Economics -The Wider economic environment

  • Created by: jacktd98
  • Created on: 16-05-16 15:56

2.1.1 Growth

For many businesses growth is an important objective. The objectives of growth are:

  • To achieve economies of scale
  • To increase market power over consumer and suppliers - The extent at which one business can affect what hapens in the market
  • To gain a greater market share and increase brand recognition - increases turnover, market power and brand loyalty 
  • To increase profitability - becoming more efficient and productive.

Problems arising from growth 

  • Diseconomies of scale occurs - increased average costs
  • Internal communication problems - contribute to Dis. of Scale 
  • Loss of corporate culture 
  • Skills shortage 
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2.1.1 Economies of Scale

Economies of scale refer to the reduction in the average cost of production brought about by a long run increase in the size and scale of output. Economies of scale can lead to a greater gross profit margin or used to gain a competitive advantage over rivals by decreasing prices

  • Technical - As a business grows it can afford bigger and better equipment and make full use of the specialised capital equipment as more sales so the high costs are then spread over a larger output
  • Marketing - The fixed cost of an advert is unchanged dependant on size but as a business grows, the advertising reaches a wider market and more sales come of it so the average cost of marketing per sale goes down 
  • Managerial - As a business grows it can employ specialist managers with particular skills to increase productivity and drive down average costs
  • Financial - As a business grows it becomes less risky in terms of applying for credit so get lower interest rates
  • Risk Bearing - As a business grows it can diversify or supply more than one market spreading the risk of economic downturn across its customer base
  • Bulk Buying - As a business grows it can buy more of a supply and negotiate lower prices as they have more of a monopsopy power
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2.1.1 Diseconomies of Scale

External eonomies of scale refers to the reduction of long run average cost for all the firms in an industry from a new innovation in investment. This usually comes from - New infrastructure - Information sharing - specialist workforces in the area - Government expenditure. External EofS lead to products being more affordable and more mass market which can result in standars of living rising
Diseconomies of scale is the increased unit costs as a business grows due to new inefficientcies, internal communication slows down and messages are lost, there can be duplication of jobs, low morale and motivation accross employees, co-ordinating becomes harder and more expensive. 

Corporate culture is the shared values, attitues, standards and beliefs that characterise members of an organisation and define its nature. Companies with strong corporate cultures can prevent diseconomies by good teamwork and managerial skills.
Strong culture

  • High Productivity and motivation among staff 
  • Staff are loyal and labour turnover is low
  • Respect between managers and employees
  • More creativity - leads to higher productivity and creative destruction
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2.1.1 MES


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2.1.2 Methods of growth

Organic Growth is the expansion of a single business by extending it own operations rather than merger or takeover. Organic growth +is safer +the culture is maintained +gradual growth can match market growth - it is slow - risk of overextending 
Inorganic Growth is the expansion of businesses by means of a takeover or merger bringing sudden increases in business size. Inorganic growth +is fast once agreed + enhances market share and power +reduces competition +leads to economies of scale +synergy from combining ideas - Risk of culture clash - Customers lose brands - there is a Debt burden - employees may lose jobs 

Synergy emerges when two businesses are combined and together are able to increase efficiency and grow faster or make more profit than if they were seperate.

  • Horizontal intergration -Two businesses in the same industry and with similar products at the same stage of production join together - Gives most scope for economies of scale and market share
  • Vertical intergration - Two businesses in the same industry but at different stages of production or supply chain merge - Forward, manufacturers moving into distribution - Backward, businesses look back to produce their own inputs
  • Conglomerate intergration - When two completely unrelated businesses join together
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2.1.3 Research and development (R&D) and innovatio

Research and development refers to any activities that a firm undertakes to develop new products or processes, or to improve existing products or processes. Product innovation is the creation and subsequent introduction of a good or service that is either new or an improved version of the product/service to improve performance and customer satisfaction. Process innovation is the implementation of a new or significantly improved production or delivory method that enhance efficiency and cut cost.   
The government intervene in markets to support research and development as it usually very expensive. The English Research, Development and Innovation State Aid Scheme distrubutes money to fund projects into R&D. The European Regional Develpment Fund (ERDF) also does this. Innovate UK and the department for business, innovation and skills provide knowledge and money. 

  • Development - Research, development and testing - High investment negative cashflow, limited promotion
  • Introduction - Negative cash flow, low sales, Heavy promotion to create awareness
  • Growth - Cash flow becomes positive as sales pick up, promotion to build brand loyalty
  • Maturity - Maximum cash flow as sales peak, economies of scale reached, promotion falls
  • Decline - Sales fall but still positive cash flow, price reductions and eventual withdrawal
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2.1.3 The product Life cycle

The product lifecycle is  series of five stages which typical products go through between their first creation and eventual decline. An extension stratergy is any way in which a business attempts to prolong the mature phase of the cycle. >Advertising >New features >Re-packaging >Target different market segments >Change of price >New image (Re-launch)

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2.1.4 How the digital economy affects markets

Asymetric information arises in free markets where either the seller or buyer has more information that the other leading to either overpricing or underpricing - one party in a transaction knows more than the other. 

Search engines, Price Comparison sites and customer reviews have almost overcome asymetric information and given the consumer the ability to maximise their spending power. 

Viral marketing is a stratergy that spreads product information and opinion from person to person each person passing it on to friends and colleagues via social media, text or email. This can greatly increse the reach of the product and increase its market size.

Social media is based on digital communication devices through which users create on-line communities to share information, ideas, personal messages, images and videos and is now one of the largest sources of advertising.

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2.1.3 Supply/Demand side

The Supply side
Ecomerse is an umbrella term for online selling. Onlines sales are increasing rapidly which has made it harder for traditional stores to compete, many now sell through physical stores and online similtaneously. Online-reatailing >reduces storage costs, >can be open 24/7, >is more convienient to consumers, >reaches more people, >allows a wider product range.
Micromarketing is a customised marketing stratergy in which advertising efforts are focussed on a small well defined group of consumers.via social media with personalised recommendations or promotions. Recruitment is easier as businesses can use sites such as LinkedIn and people can be trained online especialy in IT training.

The Demand side
The long tail can be used to show how Eretailing has affected markets. The head of the graph represents the "HIts" these are the widely known popular products that are on sale in physical stores as well as online.The Long Tail represents all the less popular specialist niches in the market these products or services are not sold in traditional stores as there is not enough demand to satisfy the cost of stocking, However these niche products or services can be sold online at very high prices to the small market.
Location of businesses is less important now as the internet allows businesses to connect with wider geographical markets 

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2.1.4 The Long Tail


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2.1.4 Impacts

  • Fixed costs can be greatly decreased - less physical stores, area not important
  • Economies of scale can be achieved without moving 
  • Lower prices can allow smaller businesses to undercut larger ones in the city
  • It is easier than ever to set up businesses, encourages competition in market and creative destruction through new Inovative products and marketing stratergies
  • Has contributed to keeping Inflation low
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2.1.5 How small firms compete

  • Product Differentiation and USP's - small manufacturers can make to order, they can provide hand made or home made products and provide interesting and unique products or services
  • Flexibility in responding to consumer needs - Small businesses often know the customers peronally and can change their prouct to meet their requirements. Combined with micromarketing, small business are more able to react faster to market changes
  • Customer service -  Smaller businesses can offer a really personal touch and Face-to-face product advice can add value to a product raisning the price
  • Targeting Niche Markets - Small businesses that embrace e-commerce can obtain National and even international markets for niches and still make a profit as they can charge a much higher price for the niches, especially of luxery goods.
  • Achieving competitive advantages through relationships with stakeholders - Employees know and can talk to the bosses in small businesses, this increases motivation and efficiency. Customers don't have to deal with call centres and faceless websites, this increases customer loyalty. Small businesses tend to have more character than the larger chains.
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2.2.1 Price elasticity of demand (PED)

Price elasticity of demand measures the responsiveness of a quantity demanded to a change in price.

This is an important concept to businesses as they need to know what will happen if they have to change their price for example a change in the costs of production. Businesses try to make their product as inelastic as possible through advertising and branding, they try to show there is no substitute for their good. A change in price can dramatically change the total revenue from sales, using PED data can predict what will happen to sales with a change in price. PED is more important to mass markets as they are generally standardised goods and have many substitutes

PED = % change in quantity demanded / % change in price

Price inelastic - A price change causes a propotionally smaller change in quantity demanded - between 0 and -1
Price elastic - A price change causes a proportionally bigger change in quantity demanded - beyond -1
Unit Price Elasticity - A price change causes the same proportional change in quantity demanded - Exactly -1 

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2.2.1 Factors affecting PED

  • Number and closeness of substitutes - The more substitutes there are the more price elastic a product will be 
  • Luxery or Neccessity - Luxeries tend to be more price elastic as they are just things people want whereas neccessities are needed by the consumer so are more price inelastic
  • Proportion of income spent on a good - Expensive products that take up a high share of a persons disposable income have a higher price elasticity as the price changes are particularly noticable.  
  • Time scale - In the short term many products will be more price inelastic than in the long term this is because people take time to adjust to price changes 

Generally a raise in price will lead to an increases in revenue for price inelastic goods and a decrease in total revenue for price elastic goods.
Highly competitive markets have products the have a higher price elasticity, cutting costs and reducing the price would create a big competitive advantage. Lower prices help raise the standard of living.
Businesses will try to select a market position for their products where demand is as price-inelastic as possible 

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2.2.1 Price elasticity of demand diagrams

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2.2.2 Competing on price

A pricing stratergy is the way in which a business decides upon the price of its product 

  • Cost plus pricing - Price is determined by adding a fixed percentage profit to the costs
  • Price skimming - Charging a very high initial price for the product to maximise profits while the product is unique in the market
  • Penetration pricing - Setting a lower initial price than competitors to pursuade buyers to try the product and gain a foot hole in the market before raising prices
  • Premium pricing - A higher price is charged than competitors because the product is seen as more desirable and of better quality, works well witth known brands
  • Predatory pricing - Setting the price below the costs of production to drive out rival firms from the market. In the UK it is illeagal
  • Competitve pricing - Setting prices very similar to or just below competitors prices in the market, often used in highly competitive markets
  • Psychological pricing - Using a price signal to suggest better value by rounding down to the '99p' or reducing the price of the main good but increasing the price of complementary goods

Factors >Number of USP's / amount of differentiation  >Price elasticity of demand >Strength of brand >Stage in the product life cycle >Costs and the need to make a profit

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2.2.3 Types of non-price competition

Non-price competition is any way of attracting customer interest other than price. Marketing is used to shift the demand curve to the right and decrease a products elasticity.

  • Quality
  • Design
  • Branding
  • Advertising and promotion
  • Customer service
  • Reliabiltiy 
  • Packaging and display 
  • Product differentiation
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2.2.4 Income elasticity of demand (YED)

Income elasticity of demand measures the responsiveness of quantity demanded to a change in income. Incomes change relatively slowly and changes in individual incomes will have no effect on YED. The usual cause of changes in income is when there are changes in the economy. 

YED = % change in quantity demanded / % change in income

Income elastic - A change in income causes a proportionately bigger change in quantity demanded - Greater than one
Unitary income elasticity - A change in income causes a proportional change in quantity demanded - exactly 1
Income inelastic - A change in income causes a proportionately smaller change in quantity demanded - Between 0 and 1

Normal goods have a positive income elasticity of demand, a rise in income leads to a rise in demand. Inferior goods have a negative elasticity of demand as income falls demand rises. Inferior goods are not always poor quality but are substitutes for expensive goods. Businesses selling inferior goods do well in economic downturn. Factors of income elasticity include: Luxery of neccassity and the share of income.

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2.3.1 Productivity

Production is the process of combining inputs (Land, Labour, Capital, Enterprise) in order to produce goods and services. Productivity measures the efficiency with which resources are used. 

Labour Productivity = Output per time period / Number of employees at work


  • Physical capital - This is the tools and machines used to make goods, they make labour more efficient and productive, improvements in technology yield improvements in productivity
  • Human capital - the skills of the workforce, education provides general skills which are refined by specialist training. The more skilled the workforce the more productive it is
  • Organising resources more efficiently - If delays cause employees' time to be wasted improving the organisation or production process can improve productivity

Increasing productivity can be very important for a business as average cost fall creating a competitive advantage and allowing the business to improve the product or charge less for it. Research and development is a big part in enhacing productivity.

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2.3.1 Labour/Capital intensive

Improving productivity makes it possible to raise pay as average costs go down, Wages are often linked to production targets; bonuses may be paid if reached. Equally, higher pay can be an incentive for increased productivity. 

Productivity contributes to economic growth as it increases the supply, increased productivity often leads to a reduction in price making products more accesible and improving the standards of living however it often leads to redundancies as less people are needed for the same output.

Capital intensive - Production uses a large amount of capital equipment and relatively little labour, productivity will be high. Labour intensive - Production uses large amounts od labour and relatively little capital, many services are labour intensive
>As an economy advances, it becomes more capital intensive, in poorer countries, labour is cheap and plentiful.

In dynamic markets both methods have problems >Tools and machinery may become obselete, >machines need upgrading and maintaining, >high levels of investment in capital. >Skills may become unneeded, >retraining is often neccessary at an expense. Physical capital is more reliable, make all product identical, increase productivity, can run all day and produce at the same quality.

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2.3.2 Capacity utilisation

Capacity utilisation desribes what proportion of the maximum possible output is actually produced by a business, expressed as a percentage.
Full capacity
means that all the resources available to the firm are being used to the fullest extent all of the time.
Spare capacity means that for some of the time some resources are not being used and therefore there is a loss of potential output.

Capacity utilisation = (Current output / Maximum possible output) x 100

Under-utilisation of capacity happens whe there is insufficient demand for a product and means that capital equipment is not used all of the time which reduces productivity. This means the business is producing less and its average cost are higher than they could be as fixed cost are spread over lower level of output, This makes the business less competitive. The business can increase demand through a marketing stratergy and can extend the range of products to make use of the machines, as a last resource they can cut capacity

Over-utilisation of capacity means that the business is trying to produce more than their capacity will allow, this will lead to bottlenecks, breakdowns and overcrowding, reducing efficiency and productivity.

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2.3.3 Efficiency using lean production

Efficiency means organising production so that waste is minimised and costs are as low as possible. Lean production is a general term given to any system of production that tries to minimise waste and cut costs at every stage of production and distribution. Lean production has many components including >Just in time(JIT) >Kaizen >TQM > Cell production >Job enrichment and empowerment > Time-based management. 

Kaizen is the Japense word for continuous improvement and summarises a whole company's approach to quality and cost control. Everyone is involved in the search for improvements to both the product and the process of production. 

Just in time (JIT) is a stock control system that involves having stock arriving as and when it is needed so there is no need to hold large quantities of stock or raw materials. Close relationships with the suppliers are needed to ensure that supplies arrive on time and to the quality needed. JIT reduces the need for warehouses and storage units therefore reducing costs.
Advantages of JIT - >Reduced costs >Less need for storage space so more for production >Greater flexibility in responding to changes in  demand
Disadvantages of JIT - >Will not benefit from bulk buying >If there is a break in supply production will be lost >Heavy reliance on reliability of supplier 

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2.3.3 Quality and efficiency

Quality control refers to the traditional method of checking that products are of an adequate standard, inspection of products takes place during and at the end of production. However this method cannot identify the cause of the defect, it is expensive in terms of implementatioin and wastage of stock and does not add value 

Lean management uses quality assurance meaning that quality standards are agreed and met throughout the organisation by every member of staff. This involves changing the corporae culture of the company so that all employees see quality as a high priority that influences all aspects of their work. This method focuses on preventing defects rather than just finding them this can contribute a zero-defects policy. Kaizen and Total quality management is important for developing quality assurance. Total quality management (TQM) is when employees are all involved in quality control and take responsibility for the quality of their team's work. 

Benefits od TQM - >Improved products >Reduced costs >Increased customer satisfaction >Repeat purchace and Brand loyalty >Improved profitability >competitive advantage >Motivated workforce
Drawbacks of TQM - >Implementation costs >Difficulties getting everyone to sign up >Takes time to set up >Retrain employees >Increased pressure on management >Does not suit all businesses

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2.3.3 Lean Production

                 Advantages                                                              Disadvantages

  • Reduces wastage and related cost                  -Does not suit all production processes
  • Reduces costs of storage and handling            -Failure by on small supplier may halt the                                                                              entire production process
  • Improves quality                                           -Some employees don't want more responsibility
  • Fewer reject costs                                         -Managers may not be flexible enough
  • Customers more satisfied with quality             - May not be able to meet unexpeted orders
  • Greater flexibility 
  • Shorter lead times 
  • More motivated staff, less staff turnover
  • No waste caused by unsold output
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2.3.4 Impact on costs and sales revenue

Lean production cuts costs by reducing the waste during the production process. Another important part of lean management is producing to order this cuts the cost of unsold goods. It cuts costs by :

  • Reducing the need to correct faults                + Cutting storage costs
  • Keeping production in line with demand         + Seeking process innovation
  • Using time-based management - aims to save time wherever possible ensuring no one is delayed by having to wait for other employees to finish their work 

Lead time is the time from the first idea of the product through to it being ready to sell as the final product, Successful businesses can adapt to a the dynamic of the market therefore having a shorter lead time benefits them. 

Benefits of a short lead time:

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2.4.1 Globalisation

Globalisation is the process through which an increasingly free flow of ideas, people, goods, services and capital leads to the integration of economies and societies. Foreign direct investment (FDI) occurs when businesses or governments invest in other countries.

Characteristics of globalisation

  • Increaseing FDI - More and more funds are coming from one country to finance investment projects in another country. FDI flows are now 25 times what they were 30 years ago
  • World trade rising as a proportion of world gross domestic product (GDP) - World trade has grown faster than world GDP, this means more goods and services are being traded across borders rather than sold in home markets
  • Increased migration - There has been increased movement of people to where the job opportunities are. This has been possible the breakdown of authoritarian regimes and creation of trading blocks

Advantages -  >Wealth and development brought to many countries >Higher living standards >Interdependence helps maintain peace >More consumer choice >Tech and knowledge transfer
Disadvantages - >Exploitation of poorer countries >Increased inequality (sweatshops) >over-dependence on other countries >Dominance of Western corporate culture across globe 

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2.4.1 Factors contributing to globalisation

  • Trade liberisation - Trade barriers have been dramatically reduced. In the late 1940's The International Monetary Fund (IMF) and the World Bank were set up. In addition the World Trade Organisation was created and discussions began about the EU. With help of these organisations international trade is flourishing, 153 countries are now part of the WTO

IMF - Co-ordinates the international monetary system, it gives advice, loans and technical assistance to try maintain stability 
World Bank - Lends to developing countries in order to fund projects which will help raise incomes and make their economies more efficient
WTO - Supervises world trade agreements and negotiations and helps resolves disputes

  • Capital market liberisation - The relaxation of government restrictions in the market allowing FDI into poorer countries. This was encouraged by the IMF in the 1980's and 1990's to encourage economic growth in developing countries. The objective to the investor could be to produce close to the market e.g producing in England to trade in the EU, or to cut costs by manufacturing in countries with lower wage rates. However an interdepence can be created leading to economic instability as if one economy declines lots of others do too.
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2.4.1 Factors contributing to globalisation

  • Political change resulting in the opening up of China and the former Soviet Union - The end of communism in Eastern Europe in 1989 and the collapse of the USSR in 1991 meant that businesses could now trade with these areas, many more countries were allowed into the EU and people can now set up businesses in China as well as chinese suppliers looking to export. This increased world trade and contributed to globalisation. China now invest a lot into poorer African countries where they can get raw materials
  • Reduced cost of transportation and communications - have made it cheaper and easier trade overseas. Cheaper air travel and telecoms has made communication between suppliers and markets easier as well as improving international relationships making international trade possible
  • Increased significance of global (transnational) companies - Multinational corporations(MNC's)  are businesses which ownor control productionor service facilities in more than one country. These have been able to expand faster in the last few decades due to market liberation, new trade blocks, the opening of china. Domestic markets become saturated for many businesses, accessing emerging economies creates huge potential profits if the company trades overseas or outsources. Outsourcing is the buying of inputs from foreign suppliers or locating the whole production process abroad. This can cut costs through cheaper inputs and lower wage rates
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2.4.2 Developed, emerging and developing economies

The five fastest growing economies are Brazil, Russia, India, China and South Africa (BRICS), these are all emerging economies and have significant influene on global affairs. The UK is an advanced economy and has a much lower growth rate.

Brazil relies heavily on commodities such as sugar, iron ore and soya, all of which have experienced a fall in demand and have resulted in Brazils growth rate slowing, progress will depend on developing manufacturing.
Russia rely on exporting oil and gas however oil prices have reamined low due to Suadi Arabia oversupplying the market. As well as this Russia's international relations have declined due to issues with Ukraine. This has also lead to the slowing of the Russian economy
India's growth has been undramatic but there is likely to be mass investment into the economy
China's rapid growth has come from exporting its goods, but this relies on there being theemand from the rest of the world, during the 2008 recession demand for chinas good went down and theyre now trying to rely more on domestic demand and trying to slow to a more sustainable level of growth. However China has investment project allover the world and a  fall in growth coul lead to a fallthrough of these projects 

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2.4.2 Indicators of growth

GDP per capita - Gives a rough idea of how wealthy a country is and is measured by   National income (GDP) / Population. However can be misleading if there is large inequality. The figure can be improved by adjusting for costs of living - Purchasing Power Parity (PPP)

Human Development Index - Ranks countries in relation to several aspect of development, it has three main strands. -HEALTH - life expectancy - EDUCATION - mean years of schooling and Expected years of schooling - LIVING STANDARDS - Gross national income adjusted to PPP. This is calculated by the United Nations Development Program and classifies into low, medium ad high HDI

Literacy rates - The percentage of adults who can read and write

Health indicators - Infant mortality rates, access to clean water

Mobile phone use - leads to economic development in remote areas 

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2.4.2 Characteristics of different economies

Developed/mature econmy - Have High levels of income, advanced technologies and infrastructure, highly developed capital markets and robust financial institutions. They will have been industrialised some time ago and tend to rely on the service sector. The HDI can be used to help classify if the value is over 0.8 the country is classified as 'advanced'. Examples include: UK, USA, Germany, Australia, Japan and South Korea 

Developing economies - In the early stages of industrialisation and may still rely on agricultural activity, they have lower standards of living, low incomes, low levels of healthcare and education and a low HDI. Examples include: Angola, Afghanistan, Cambodia and Mali

Emerging economies - shares characteristics of bothe developing and mature economies as these economies are in transition. Often they have high levels of growth and some areas with high levels of disposable income but there are still areas of serious poverty and deprivation. Often there is a large manufacturing output. Example include: BRICS, Mexico, Indonesia and Turkey.

The Mean income is the average income, total incomes / population. The Median income is the middle income when all incomes are arranged in order. If there is large inequality, the mean will be high and the median lower.

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2.4.3 International trade

Free trade area - a group of countries that trade completely freely with each other, with no trade barriers, but each member country retains its own independent trade policies in relation to the rest of the world. Examples are the North American Free Trade Area (NAFTA)
Common Market - All members of the marekt have completely free trade internally including goods, services, people and capital and individuals can work in and member country. There is a common external trade policy covering all members countries' trade with the rest of the world.

Most economies will specialise in producing and exporting the things they are best at. They do this as they have a competitive advantage over other countries including: natural resources, abundant land, cheap labour, technical know-how, a favourable climate, accessible sources of finance. By specialising, output can be increased and the good or service can be traded, this contributes to economic growth as output and income is increased and by trading their surplus for other products, consumer choice and welfare can be increased. Exporting more raises GDP.
ADVANTAGES >increased output and efficiency >Econmies of scale >export earnings increase >competition drives innovation and prices down >Good produced more cheaply
DISADVANTAGES >over-reliance on one are of the economy >If demand falls, structural unemployment >reliance on imports for other goods >emerging economies rely on a commodity

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2.4.3 Imports and Exports

Exports are goods and services produced in a country that are sold to another country. Imports are goods and services that are bought in from a foreign country. A visable export or import is one that is tangible, it is a physical good. An invisable import or export is intangible and usually a service e.g insurancem banking and tourism.

Imports and exports generate flows of money, when the flows are added together a balance is created which can be negative or positive. A positive balance of trade is known as a trade surplus, exporting more than you import. A negative balance of trade is known as a trade defecit, importing more than you export. 

Importing allows countries to achieve higher standards of living by obtaining goods and services from the most efficient source creating consumer choice. Cheaper imports raise standars of living as the consumer has a larger disposable income left.Producers can source cheaper raw materials from other countries making them more competitive. Cheaper imports keep inflation low.

Cheap imports can harm domestic producers as consumers switch to the cheaper substitute good. it can lead to structural change in an economy e.g steel

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2.4.4 Exchange rates

Exchange rates are the value of one currency in terms of another country. Floating exchange rates are determined by market forces (supply and demand). The demand for pounds comes from when the UK exports and the buyer must switch their currency for pounds and from FDI from other countries setting up in the UK. The supply comes from when the UK buys imports and we invest abroad.

Exchange rates are flexible and fluctuate over time this can bring uncertainties for business trading overseas. SPICED means that a strong pond make UK businesses less competitive. China have kept the value of the Yuan low to boost its exports and to make it hard for others to penetrate the domestic market. 

Exchange rates change all the time but marked changes can be traced to causes e.g the £ in 2008. Appreciation means that a currency increases in value compared to other currencies, Depreciation means that a currency decreases in value compared to other currencies.

An effective exchange rate is based on an exchange rate index that shows the relative strength of a currency compared to a basket of goods  

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2.5.1 The economic cycle

The economic cycle describes the fluctuations in the levels and rates of growth of GDP over a period of time. It is sometimes referred to as the trade or business cycle. Gross Domestic Product is the value of goods and services produced in the economy over a period of time.

Boom - A time of rapid growth and expansion in the economy. Characteristics include >High GDP >High demand  > Increased output-resource shortages >Unemployment falls >Possible inflation-demand pull >Increased investment >High consumer confidence
Recssion - Two consecutive quarters of negative growth. Characteristics include >Unemployment rises >GDP falls >Output falls >Investment falls >spending drops >demand falls >businesses close
Downturn - the boom slows and the rate of growth decreases
Recovery - positive growth returns, slowly at first then picking up pace  

                                              photocopy of pg 95

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2.5.1 Impact on businesses

                                      INSERT TABLE PRINT OUT 

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2.5.2 Circular flow of income, expenditure and out

The circular flow of income is an economic model showing the flow of goods and services, the factors of production and their payments between households and firms within an economy 


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2.5.2 Injections and leakages

Injections are additions of extra spending into the circular flow of income and increase demand for domestically produced goods

  • Investment (I) - Money spent by firms on capital goods
  • Government Spending (G) - Money spent by the government on NHS, defence, benefits, eucatuion
  • Exports (X) - Goods and services sold abroad by UK firms bring foreign money into the economy

Leakags reduce the demand for domestically prouced goods and services by diverting part of peoples income.

  • Taxation (T) - Taken from wages and off the price of goods(indirect) 
  • Savings (S) - Households keep their money in the bank not spending all their income
  • Imports (M) - Households and firms spend on foreign goods and services giving money to foreign countries

If leakages equal Injections the economy is in equilibrium. If leakages are larger than injections then incomes will fall and spending will fall. The same is said for the reverse

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2.5.2 Aggregate demand and supply

Aggregate demand is the sum total of demand for goods and services produced in and economy at a given price level and at a given time. Souces of demand are households, the government, firms and foreigners.                       AD = C + I + G + (X-M)
Consumption (C) is total household spending on goods and services 
Investment (I) is spending now on capital assets that will generate income in the future - can be physical or human capital
Government Expenditure (G) - all public spending
Exports(X) - Imports(M) is the balance of trade

Aggregate supply is the total output in the economy that producers are able and willing to supply at a given price at a given time.
An AS/AD diagram. The horizontal part of the AS curve shows that so long as there is plenty of spare capacity in the economy, the input prices will not rise. As an economy gets closer to full capacity output, the AS line starts to curve as resources get scarcer and more expensive (overheating). At full capacity output, there are no more resources so AS goes vertical  
An increase in input costs will shift AS up and a decrease would shift it down. The AS curve can be shifted outward (right) if >productivity increases >New tech increases efficiency >An increase in available resources >Invest in Capital assests

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2.5.3 Inflation

Inflation is the sustained increase in the average price level in the economy. Disinflation is a decrease in the rate if inflation. Deflation is the sustained decrease in the average price level in the economy. The rate of inflation is the annual percentage change in the average level of prices from year to year. There are two measures of inflation, they are compiled by the Office of National Statistics, 700 items are put into a basket and weighted according to their relative importance and published every month 

Consumer Price Index (CPI) - The headline rate and forms the basis for the governments inflation target. It excludes mortgage interest payment and housing costs.

Retail Price Index (RPI) - Includes housing costs such as council tax and mortgage interest payments. It is used to decide state pension and benefit levels.

Anything that is described as real has had the effect on inflation taken into account. Nominal values is expressed in terms of current prices.

Current prices value each item in terms of the prices in that year. Real values are expressed in Constant prices, the data for each year is shown as the value they would have had in the prices od the base year.  

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2.5.3 Causes of inflation

Demand-Pull inflation - Arrises when the economy is overheating in a boom. Aggregate demand exceed Aggregate supply therefore a general raise in prices is caused from the market pressures 
Causes - >Low interest rates >Reduced taxation >rise in consumer spending

Cost-Push inflation - Occurs when the costs of production rise, this leads to the businesses passing on the cost to the customer raising the general price level and moving the AS curve upwards.
Causes - >Wage increases >Import prices up >Higher taxes >Rents increase

If inflation accelerates for a period of time there will be both cost-push and Demand-pull pressures leading to an inflationary spiral.

Inflation can lead to increased uncertainty in business making it harder to make cash flow forecasts and expansion plans become riskier so lower investment. Businesses can lose competitiveness if other countries have lower interest rates, this can be managed by lowering the exchange rate.
Inflation can lead to a loss of real income if wages do not increase at the same rate as inflation and if interest rates are lower, savers will lose out as there savings are less in real terms.

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2.5.4 Employment and unemployment

Employment refers to all those people between 16 and 64 who are in work. Unemployment refers to the number of people who are able and willing to work but not able to find a paying job. Underemployment refers to those who are employed but are in work that does not fully utilise their qualifications. There are two measures of unemployyment

The Claiment count - measures the number of people claiming unemployment benefits (jobseeker's allowance). U18s and over 60s are not included and some have jobs in the black economy but still claim benefits
The International Labour Organisation (ILO) - Uses the The Labour Force Survey (LFS) to count all those people who are available and seeking work. This is a better guide for policy makers and is internationally recognised but it is very costly to compile and is subject to sampling errors.

  • Structural - When there is structural change in an industry that leaves workers with the wrong skills for the employment on offer often mass unemployment
  • Occupational immobility - Unemployed people do not have the neccesary skills and abillities to adapt to changing job requirements 
  • Geographical immobility - the labour cannot move to where the jobs are available
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2.5.4 Unemployment causes and impacts

  • Technological unemployment - Unemployment caused by a technological change in an industry often linked to businesses being more efficient so needing less workers
  • Demand deficiency (cyclical) unemployment  - Caused by a downturn in the economic cycle, sales fall so does then output meaning less workers are needed.  


  • Opportunity cost - could be employment contributing to GDP 
  • Rise in govt. spennding on benefits - could be used better elsewhere
  • Loss of tax revenue, less direct and indirect taxation, strain on govt. finances
  • Social costs due to social problems, government intervention and spending needed
  • Leads to depression
  • loss of skills and work habits
  • Less aggregate demand so fall in profitibility 
  • Less disposable income so fall in sales
  • Inferior good will have an increase in demand
  • Easier to fill job vacancies - lots of skilled workers
  • Wages will be static or even go down meaning lower costs
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2.6.1 Possible macroeconomic objectives

Macroeconomic policy aims to control the level of activity in the economy so that the standard of living improves and stability is maintained 

SUSTAINABLE ECONOMIC GROWTH - The government aims to manage economic growth so that is not too fast and not too slow. Too fast could lead inflation to accelerate. The government aims to have GDP growing in real terms leading to higher living standards, but not to accelerate inflation
LOW UNEMPLOYMENT - Low unemloyment maximises incomes and increases output leading to better standards of living and less waste of resources
LOW AND STABLE RATE OF INFLATION - The governments target rate is 2% this helps prevent inflation accelerationg and avoids deflation which can shrink the economy
BALANCE OF PAYMENTS (TRADE BALANCE) - A positive banlance of payments is faourable as it means we earn more money from exports than we pay for imports. If imports are greater a trade defecit develops this will have to be financed by borrowing money. The current account is the sum of the balance of trade 
REDISTRIBUTION OF WEALTH - To decrease the divide between rich and poor


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2.6.2 Policy instruments

There are 4 types of policy the government uses to achieve its objectives. If the economy is growing too quickly and there is inflationary pressures then Contractionary policies are used to reduce the level of economic activity and national income. If the economy is not growing fast enough or if unemployment is too high, expansionary policies are used to stimulate the level of economic activity and in turn stimulate growth and reduce unempoyment 
 Contractionary policy                                     Expansionary policy
-Higher interest rates                                           -Lower interest rates
-Tax increases                                                    -Tax cuts 
-Cuts in govt. spending                                        -Increased govt.expenditure 

Fiscal Policy involves changes in the level of taxation and/or government expenditure in order to influence the level of activity in the economy. Spending and taxation does not have to match, the govenrnment can spend more than it gets by borrowing and going into defecit. A public sector defecit occurs when the government must borrow to fund its spending.

                                          INSERT CHART ON PG 106

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2.6.2 Monetary policy

Monetary Policy - The manipulation of interest rates to vary the costs of borrowing and influence the level of aggregate demand. Monetary Policy is set by the Monetary Policy Comitee (MPC) this is an independent comitee set up by the labour government in 1997 as part of the Bank of England. The MPC meets once a month to decide the base rate of interest.
The base rate is at 0.5% now and has been since 2009

                                        stick in table from pg 107 

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2.6.2 Supply side policies

Supply side policies - All measures taken to increase the productive capacity of the economy by influencing aggregate supply. Supply-side policies can be used to reduce inflationary pressure as if AS is growing, AD can afford to expand without causing excess demand. 
Objectives of supply-side policies are to >increase the number of workers >increase R&D >encourage start up and expansion of businesses

  • Taxes - tax credits provide an incentive to work
  • Benefits - Benefit cuts provide a greater incentive to work
  • Education and training - Improves the skills and flexibility of the labour force - reduces the occupational immobility of labour and makes UK more competitive
  • Grants and subsidies - can support desirable outcomes > R&D spending >environmentally friendly energy production >apprenticeships 
  • Privatisation  - increase competition and efficiency 
  • Minimum wage - introducing living wage increases incentive to work 

EXCHANGE RATE POLICY - Higher interest rates tend to make the pound appreciate as investment in UK sterling becomes more attractive, This will make imports cheaper and help reduce inflationary pressure, UK exports will become less competitive.

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2.6.3 Potential policy conflicts and trade-offs

Inflation vs Unemployment - It is normally hard to maintain low inflation and low unemployment as to reduce inflation contractionary polies are used but to reduce unemployment expansionary policies are used, these usually lead to higher inflation. - Inflation is not rising at the moment due to the low prices of oil due to Saudi Arabia oversupplying the market, this is set to continue for the forseeable future

Economic growth vs negative externalities - to increase economic growth, output must increase requiring more energy, this increases pollution and adds to the depletion of non-renewables and our natural resources.

Politics vs Economy - Some policies such as tax increases and spending cuts can be unpopular and the goverrnments focus on reducing the defecit has lead to a greater strain on the NHS. There are also time lag problems, changes in the base rate can take almost a year to show, changes to education and training take many years to show and changes in spending take a long time to filter through. External shocks can render all policies ineffective 

There is a split between labour and conservative ideas, labour wants to tax more and spend more, whereas consservatives want to make cuts and reduce defecit and leave to the free market

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2.6.3 Unintended consequences

The governments help to buy scheme for young house buyers has pushed house prices even higher due to increased demand

Governments that impose high import duties (tariffs) to protect domestic industries can increase costs to the industries

An increase in taxes can lead to increased tax evasion and some big business pulling out of the country

The implementation of a minimum wage increases cost to the business so they employ less people increasing unemployment

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Thank you for your effort. Extremely Helpful!!

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