Download inflation and unemployment slide show a2 2009 - burgate

A2 External Influences
The Business Cycle
The Business (trade) Cycle

The regular patterns of ups and downs in demand
and output, or of gross domestic product (GDP),
growth over time.

It is characterised by 4 main phases boom,
recession/downturn, slump, recovery/upturn
UK Gross Domestic Production
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
6
5
4
3
2
1
0
-1
-2
1982
% change in growth
from last year
UK GDP
Year
Label the following on the diagram above:
a) Boom b) Recession/downturn c) Slump d) Recovery/slowdown
The Business Cycle
Gross Domestic Product – the total value of a
country’s output over the course of a year.
GDP
Trend of
GDP over
time
Boom
Recovery/Upturn
Recession/Downturn
Time (years)
Slump
Boom

High consumer demand greater than supply = excess
demand = higher prices

High business confidence

High profits , dividends and retained profit

High levels of investment

Firms working at full capacity, firms may consider
expansion

Rising costs due to shortage of resources e.g. paying
for skilled workers may = higher prices
Recession

Falling demand may = excess stock = price fall to sell it

Falling output as not enough demand = low profits may =
redundancies

As incomes fall inferior goods may see demand increase
as consumers switch from luxury goods

Falling business confidence and little investment

Spare capacity

Business closures and an increase in bad debts

Firms will need strong balance sheets, liquidity, low
gearing and increased efficiency
Slump

Very low demand, investment and consumer demand

Increasingly high unemployment and business failure

Firms charge low prices to increase demand

Deflation may occur
Recovery/Upturn

Slowly rising demand, investment and business
confidence

Falling unemployment

Demand  = Profits

May encourage new business start-ups

Firms borrowing 

Spare capacity will be used to meet new demand
A2 External Influences
Unemployment
Types of Unemployment

Structural – changing structure of the economy
causes some jobs to be no longer required e.g. miner

Cyclical – lack of demand in the market due to stage
in the business cycle e.g. recession

Frictional – people between jobs

Seasonal – certain jobs only needed at certain times
of year
Student Activity:
Which industries will each type of unemployment hit hardest?
Describe how a high level of unemployment will affect:

Consumer incomes
Company sales
Workers bargaining power over wages
Firms cost control – discuss short term and long term
decisions
Investment levels in firms
Need for investment in training for firms

Costs of wages for firms





Implications of high levels of unemployment

Less pressure on wage levels as plenty of supply of
labour therefore wages fall

Less income = lower sales & profit = less production
& redundancies

Normal goods (income-elastic) will suffer worst

Inferior goods may benefit from higher sales with
lower incomes
Implications of high levels of unemployment
(contd.)

Workers bargaining power over wages 

Firms may introduce cost-saving measures and improve
efficiency for the long-term

Others make short-sighted changes which may effect the
long term success of the firm

e.g. reducing training investment, delayering may lose
essential skills

Firms may consider rationalisation – reorganising the
business to improve efficiency and cut back on fixed
overheads. E.g delayering, closing a site, or outsourcing
Implications of low levels of unemployment



UK level has been low since 2000
Consumers income  therefore more spending.
Luxury goods (income-elastic) particularly benefit.
Labour market ‘tightens’ less people looking for work
therefore difficult to attract skilled employees. This
gives workers bargaining power over wages.
A2 External Influences
Inflation
£
Inflation

An increase in the general levels of prices of goods
and services within an economy, which means that
there is a fall in the purchasing power of money.

Deflation - A decrease in the general level of
prices of goods within an economy, or a rise in the
purchasing power of money.

Inflation Rate - The Chancellor of the Exchequer sets the
inflation target for the UK. The Monetary Policy Committee
of the Bank of England sets interest rates in order to keep
inflation at or below this target
Inflation
(%)
2000
2001
2002
2003
2004
3.0
1.8
1.7
2.9
2.7
Source: HM Treasury web-site. www.hm-treasury.gov.uk/
Measuring Inflation

The Retail Price Index (RPI) - This shows changes in the
price of the average persons shopping basket. Calculated
using a weighted average of each months price change.

Looks at average household spending patterns and
attempts to assess average household expenditure

Weights are allocated to different categories according to
importance. Difficult as many households have different
incomes.

It is an index number
An alternative measure.

RPIX - RPI which excludes mortgage interest
payments.
Cost-push Inflation

An increase in the cost of production (wages, raw
materials, fuel, taxation and interest rates)

This forces a firm to increase their prices in order to
protect their profit margins.

E.g. trade unions achieving wage increases
Example of cost-push inflation - Juan
grows bananas, which he then sells to Tescos.
Dominican Republic banana farmer
 Cost of growing bananas
£200
 Petrol cost of harvesting
£100
 Total costs
£300

Price (cost plus 100%)
Tesco
 Cost of buying bananas
 Cost of petrol to
distribute bananas

Price to consumers
(cost plus 100%)
£600
£600
£100
£1400
Task:
•Calculate what
happens to the price
of bananas if Petrol
doubles in price.
•What is the overall
% increase in price
to the customer?
Answers





Banana prices:
Juan - £800
Tesco - £2000
% change:
600/1400 x 100 = 42.9%
Demand-Pull

the process by which prices rise because there is
excess demand in the economy.
An example of Demand-pull Inflation
China’s increasing demand for Oil as it is no longer self
sufficient

‘China has been on a
buying spree, and is
prepared to pay top-dollar
to get its hands on the oil it
needs. But it is more than a
slight exaggeration to say
China is to blame for $70 a
barrel oil prices. ‘

Taken from a BBC news
story.
Student Activity:
Cost-push or Demand-pull inflation? (5 minutes)

A fall in the value of the pound - cost-push (imports)

Rapidly rising consumer spending - demand-pull

Shortage of production capacity - demand-pull

World shortage of oil

Rising wage expectations - cost-push

Large increase in government spending - demand-pull
- cost-push
Inflationary Expectations

Views about what will happen to the rate of inflation
in the future.

People expect inflation to continue into the future and
therefore attempt to negotiate better pay deals at
work to keep their standard of living.

This leads to the wage price spiral
Wage Price Spiral

Demand is high so inflation rises

Workers will demand higher wages as the cost of
living increases

This increase in the cost of wages means firms push
prices higher

The cycle continues.
Hyperinflation

Prices spiral upwards uncontrollably and extremely rapidly with
devastating economic consequences.

Inflation in excess of 50% a month.

The value of money decreases so fast people lose confidence in
it and avoid transactions and begin to barter or trade in
commodities such as gold with its own intrinsic value.

In the 1920s Germany experienced hyperinflation, which peaked
at 700,000,000,000% in 1923, the currency had to be replaced
in 1924 with a new currency.
BBC News Stories

The real cost of inflation:

http://search.bbc.co.uk/cgibin/search/results.pl?tab=av&q=inflation
&recipe=all&scope=all&edition=
Student Activities:

Positive and negative effects of inflation:
Produce a mind map for both the positive and
negative effects of inflation. You may use the
A2 AQA textbook page 350 - 351. (15/20
minutes)

What is the difference between a fall in
inflation and a fall in prices? (10 minutes)
A2 External Influences
Inflation – Lesson 2
Starter - Recap

What are the positive and negative effects of
inflation?

What is the difference between a fall in
inflation and a fall in prices?
Student Activity

Briefly describe the 6 effects of a low rate of
inflation. You may use the A2 AQA textbook
page 352 (10 minutes)
Implications for strategy of
changes in inflation


What happens to the value of money if inflation is high?
Value of money 
Is a business more/less likely to borrow money?
Borrowing more likely since payback will be  in ‘real terms’
 What happens to the value of the companies fixed
assets (e.g. land/building)?
Balance sheets look better and so ‘reserves’ are bigger

How will general  prices affect firms pricing strategy?
Lower-price products/services may benefit as ‘premium-priced’
products now ‘look’ too expensive
Firms will find it easier to ‘pass on costs’ to consumer if ALL prices
are rising.
Implications for strategy of changes in inflation

How will prices affect sales?
May mean lower sales…internationally.

How will prices affect ‘menu’ prices?
Firms will keep needing to change the prices advertised

How will ‘branded’ products be affected?
Customers more aware of price (become price sensitive) and may switch,
firms may either  advertising (costs) or Prices to regain customers

How will the workers react?
Cost of living , so if inflation is 10%, they want at least 10% wage increases

How will the suppliers react?
‘They put up their price to the business to try and do the same (cost-push)

What happens to (international) competition?
If Inflation is only happening in the UK, product less price competitive

Implications for the business plan?
If future is uncertain, planning is less reliable- less likely to take risks

How will the MPC react?
Increase interest rates to reduce spending