External influences- economic influences 3 external influences to consider Economic influences Legislation The competitive environment The effect on business of changes in: 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 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? GDP Time Boom Downturn trough/slump Recovery

Actual pattern The economy was very weak (output fell a lot) in 2008/2009 Unemployment rose dramatically and spending by households fell Revenues decreased and profits collapsed for many companies Since then the economy has recovered How much did the economy grow in 2015?

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? Cost of basket (£) Consumer Price Index 2005 = 100 Annual % increase House price index 2005 = 100 2005 402.0 100 2006 411.2 102.3 2.3 108.3 2007 420.9 104.7 118.5 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 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 Example 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: For example a good selling for £1,000 in the UK previously sold for $1,450 in the US. Keeping the same profit margin means keeping the price at £1,000 which means the dollar price falls to $1,350 This means demand in the US will increase because the price is lower. How much it increases depends on the PED The price in dollars remains at $1,450 But since the pound has fallen from $1.45/£ to $1.35/£, the price it received in pounds rises from £1,000 to £1,074 ($1,450 divided by 1.35, the new exchange rate) so the firm makes an extra £74 per unit sold

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 Imported at 900 rupees. Used to be £10, now costs £9 This lowers the costs for importers, and so allows firms to either: Cut their prices, and so see an increase in demand, or Keep prices unchanged and so with lower costs, increase their profit margin Firms must either increase price, which means demand falls (how much depends on PED, or accept a lower profit margin

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 Spending depends on: Political choice State of the economy – will want to spend more to boost the economy when it is weak, and to reduce spending when the economy is too strong How much we can afford – tax or borrowing Spending includes Health, Education, Welfare (pensions, benefits)

Taxation Government raises taxes in many ways, but the most important include: Effects on business of change in taxes Income tax above £10,600 at 20% (£11,000 next financial year) VAT of mostly 20% on most goods except food, childrens clothes, books Corporation tax – a tax on company profits. Currently at 20% but is being reduced and is low relative to our competitors Income tax affects how much consumers have to spend and thus demand for goods and services

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