Download External economic influences

EXTERNAL ECONOMIC
INFLUENCES ON BUSINESS
BEHAVIOUR
Iceland’s Economy boils over
Read the case study on page 110
Consider the points to think about
You will be sharing your thoughts with the class!
The Economy ...
 What contributes to the success or failure of a
countries economy?
The rate of economic growth
The rate of price inflation
The unemployment levels
Exchange Rates
What factors could affect a business deciding to
expand before an economic recession?
Things to consider: Cost of borrowing,
decline in sales ...
External economic influences
 What do governments do to control the
nation’s economy?
 They set objectives and take economic policy
decisions that can have a significant impact on the
success and profitability of businesses
 Being aware of these objectives and policies can
help protect a business from negative policy
changes and to take advantage of positive policy
changes
External economic influences
 So, what are the economic objectives of
governments – Economics students ....?
 Economic Growth (% increase in GDP, based on





productivity output)
Low inflation (rate of price increases)
Low unemployment rates
Long term balance of imports and export value
(balance of payments)
Exchange rate stability – prevention of fluctuations
Equality of personal income – controlling the tax
system
External economic influences
 How do these objectives conflict with each
other?
 If inflation is too high, what other objective
could be affected?


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Reduce Consumer Spending resulting in...
Lower demand for a product resulting in ...
High unemployment 
External economic influences
 So, lets take a look at the objectives in more detail ...
 ECONOMIC GROWTH ...
Measured by GDP – level of output – how much is made!
If an economy is in a state of economic growth, it is
becoming richer 
Why is Economic growth NOT measured in monetary
terms?
Because inflation can increase the value of GDP in
monetary terms which will not be realistic in terms of
output!
External economic influences
Why is Economic Growth important for a country?
Higher GDP results in more goods being available to consumers,
increasing their standards of living
Increased employment, which will again increase spending as more
people will have money for a wage
BUT... Economic Growth does have it’s
...government is
Tax – from wages – for public services, down
which side!
means
spending less on unemployment benefits and more in areas of
real need!
Pollution!
Affects on Health! (China!)
Technology
place
jobs
Increase in sales for businesses
– but only taking
if demand
forof
their
product is income elastic!
GDP ...
GDP ...
GDP ...
External economic influences
THE BUSINESS CYCLE ...
Def:
“Regular swings in economic activity that occur in most
economies varying from boom conditions to recession “
RECESSION ...
6 months or more of
declining GDP
External economic influences
The stages ... What happens at each stage?
Consider: profits, employment, interest rates, consumer
demand
BOOM
So, there are some benefits as a result of a recession!
DOWNTURN (RECESSION)
Cheap capital assets?
Demand for “inferior” products?
SLUMPIncreases workload (due to risk of redundancies)?
Businesses becoming “lean” – improved efficiency?
RECOVERY AND GROWTH
External economic influences
What could each of the following do during:
Periods of economic growth
Periods of recession
Mercedes cars (Luxury Good)
Watties tinned foods (Normal Good)
Factory Outlet inferior clothing (Inferior Good)
Which of these is not really going to be affected by
growth or recession?
External economic influences
INFLATION:
A RISE in the average price level of goods and services (getting less for your
money)
DEFLATION:
A Fall in the average price level of goods and services
2008:
Zimbabwe Inflation rose above 100,000%
The price of chicken rose more than 236,000%
(52,500 NZD today!)
Hyperinflation (no confidence in the value of money!)
External economic influences
How is inflation measures?
RPI – retail price index
About 6,000 items commonly found in a household budget
An index number can be used to record average changes in the items
Prices are compared monthly for changes, and items are “weighted” in
terms of their importance in a household budget
All weighted price changes are averaged to give an “index number”
All index numbers have a start value of 100 ...
So, if an RPI started at 140 in 2008, using a base period of 2000 ...
Weighted Average of Price Inflation since 2000 is 40%
Or ... The value of money has fallen by 40%!
External economic influences
What causes inflation?
Cost Push Inflation ...
Businesses have to increase selling prices to maintain profit margins due to
increased costs of production
Reasons for having to increase prices?

Lower exchange rate of imported goods

Demand of materials push up the prices (oil, wheat, cotton)

Workers demanding higher wages (to improve standards of living in line with
inflation!)
Demand Pull Inflation ...
During the “Boom” of the Business Cycle
Goods can be sold at higher prices in order to reduce demand
Will also lead to higher profit margins 
External economic influences
So, what is the impact of inflation on business strategy?
If the rate of inflation is LOW, benefits can include:
 Cost increases to a business can be passed on more easily to the consumer – customers
won’t feel the pinch so much with increased prices
 Gearing for a business can become favourable – the value of the debt they owe to the
bank can reduce (the money is now of less value)
 The value of assets can rise (now worth more!)
 What account will this be reflected in?
If the rate of inflation is HIGH, Drawbacks can include:
 Unhappy workers – pay not supporting their living costs = disputes 
 Big brands will take a hit – consumers want a bargain (good for low value goods)

Higher interest rates – highly geared companies can suffer – not able to pay
back the interest on loans
 Raise in costs of materials can cause cash flow problems
What will happen in the future? Uncertainty ... What does a company
do?
External economic influences
So Deflation – is it beneficial? Does a period of falling prices benefit a
business?
 Would customers still want to buy if prices could fall further?
Perhaps demand for goods will reduce leading to another
recession!
 Profitability could reduce – businesses might not want to
invest in future developments
 JIT might need to be considered and invested in – stocks in the
warehouse will be falling in value! But, this will mean suppliers
suffering also with reduced orders
External economic influences
So, what strategies can a company potentially take in times of high inflation?
 Cut back on investment spend
 Cut profit margins – they will need to be more competitive than ever to
keep consumers interested
 Reduce borrowing to manageable repayments (reduce gearing)
 Debtor management – keep payment time to a minimum
 Reduce labour costs!
Activity 7.2 – Pg 119 – China to Take Action
Activity 7.2 – Pg 119 – China to Take Action
Suggested responses ...Q1 and Q2
1 State two reasons for the reported increase in inflation in China. [2]
 the increase in oil and petrol prices
 excess demand due to increased wealth in the economy
2 Are these causes of inflation ‘cost–push’ or ‘demand–pull’ pressures? Explain
your answer. [4]
The increase in oil prices is an example of cost−push inflation.
Oil is an important input into business activity; as its price increases this
represents an increased cost to businesses for energy and transportation.
Thus, they are forced to increase prices to recover these additional costs.
Excess demand causing the price of pork and vegetables to increase is an example
of demand−pull inflation. High levels of consumer demand relative to the
economy’s ability to supply leads to price increases as consumers are
effectively competing for limited supply.
Suggested responses ...Q3
If the Chinese government increased interest rates again, explain what impact this could have on:
• consumer spending on luxury goods
• spending on new investment projects by Chinese businesses
• the external value of the Chinese exchange rate.
[9]
• Consumer spending on luxury goods − as the cost of borrowing rises consumers will face
higher interest charges on any new borrowing. Therefore, they will reduce their
expenditure on luxury goods that require finance to purchase.
• New investment projects by Chinese businesses − as higher interest rates will reduce the
growth of consumer spending, this will reduce the potential returns from new investment.
Thus, investment will fall. Further, as some investment is financed from borrowing, an
increase in interest rates will reduce the potential profit of investment due to the increased
repayments needed to service debt.
• The external value of the Chinese exchange rate − two forces will influence the
exchange rate. The increase in interest rates will encourage currency flows into the Chinese
financial sector, attracted by the higher rates of interest available. This will create a
demand for the yuan, leading to an appreciation of the exchange rate.
Suggested responses ... Q4
Examine the long-term problems for Chinese businesses if inflation is not brought
under control. [10]
This question requires an analysis of the costs of high rates of inflation. You should
develop a number of the following issues and identify which are the most
significant.
• There is greater uncertainty about the future. High rates of inflation make it
more difficult to predict the revenues and costs associated with long-term
investment. Thus, investment is discouraged.
• The government may be forced to increase interest rates to control inflation.
This will lead to a decrease in demand in the economy.
• Employees will demand higher wages and there may be an increase in industrial
unrest. A wage−price spiral may result. However, this is less likely in China
due to strong centralised control of the economy. Workers may have less
influence than in mixed economies.
• If inflation is higher in China relative to its competitors, then, over time, the
competitive position of Chinese firms will be eroded. This will lead to a
reduction in exports and an increase in imports.
Suggested responses ...Q5
China has experienced rapid economic growth in recent years. Discuss the likely effects
of this on Chinese manufacturing businesses. [10]
Manufacturing business will benefit from increasing demand due to rising incomes.
This will lead to higher levels of profit and reduced pressure to be price competitive.
There may be a shortage of key skilled workers, leading to higher wage costs.
Although China has significant labour resources working on the land, which can be
transferred to the manufacturing sector, this labour may lack the skills needed by industry
and thus require training.
If growth is a consequence of the relative competitiveness of Chinese industry, then there
will be an increase in demand for Chinese exports.
The economy may overheat, that is, the growth rate is unsustainable. This will lead to
increasing costs for businesses as they compete for resources.
Increased growth leading to higher profits will lead to increased investment and
technological change. Thus, Chinese industry will become more competitive on world
markets.
External economic influences
UNEMPLOYMENT ...
3 Different types of unemployment ...
CYCLICAL UNEMPLOYMENT
Resulting from low demand for goods/services in the economy
During low Econ Growth or recession
Related to the Business Cycle
Demand Reduced
Less labour needed
Lower incomes
Spending reduced
Worse recession!
External economic influences
STRUCTURAL UNEMPLOYMENT
Related to the decline of important industries
Significant job losses in one sector of industry
eg’s coal mining, ship building, car manufacturing
Certain skills cannot be used elsewhere ...
Causes of Structural Unemployment ...
 Changing consumer tastes and spending patterns
 Demand for services declining (banks!)
 Transfer of skills difficult
 Multi Skilling now important – need to be trained to adapt (IT)
External economic influences
FRICTIONAL UNEMPLOYMENT
Losing your job or leaving you job
Taking a long period of time to find alternative employment
Due to changing labour demands – constant need to change and adapt
to consumers wants and product developments
Increases when the overall turnover rate of unemployment increases in
the economy, so does frictional unemployment
External economic influences
Humans are the most valuable resource a company has ... So
unemployment is seen a waste to the economy ...
What are the COSTS of unemployment to an economy?
 Not as much goods be produced as there could be
 Taxpayers money is substantial to support them (Societal Cost)
 Social problems?
 Reduced demand – lower incomes – lower standards of living
(Personal Costs)
 Skills become outdated the longer you are unemployed
So, if a company has to negotiate lower wages during slow
growth, does this mean they are exploiting the workers?
External economic influences
SO, WHAT CAN THE GOVERNMENT DO ... It needs to avoid
unemployment of any kind!
Lower inflation
Competitive rate of exchange – keep overseas demand up
Provide training programmes
Provide info on job opportunities – job centres/ agencies
Perhaps ... Reduce unemployment benefits ??? Make it difficult for
them to live off taxes ????
Who has the lowest unemployment?
Rank them!
Japan
New Zealand
Korea
Netherlands
Mexico
Norway
Luxembourg
Switzerland
Australia
Austria
External economic influences
Exchange Rates – a favourite in the exam!
The Price of one Currency in terms of another
E.R. Depreciation – A fall in the external value of a currency as
measured by it’s exchange rate against another currency
So, if $1 falls in value from €2 to €1.5, the value of the dollar has
depreciated
ER Appreciation – the opposite!
External economic influences
How would an IMPORTER and an exporter be affected by the
following?
The dollar has appreciated from €8.60 to €10.00 = $1
So, if an importer in NZ places an order for €86,000 worth of
components from Europe, what would the affect be on the importer
using the old and the new exchange rate?
Which rate is the more favourable to the importer?
Why is it the more favourable rate?
What is the affect on the European company with the new exchange
rate?
External economic influences
How would an EXPORTER and an exporter be affected by the
following?
The dollar has appreciated from €8.60 to €10.00 = $1
So, if an exporter in NZ receives an order to supply $50,000 worth of
components to Europe, what would the affect be on the exporter
using the old and the new exchange rate?
Which rate is the more favourable to the exporter?
Why is it the more favourable rate?
What is the affect on the NZ Exporting company with the new
exchange rate?
What will the effect be on the NZ market for these products?
External economic influences
So, who benefits and who loses out?
Domestic firms that benefit from APPRECIATION ...

Importers of foreign raw material = costs of imports decline = makes them
more competitive
Importers of foreign manufactured goods= cheaper to import than to make
in domestic market = higher profits (if you don’t reduce your selling price to
benefit consumers!)
Domestic firms that lose out from APPRECIATION ...

Exporters of goods/services – this includes tourism – a fall in demand from
overseas tourists = loss of domestic manufacture – relocate abroad
Foreign competition in domestic market – they can supply the same
imported goods much cheaper