How does inflation affect us all? AS Business

Lesson Objectives To be able to discuss the effects of inflation on business; uncertainty, re-distribution of wealth, loss of competitiveness and skills shortages To be able to answer a past paper question based on the topic areas

Starter Write down what you think inflation is and what effects you think it might have on business. Keep this piece of paper until the end of the lesson. Do not look at it, do not change it as the lesson goes on. You will get further instructions later on….

Inflation A sustained general rise in prices

Inflation rate (%) Defined as: Change in the average prices in an economy over a given period Price level is measured by an index Example: If the price index was 100 today and 120 in a years time then the rate of inflation would be 20% Calculating a price index is complicated (and you do not have to do it in the exam) In the UK they use the retail price index and surveyors are sent out to find 150,000 prices for 600 items every month. Changes in food price is more important than changes in alcohol or tobacco as more households buy food, so figures are weighted Information from the RPI gives the government important data on spending patterns and price rises

Example diagram showing the consumer price index and the Retail price index. Students could be encouraged to plot a trend line and speculate on why that might be happening.

Declan Curry explains inflation

The costs of inflation Inflation is a problem, if food keeps going up in price and wages don’t then soon consumers will feel poorer and not be able to afford to buy as much. If prices are stable then consumers and business have a rough idea of how much items cost.

How much is? Guesstimate these items and their cost: A Pint of milk A Loaf of white bread A can of baked beans May need to update this slide from time to time due to inflation. Prices Aug 2014 ASDA website 1 49p 2 55p 3 68p

1. Effect of inflation on business Uncertainty Inflation creates uncertainty for business. This makes prediction of future revenue (money in) and costs (money out) very difficult for the business. Uncertainty means business is more risky and therefore less likely to gain investment

2. Effect of inflation on business Re-distribution of wealth Those on a fixed income may feel poorer during inflation as prices rise but their income does not This can include those on pensions and low wages Those with a mortgage become better off as prices of houses rise and give them more wealth because their house is worth more Some workers may get wage rises to compensate for the rise in inflation

3. Effect of inflation on business Loss of competitiveness Many businesses in UK trade in a global market – especially Europe. If our inflation is high and so our costs and therefore prices are rising quicker than our competitors abroad then the company are likely to lose business as they will not be able to compete. UK goods become more expensive Imports start to look more attractive by comparison#’ Exports decline as UK cannot compete with prices from abroad Can make long-term projects unprofitable if prices rise too high during the duration of the project

4. Effect of inflation on business Skills shortages If employees get wage rises in line with inflation this can cause other firms employees to press for wage rises through their unions This can mean that only some companies can afford to attract certain skilled staff

What is deflation? A fall in the general price level is known as deflation

Sample question 1

Answer question 1

Sample question 2 [4]

Answer question 2 Correct answer A it causes a loss in competitiveness Inflation can be defined as a general rise in the price level. (1 mark) • If UK goods are competing with foreign goods and services then UK products are likely to become more expensive and therefore less competitive. (1 mark). • This can result in UK exports declining and import penetration increasing. (1 mark) • UK businesses may struggle to compete with cheaper goods from abroad. (1 mark) • Wage demands should increase rather than decrease with high inflation so that workers do not experience a reduction in standard of living. (1 mark) • People with loans become better off in real terms rather than worse off because the real rate of interest is lower. (1 mark) • Saving is likely to fall as its value is eroded in real terms and a higher proportion of income is needed to purchase the same level of goods and services. (1 mark)

Revision Video

Starter Remember this instruction? Write down what you think inflation is and what effects you think it might have on business. Take your inflation note now and look at what you knew at the start and what you know now. There may be a gap between the start and the end. Now imagine if that was a business and the effect that knowing about inflation may have upon its trading…