A business does not operate in isolation. External influences: the state of the economy, government decisions, environmental and ethical pressures and the global economy, create opportunities and constraints.
6.1 Economic issues
The business cycle
The business cycle is the pattern of ups and downs in economic activity over time.
| Stage | What happens |
|---|---|
| Growth (expansion) | output, incomes and spending rise; unemployment falls |
| Boom | the peak: very high demand, low unemployment, but prices and wages may rise fast |
| Recession | output falls; spending drops and unemployment rises (usually two or more quarters of falling GDP) |
| Slump (depression) | the lowest point: very low demand, high unemployment, many business failures |
Effects on businesses
| Indicator | Effect on businesses |
|---|---|
| Employment level | high employment means more spending and higher sales but labour is harder to recruit and wages rise; high unemployment means weak demand but easy recruitment |
| Inflation (a general rise in prices) | costs rise (wages, materials), customers' spending power falls, it is harder to plan; very low or negative inflation can mean weak demand |
| GDP (total output of the economy) | rising GDP means higher incomes and demand; falling GDP (recession) cuts demand, especially for luxuries |
In a boom businesses expand and invest. In a recession they cut costs, lower prices, cut production, make workers redundant and focus on essential products.
Government control over the economy
Government objectives often include economic growth (increasing GDP), low unemployment, stable prices (low inflation) and a healthy balance of payments.
| Government action | Effect on businesses | How businesses may respond |
|---|---|---|
| Higher taxes (income tax, VAT, corporation tax) | customers have less to spend; business profits fall (corporation tax); VAT raises prices | cut costs, absorb the tax or raise prices, find cheaper suppliers |
| Lower taxes | more spending power and higher profits | expand and invest, hire |
| Higher government spending | more demand, especially for firms that supply the government (construction, defence, health) | increase output |
| Cuts in government spending | contracts and demand fall | find new customers, cut capacity |
| Higher interest rates | borrowing costs rise (loans, overdraft), customers spend less (loan costs, saving becomes attractive), demand falls; sectors that rely on credit (cars, housing) are hit hardest | reduce borrowing, delay expansion, cut costs |
| Lower interest rates | cheaper borrowing, more spending | expand, invest and borrow |
6.2 Environmental and ethical issues
The environment
Business activity can harm the environment: pollution (air, water, noise), global warming (greenhouse gas emissions), waste, use of non-renewable resources, deforestation.
Externalities are the costs or benefits of a business's decisions that fall on people other than the business:
- External costs: pollution from a factory, noise, traffic congestion, loss of green space.
- External benefits: jobs and income for the local community, better roads, training and skills.
Sustainable development means meeting today's needs without harming the ability of future generations to meet theirs. Businesses can contribute by using renewable energy, recycling and cutting waste, sourcing sustainable materials and reducing emissions.
Environmental concerns as opportunities and constraints
| Examples | |
|---|---|
| Constraints | higher costs (clean technology, waste disposal), laws and fines, restrictions on production |
| Opportunities | green products that customers value, a better brand image, lower costs from saving energy and materials, new markets (renewable energy) |
Why and how businesses respond to pressure: because of consumer pressure (people prefer green firms), pressure groups and bad publicity, government rules, and the chance of lower costs and a better reputation. They respond by cutting emissions, recycling, using sustainable packaging, publishing environmental reports.
Legal controls over the environment: pollution controls, limits on emissions, waste-disposal rules, and fines or closure for breaking them. They raise costs but protect the environment and create a level playing field.
Ethical issues
Ethics are principles about what is right and wrong. Businesses can face a conflict between profit and ethics: using child labour, paying very low wages, using cheap, unsafe materials, misleading advertising or bribery.
Responses: refuse to use child labour, pay a fair price to suppliers (fair trade), improve working conditions, be honest in advertising. Benefits of acting ethically: better reputation, loyal customers, motivated staff; limitation: higher costs, and competitors who do not act ethically may be cheaper.
6.3 Business and the international economy
Globalisation
Globalisation is the growing connection of the world's economies: more trade, movement of capital and people, and spread of ideas and brands.
Reasons for it: faster transport and communication (the internet), lower trade barriers, multinational companies, cheaper travel, and demand for goods from abroad.
| Opportunities | Threats | |
|---|---|---|
| For businesses | bigger markets, cheaper raw materials and labour abroad, spreading risk, economies of scale | more competition from foreign firms, exchange rate risk, cultural differences, risk of bad publicity over overseas working conditions |
Import tariffs and quotas: a tariff is a tax on imports; a quota is a limit on the quantity of imports. Governments use them to protect domestic businesses and jobs from foreign competition, raise revenue (tariffs), protect new industries and respond to dumping. Effect on business: imported goods cost more or are scarcer, which helps local firms but raises costs for firms that use imports and may prompt retaliation.
Multinational companies (MNCs)
An MNC is a business that operates in more than one country. Reasons for their growth: access to new markets, lower costs (cheap labour, materials), avoiding trade barriers (producing inside a country that has tariffs), economies of scale, spreading risk.
Benefits to the business: bigger sales, lower costs, brand recognition, risk spread across countries. Impact on stakeholders: shareholders gain from higher profit; employees may gain jobs or lose them if work is moved abroad; customers may get better products; local communities may face pollution.
Benefits to the host country: jobs, exports, investment, taxes, greater choice, new skills and technology.
Drawbacks to the host country: local businesses may lose sales and close, profits may be sent back to the home country (repatriation of profits), pressure on resources and the environment, the MNC may leave if conditions change, and cultural influence.
Exchange rate changes
An exchange rate is the price of one currency in terms of another (for example, $1 = 280 rupees).
- Appreciation: the currency rises in value (it buys more foreign currency).
- Depreciation: the currency falls in value (it buys less).
Effect on businesses (exchange rate calculations are not assessed; you need the effects):
| Currency appreciates (stronger) | Currency depreciates (weaker) | |
|---|---|---|
| Exporters | exports cost more abroad, so less competitive and sales may fall; profit per unit falls | exports cheaper abroad, more competitive, higher sales |
| Importers | imports become cheaper, costs fall | imports become dearer, costs rise (raw materials, components) |
| Overall | good for importers, bad for exporters | good for exporters, bad for importers |
An exporter that earns foreign money loses when that money buys fewer units of home currency. A business that imports materials and exports goods has effects in both directions.
Practise this chapter
Every past-paper question on these topics, with the mark scheme.