1. 1.5.2 I MPACT OF CHANGES IN INTEREST RATES ON SMALL BUSINESSES A Love story Luca and Karen were childhood sweethearts but drifted apart in the Sixth Form. Karen was very conscientious and trained hard to become a nurse. At the age of 20 she started putting £50 a month away in a bank account. She managed to get an excellent rate of interest, averaging 8%. She did this for 10 years until she was 30. Luca liked to party. Although he had a good job he used to spend all of his money on going out. One night Luca bumped into Karen and the flame was rekindled. It wasn’t long before they were married and when they were both 30 they were expecting their first child, Francesca. Luca decided to take his responsibilities seriously. He stopped going out and opened a bank account. He put £50 a month into the account and kept this going for the next 20 years. At the same time Karen stopped paying into her account. However, she kept it open and still gained 8% interest per year for the next 20 years. At the age of 50 they celebrated Francesca’s 20 th Birthday. Luca and Karen looked into their separate bank accounts to see how much they had available to celebrate Francesca’s 21 st in style. Who had the most money – Luca or Karen?

2. What is an interest? The interest rate is the price of money - the cost of borrowing or the reward for saving money. If I buy a can of Coca-Cola it might cost me 70p. If I buy (borrow) £1000 from the bank for one year it might cost me £50 for the right to do so. So the price of borrowing £1000 would be £50 or 5%. This 5% is my interest rate. W HAT ARE INTEREST RATES ? A small business borrows £17000 at an interest rate of: a)2%, b) 5% c) 8% d) 12% How much does the business have to pay back in interest after one year for each interest rate?

3. Bank loans and overdrafts  firms that have a high level of bank loans or overdrafts are sensitive to interest rates. If the rate increases they pay more back. H OW DO INTEREST RATES AFFECT SMALL BUSINESSES ? Can small businesses access bank loans at low interest rates? If you were a bank manager what criteria might you use in deciding whether to provide a bank loan to a small business? Would you charge different rates of interest to different businesses? Why? 1.5.2 I NTEREST RATES

4. Supply of goods and services  if the cost of borrowing increases it becomes more expensive to invest in capital equipment such as machinery  B2B (Business to Business) transactions will fall as firms buy less capital goods and some firms might go out of business due to lack of demand for this type of good Demand for goods and services  higher interest rates will mean that consumers have less disposable income e.g. higher mortgage payments and there will be a fall in demand for other products H OW DO INTEREST RATES AFFECT SMALL BUSINESSES ? 1.5.2 I NTEREST RATES

5. H OW DO INTEREST RATES EFFECT CONSUMER SPENDING ? 1.5.2 I NTEREST RATES  Gross wage – compulsory deductions e.g. tax 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

6. H OW DO INTEREST RATES EFFECT CONSUMER SPENDING ? 1.5.2 I NTEREST RATES 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

7. MULTIPLE CHOICE 1.5.2 I NTEREST RATES 1. If interest rates rise in the UK which two of the following are the most likely effects on a small business? Select two answers The business would see: □ A An increase in its costs □ B An increase in demand for its product □ C An increase in its raw material costs from abroad □ D A fall in its rate of corporation tax □ E A fall in sales of its product