stock)
- recruit new staff
- market research to capture emerging opportunities
Strategic decisions when in a BOOM
- enter new market to take advantage of high demand
- diversification
- increase facilities (warehouses)
- sponsorships
Functional decisions when in a boom
- automation investment to improve efficiency and reduce unit costs
- market segmentation ( target high growth customer segment with tailored messages and offers)
- training so staff an handle demand and technology
Strategic decisions when in a recession
- close underperforming facilities
- discount to stimulate demand
- incentives (loyalty programs)
- automation
Functional decisions when in a recession
- postponing non essential maintenance to conserve cash.
- reduce spending on advertising
- redundancies and halting new hires
Strategic decisions when in a slump
- simplify corporate structure to reduce costs
- debt restructuring
- focus on core
Functional decisions when in a slump
- seek financial help from the government
- tighten quality control
- shut down non essential functions and operations
- prioritise existing customers
- move to digital marketing to save costs
Implications of a recession for a firm selling inferior goods
- Opportunity due to increase in demand due to reduced incomes, therefore customers have less disposable income so increase revenues
- however may face pressure on its supply chain as suppliers are also dealing with recession so may have to renegotiate payment terms
- may need to increase production to meet rising demand
Implications of a recession for a firm selling luxury products
- significant drop in demand due to low consumer income so less disposable income so decrease revenues
- must maintain customer relationship e.g. price reductions
Why might a skills shortage occur during periods of economic growth?
- rapid expansion (demand can outpace the supply of qualified workers)
- growth accelerates technological innovation ( High demand for workers with tech skills)
- industries evolve so skill set required for job changes (workers with outdated skills)
- training programs outdated
- ageing workforce
UK economic objectives
- low unemployment
- steady growing GDP
- stable and low inflation
- balance of imports and exports
Fiscal policy
The use of taxation and government expenditure to influence the economy
Fiscal policy includes… (3)
- direct taxes
- indirect taxes
- government expenditure
Direct taxes
Taxes on incomes/profits
E.g. income tax, corporation tax, national insurance
Indirect taxes
Taxes on spending
E.g. VAT, excise duty, alcohol duty
Government expenditure
Often in the form of subsidies to support businesses that are importantly to the economy and that might otherwise fail, and to encourage business activity that would otherwise not take place
E.g. health, housing, education subsidies
Fiscal policy aims to…
- expand demand during a slump in the economy
- contract (increase taxation) demand during a boom in the economy
Effects of decrease in tax for businesses
- cutting indirect taxes reduces prices which may boost consumer spending (especially income elastic products)
- reduction in income tax increases consumer disposable income (good for luxury product)
- falling corporation tax promotes investment , output and economic activity
Effects of an increase in tax on businesses
- increased VAT increases prices which decreases demand
- producers may increase prices or absorb the indirect tax to avoid raising prices, both of which cuts profits and reduces investment
- less disposable income for customers
Inflation
An increase in the general level of prices within an economy. There is a fall in the purchasing power of money
Retail price index (RPI)
Cost of a fixed basket of goods
Consumer price index (CPI)
Includes housing costs as well
E.g. council tax and mortgage
If the RPI increases from 3% to 4%…
… prices are rising fast
If RPI decreases from 3% to 2%…
Prices are still rising but not as fast
If RPI is negative (e.g. -1%)…
Prices are lower than a month ago
Demand pull
When there is excess demand
Cost push
When costs rise
Main causes of inflation
- demand pull
- cost push
How are customers impacted by inflation?
Rising prices and less disposable incomes so they lose purchasing power
How are suppliers impacted by inflation?
Costs increase so less demand from businesses so less revenues
How are employees impacted by inflation
Income power decreases as salary stays the same but inflation is increasing so purchasing power falls so employees may strike
How are businesses impacted by inflation
Cost rises so supply pressure occurs as they pay more to buy materials and products whilst customers are more reluctant to spend
Impact of inflation on a business with high gearing
- can be good as business is paying back long term debts that are worth less over time (ignoring interest rates) so easier to pay loan towards end of life.
- firms income will have increased while loan stays the same (fixed not variable loan)
Impact of inflation for a business with price elastic products
Increased inflation leads to reduced purchases of luxury goods and an increase in necessities
Impact of inflation on a business with lots of competition
Customers are more spending aware so they shop around to find best deal so businesses become more price competitive (reduced prices) or if not then they reduce their profit margins
Impact of inflation for businesses trading internationally
High inflation in UK may deter international buyer if prices are high
Monetary policy
Controlling the money supply and the interest rate in order to influence the level of spending and demand in the economy
What is the Bank of Englands responsibilities
- setting interest rates (base rate)
- controlling the money supply
- meet every month
The lower the interest rates, the BLANK you are paying on borrowed money from Bank
LOWER
e.g. on mortgage loans installments overdraft credit card
Move interest rates to…
Manage economy / demand
E.g. lowering rates means people spend less on loans and more disposable income to spend in economy
Fixed loan
Agreed rate (moving interest rates doesn’t affect payment)
Variable loan
Changes with changing interest rates
What is the impact of a rise in interest rates on a highly geared business
- interest payments rise if variable loans
- out of business / assets taken away to pay back loan if unlimited liability (sole trader)
- costs rise so business must sell assets/ make redundancies/ downsize
- could increase price but customers may not have the income due to increase in rates so depends on income or price elasticity
What is the impact of a rise in interest rates on a durable manufacturer (e.g. cars)
- demand may decrease as costs increases to buy
- second hand market may boom
- import cars
What is the impact of a rise in interest rates on a supermarket
- consumers may change to other supermarkets with lower quality or with cheaper prices (e.g. M&S to Lidl)
- consumers may change brand (e.g Kelloggs to own brand)
Monetary policy decisions when in a recession
- decrease interest rates to encourage spending
- durable products (cars) decrease/ lower instalment payments
Fiscal policy decisions when in a recession
- decrease VAT by 2% to encourage spending due to unemployment and low disposable incomes
- decrease direct tax (e.g. income tax) to encourage spending
- lower corporation tax so PLC and LTD can pay less so costs reduce therefore they can maximise profits or reduce price is product is inelastic to increase
- invest in infrastructure to create jobs
Monetary policy decisions in a BOOM
- increase interest rates due to high demand (not sustainable) and higher disposable incomes
- increase in rates makes products more expensive so decreases disposable incomes
- increase in rates increases mortgage payments so less disposable incomes to stabilise economy
Fiscal policy decisions in a boom
- increase taxation e.g. direct tax (tax on income) to decrease disposable incomes and to give back to government entities
The impact of monetary and fiscal decisions depends on…
- the nature of the product being sold
- where the business operates (domestic or international)
- whether the business has a competitive advantage it can maintain
- capacity utilisation
- financial strength
Quantitative easing
A monetary policy action whereby a central bank purchases government bonds or other financial assets in order to inject monetary reserves into the economy to stimulate economic activity. This encourages financial institutions to lend more to a business and individuals
Open trade
Trading with other countries openly and without restrictions
E.g. EU; US,Mexico, Canada Agreement
Protectionism
The extent to which a government uses controls to restrict the amount of imports entering the country. This supports domestic markets
Import tariffs
Taxes on imports to protect the domestic markets and generate tax revenues for the government
E.g. UK tariff on agricultural products in 2021
Import quotas
A quantity limit on the volume of imports coming into a country.
This pushes up the prices due to reduced supply, encouraging domestic producers to enter the market or increased sales.
E.g. China has a quota on Cambodia rice exports of 300000 tonnes a year
Domestic subsidies (non tariff barrier)
A form of financial help given to domestic producers to help reduce costs and help them to compete in international markets
E.g. US heavily subsidies domestic agricultural sector
Other non tariff barriers
- constantly changing technical regulations
- introducing regulations that favour domestic production e.g. labelling that conforms to a local language
Embargos
An order forbidding trade with a particular country
E.g. UK and Russia or US and North Korea
Import dumping
When a country sells products products abroad at below costs or significant below the prices in the home markets
Import dumping
When a country sells products products abroad at below costs or significant below the prices in the home markets
Motivations of protectionism
- employment protection
- raised tax revenues
- responses to a recession
- protect domestic markets
Arguments against protectionism
- risk of retaliation
- higher prices for consumers
- higher costs for exporters
