AS Business The Current Economic Climate Unit 1

Lesson objectives To be able to discuss the implications for business in a change in the interest rates To be able to discuss the effect of government spending or taxation on business To be able to discuss the potential consequences for business of unemployment, inflation and changes in the exchange rate. To be able to answer a past paper questions on the current economic climate

Starter What effect do you think that local unemployment has on demand for products and services? Is there a link?

Uk government

Task 1- in teams – find out... Who is the current Prime Minister? What is the name of the current Government? What is Parliament? What is the current UK interest rate? What is the current UK unemployment rate? What is the current UK rate of inflation? What is the exchange rate today £ against Euro £ against dollar?

Answers

Prime Minister http://www.youtube.com/watch?v=V1PtviBsJ1s

Current Government (Parliament) http://www.parliament.uk/education/online-resources/videos2/youve-got-the-power/ygtp-parliament-overview/

House of commons Led by the prime minister, the UK government is formed by the political party (or coalition of parties) with the greatest number of MPs elected in the House of Commons. The prime minister selects a team of MPs and members of the House of Lords to help run the country.

Government: running the country The government is in charge of managing the country and deciding how our taxes are spent. Different government departments run different things. For example, there is a department in charge of health and another in charge of transport.

How Government creates the business climate Voters expect the government to manage the economy well. Government economic objectives include: Full employment, that is, as many workers in jobs as possible. Lower prices. Continually rising prices is called inflation. Low inflation is an aim of any government. Economic growth. The aim is to produce more goods and services each year so that individuals have a higher standard of living. http://www.guardian.co.uk/society/video/2012/nov/14/unemployment-work-jobs-minister-video Video on employment

Interest rates

UK interest rate http://www.bankofengland.co.uk/Pages/home.aspx This is the cost of borrowing money. If the bank of England pushes up interest rates consumer and business spending will fall. http://www.bankofengland.co.uk/Pages/home.aspx Video here: http://www.youtube.com/watch?v=7I48BA9-iu4&list=PLslyOrpjJ0z2H8B-ZjGgFjNCZHcHqASmr

Changes to interest rates – effect on business What is the impact on the cost of borrowing to business? If interest rates rise then the cost of borrowing will rise and this will mean that the cost of supplies for a business may increase A fall in interest rates means that the cost of servicing debt falls which may lead to an increase in profits (costs less to borrow so less to pay back)

Unemployment rates

Unemployment This exists when people seek work but there is no job for them. Different types of employment: Structural – when economy changes in a significant way , coal industry being an example Cyclical – when demand is at the bottom of the trade cycle Seasonal – where people are laid off in low season Frictional – where people find themselves temporarily unemployed between jobs http://www.bbc.co.uk/news/10604117 Video here: http://www.bbc.co.uk/news/business-24044528 Cartoon here: http://www.youtube.com/watch?v=ulyVXa-u4wE

Consequences for business of unemployment If the government tightens monetary policy by raising interest rates this will lead to a decrease in demand therefore an increase in unemployment High unemployment in an area will mean reduced demand for normal goods and services and an increase in demand for inferior goods

inflation

Inflation videos from bbc

UK rate of inflation http://www.bbc.co.uk/news/uk-24126096 http://www.bbc.co.uk/news/10612209 Cake maker notices that prices keep going up: http://www.bbc.co.uk/news/business-24127012

What is inflation? http://www.bbc.co.uk/news/business-14115829 Inflation explained by Declan Curry Inflation is a sustained rise in the general price level. The inflation rate is the percentage by which the general price level is increasing. A fall in the rate of inflation from 6% to 3% still means average prices are rising but at a slower rate. A fall in the general price level is known as deflation

Inflation Inflation is a rise in the price of goods and services we buy The annual rate of inflation shows how much higher or lower prices are compared with the same month a year earlier. It indicates changes to our cost of living So if the inflation rate is 3% in January, for example, prices are 3% higher than they were 12 months earlier. Or, to look at it another way, we need to spend 3% more to buy the same things We compare this to the annual change recorded in the previous month to get an idea of whether price rises are getting bigger or smaller If the annual rate has risen from 3% to 4% from one month to the next, prices are rising at a faster rate Bank of England ideal is 2% Source: http://www.bbc.co.uk/news/10612209

Consequences of changes in inflation on business What impact will a change in inflation rates have on the cost of supplies? As inflation rises so does the cost of products and services Cost of supplies, ingredients and raw materials will go up Suppliers likely to be also within UK so will also be suffering from a rise in prices Business owners may need to increase their prices to maintain profitability Profit margins will be squeezed

Consequences of changes in inflation on business What impact will a change in inflation rates have on labour wages? As inflation rises then this lowers the real wage rate, increases the demand for labour and lowers unemployment As inflation lowers this raises the real wages, reduces the demand for labour and increases unemployment

Government spending and taxation

Government spending and taxation The government can change the way businesses work and influence the economy either by passing laws, or by changing its own spending or taxes. For example: Extra government spending or lower taxes can result in more demand in the economy and lead to higher output and employment. Governments can pass legislation protecting consumers and workers or restricting where businesses can build new premises.

Government and taxation The main types of tax include: Income tax taken off an employee's salary. This results in less money to spend in the shops. Value added tax (VAT) added to goods and services. A rise in VAT increases prices. Corporation tax is a tax on company profits. A rise in this tax means companies keep less of their profits leading to less company investment and the possible loss of jobs. National Insurance contributions are payments made by both the employee and the employer. They pay for the cost of a state pension and the National Health Service. An increase in this tax raises a company's costs and could result in inflation. Two roles: Take tax from business and workers Spend tax on: http://www.guardian.co.uk/news/datablog/interactive/2012/mar/20/budget-2012-how-taxes-spent-interactive Interactive graphic showing what tax is spent on. Click and choose a wage of £40,000 – how much tax a year would you pay? Taken from bitesize

Money out Money in

Implications of government decisions on business Governments can control the rate of interest and the amount of money circulating in an economy. Government can also affect the amount of borrowing or credit available from financial institutions like banks. This is called MONETARY policy and they manipulate these variables to achieve their political party’s objectives The rate of interest is the price of money and the key instrument of monetary policy

Government policy continued The government may change the way that it spends and this may effect business The government may change the tax that it charges in the UK and this may effect business There are consequences for business of unemployment and inflation Business will be effected by changes in the exchange rate Changes in economic indicators such as unemployment will have a knock on effect to business (such as demand or larger pool of applicants for vacancies )

Changes in taxation – effect on business If the % of VAT goes up a business will have to pass this cost on to the consumer so if makes goods more expensive to buy The alternative is that the business absorbs this extra costs and the price of the goods remain the same to the customer – therefore lowering profit margins http://www.bbc.co.uk/news/business-12099638

Lower real wages as inflation rises As the cost of goods rise this means if your wages stay the same you may not be able to buy as much…

Exchange rates

Exchange rates today What 3 reasons can you think of that people would want foreign money for? Video here on exchange rate Current exchange rates (bbc again) http://www.bbc.co.uk/news/business/market_data/currency/default.stm Exchange rate – the price of one country’s currency expressed in terms of another.

Consequences of changes in exchange rates on business What impact will a change in exchange rates have on the cost of supplies? It depends if they were purchased from abroad. If our pound increased (or appreciates) against another currency this will make imported supplies cheaper: Strong Pound Imports Cheaper Exports Dearer

Today’s market data for currencies http://www.bbc.co.uk/news/business/market_data/currency/default.stm Try looking at this website every day – it changes with the fluctuating exchange rates. You can track prices over a week and see how much they change.

Glossary Interest rates – cost of borrowing, the price of money Inflation rates – rise in cost of goods and services to buy (persistent increase in costs) Unemployment rates – rise in numbers not in employment Tax – monies demanded from the government so they have money to spend elsewhere like the NHS and on roads and education Exchange rate – the rate at which one currency can buy another £1 = $1.67

How will the following government decisions impact business? Over to you...... Group A How will the following government decisions impact business? Changing interest rates? Changing the exchange rate? Hit the books – take the big paper – come back with two answers Poor answers will have to do this as an essay for homework

What are the consequences for business of changes in: Over to you ...Group B What are the consequences for business of changes in: The unemployment rate? The rate of inflation? Hit the books, or computers, big paper, big ideas, feedback....

Sample question 1 [8] [8]

Answer question 1

Sample question 2 Between 2009 and 2011, the annual rate of CPI inflation was above the UK government’s target range. Which one of the following could be an effect of higher inflation rates for UK manufacturer’s, such as JCB Ltd? A Fall in cost of supplies B Reduction in real wages for its staff C Increase in exports D Increase in recruitment [4]

Answer question 2 Answer option B – reduction in real wages - Inflation is a persistent increase in the aggregate/general level of prices in an economy (1 mark) - Which can cause the cost of living to increase because less can be bought for the same amount of money (1 mark) - So unless wages are increased in line with prices, consumer purchasing power will fall (1 mark) - Cost of supplies is likely to increase during inflation because the stock may be purchased from within the UK from suppliers charging higher prices (1 mark) - Exports may fall because UK goods may become less price competitive given inflation (1 mark)

Sample question 3 (from second half of the paper) Exchange rates and interest rates are economic external influences. Assess their likely significance to Cebu Home. [12]

Answer question 3 Level of answer Marks (per factor) Level 1 1 e.g. the exchange rate is the price of one currency in terms of another, or interest rates are the price of money paid to lenders or by borrowers Level 2 2 e.g. higher interest rates may cause a reduction in the demand for Cebu Home furnishings. Level 3 3 4 e.g. exchange rates may affect cost of importing products, e.g. a fall in costs if the pound strengthens might lead to an increase in profit. e.g. increases in interest rates could cause a reduction in disposable incomes, which will mean spending on luxuries such as home furnishings might fall, so Cebu Home’s sales/stock turnover will fall. Level 4 5 6 e.g. Cebu Home imports its stock from the Philippines so the cost of stock is likely to be affected by fluctuations in the exchange rate because a strong £ will make furniture purchasing cheaper. However, quality may be more important than price, in which case the strong £ will not be significant. e.g. if interest rates fall this may lead to an increase in consumer borrowing like mortgages which may increase the demand for Cebu Home furniture. However, the changes in interest rate may not actually affect her typical customers (thespians) because they will not need to borrow to buy the products, in which case demand for Cebu Home homeware may not decline if interest rates increase.

Sample question 4 Throughout 2007, the UK experienced a gradual decline in interest rates. Which of the following is the most likely consequence for a small electrical retailer? A Spending on stock decreases B Staff wages are increased C Borrowing increases D Average cost of stock increases [4]

Answer to question 4 Answer C – borrowing increases Interest rates are the price of borrowing money (1 mark knowledge/understanding), so a reduction in interest rates effectively means a reduction in the cost of borrowing (1 mark analysis), which, other things being equal, should lead to an increase in the demand by businesses for investment funds not an increase in bank deposits (1 mark evaluation). • A fall in interest rates means that the cost of servicing debt falls (1 mark knowledge) which may lead to an increase in profits (1 mark analysis) which will not necessarily be spent on increasing the wages of staff (1 mark evaluation).

Sample question 5 The value of the £ (pound sterling) fell against the euro in late 2008 and 2009. This change would have most likely benefited British: A tourists holidaying in France and Spain B exporters who sold their products in countries using the euro C consumers, because overall the inflation rate fell as a result D importers, because they were able to improve their profit margins

Answer to question 5 Answer option B - exporters Definition of exchange rate, i.e. the price of one currency in terms of another (1 mark); - Because the relative price of British exports will fall as a result (1 mark); - Which, providing competitiveness is based on price, will increase demand (1 mark) - British tourists abroad will get less foreign currency for their £ sterling which will make things more expensive (1 mark) Spiced / wpidec

Revision Video