Download External Influences

External Influences
By Richard Grover
The Business Cycle
If you were to study a graph of economic
growth over time it is clear that it fluctuates
but in a fairly routine pattern.
This pattern of recession and boom is
known as ‘The business cycle’.
The next section will outline the stages of
the cycle and the effect on the firm.
Recession
• Characterised by decreasing output and
gloomy outlook.
• Firms may experience falling demand and
so cut prices and dismiss staff; losses are
made; investment falls; some go out of
business.
Recovery
• The economy begins to expand again,
expectations begin to rise although they
are limited.
• The firm will find demand increases again,
they may review employment and
investment positions but may still be
cautious.
Boom
• Rapid growth in output, confidence is high
but fear of inflation.
• Firms tend to increase investment, hire
more staff, however skill shortages may
occur, increase in prices and profit
margins.
Downturn
• Cycle returns to beginning, growth starts
to slow again.
• Demand falls and reductions in output and
investment can be expected.
Effect on firms
In the cycle personal consumption usually
fluctuates less than business investment so
different firms are affected in different ways
when a slump occurs.
Firms producing capital equipment (e.g.
machinery) will be badly affected due to
reduced investment undertaken by other
firms.
Effect on firms (Episode two)
Firms selling durables will be badly hit as
people put off buying these items until an
upturn when their confidence in
employment and income is higher.
Firms selling basic necessities will
experience less of a fall, it may even
increase as people switch expenditure
from luxuries onto these items.
Benefits of Recession
Firms are forced to examine its weaknesses
in product range, organisation etc and to
become more ‘lean’.
This can lead to improved efficiency and if
competitors have gone bust the firm may
get a chance to increase its market share.
Interest Rates
Interest rates are a key tool of economic
policy. They determine the cost of
borrowing and therefore also the level of
spending.
This means that they have huge impacts
upon individuals (e.g. mortgage
repayments) as well as firms (cost of
loans, highly geared firms affected more).
Interest Rates (continued)
If interest rates go up firms are hit twice as cost of
borrowing increase but in addition spending will
usually be reduced so demand for its products
may also fall.
Low interest rates may be used to stimulate growth
in an economy (e.g. interest rates after 9/11 kept
low to curb downturn). High interest rates may
be used to curb growth and inflation as too faster
growth can be dangerous.
Interest Rates (UK examples)
Interest rates are currently 4% and are
expected to rise in the near future. But this
is typically very low. Long-term average is
5%.
As recently as 1998 interest rates were as
high as 7.5% and in the depression of the
late 80’s were sky high as 15% (duepartly
to incompetent Tory government)
Exchange Rates
Exchange rates are constantly fluctuating
this depends on demand and supply of
currencies.
If demand is high i.e. there is a lot of
investment in that country then the
currency will increase in value. In turn if
the market is flooded with a particular
currency it will decrease in value.
Exchange Rates (series 2)
A rising exchange rate means:
• For an importer, lower costs for imported
items.
• For an exporter, reduced price
competitiveness and profit margins.
Similarly falling exchange rates benefit
exporters but disadvantage importers.
Exchange Rates
Multinationals are in a stronger position to
deal with these fluctuations, compared to
firms based in one country, as they can
move resources and accounting
procedures in order to take advantage of
these fluctuations.
Inflation: Causes
• Cost-push inflation occurs when production
costs increase, perhaps due to pay rises or
through exchange rate changes on imports, that
are not supported by productivity increases.
• Demand-pull occurs when demand exceeds
supply. This can be controlled by limiting credit
or increased taxation to reduce spending power.
Inflation: Measuring it.
The most common measure of inflation is
the retail price index (RPI). The prices of
a typical sample of purchases or a typical
‘shopping basket’ are weighted by
importance and recorded. The index is
calculated against a base year has a
figure of 100.
Inflation: Importance
Firms and entrepreneurs have inflationary
expectations, their business plans are affected
by what they expect to happen to inflation. For
example in R of I is expected to increase then
they may buy large quantities of goods now thus
increasing demand-pull inflation, their workers
may demand a rise due to the expected
increase in cost of living thus producing cost
push inflation. This is known as a self-fulfilling
prophecy as their actions actually make what
they expected to happen to be true.
Inflation: Importance
Inflation affects firms behaviour and
chances of survival. Long-term planning
becomes more difficult, profit margins may
be squeezed as the firm cannot always
pass on rises in costs to the customer.
Increased interest rates during high
inflation periods makes it doubly difficult
for firms.
Unemployment: Types
• Structural - is where industries are in structural
decline through lack of competitiveness. Mining
is a good example of this, huge job losses
occurred in the late 80’s. Steel and shipbuilding
are other examples.
• Frictional – caused by time lag between one job
and the next.
• Seasonal – found in sectors such as agriculture
and tourism.
• Cyclical – due to downturn in the business cycle.
Unemployment
Seasonal, frictional and cyclical unemployment will
always occur and these are not usually too
greater threat to an economy.
Structural unemployment causes major problems
for government and society as it is often large
numbers it can be difficult to re-train people and
find them new jobs, whole areas can go into
decline etc. A declining industry needs to be
managed to reduce its impacts. (A good
example of how not to do this is Thatchers
approach to mining in the late 80’s)
Macroeconomics: It’s all related!
All macroeconomic issues are interrelated
inflation affects interest rates which affect
exchange rates and so on.
Nothing can be viewed in isolation when
studying an economy all macroeconomic
data must be looked at together.
They think its all over!
IT IS NOW!
Thank you for
Listening