1. Assessing Changes in the Business Environment The Relationship between Businesses and the Economic Environment
“Trickle down theory – the less than elegant metaphor that if one feeds the horse enough oats, some will pass to the road for the sparrows.” JK Galbraith
“The market is a mechanism for sorting the efficient from the inefficient, it is not a substitute for responsibility.”
Charles Handy
BUSS4.2 Economic Environment

2. In this topic you will learn about:
Assessing the effects of the following factors on business organisations:
Impact of economic factors
Trends in key economic variables
Globalisation of markets
Developments in emerging markets
Evaluating the strategies businesses might deploy in response to these changes.
BUSS4.2 Economic Environment

3. The Impact of Economic Variables on a Business Organisation
Up until this point you have largely focussed on internal factors affecting business behaviour. In this unit you are going to look at the wider impacts starting with the economic environment
The economic environment consists of many key factors that influence the behaviour of businesses and their customers. These include:
The Business Cycle
Interest Rates
Exchange Rates
Inflation
Unemployment
Economic Growth
The economic environment effects business and customer behaviour
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4. Business Cycle
The level of economic activity fluctuates over time, this pattern is referred to as the business cycle
Economic activity is measured by GDP (Gross Domestic Product)
GDP is the total value of a country’s output in a year
Real GDP takes into account inflation. If GDP growth is 5% and inflation 2% real GDP growth will be 3%.
There are four main stages to the Business Cycle:
Trend rate of economic growth
Real GDP
Boom
Recovery
Slump
Recession
BUSS4.2 Economic Environment
Time 4

5. Business Cycle - Boom A period of high levels of economic activity
Characterised by:
High rate of economic growth
High demand
Low unemployment
Inflationary pressure
Labour skills shortages
High confidence in the economy
Capital Investment is high
Once you have studied each of the economic variables in turn you may wish to revisit the business cycle to discuss why some of these characteristics of a boom in time lead to a downturn
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6. Business Cycle – Boom Business impact
Firms struggle to find skilled workers
Capacity utilisation is close to full capacity due to the high rate of economic growth
Demand is more price inelastic - price becomes less significant
Quality will be seen as more attractive
More difficult to retain staff as firms compete for workers – wages are bid up
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7. Business Cycle - Recession
The rate of economic growth starts to fall in a downturn
If real GDP falls for 6 months then this is known as a recession
Characterised by:
Demand falls
Unemployment begins to rise
Some firms will go out of business
Confidence in the economy is low and most firms will reduce investment
The worst recession in the UK since 1979
The Government state that recession is officially two quarters of negative economic growth. However, it is often regarded as a period of low economic growth.
1979 saw the start of Britain’s decline into a recession – mirrored in the music of the day
Ghost Town The Specials
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8. Business Cycle – Recession Business impact
Firms will rationalise – laying off workers and reducing capacity
Cost minimisation will become a key factor
Demand is more price elastic - price becomes more significant
‘Value for money’ will be seen as more attractive
Staff fear for their jobs and motivation will be affected
Corus job losses
What actions has the business taken to try and avoid job losses?
What is the likely knock on effect of the job losses in the local area?
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9. Business Cycle - Slump
The bottom of the business cycle which represents a period of serious economic decline
Characterised by:
Low or negative growth
Demand and inflation are low
Unemployment is high
Confidence in the economy is low
High rate of bankruptcy
Why is the housing market frequently quoted as a key indicator of economic activity?
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10. Business Cycle – Slump Business impact
Many firms have gone out of business – less competition for those who survive
Many more are fighting for survival
Price is pre-eminent for many firms
However, less competition leads to monopoly and oligopolistic (few firms in an industry) markets
Wage costs are lower as too many workers vie for too few jobs
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11. Business Cycle - Recovery
When there are signs that economic growth is starting to rise, often referred to as the ‘green shoots of recovery’
Economic growth starts to rise
Demand increases
Unemployment falls
Inflation starts to rise
Confidence in the economy increases
Capital Investment increases
Why is business confidence so important for a recovery?
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12. Business Cycle – Recovery Business impact
Firms will take on more workers
Capacity utilisation increases
Investment in all areas starts to increase
Price begins to be a less important factor
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13. Evaluating strategies that businesses might deploy in response to changes in the business cycle
Recovery/Boom
Increase capacity utilisation – can the firm afford to take on new workers and increase production? This will depend on other factors such as the finance available, particularly in the short-run
Increase capacity – can the firm afford to invest in capital equipment? This will require longer term sources of finance. Gearing will be a significant issue here
Target new markets – Ansoff’s Matrix can be used to look at business strategy here. The firm might develop new products with a high positive income elasticity e.g. luxury goods
Increase price – what is the price elasticity of the product? As the economy grows price become less important to customers
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14. Evaluating strategies that businesses might deploy in response to changes in the business cycle
Recession/Slump
Cut capacity – there is an opportunity cost involved. Will the recession be short lived? Once changes have been made they are often difficult to reverse
Lay off workers – this can cause demotivation and initial cash flow problems with high redundancy costs
Target new markets – Ansoff’s Matrix can be used to look at business strategy here
Reduce price – what is the price elasticity of the product. This could lead to price wars where only the consumer benefits. Not everyone suffers in a recession! Are the firm reducing the price of a price inelastic product?
Go on a buying spree! – takeover activity often increases in a recession – other companies are suddenly a bargain!
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15. Economic Variables - Interest Rate
What is it?
The price of money - the cost of borrowing or the reward for saving money
How do interest rates affect a business?
Gearing
firms that have high gearing are sensitive to interest rates
Supply
if the cost of borrowing increases it becomes more expensive to invest in capital equipment
B2B (Business to Business) transactions will fall as firms buy less capital goods and there will be less capacity in the economy
Demand
higher interest rates will mean that consumers have less disposable income e.g. higher mortgage payments and therefore fall in demand for other products
Exchange rates
higher interest rates mean that foreign investors will invest in UK banks for higher returns
an increase in demand for the £ will see its value appreciate – making exports dearer
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16. How do interest rates effect consumer spending?
Gross wage – compulsory deductions e.g. tax, NI and pensions = Net or take home wage. We call this disposable income.
Net wage – compulsory payments e.g. mortgage, loan repayments, insurance etc = Discretionary income i.e. the proportion of our wage that we spend at our discretion
As interest rates go up our discretionary income goes down
Interest rates also affect our ability and willingness to buy on credit
Look at the items of expenditure below. Rank these in an order to show how likely it is demand will fall for them if interest rates go up. Justify your ranking.
Milk, Cigarettes, Daily Newspaper, Freezer, Petrol, Cinema tickets, Restaurant meal, New car, School shoes, Designer jacket, Gym membership, Packet of crisps, Sofa, Light bulbs, Organic vegetables, DIY equipment
BUSS4.2 Economic Environment

17. Economic variables - Exchange Rates
What is it?
The price of one currency in terms of another e.g. £1 = $1.50
An increase in the value of a currency is called an appreciation and
means the currency is worth more e.g. £1 = $1.60
A decrease in the value of a currency is called a depreciation and
means the currency is worth less e.g. £1 = $1.40
How do exchange rates affect a business?
SPICED (strong pound: imports cheaper, exports dearer)
Firms that import will be able to buy cheaper raw materials and finished goods
Firms that export will see less demand
WPIDEC (weak pound: imports dearer, exports cheaper)
There will be greater demand from abroad for UK goods
Input prices will increase if raw materials are imported
If the firm has a price inelastic product it will be able to pass the increase in costs onto the consumer
Explain why a depreciation of the Pound will lead to increased tourism from the EU
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18. Economic variables - Inflation
What is it?
A general rise in prices or a fall in the value of money
There are two main types of inflation:
Cost push – an increase in input prices e.g. raw materials and wages
Demand pull – an increase in demand allowing firms to raise prices
There are two main measurements:
Retail Price Index (RPI) – a measurement of a ‘basket’ of goods and services representative of what people buy in the UK
Consumer Price Index (CPI) – similar to RPI but mainly excluding housing costs
Explain the relationship between inflation, pay and cost of living.
What happens to inflation in a recession?
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19. Economic variables - Inflation
How inflation affects a business:
The Government have set an inflation target of 2%. The Bank of England’s Monetary Policy Committee (MPC) meet once a month to decide the Bank’s Rate of Interest. If CPI is too high they might raise interest rates to reduce the rate of inflation
Increased costs due to higher inflation can be passed onto the consumer if the product is price inelastic. If not the firm will have to try and absorb the increased costs through lower profit margins
Clearly, this has an impact on the pricing strategy of a firm. Some firms will reduce the supply of the product, having a major affect on operations management as capacity is reduced and the firm rationalises with a greater focus on cost minimisation
It becomes increasingly difficult to maintain competitiveness. Demand will fall if the firm has to raise price. If it exports then it will see customers move to companies abroad where prices are not rising as fast
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20. Economic variables - Unemployment
What is it?
Those people looking for work who cannot find a job.
It can be measured in two main ways:
Claimant count – those claiming Unemployment Benefit
Labour Force Survey – those without a job, want a job, have sought work in the last 4 weeks and are available to start work in the next 2 weeks
How unemployment affects a business:
Skills shortage/surplus – too few workers will lead to less suitable skills for the position, too many plenty of choice
Demand – high unemployment leads to less demand and vice-versa
High/low costs – wage rates are affected by the number of people available for a position
Use the evidence presented in these BBC clips to discuss the affects listed above
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21. Economic variables - Unemployment
Types of unemployment:
Structural – this occurs because of fundamental changes to the economy and whole industries are in decline
Cyclical – this is linked to the business cycle and occurs due to the position on the cycle e.g. slump equals high unemployment
Frictional – this occurs when people are unemployed as they are moving between jobs. With a job awaiting them, this type of unemployment does not have a major impact on the economy
Seasonal – as we move through the seasons different kinds of job are created or lost e.g. holiday jobs due to the summer
The Chief US Economics advisor gives advice on economics
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22. Economic variables - Economic Growth
What is it?
A rise in the value of Gross Domestic Product (GDP)
This measures the value of goods and services produced in an economy each year.
How economic growth affects a business:
Demand – consumers will have more disposable income e.g. higher wages. Firms will have higher profits which can be reinvested
New business start-ups – more new firms will be created due to confidence in the state of the economy
Inflation – higher demand in the economy can lead to skills shortages and demand-pull inflation
Negative economic growth occurs when the value of GDP starts to fall. If this occurs for at least two quarters of a year i.e. 6 months we are officially in a recession
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23. Globalisation of markets
Remember, questions should be answered about the impact on the firm NOT the impact on the UK economy
Globalisation is the integration of international economies leading to a world market in goods and services
This has meant that markets are increasingly global i.e. trading and/ or operating internationally
Greater interdependency amongst countries – they rely on each other
Globalisation has led to the movement and exploitation of factors of production by Multinational Corporations (MNCs) around the world
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24. Globalisation of markets
Benefits of Globalisation
Opportunities to sell into new markets
Economies of scale as the firm grows globally
Global marketing strategies can be used
Cheaper raw materials from low cost countries
Cheaper labour costs abroad
Free movement of labour providing cheap labour in the UK
Off-shoring provides greater scope for optimal location
Look at one of the UK’s large supermarkets. Choose three different products. How have the factors of production used in putting these products into the supermarket been exploited on a global basis?
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25. Globalisation of markets
Disadvantages of Globalisation
Increased competition – although this can make firms more efficient
‘Global localisation’ – altering products to meet local tastes - may be required to meet local cultures
Communication and transport problems
Firms can gain a bad reputation for making UK workers redundant
Exploitation of foreign workers can lead to criticism of being unethical
Exploitation of the global environment can lead to bad publicity
HSBC The world’s local bank.
Can Global localisation be a strength of a business?
Are business leaders in France right to fear globalisation?
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26. Developments in emerging markets
An emerging market is a country with low to middle per capita income (Average income per person) Antoine Van Agtamael - World Bank (1981)
This refers to 80% of the World’s population but only 20% of its countries.
Emerging markets are seeing rapid growth through economic reform. They are emerging from ‘closed’ economies (no international trade) to ‘open’ economies (increasing international trade)
This encompasses the BRIC countries (Brazil, Russia, India and China) as well as smaller nations such as Pakistan, Peru and Singapore
HSBC The world’s local bank moves into emerging markets
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27. Developments in emerging markets
How can an emerging market benefit UK firms?
In terms of the Boston Matrix many emerging markets can be seen as rising stars. They have in common:
Rapidly rising consumer incomes
Fast growing markets
Exploitable natural resources
Exploitable cheap labour
Rising Star
High Market Growth
High Market Share
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28. Developments in emerging markets
However emerging markets can cause UK firms problems
In terms of the Boston Matrix emerging markets can also become problem children or even dogs:
Poor infrastructures e.g. transport and communication
Political instability
Accusations of exploitation from an ethical and environmental perspective
Cultural and legal differences
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29. ACTIVITY – Economic Environment Terminology
You have been introduced to a lot of new terminology in this unit, it is important that you are confident with the language of accounts before moving onto the next unit.
Draw a mind map to summarise the terminology you have been introduced to in this unit, make sure that all the correct terms are included, with explanations and examples where appropriate.
As a class individually draw a grid with 9 squares in it - put in 9 words to do with the economic environment in a random order
Nominate one person or the teacher to call out words or definitions. As they appear on your grid cross them off as if playing bingo.
BUSS4.2 Economic Environment

30. Essay
In 2007 Costa Coffee opened its first store in China with plans to open a total of 300. Chief executive Alan Parker said "China is a very attractive market, making this a major deal for Costa.” With reference to Costa Coffee and/or other businesses you have studied to what extent do you agree that emerging economies are attractive markets for global expansion. Justify your answer.
BUSS4.2 Economic Environment