A2 External Influences The Business Cycle

The Business (trade) Cycle n The regular patterns of ups and downs in demand and output, or of gross domestic product (GDP), growth over time. n It is characterised by 4 main phases boom, recession/downturn, slump, recovery/upturn

Label the following on the diagram above: a) Boom b) Recession/downturn c) Slump d) Recovery/slowdown

Boom Slump Recovery/Upturn GDP Time (years) Trend of GDP over time Recession/Downturn The Business Cycle Gross Domestic Product – the total value of a country’s output over the course of a year.

Boom n High consumer demand greater than supply = excess demand = higher prices n High business confidence n High profits, dividends and retained profit n High levels of investment n Firms working at full capacity, firms may consider expansion n Rising costs due to shortage of resources e.g. paying for skilled workers may = higher prices

Recession n Falling demand may = excess stock = price fall to sell it n Falling output as not enough demand = low profits may = redundancies n As incomes fall inferior goods may see demand increase as consumers switch from luxury goods n Falling business confidence and little investment n Spare capacity n Business closures and an increase in bad debts n Firms will need strong balance sheets, liquidity, low gearing and increased efficiency

Slump n Very low demand, investment and consumer demand n Increasingly high unemployment and business failure n Firms charge low prices to increase demand n Deflation may occur

Recovery/Upturn n Slowly rising demand, investment and business confidence n Falling unemployment n Demand  = Profits  n May encourage new business start-ups n Firms borrowing  n Spare capacity will be used to meet new demand

A2 External Influences Unemployment

Types of Unemployment n Structural – changing structure of the economy causes some jobs to be no longer required e.g. miner n Cyclical – lack of demand in the market due to stage in the business cycle e.g. recession n Frictional – people between jobs n Seasonal – certain jobs only needed at certain times of year

Student Activity: Which industries will each type of unemployment hit hardest? Describe how a high level of unemployment will affect: n Consumer incomes n Company sales n Workers bargaining power over wages n Firms cost control – discuss short term and long term decisions n Investment levels in firms n Need for investment in training for firms n Costs of wages for firms

Implications of high levels of unemployment n Less pressure on wage levels as plenty of supply of labour therefore wages fall n Less income = lower sales & profit = less production & redundancies n Normal goods (income-elastic) will suffer worst n Inferior goods may benefit from higher sales with lower incomes

Implications of high levels of unemployment (contd.) n Workers bargaining power over wages  n Firms may introduce cost-saving measures and improve efficiency for the long-term n Others make short-sighted changes which may effect the long term success of the firm n e.g. reducing training investment, delayering may lose essential skills n Firms may consider rationalisation – reorganising the business to improve efficiency and cut back on fixed overheads. E.g delayering, closing a site, or outsourcing

Implications of low levels of unemployment n UK level has been low since 2000 n Consumers income  therefore more spending. Luxury goods (income-elastic) particularly benefit. n Labour market ‘tightens’ less people looking for work therefore difficult to attract skilled employees. This gives workers bargaining power over wages.

A2 External Influences Inflation £

n An increase in the general levels of prices of goods and services within an economy, which means that there is a fall in the purchasing power of money. n Deflation - A decrease in the general level of prices of goods within an economy, or a rise in the purchasing power of money.

n Inflation Rate - The Chancellor of the Exchequer sets the inflation target for the UK. The Monetary Policy Committee of the Bank of England sets interest rates in order to keep inflation at or below this target Inflation (%) Source: HM Treasury web-site.

Measuring Inflation n The Retail Price Index (RPI) - This shows changes in the price of the average persons shopping basket. Calculated using a weighted average of each months price change. n Looks at average household spending patterns and attempts to assess average household expenditure n Weights are allocated to different categories according to importance. Difficult as many households have different incomes. n It is an index number

An alternative measure. n RPIX - RPI which excludes mortgage interest payments.

Cost-push Inflation n An increase in the cost of production (wages, raw materials, fuel, taxation and interest rates) n This forces a firm to increase their prices in order to protect their profit margins. n E.g. trade unions achieving wage increases

Example of cost-push inflation - Juan grows bananas, which he then sells to Tescos. Dominican Republic banana farmer n Cost of growing bananas£200 n Petrol cost of harvesting£100 n Total costs£300 n Price (cost plus 100%)£600 Tesco n Cost of buying bananas £600 n Cost of petrol to£100 distribute bananas n Price to consumers£1400 (cost plus 100%) Task: Calculate what happens to the price of bananas if Petrol doubles in price. What is the overall % increase in price to the customer?

Answers n Banana prices: n Juan - £800 n Tesco - £2000 n % change: n 600/1400 x 100 = 42.9%

Demand-Pull n the process by which prices rise because there is excess demand in the economy.

An example of Demand-pull Inflation n ‘China has been on a buying spree, and is prepared to pay top-dollar to get its hands on the oil it needs. But it is more than a slight exaggeration to say China is to blame for $70 a barrel oil prices. ‘ n Taken from a BBC news story. China’s increasing demand for Oil as it is no longer self sufficient

Student Activity: Cost-push or Demand-pull inflation? (5 minutes) n A fall in the value of the pound n Rapidly rising consumer spending n Shortage of production capacity n World shortage of oil n Rising wage expectations n Large increase in government spending - cost-push (imports) - demand-pull - cost-push - demand-pull

Inflationary Expectations n Views about what will happen to the rate of inflation in the future. n People expect inflation to continue into the future and therefore attempt to negotiate better pay deals at work to keep their standard of living. n This leads to the wage price spiral

Wage Price Spiral n Demand is high so inflation rises n Workers will demand higher wages as the cost of living increases n This increase in the cost of wages means firms push prices higher n The cycle continues.

Hyperinflation n Prices spiral upwards uncontrollably and extremely rapidly with devastating economic consequences. n Inflation in excess of 50% a month. n The value of money decreases so fast people lose confidence in it and avoid transactions and begin to barter or trade in commodities such as gold with its own intrinsic value. n In the 1920s Germany experienced hyperinflation, which peaked at 700,000,000,000% in 1923, the currency had to be replaced in 1924 with a new currency.

BBC News Stories n The real cost of inflation: n bin/search/results.pl?tab=av&q=inflation &recipe=all&scope=all&edition= bin/search/results.pl?tab=av&q=inflation &recipe=all&scope=all&edition

Student Activities: n Positive and negative effects of inflation: Produce a mind map for both the positive and negative effects of inflation. You may use the A2 AQA textbook page (15/20 minutes) n What is the difference between a fall in inflation and a fall in prices? (10 minutes)

A2 External Influences Inflation – Lesson 2

Starter - Recap n What are the positive and negative effects of inflation? n What is the difference between a fall in inflation and a fall in prices?

Student Activity n Briefly describe the 6 effects of a low rate of inflation. You may use the A2 AQA textbook page 352 (10 minutes)

Implications for strategy of changes in inflation n What happens to the value of money if inflation is high? n Is a business more/less likely to borrow money? n What happens to the value of the companies fixed assets (e.g. land/building)? n How will general  prices affect firms pricing strategy? Value of money  Borrowing more likely since payback will be  in ‘real terms’ Balance sheets look better and so ‘reserves’ are bigger Lower-price products/services may benefit as ‘premium-priced’ products now ‘look’ too expensive Firms will find it easier to ‘pass on costs’ to consumer if ALL prices are rising.

Implications for strategy of changes in inflation n How will  prices affect sales? n How will  prices affect ‘menu’ prices? n How will ‘branded’ products be affected? n How will the workers react? n How will the suppliers react? n What happens to (international) competition? n Implications for the business plan? n How will the MPC react? May mean lower sales…internationally. Firms will keep needing to change the prices advertised Customers more aware of price (become price sensitive) and may switch, firms may either  advertising (  costs) or  Prices to regain customers Cost of living , so if inflation is 10%, they want at least 10% wage increases ‘They put up their price to the business to try and do the same (cost-push) If Inflation is only happening in the UK, product less price competitive If future is uncertain, planning is less reliable- less likely to take risks Increase interest rates to reduce spending