Income and interest rates 1.3 Understanding that businesses operate within an external environment Income and interest rates

Learning outcomes Understanding the nature and purpose of business What you need to know: How the external environment can affect costs and demand.

Incomes Income levels in the market will clearly have an impact on the demand for all goods. Some products such as normal and luxury goods will see sales rise as income levels rise. However, some goods may see their demand fall as consumers’ incomes rise and these are known as inferior goods. Products where demand will rise as consumer income rises Products where demand will fall as consumer income rises Rise Fall Task: Make a list of at least 5 product types for which demand will increase as general consumer incomes rise and 5 for which demand will fall. Make another list of 5 product types for which demand is likely to be completely unaffected by consumer income changes.

Interest rates Interest rates: the cost of borrowing money and the return for lending it. Interest rates are set by the Monetary Policy Committee of the Bank of England to control inflation and economic growth by impacting consumer and business borrowing and spending. When interest rates are higher it will impact consumer and business spending in the following ways: Consumers with mortgages, loans and credit cards have less discretionary income available so will spend less. Sales of consumer products on credit (cars, electrical goods, furniture, holidays, etc.) may fall as it becomes more expensive to borrow. Saving becomes more attractive than spending because of the interest earned. The increased cost of borrowing may encourage businesses to delay any investment in growth as the benefit of saving is greater than that of the project. Therefore, the demand for capital goods (machinery, etc.) will fall. The cost of borrowing is a fixed cost, therefore a rise will increase unit costs and the break-even point and lower profit margins.  The fall in demand for consumer and capital goods will slow down economic growth. When interest rates are lower the opposite will be true. Discuss: The Bank of England brought rates down to 0.5 per cent after the great recession of 2008/09. What did they hope to achieve?