External influences


Market failure

Explain market failure

When free markets fail to produce the best use of resources

What is a free market?

In a free market, the forces of supply and demand interact without government intervention

List 3 ways product markets fail

  • Negative externalities (polution, noise and congestion)
  • Positive externalities (improved roads and new jobs from business expansion)
  • Market dominance- where monopolies use the lack of competition to charge high prices

Why is market failure a problem?

  • inefficient use of scarce resources
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Market failure

Distinguish between product and labour markets

  • Product markets refer to trading in goods and services
  • Labour markets refers to the forces of supply and demand for jobs

Why are free markets efficient?

Highly competitive markets operating without government intervention make best use of scarce resources. 

Explain negative externalities

Are the costs imposed on others by consumers and producers

Explain positive externalities

Are the benefits to others from the actions of consumers or producers

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Market failure

Why can monopolists abuse their market power?

Barriers to entry, prevent new firms entering the market and competing with a monopolist. This means monopolies can set high prices

How can labour markets fail?

  • When firms are reluctant to train staff for fear they will leave and join a competitor who acquires a newly skilled worker at no direct cost
  • The jobless cannot find jobs

Identify examples of stakeholder's response to market failure

  • Local communities and pressure groups- try to influence the behaviour of firms
  • Government- can use taxes, subsidies, laws and regulations to change firm's behaviour
  • Customers can boycott products and use the internet to generate bad publicity
  • Employees can negotiate with management and threaten industrial action
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Market failure

How can the government tackle market failure?

  • Taxing harmful demerit goods
  • Subsidising merit goods (education)
  • Laws and regulations to force consumers and firms to change their behaviour or face fines and imprisonment
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Economic growth

Explain macroeconomics

Refers to the whole economy

List the 4 main sections in the economy

  • Households: spendingon goods and services (consumption)
  • Firms: businesses spending on fixed assets 
  • Government: tax revenues to provide public services
  • International sector: imports and exports

Define economic activity

Productiong of goods and services

What is GDP?

Total value of goods and services produced in a country in a given time period (Gross domestic product)

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Economic growth

How is the level of economic activity measured?


What does economic growth mean?

Growth means economic activity has increased over time. Total output, income employment and demand are higher than in previous time periods)

List 3 disadvantages of economic growth

  • Noise pollution
  • Congestion
  • Threatens sustainability

What causes economic growth?

  • Increase in the quantity of resources available
  • Increase in the quality of resources available resulting in higher productivity
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Economic growth

How can economic growth impact on a business?

  • Demand in the economy rises
  • Increasing demand means firms find less cusotmer resistance to price increases
  • Higher sales and profits, improve business confidence and encourage firms to expland
  • As businesses expand, shortage of materials and skilled labour may occur

How does economic growth affect the economy?

  • Household income and employment rise
  • Customer confidence about the future state of the economy improves
  • Households use extra income to increase their spending
  • Consumers are more willing to borrow
  • Demand in the economy rises
  • Increased demand- incentive to invest in new offices/technology
  • Government - reduced benefit payments
  • Increased imports
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Economic growth

How can economic growth impact on a business?

  • Demand in the economy rises
  • Increasing demand means firms find less cusotmer resistance to price increases
  • Higher sales and profits, improve business confidence and encourage firms to expland
  • As businesses expand, shortage of materials and skilled labour may occur

How does economic growth affect the economy?

  • Household income and employment rise
  • Customer confidence about the future state of the economy improves
  • Households use extra income to increase their spending
  • Consumers are more willing to borrow
  • Demand in the economy rises
  • Increased demand- incentive to invest in new offices/technology
  • Government - reduced benefit payments
  • Increased imports
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Economic cycle

Explain the business cycle


1. Slump: low point of a business cycle
2. Recovery: upturn in the economy sees GDP increasing
3. Boom: high point of a business cycle
4. Recession: downturn in the economy means less GDP

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Economic cycle

Define recession

Recession occurs when there are two consecutive quarterly falls in GDP. Income output and employment have fallen for sixth months more

What is an economic recovery?

Occurs when a recession ends, GDP becomes positive indicating economic growth

Identify industries most susceptible to a recession

  • Firms selling products with a high elasticity of demand
  • Firms making capital equipment suffer if investment spending is cut following a loss of business confidence
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Economic cycle

List 7 potential responses to recession

  • Stimulate demand through increase promotion and price cutting
  • Enter new markets less sensitive to economic cyle
  • Cut costs (wages etc..)
  • Cut back production
  • Improve cash flow (improved credit control)
  • Reduce scale (sell low profit assets, and postpone expansion plans)
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Labour markets

Define labour market

The place where workers offer their time to employers in exchange for workers

List 4 ways the government can affect a labour market

  • Minimum legal wage levels
  • Legislation- employment laws
  • Supply side policies- education and training
  • Immigration policy- issuing visas to skilled workers

List 6 ways firms respond to skills shortages

  • Replace workers with machines
  • Offer higher wages
  • Improve labour flexibility by training existing staff
  • Train new staff
  • Outsource work
  • Relocate production to areas with skills surpluses
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Define unemployment

A situation when people are willing and able to work but are unable to find a paying job

Define unemployment rate

The proportion of the labour force that is unemployed

What is frictional unemployment?

Search unemployment- job seekers with skills required by companies take time to find new employment

What is structural unemployment?

Occurs when workers in declining industries lose their job but have inappropriate skills or mobility to fill vacancies

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What causes structural unemployment?

Is a result of a change in the economy and the immobility of labour. The unemployed are unable to fill job vacancies

What is cyclical unemployment?/

Is the result of insufficient demand. Workers lose their job because of a downturn in the economy. 

List 5 factors that affect the impact on a business a rise in unemployment has

  • Size and duration of unemployment
  • Type of unemployment (cyclical- easier to recruit)
  • Customer response
  • Competitor response
  • Local economy
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Inflation and deflation

Define inflation

Inflation is a sustained rise in the price level over time

How is inflation measured?

  • Consumer prices index (CPI)
  • Retail price index (RPI)

Define inflation rate

The rate of inflation is the % increase in the price level over a given period of time, usually one year

List 2 causes of inflation

  • Cost push inflation- caused by increasing prices of inputs (wages, import price, taxation)
  • Demand pull inflation- when demand exceeds supply 
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Inflation and deflation

How can inflation affect profit margins?

  • Cost push inflation- increases unit costs- cutting profit margins
  • Demand pull inflation- causes price rises before costs go up- profit margins improve

How does inflation affect international competitiveness?

  • If inflation rates are higher in UK than overseas, then UK products will become increasingly price uncompetitive ovetime

How does inflation affect investment?

Increase risk of investment as managers are unclear about future costs and prices

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Inflation and deflation

How does inflation impact on business?

  • Size and duration of inflation
  • Type of inflation (pressure on profit margins)
  • Customer response
  • Competitor response

Define deflation

Deflation is the opposite of inflation and is a sustained fall in the price level

How does deflation affect demand?

  • Demand falls if consumers and firms opt to delay purchases because they expect further price cuts
  • Consumer confidence and business expectations about the economy deteriorate reducing demand
  • Where firms lay off staff because of falling demand lower employment (reduces demand)

How does deflation affect profit margins?

Lower prices, reduce profit margins. 

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Government macro objectives

List 4 government macro objectives

  • Price stability (low inflation)
  • High levels of employment
  • Economic growth 
  • Satisfactory balance of payments (exports matching imports)

How can the government meet its macroeconomic objectives?

By using public spending, taxes, subsidies, benefits interest rates and the law

List 3 main types of economic policy use by government

  • Fiscal policy- use of government spending and taxation to manipulate the level of demand
  • Monetary policy- use of government spending and taxation to manipulate the level of demand
  • Supply side policies- measures to improve the quantity and quality of economic resources

How does an increase in public spending affect the economy?

Increase demand in the economy- reduce cyclical unemployment

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Government macro objectives

What is the chain of production?

The difference stages of making, distributing and selling a product

How are firms interdependent?

Organisations at each stage of business activity rely on each other

What is the supply chain?

Is the system of inter linked business activites involved in getting a product through manufacture and distribtuion

Why is the supply chain important?

  • If suppliers improve productivity, manufacturers may find the cost of components fall
  • Falling high street shop sales means manufacturing orders fall
  • A failure in lower down the supply chain halts production- unless stocks are held
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Government macro objectives

What is the multiplier effect?

  • A change in demand, output or employment levels in one business, causes a knock on multiplier effect for affected regional economies and local communtiies, other firms in the suppyl chain and competitors
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International competitiveness

Define international trade

Is the exchange of products between countries

List 3 potential gains from international trade

  • An increase in the size of the market offering opportunities for economies of scale
  • Competition for domestic firms who must minimise costs and innovate to remain competitive
  • Greater choice of consumers who can now buy imports 

A country can make cheaper or better products than rival nations if...

  • Productivity is higher- unit costs are lower
  • Inflation rates are lower- prices rise less rapidly
  • Products have better functions, desing and appearance
  • A strong pound means Sterling is overvalued resulting in relatively expensive UK exports in terms of foreing currency, whilst imports into UK are relatively cheap
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International competitiveness

How can governments restrict imports?

  • Tariffs- an indirect tax on imported products that raises the price of imports
  • Quotas- physical limits on the volume of imports allowed into a country

What is free trade?

Occurs when no controls or restictions are place on the imprts and exports of goods and services

What is a single market?

Is an area in which member countries trade freely within a common set of rules and regulations

List 6 characteristics of the EU

  • Free trade beteween member countries
  • Freedom of movement for labour and capital across borders
  • Optional monetry union- the Euro
  • Harmonisation of policies
  • Common external tariffs on imports from non-member countries
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International competitiveness

How does membership of the EU affect British businesses?

  • Free trade access to a market of 500 million citizens and can freely recruit EU nationals
  • Increasing sales may cause economies of scale 
  • Increasing competition from EU firms who have free trade access to UK markets
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Interest rates

What is interest?

Is the amount paid by a debtor to a lender for the use of money. It is the cost of borrowing and the reward for saving

Why do interest rates change?

To encourage savings and discourage borrowing, reducing demand. Less demand reduces inflationary pressure but may result in more cyclical unemployment

What is the effect on individial businesses of an increase in interest rates?

  • Internally: the cost of overdrafts increase, less incentive to borrow funds to finance investment
  • Externally: households have less disposable income, demand falls- high income elasticity demands

The overall impact on individuals depends on:

Size of changes, amount of variable rate borrowing used by the firm, the individual context of the firm

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Interest rates

Are the costs of every business equally affected by interest rate change

Depends on sources of finance

Are the revenues of every business equally affected by interest rate change?

  • Encourages savings and discourages borrowing
  • Market demand will fall
  • Less disposable income

How are interest rates and international competitiveness linked?

  • A rise in UK interest rates, attracts savings from overseas
  • Stronger pound puts pressure on exporters to increase their prices to maintain profit margins
  • The price of import prices fall
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Exchange rates

What is an exchange rate?

It is the price of one currency in terms of another. 

Why are pounds demanded on the foreign exchange market?

  • Overseas customers to pay for UK exports
  • Inward foreign direct investment

Why are pounds supplied to the foreign exchange market?

  • UK customers to pay for UK imports
  • Outward foreign direct investment

Why do exchange rates rise?

  • Exports rise or imports fall because UK goods become more competitive
  • Increase in foreign direct investment into the UK
  • Hihgh UK interest rates attract hot money inflows
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Exchange rates

Why are exchange rate movements important?

Affects the price of imports and exports and so influences price competitivenss of UK products

How does an exchange rate fall affect UK imports and exports?

A fall in the value of the pound reduces prices of UK exports in terms of foreign currency and increase the price of UK imports. UK price competitiveness improves

Outline 4 factors the impact on individual businesses of exchange rates changes depends on

  • Extent of the change: large the currency movement, the greater the impact
  • The duration of the change: is a given movement likely ot be reversed in th enext 6 months or the start of a trend
  • The extent to which a firm is dependent on exports for sales
  • The extent to which a firm imports raw materials and components for manufacture

How can firms react to exchange rate changes?

Adapt its strategy or tactics

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Explain taxation

Is the money raised by the government from consumers and firms to pay for government spending on services such as defence, education, improvements to social capital (roads) and benefits (child)

Why do governments tax?

  • Finance spending on public services
  • Discourage peoole buying harmful products such as cigarettes
  • Influence the level of demand in the economy

State the two main types of tax in the UK

Direct taxes (taxes on income)

  • Income tax is a tax on earnings
  • Everyone is given a tax-free personal allowance above which additional earnings are taxed at an increasing rate 
  • Corporation tax- tax on companies profit
  • National insurance contributions- paid by employees and employers to fund pensions
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Indirect taxes (taxes on expenditure)

  • Value added tax (VAT)- 17.5% is added onto the selling price of most non-essential goods
  • Excise duties- are taxes on the sale of 'luxury goods' 

How do direct tax changes affect business?

  • An increase in income tax leaves consumers with less disposable income to buy goods
  • A change in corporation tax affects the amount of profit firms can distribute to owners or retain investment for growth
  • National insurance contribution changes affects consumers income and firms costs

How do indirect tax changes affect business?

  • Consumers: an increase in VAT raises the price of products, reducing demand
  • Producers: an increase in petrol duties, increases a firms costs of production

How can firms respond to changes in given taxes?

Adpot its strategy and tactics

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Legal issues

Define a company

A company has a legal identity separate from its owners. (excluding sole traders and partnerships)

Explain the legal status of a company

Own property, sign contracts and take legal action in their own name. Responsible for their own debts which means shareholders have limited liability. 

State the two main types of company in the UK

  • Public limited company- owned by a large number of shareholders (trade on stock exchange)
  • Private limited company- owned by a small number of shareholders who enjoy limited liabiltiy (cannot trade on public exchanges)

How does the law protect a busines?

  • Property rights e.g copyright, trademark and patents
  • Law of contract
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Legal issues

Outline the 12 major provisions of laws relating to business activity

  • Health and Safety Acts- firms havee a duty to create a safe environment
  • Discrimination Acts- sex race, disability- encourage equality
  • Consumer protection laws- Sales of Goods and Trading Description Acts (fit for purpose)
  • Data protection acts- privacy
  • Health and safety laws- stop staff from being harmed
  • Employment protection acts- fair dismissal
  • EU working time directive- sets limit on working hours
  • Minimum wage legislation- minimum level of pay
  • Trade Union Act- secret ballot before calling a strike
  • Environmental laws- regulating waste disposal
  • Planning regulations- state permission for building or extending premises
  • Competition law- stop price fixing monopolies abusing their power

How can the law impact on the competitive position of a business?

Restrict certain business behaviours (sacking without reason), Increase costs (extra staff hours) and create opportunities

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Legal issues

How can different legal regimes impact on location decisions?

  • Locating in an area where laws and regulations have minimal impact on costs and processes

How can legal regimes impact on employment practice?

  • Firms may locate in areas where employment laws are flexible to make it easier to hire and fire staff
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Political issues

What are the 4 levels of government in the UK?

  • European: Eu directives
  • National: passes laws, collects taxes and manges the economy
  • Local authorities: provides services grant planning and collect rates
  • Private sector: private individuals/ Public sector: central government and public corporations

How can governments intervene in a market?

  • Laws and regulations to force consumers and firms to alter their behaviour
  • Own spending and taxes (fiscal policy) or interest rates (monetary policy) to influence demand
  • Taxes and subsidies to change prices in a given product or labour market

Outlline the 2 main styles of government intervention

  • Laissez faire: leave alone
  • Interventionist politicians believe markets fail and government action is essential to improving the working of the economy. High taxes fund extensive subsidised public services and benefit payments
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Political issues

What is government failure?

When government intervention results in an unsatisfactory outcome (encouraging wasteful over production)

Explain deregulation

When governmnet removes laws and regulations restricting business activity. 

What is nationalisation?

Transfer of a firm from the private to public sector

What is privatisation?

Where state-owned firms are sold to the private sector

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Social issues

Give examples of social issues of strategic importance

  • Demographics- size and composition of the population
  • Employment patterns

How can changing employment patterns impact on a business?

  • Flexible working- for parents to care for their children
  • IT advances enable homeworking
  • Improved motivation and staff retention
  • Monitoring staff becomes harder

What is corporate social responsibility (CSR)?

When an organisation voluntarily considers the itnerest of society by taking responsibility for the impact of their activities on external stakeholders 

How can CSR impact on profits?

Increases costs and dents profits (short-term)

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Technological factors

Assess the potential business impact of new technologies

  • Lower unit costs in production and distribution
  • Business capability to respond to consumer needs is improved
  • However, it requires research and development and staff training

How does technology affect competitive advantage?

  • It is better to be the first to introduce new but untried solutions or to wait for teething problems to be resolved

4 threats of new technology

  • Workers need new skills 
  • New IT systems mean organisational change (paperless)
  • Investment in R and D, new equipment and staff training is required
  • Can lead to redundancies
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Environmental issues

How does business activity impact negatively on the environment?

  • Business activity turns inputs such as natural resources, into final products
  • Production uses up non-renewable resources
  • Generates waste and pollution that damages ecosystems

What are the social costs of negative externalities?

  • Noise pollution
  • Congestion

Explain sustainability

Sustainable production meets the need of the present consumers without compromising the ability of future generations to meet their own needs

Why are businesses concerned with environmental impacts?

They are complying with laws and regulations to control environmental damage/ they are seen to be acting with corporate social responsibility

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Environmental issues

How can a firm minimise its environmental impacts?

  • Production methods (less packaging)
  • Sustainable sourced resources
  • Minimising energy usage
  • Investing in green technologies that reduce the pollution

Is minimising environmental damage expensive?

Higher cost sustainable components invovles expense

How can government environmental policy impact on business decisions?

  • Tax on polluting behaviour
  • Legal pollution limits force firms to invest in green technologies or face fines which would increase costs
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Moral and ethical issues

What are the costs of ethical behaviour?

  • Increases costs of production
  • Conflict of stakeholder objectives
  • Incurs the cost of an audit, monitoring and reporting

What are the benefits of ehtical behaviour?

  • Strong brand image
  • Premium price for ethical products
  • Recruit and retain, like-minded staff 
  • Motivated staff
  • Higher productivity
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