Transcript Economic-influences

External influences- economic influences
• 3 external influences to
consider
• Economic influences
• Legislation
• The competitive
environment
• Economic influences
• The effect on business of
changes in:
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The business cycle
Inflation
Interest rates
Exchange rates
Taxation and government
spending
What is the economy?
• The interaction of many individuals, each going about
their own business of working, to earn an income to:
• Spend on goods and services
• Give to our children (!) to buy crisps and chocolate (and
clothes)
• In the UK there are over 31 million people working
• Firms are rely on people to keep on buying their
products, so Cadbury and Topshop are only successful if
consumers keep on buying chocolate and clothes
• The total value of all the goods and services produced
in a country in a year is known as GDP
• When GDP rises, this is called economic growth
The business cycle
• Economies go through periods of fast
GDP
growth, or booms, and periods of
slow growth or even falling output,
known as recessions
• When the economy is growing
quickly, workers receive higher
wages and spend more, and firms
will see higher revenues and profits
• This can get out of control leading to
an unstainable boom followed by a
downturn and perhaps slump
• When growth, or even output falls,
workers receive lower income, and
might even lose their jobs. This
means lower spending and so lower
revenues and profits for firms
• Where is the UK now?
Boom Downturn
Recovery
trough/slump
Time
Actual pattern
• The economy was very
weak (output fell a lot) in
2008/2009
450
400
350
300
250
2014
2012
2010
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
200
1988
• Since then the economy
has recovered
• How much did the
economy grow in 2015?
£bn
1986
• Unemployment rose
dramatically and spending
by households fell
• Revenues decreased and
profits collapsed for many
companies
Inflation
• Inflation means an increase in the
average price level
• The process of measuring inflation is
as follows:
• Surveying households once a year to
find out what they spend their money
on in an average month
• Creating a basket of about 700 goods
and services which represents the
average household’s spending
• Checking each month what has
happened to the prices of the items in
this basket, and from this calculating
what has happened to the cost of this
basket
• This is done by creating an index of
prices, called the Consumer Price
Index
• An index is used so it is easier to see
trends and to compare with other data
• How much have house prices
increased by since 2005 and how does
this compare with the increase in CPI?
Consumer
House
Cost of Price Index Annual % price index
basket (£) 2005 = 100 increase 2005 = 100
2005
402.0
100
100
2006
411.2
102.3
2.3
108.3
2007
420.9
104.7
2.3
118.5
2008
436.2
108.5
3.6
109.2
2009
445.4
110.8
2.1
97.8
2010
460.3
114.5
3.3
100.6
2011
480.8
119.6
4.5
97.9
2012
494.5
123.0
2.8
97.3
2013
506.9
126.1
2.5
101.9
2014
514.6
128.0
1.5
110.6
2015
514.6
128.0
0.0
120.8
Effects of inflation on business
• Complicated. What do you think?
• May depend on whether costs to firms are rising at
the same pace as prices consumers pay
• In general, the benefits of inflation are:
• Firms with large loans see the real value of these loans
fall. For example, a loan of say £400,000 20 years ago to
buy a house worth £500,000 in Wimbledon looks easier
to pay back if the house is now worth £2.5m
• If prices are rising because of strong demand, and costs
are not increasing as quickly, then firms may make
higher profits
Negative effects on business
In general, the costs of inflation are:
• If costs are rising faster than prices, then profitability gets
worse. This may happen if a firm offers a fixed price for a
contract (eg to build a factory), and costs rise faster than
expected
• If inflation is higher in the UK than in other countries, then
firms based in the UK will not be able to compete as easily
with foreign firms. This means:
• It will be harder and less profitable to sell products overseas
because the price of UK produced goods will be higher, or firms
have to accept lower profits
• Similarly, products imported from overseas will be cheaper than UK
products
• If inflation is high, then the Bank of England may raise
interest rates – see following
Interest rates
• Banks pay savers an interest rate if they deposit money
• Banks then lend this money. The interest rate for borrowers
(firms and some individuals) is the price charged by a bank
each year for lending money in the form of loans, overdrafts
or credit cards
• A loan to a firm of £100,000 with an interest rate of 8%
means the firm has to pay £8,000 each year in interest (and
then repay the loan when it is due)
• Banks can decide what rate to pay savers, and to charge
borrowers, but this is based on what the Bank of England
charges high street banks for borrowing money. This rate is
known as the base rate
• The Bank of England sets the base rate in order to keep
stable prices – the target is for inflation of 2%
Changing interest rates
• If inflation is expected to be high (above target), then the
Bank of England will raise the base rate
• This means households are likely to spend less, since it is more
attractive to save money in banks, because it is more expensive to
borrow money to buy goods such as cars, or houses, and because
households will have less money to spend after paying their
mortgage
• Firms are also less likely to spend money on new equipment to
improve productivity or to increase capacity since it is more
expensive to borrow money so it is less worthwhile investing.
• As a result of this, spending falls, which means firms will not be able
to raise prices as easily, since the demand for their products will
fall.
• The opposite applies if inflation is expected to be below
target
• What’s the position now – what is inflation and what is the
base rate
Impact of interest rates on business
• Higher interest rates are bad for business:
• As before, demand falls, so firms may see a fall in
demand for their products
• Most businesses have loans, so if interest rates increase,
firms have to pay higher interest costs to their banks,
which means an increase in costs, and so a reduction in
profits
• As before, it becomes less worthwhile investing in new
machinery (or in training)
Exchange rates
What are exchange rates?
• The exchange rate measures the
quantity of a foreign currency that
can be bought with one unit of
domestic currency
• If a currency appreciates, this means
it is stronger and can buy more of a
foreign currency
• Depreciation means it is weaker and
can buy less
• How does the exchange rate affect
business?
• Effect on firms which export and an
example
• Effect on competition in the UK and an
example
• Effect on firms which import raw
materials and an example
$
£ now
£ a year
ago
£ stronger
or weaker
€
¥
Impact of appreciation and depreciation
Appreciation/ Example
depreciation
Impact on exports
Impact on imports
£ appreciates
£1 was $1.44,
but now buys
$1.65
UK exports more
expensive in $, so
demand falls, so sale
volume falls
Imports to the UK are
cheaper so increase and
harder for UK firms to
compete
£ depreciates
£1 was €1.45
but now slips
to €1.30
UK exports cheaper, so
demand rises, so sales
volume increases
Imports to the UK are
more expensive so UK
firms can compete more
easily
Impact on exporters
• A weaker currency, say the pound falls from $1.45/£ to
$1.35/£, is good for an exporter. An exporting firm can
either
• Keep the same profit margin, which means the price in
pounds is unchanged, which means a lower price in dollars
and so more demand. Imagine a price of £1,000
• Alternatively, the firm could keep the same price in dollars.
This means:
Impact on exporters
• A stronger currency has the opposite effect. Say if the
pound rises from $1.45/£ to $1.55/£, this will hurt exports
because an exporting firm can either
• Keep the same profit margin, which means the price in pounds is
unchanged, which means a higher price in dollars and so less
demand
• What happens to the price of a good in dollars if the UK price is £10.00,
and so it previously sold for $14.50? What happens to demand?
• Alternatively, the firm could keep the same price in dollars. This
means:
• The price in dollars remains at $14.50
• But since the pound has risen from $1.45/£ to $1.55/£, the price it
received in pounds falls from £10.00 to what?
Impact on importers
• Firms which import a lot of material or products – perhaps they
source clothes from China or India – will also be affected.
• A strong pound means raw materials or stock will be cheaper
• For example, if the pound rose from INR90/£ (Indian rupees) to INR100
what happens to the cost of importing in pounds if a batch of 4 t-shirts
costs INR900
• A weak pound means the opposite, since the cost of imported
raw materials will rise.
• Say it was INR100 and the pound falls to INR90. Same batch of shirts
UK based firms selling in the UK
• How does a weak pound affect eg Jaguar Land
Rover sales in the UK
• How does a strong pound affect eg Jaguar Land
Rover sales in the UK?
Taxation and spending
• Governments tax individuals and firms, and use this
revenue to spend on public services
• What determines how much we spend on public
services?
• What are the main types of spending
• Which firms benefit if spending increases/reduces
Taxation
• Government raises taxes in many ways, but the
most important include:
• Effects on business of change in taxes
Economic Uncertainty
• What is the price of oil now?
• What was it 1 year ago?
• It is difficult to forecast the future – what will
growth be, what will the value of the pound be in a
year, what will the price of oil be?
• Will we have Brexit or not?
• Would it have an impact (fears of Brexit are affecting the
exchange rate)
• Is the Chinese economy about to go into a full
recession (decline in GDP)?
Economic Uncertainty
• Faced with uncertainty firms need to be prepared
• Good times may not always last – a firm should make
sure it builds up cash during good times
• Bad times do not always last – a firm should look for
opportunities which come up when other firms weaken