Economic Factors

Question 1

SPICED

Answer 1

strong
pound
import
cheaper
export
dearer
- high exchange rates

Question 2

WPIDEC

Answer 2

weak
pound
import
dearer
export
cheaper
- low exchange rates

Question 3

Explain exchange rates

Answer 3

The price of one currency expressed in terms of another. There is an important link between the domestic rate of interest and the value of a nation’s currency.
Exchange rates between most currencies vary regularly according to the balance of supply and demand for each individual currency. If the demand for pounds increases (for example, more tourism to the UK), the
exchange rate goes up; if the supply increases (such as more UK citizens holidaying abroad),
the exchange rate falls.

Question 4

Define interest rates

Answer 4

The price paid for borrowed
money. The base rate of interest is the rate set by the Bank of England.

Question 5

Effect of high interest rates on consumers:

Answer 5

• Less spending by borrowers – the cost of borrowing increases so people borrow less (as the cost of repaying the loan is more).
• More saving by savers – there is an appeal to saving as they will earn a higher rate of interest on their money and hence spend less money.
• Less spending as smaller amount of disposable income (hits those selling luxury items). Also millions of consumers have mortgages – when interest rates rise there is less money to spend on other
  items.

Question 6

Effect of high interest rates on businesses:

Answer 6

• Reduction in the sale of luxury items and items normally bought on credit – businesses selling wants, such as televisions and sofas, may see a substantial fall in sales.
• Higher overheads for businesses – loans become more expensive due to the increase in interest charges.
• Reduction in expansions/growth – businesses may decide to postpone decisions to buy new machinery or build new factories.
• No real change in sales for businesses selling ‘needs’.
• Encourages businesses to save more as the returns are greater.
• Sees businesses reducing their levels of stocks (maybe selling at reduced prices) to reduce the need to borrow money.
• Sees businesses reducing production to reduce the costs of credit.
• Encourages debtors to delay payment in order to earn interest.
• Sees creditors wanting their money more quickly

Question 7

Exchange rates effect on exports

Answer 7

• a rise in the value of the pound means exported goods cost more for overseas customers, so
  demand falls
• a fall in the value of the pound means exported goods cost less for overseas customers so
  demand rises.

Question 8

Exchange rates effect on imports

Answer 8

• a rise in the value of the pound means imports cost less so more profit can be made or prices can be reduced
• a fall in the value of the pound means imports cost more so less profit is made or prices are increased.

Question 9

Link between rise in interest rates and exchange rates

Answer 9

UK becomes a more attractive location for foreign investors g foreign investors purchase pounds to invest in UK banks demand for pounds increases, raising the price
(exchange rate).

Question 10

Link between fall in interest rates and exchange rates

Answer 10

UK becomes less attractive to investors g foreign investors sell pounds to purchase other currencies g supply of pounds
increases causing the exchange rate to fall.

Question 11

Define interest rate - monetary policy

Answer 11

Since May 1997 the Monetary
Policy Committee of the Bank of England has had responsibility for setting interest rates, which it does monthly, with the aim of achieving the government’s target for inflation (2% ± 1%) whilst attaining long-term growth in the economy.

Question 12

Objectives of raising interest rates

Answer 12

• reducing the level of consumer spending
• reducing inflation
• slowing the level of economic growth (GDP)
• reducing the number of imports
• dampening down an economic boom.

Question 13

Implications of rising interest rates

Answer 13

• many businesses may experience falling sales as consumers increase savings
• demand for products purchased on credit may decline significantly
• business cancelling or postponing investment plans
• businesses reduce borrowing
• increased value of sterling increasing the prices of exports while reducing import prices.

Question 14

Objectives of reducing interest rates

Answer 14

• reducing levels of unemployment
• stimulating the level of production in the economy
• promoting exports sales by reducing the exchange rate of the pound
• increasing rates of economic growth in the economy
• assisting in recovering from a slump.

Question 15

consequences of falling interest rates

Answer 15

• demand and sales are likely to increase
• production is likely to be stimulated by increasing employment
• export sales of price sensitive products may increase whilst imports become less competitive.

Question 16

Define fiscal policy

Answer 16

The use of taxation and public
(government) expenditure as a means of controlling the level of activity within the economy.

Question 17

The government can operate two types of fiscal policy

Answer 17

• To increase the level of economic activity – achieved by cutting rates of taxation; increasing government expenditure. This results in increased output and spending, less unemployment, possible
  increase in inflation and more imports.
• To reduce the level of economic activity – achieved by increasing rates of taxation; cutting government expenditure. This results in lowered output, spending and employment, lower inflation and fewer imports.

Question 18

Government expenditure is in two broad categories

Answer 18

• Transfer payments – this is expenditure on unemployment benefit, pensions and other social security payments. An increase in transfer payments often results in substantial increase in demand for basic goods, such as food, public
  transport and gas.
• The infrastructure – governments improve the infrastructure through their spending on housing, roads and flood protection. Investment in these areas can increase the level of economic activity by boosting demand for the services of construction businesses whilst reducing costs for other businesses.

Question 19

Define inflation

Answer 19

Inflation is the rate at which the general level of prices is rising. Inflation is measured by the Consumer Price Index (CPI) which measures the rate of inflation based on the changes in prices of a basket of goods and services.
For many businesses, a low rate of inflation is not a problem. Inflation only becomes a major problem when it is high, rising rapidly or doing both together. Inflation occurs in two ways

Question 20

Demand-pull inflation

Answer 20

The demand for the country’s goods and services exceeds its
ability to supply the products. Prices rise generally as a means of restricting demand to the
available supply.

Question 21

Cost-push inflation

Answer 21

Costs rise due to factors such as rising wages or costs of raw
materials and components

Question 22

The government’s main weapon against inflation has been to raise interest rates. The effects of this are:

Answer 22

• consumers are discouraged from spending their money by higher savings rates and are less likely to buy on credit as it is more expensive
• businesses reduce investment as borrowing becomes more expensive
• output and sales decline and the inflationary pressure reduces.

Question 23

High rates of inflation affect businesses because
(If inflation rates are low: Opposite )

Answer 23

• rising wages and raw materials costs may force businesses to accept lower profit margins or to raise prices
• businesses face menu costs as prices listed have to be frequently updated
• businesses face shoe leather costs (businesses frequently need to spend time and money trying to find out which supplier has the cheapest prices)
• overseas businesses (with lower inflation rates) may gain a competitive advantage
• some businesses will invest more as the real value of loans falls quickly
• other businesses will hold back on investment because interest rates are likely to rise
• people save more due to uncertainty and because interest rates are frequently raised, so demand falls.

Question 24

define taxation

Answer 24

Part of any income earned by a
business must be paid to the government.
The revenue generated is used to fund public services such as education, health and the
armed forces.

Question 25

Examples of direct tax

Answer 25

- Income - Corporation - National Insurance - Capital Gains

Question 26

Income tax

Answer 26

This is paid by individuals, sole traders and partnerships. All the money sole traders and partners earn belongs to them as they and the business are one. They, therefore, pay Income Tax and not Corporation Tax.

Question 27

Corporation Tax

Answer 27

This is paid by all types of businesses except sole traders and partnerships on the profit that they earn

Question 28

National Insurance

Answer 28

This is paid by both employers and employees on an individual’s salary. The contributions are used to fund part of the NHS, state pensions and the Job Seekers’ Allowance

Question 29

Capital Gains Tax

Answer 29

This is paid by businesses and individuals on the profit that they generate from buying and selling assets.

Question 30

Examples of indirect tax

Answer 30

- VAT - Excise/Custom Duties

Question 31

Value Added Tax (VAT)

Answer 31

This is paid by consumers on the goods and services that they buy.

Question 32

Excise/Custom Duties

Answer 32

This tax is paid on goods exported out of / brought into the UK from abroad (outside the European Union).

Question 33

The government can affect the level of spending and economic activity in the country by:

Answer 33

* altering interest rates – monetary policy * altering tax and public expenditure – fiscal policy.

Question 34

Gross Domestic Product (GDP)

Answer 34

It measures the value of a nation’s output over a period of time – normally a year. This figure is dependent upon the level of economic activity. Rising economic activity will cause a higher level of GDP. The business cycle (also called the trade cycle) describes the regular fluctuations in economic activity (and GDP) occurring over time. Note that the degree to which a business will be affected by the business cycle will depend on whether it produces ‘needs’ or ‘wants’.

Question 35

Economic Activity

Answer 35

relates to the level of spending, production and employment in the economy at any given time.

Question 36

Boom - The business cycle

Answer 36

The level of economic activity is rising rapidly, leading to higher inflation and increased imports. Wages may rise as businesses can afford to pay the additional costs. Prices may rise as shortages occur. (Government policies try to head off the worst excesses of a boom. The reduction of growth in GDP is achieved by increasing interest rates and/or increasing taxation and/or cutting government expenditure.)

Question 37

Recession - The business cycle

Answer 37

Economic activity declines as the economy moves into recession, with production rising less quickly, or declining, and unemployment increasing. Wages are likely to remain static and prices may fall to encourage consumers to purchase. Imports may fall as consumers do not have sufficient funds to purchase them and businesses do not need to purchase as many raw materials from overseas. (The government is likely to reduce interest rates or reduce taxes to encourage consumers to spend or it could increase public expenditure.)

Question 38

Slump - The business cycle

Answer 38

Demand falls, unemployment is relatively high and there is low inflation. Businesses may have to reduce prices and they will be reluctant to invest. There will be spare capacity in the economy. (Interest rates are likely to be low, taxes may have been reduced and public expenditure increased.)

Question 39

Recovery - The business cycle

Answer 39

The rate of growth of GDP starts to increase, unemployment begins to fall as businesses take on more workers to cope with the rise in economic activity, inflation might start to increase as prices rise and businesses begin to increase their investment spending as business confidence increases. Imports are likely to increase. (The government may raise interest rates to reduce inflation.)

Question 40

Business cycle affect on businesses supplying wants / needs

Answer 40

Businesses supplying ‘wants’ may be affected significantly by the businesses cycle. Examples include wine, sports and leisure goods, restaurant meals, jewellery and household furniture. Businesses supplying ‘needs’ are unlikely to be affected to a great extent by the business cycle – in fact, demand may rise for some of these products in a recession or slump: coal, bread, petrol, fresh vegetables and tobacco.

Question 41

Explain unemployment

Answer 41

Unemployment will always be with us. This may seem a slightly contentious statement, but the fact is that every economy has a natural rate of unemployment. This natural rate of unemployment does alter over time and will depend on such things as mobility of labour, availability of training, trade union power and the skills of labour. Types of unemployment: * structural unemployment * cyclical unemployment * frictional unemployment.

Question 42

Impact of high levels of unemployment on UK businesses

Answer 42

The major impact of unemployment is reduced demand for goods and services. * The economic crisis of 2008 saw the unemployment figure reach 3 million and this had a very significant impact on the sales and orders of UK businesses. Sales forecasts were radically revised and survival became the major objective of the majority of enterprises. * This fall in demand can result in a fall in output and then possible redundancies for some workers if they are not needed.

Question 43

Frictional Unemployment

Answer 43

This perhaps is the least problematic of the three types of unemployment and occurs when there is a delay in finding a job after losing a previously held job. This unemployment is obviously less long-term than structural unemployment; it tends to be temporary. Nonetheless, the government still tries to reduce it by increasing information available of vacancies that exist. This can be done through job centres and other employment recruitment services.

Question 44

Cyclical Unemployment

Answer 44

Cyclical unemployment, as its name indicates, appears as part of the business cycle. As an economy enters a downturn, unemployment increases; this will peak during any subsequent recessionary period. This type of unemployment will fall during recovery and reach a minimum at the peak of the boom period. The government has tried to tackle cyclical unemployment in two ways. Firstly, by encouraging wage flexibility, for example, by making part of employees’ wages relate to profits of the company (profit-related pay). It is then not so expensive to employ employees when there is a downturn in profits. Also the government has tried to reduce the nature of the economic cycle and the large variations between boom and bust. One important way of doing this is to encourage investment in labour and so make it more expensive to shed workers during an economic downturn.

Question 45

Structural Unemployment

Answer 45

This appears when there have been large changes in patterns of demand or developments in technology which have caused long-term unemployment in regions or industries. These changes mean that the structure of the industry or service has changed, and that jobs in their previous form are unlikely to return. A good example would be the high levels of male unemployment in South Wales valleys and regions of Yorkshire which had previously large coal-mining and steel-producing areas. In this case, decline in the industries has been caused by cheap imports and by the switch to natural gas for heating and in power stations. Providing a solution to structural unemployment when it occurs is one of the largest problems facing any government. Quite often, families have previously been employed for many generations within the same industry. It is difficult to encourage retraining and mobility of labour from these regions. It is also difficult to encourage businesses to move to the areas which are so obviously depressed.