2. Iceland’s Economy boils over Read the case study on page 110 Consider the points to think about You will be sharing your thoughts with the class!

3. The Economy...  What contributes to the success or failure of a countries economy? The rate of economic growth The rate of price inflation The unemployment levels Exchange Rates What factors could affect a business deciding to expand before an economic recession? Things to consider: Cost of borrowing, decline in sales...

4. External economic influences  What do governments do to control the nation’s economy?  They set objectives and take economic policy decisions that can have a significant impact on the success and profitability of businesses  Being aware of these objectives and policies can help protect a business from negative policy changes and to take advantage of positive policy changes

5. External economic influences  So, what are the economic objectives of governments – Economics students....?  Economic Growth (% increase in GDP, based on productivity output)  Low inflation (rate of price increases)  Low unemployment rates  Long term balance of imports and export value (balance of payments)  Exchange rate stability – prevention of fluctuations  Equality of personal income – controlling the tax system

6. External economic influences  How do these objectives conflict with each other?  If inflation is too high, what other objective could be affected?  Reduce Consumer Spending resulting in...  Lower demand for a product resulting in...  High unemployment 

7. External economic influences  So, lets take a look at the objectives in more detail...  ECONOMIC GROWTH... Measured by GDP – level of output – how much is made! If an economy is in a state of economic growth, it is becoming richer Why is Economic growth NOT measured in monetary terms? Because inflation can increase the value of GDP in monetary terms which will not be realistic in terms of output!

8. External economic influences Why is Economic Growth important for a country? Higher GDP results in more goods being available to consumers, increasing their standards of living Increased employment, which will again increase spending as more people will have money for a wage Tax – from wages – for public services, which means government is spending less on unemployment benefits and more in areas of real need! Increase in sales for businesses – but only if demand for their product is income elastic! BUT... Economic Growth does have it’s down side!... Pollution! Affects on Health! (China!) Technology taking place of jobs

9. GDP...

12. External economic influences THE BUSINESS CYCLE... Def: “Regular swings in economic activity that occur in most economies varying from boom conditions to recession “ RECESSION... 6 months or more of declining GDP

13. External economic influences The stages... What happens at each stage? Consider: profits, employment, interest rates, consumer demand BOOM DOWNTURN (RECESSION) SLUMP RECOVERY AND GROWTH So, there are some benefits as a result of a recession! Cheap capital assets? Demand for “inferior” products? Increases workload (due to risk of redundancies)? Businesses becoming “lean” – improved efficiency?

14. External economic influences What could each of the following do during: Periods of economic growth Periods of recession Mercedes cars (Luxury Good) Watties tinned foods (Normal Good) Factory Outlet inferior clothing (Inferior Good) Which of these is not really going to be affected by growth or recession?

15. External economic influences INFLATION: A RISE in the average price level of goods and services (getting less for your money) DEFLATION: A Fall in the average price level of goods and services 2008: Zimbabwe Inflation rose above 100,000% The price of chicken rose more than 236,000% (52,500 NZD today!) Hyperinflation (no confidence in the value of money!)

16. External economic influences How is inflation measures? RPI – retail price index About 6,000 items commonly found in a household budget An index number can be used to record average changes in the items Prices are compared monthly for changes, and items are “weighted” in terms of their importance in a household budget All weighted price changes are averaged to give an “index number” All index numbers have a start value of 100... So, if an RPI started at 140 in 2008, using a base period of 2000... Weighted Average of Price Inflation since 2000 is 40% Or... The value of money has fallen by 40%!

17. External economic influences What causes inflation? Cost Push Inflation... Businesses have to increase selling prices to maintain profit margins due to increased costs of production Reasons for having to increase prices?  Lower exchange rate of imported goods  Demand of materials push up the prices (oil, wheat, cotton)  Workers demanding higher wages (to improve standards of living in line with inflation!) Demand Pull Inflation... During the “Boom” of the Business Cycle Goods can be sold at higher prices in order to reduce demand Will also lead to higher profit margins

18. External economic influences So, what is the impact of inflation on business strategy? If the rate of inflation is LOW, benefits can include:  Cost increases to a business can be passed on more easily to the consumer – customers won’t feel the pinch so much with increased prices  Gearing for a business can become favourable – the value of the debt they owe to the bank can reduce (the money is now of less value)  The value of assets can rise (now worth more!)  What account will this be reflected in? If the rate of inflation is HIGH, Drawbacks can include:  Unhappy workers – pay not supporting their living costs = disputes   Big brands will take a hit – consumers want a bargain (good for low value goods)  Higher interest rates – highly geared companies can suffer – not able to pay back the interest on loans  Raise in costs of materials can cause cash flow problems What will happen in the future? Uncertainty... What does a company do?

19. External economic influences So Deflation – is it beneficial? Does a period of falling prices benefit a business?  Would customers still want to buy if prices could fall further? Perhaps demand for goods will reduce leading to another recession!  Profitability could reduce – businesses might not want to invest in future developments  JIT might need to be considered and invested in – stocks in the warehouse will be falling in value! But, this will mean suppliers suffering also with reduced orders

20. External economic influences So, what strategies can a company potentially take in times of high inflation?  Cut back on investment spend  Cut profit margins – they will need to be more competitive than ever to keep consumers interested  Reduce borrowing to manageable repayments (reduce gearing)  Debtor management – keep payment time to a minimum  Reduce labour costs! Activity 7.2 – Pg 119 – China to Take Action

21. Suggested responses...Q1 and Q2 1 State two reasons for the reported increase in inflation in China. [2]  the increase in oil and petrol prices  excess demand due to increased wealth in the economy 2 Are these causes of inflation ‘cost–push’ or ‘demand–pull’ pressures? Explain your answer. [4] The increase in oil prices is an example of cost−push inflation. Oil is an important input into business activity; as its price increases this represents an increased cost to businesses for energy and transportation. Thus, they are forced to increase prices to recover these additional costs. Excess demand causing the price of pork and vegetables to increase is an example of demand−pull inflation. High levels of consumer demand relative to the economy’s ability to supply leads to price increases as consumers are effectively competing for limited supply.

22. Suggested responses...Q3 If the Chinese government increased interest rates again, explain what impact this could have on: consumer spending on luxury goods spending on new investment projects by Chinese businesses the external value of the Chinese exchange rate. [9] Consumer spending on luxury goods − as the cost of borrowing rises consumers will face higher interest charges on any new borrowing. Therefore, they will reduce their expenditure on luxury goods that require finance to purchase. New investment projects by Chinese businesses − as higher interest rates will reduce the growth of consumer spending, this will reduce the potential returns from new investment. Thus, investment will fall. Further, as some investment is financed from borrowing, an increase in interest rates will reduce the potential profit of investment due to the increased repayments needed to service debt. The external value of the Chinese exchange rate − two forces will influence the exchange rate. The increase in interest rates will encourage currency flows into the Chinese financial sector, attracted by the higher rates of interest available. This will create a demand for the yuan, leading to an appreciation of the exchange rate.

23. Suggested responses... Q4 Examine the long-term problems for Chinese businesses if inflation is not brought under control. [10] This question requires an analysis of the costs of high rates of inflation. You should develop a number of the following issues and identify which are the most significant. There is greater uncertainty about the future. High rates of inflation make it more difficult to predict the revenues and costs associated with long-term investment. Thus, investment is discouraged. The government may be forced to increase interest rates to control inflation. This will lead to a decrease in demand in the economy. Employees will demand higher wages and there may be an increase in industrial unrest. A wage−price spiral may result. However, this is less likely in China due to strong centralised control of the economy. Workers may have less influence than in mixed economies. If inflation is higher in China relative to its competitors, then, over time, the competitive position of Chinese firms will be eroded. This will lead to a reduction in exports and an increase in imports.

24. Suggested responses...Q5 China has experienced rapid economic growth in recent years. Discuss the likely effects of this on Chinese manufacturing businesses. [10] Manufacturing business will benefit from increasing demand due to rising incomes. This will lead to higher levels of profit and reduced pressure to be price competitive. There may be a shortage of key skilled workers, leading to higher wage costs. Although China has significant labour resources working on the land, which can be transferred to the manufacturing sector, this labour may lack the skills needed by industry and thus require training. If growth is a consequence of the relative competitiveness of Chinese industry, then there will be an increase in demand for Chinese exports. The economy may overheat, that is, the growth rate is unsustainable. This will lead to increasing costs for businesses as they compete for resources. Increased growth leading to higher profits will lead to increased investment and technological change. Thus, Chinese industry will become more competitive on world markets.

25. External economic influences UNEMPLOYMENT... 3 Different types of unemployment... CYCLICAL UNEMPLOYMENT Resulting from low demand for goods/services in the economy During low Econ Growth or recession Related to the Business Cycle Demand Reduced Less labour needed Lower incomes Spending reduced Worse recession!

26. External economic influences STRUCTURAL UNEMPLOYMENT Related to the decline of important industries Significant job losses in one sector of industry eg’s coal mining, ship building, car manufacturing Certain skills cannot be used elsewhere... Causes of Structural Unemployment...  Changing consumer tastes and spending patterns  Demand for services declining (banks!)  Transfer of skills difficult  Multi Skilling now important – need to be trained to adapt (IT)

27. External economic influences FRICTIONAL UNEMPLOYMENT Losing your job or leaving you job Taking a long period of time to find alternative employment Due to changing labour demands – constant need to change and adapt to consumers wants and product developments Increases when the overall turnover rate of unemployment increases in the economy, so does frictional unemployment

28. External economic influences Humans are the most valuable resource a company has... So unemployment is seen a waste to the economy... What are the COSTS of unemployment to an economy?  Not as much goods be produced as there could be  Taxpayers money is substantial to support them (Societal Cost)  Social problems?  Reduced demand – lower incomes – lower standards of living (Personal Costs)  Skills become outdated the longer you are unemployed So, if a company has to negotiate lower wages during slow growth, does this mean they are exploiting the workers?

29. External economic influences SO, WHAT CAN THE GOVERNMENT DO... It needs to avoid unemployment of any kind! Lower inflation Competitive rate of exchange – keep overseas demand up Provide training programmes Provide info on job opportunities – job centres/ agencies Perhaps... Reduce unemployment benefits ??? Make it difficult for them to live off taxes ????

30. Who has the lowest unemployment? Rank them! Japan Netherlands New ZealandMexico Korea Norway Luxembourg SwitzerlandAustralia Austria

31. External economic influences Exchange Rates – a favourite in the exam! The Price of one Currency in terms of another E.R. Depreciation – A fall in the external value of a currency as measured by it’s exchange rate against another currency So, if $1 falls in value from €2 to €1.5, the value of the dollar has depreciated ER Appreciation – the opposite!

32. External economic influences How would an IMPORTER and an exporter be affected by the following? The dollar has appreciated from €8.60 to €10.00 = $1 So, if an importer in NZ places an order for €86,000 worth of components from Europe, what would the affect be on the importer using the old and the new exchange rate? Which rate is the more favourable to the importer? Why is it the more favourable rate? What is the affect on the European company with the new exchange rate?

33. External economic influences How would an EXPORTER and an exporter be affected by the following? The dollar has appreciated from €8.60 to €10.00 = $1 So, if an exporter in NZ receives an order to supply $50,000 worth of components to Europe, what would the affect be on the exporter using the old and the new exchange rate? Which rate is the more favourable to the exporter? Why is it the more favourable rate? What is the affect on the NZ Exporting company with the new exchange rate? What will the effect be on the NZ market for these products?

34. External economic influences So, who benefits and who loses out? Domestic firms that benefit from APPRECIATION... Importers of foreign raw material = costs of imports decline = makes them more competitive Importers of foreign manufactured goods= cheaper to import than to make in domestic market = higher profits (if you don’t reduce your selling price to benefit consumers!) Domestic firms that lose out from APPRECIATION...  Exporters of goods/services – this includes tourism – a fall in demand from overseas tourists = loss of domestic manufacture – relocate abroad Foreign competition in domestic market – they can supply the same imported goods much cheaper