Current Economic Climate

AS Economics and Business
The Current Economic Climate
Unit 1
By Mrs Hilton for revisionstation
Lesson objectives
• To be able to discuss the implications for business in a
change in the interest rates
• To be able to discuss the effect of government spending or
taxation on business
• To be able to discuss the potential consequences for
business of unemployment, inflation and changes in the
exchange rate.
• To be able to answer a past paper questions on the current
economic climate
• What effect do you think that local
unemployment has on demand for products
and services? Is there a link?
Implications of government decisions on
• Governments can control the rate of interest and the
amount of money circulating in an economy.
• Government can also affect the amount of borrowing
or credit available from financial institutions like
• This is called MONETARY policy and they manipulate
these variables to achieve their political party’s
• The rate of interest is the price of money and the key
instrument of monetary policy
Government policy continued
• The government may change the way that it spends and
this may effect business
• The government may change the tax that it charges in
the UK and this may effect business
• There are consequences for business of unemployment and
• Business will be effected by changes in the exchange rate
• Changes in economic indicators such as unemployment
will have a knock on effect to business (such as
demand or larger pool of applicants for vacancies )
• Interest rates – cost of borrowing, the price of money
• Inflation rates – rise in cost of goods and services to
buy (persistent increase in costs)
• Unemployment rates – rise in numbers not in
• Tax – monies demanded from the government so
they have money to spend elsewhere like the
NHS and on roads and education
• Exchange rate – the rate at which one currency can
buy another £1 = $1.67
Changes to interest rates – effect on business
• What is the impact on the cost of borrowing
to business?
• If interest rates rise then the cost of borrowing
will rise and this will mean that the cost of
supplies for a business may increase
• A fall in interest rates means that the cost of
servicing debt falls which may lead to an
increase in profits (costs less to borrow so less
to pay back)
Changes in taxation – effect on business
• If the % of VAT goes up a business will have to
pass this cost on to the consumer so if makes
goods more expensive to buy
• The alternative is that the business absorbs
this extra costs and the price of the goods
remain the same to the customer – therefore
lowering profit margins
Consequences for business of unemployment
• If the government tightens
monetary policy by raising
interest rates this will lead to a
decrease in demand therefore
an increase in unemployment
• High unemployment in an area
will mean reduced demand for
normal goods and services and
an increase in demand for
inferior goods
• Inflation is a rise in the price of goods and services we buy
• The annual rate of inflation shows how much higher or lower prices
are compared with the same month a year earlier. It indicates
changes to our cost of living
• So if the inflation rate is 3% in January, for example, prices are 3%
higher than they were 12 months earlier. Or, to look at it another
way, we need to spend 3% more to buy the same things
• We compare this to the annual change recorded in the previous
month to get an idea of whether price rises are getting bigger or
• If the annual rate has risen from 3% to 4% from one month to the
next, prices are rising at a faster rate
• Bank of England ideal is 2%
• Source:
Inflation videos from bbc
Consequences of changes in inflation on
• What impact will a change in inflation rates have on
the cost of supplies?
• As inflation rises so does the cost of products and
• Cost of supplies, ingredients and raw materials will go
• Suppliers likely to be also within UK so will also be
suffering from a rise in prices
• Business owners may need to increase their prices to
maintain profitability
• Profit margins will be squeezed
Consequences of changes in inflation on
• What impact will a change in inflation rates
have on labour wages?
• As inflation rises then this lowers the real
wage rate, increases the demand for labour
and lowers unemployment
• As inflation lowers this raises the real wages,
reduces the demand for labour and increases
Lower real
wages as
As the cost of goods rise this means
if your wages stay the same you may
not be able to buy as much…
Consequences of changes in exchange rates on
• What impact will a change in exchange rates have on
the cost of supplies? It depends if they were
purchased from abroad. If our pound increased (or
appreciates) against another currency this will make
imported supplies cheaper:
• Strong
• Pound
• Imports
• Cheaper
• Exports
• Dearer
Today’s market data for currencies
Try looking at this
website every day – it
changes with the
fluctuating exchange
rates. You can track
prices over a week and
see how much they
Sample question 1
• [8]
Answer question 1
Sample question 2
• Between 2009 and 2011, the annual rate of CPI
inflation was above the UK government’s target range.
• Which one of the following could be an effect of higher
inflation rates for UK manufacturer’s, such as JCB Ltd?
A Fall in cost of supplies
B Reduction in real wages for its staff
C Increase in exports
D Increase in recruitment
Answer question 2
• Answer option B – reduction in real wages
- Inflation is a persistent increase in the aggregate/general level of prices in an
economy (1 mark)
- Which can cause the cost of living to increase because less can be bought for
the same amount of money (1 mark)
- So unless wages are increased in line with prices, consumer purchasing
power will fall (1 mark)
- Cost of supplies is likely to increase during inflation because the stock may
be purchased from within the UK from suppliers charging higher prices (1
- Exports may fall because UK goods may become less price competitive given
inflation (1 mark)
Sample question 3 (from second half of the
• Exchange rates and interest rates are
economic external influences.
• Assess their likely significance to Cebu Home.
Answer question 3
Level of
Marks (per
Level 1
e.g. the exchange rate is the price of one currency in terms of another, or
interest rates are the price of money paid to lenders or by borrowers
Level 2
e.g. higher interest rates may cause a reduction in the demand for Cebu
Home furnishings.
Level 3
e.g. exchange rates may affect cost of importing products, e.g. a fall in costs if
the pound strengthens might lead to an increase in profit.
e.g. increases in interest rates could cause a reduction in disposable incomes,
which will mean spending on luxuries such as home furnishings might fall, so
Cebu Home’s sales/stock turnover will fall.
e.g. Cebu Home imports its stock from the Philippines so the cost of stock is
likely to be affected by fluctuations in the exchange rate because a strong £
will make furniture purchasing cheaper. However, quality may be more
important than price, in which case the strong £ will not be significant.
Level 4
e.g. if interest rates fall this may lead to an increase in consumer borrowing
like mortgages which may increase the demand for Cebu Home furniture.
However, the changes in interest rate may not actually affect her typical
customers (thespians) because they will not need to borrow to buy the
products, in which case demand for Cebu Home homeware may not decline
if interest rates increase.
Sample question 4
• Throughout 2007, the UK experienced a gradual
decline in interest rates.
• Which of the following is the most likely
consequence for a small electrical retailer?
A Spending on stock decreases
B Staff wages are increased
C Borrowing increases
D Average cost of stock increases
Answer to question 4
• Answer C – borrowing increases
Interest rates are the price of borrowing money (1 mark
knowledge/understanding), so a reduction in interest rates
effectively means a reduction in the cost of borrowing (1
mark analysis), which, other things being equal, should lead
to an increase in the demand by businesses for investment
funds not an increase in bank deposits (1 mark evaluation).
• A fall in interest rates means that the cost of servicing debt
falls (1 mark knowledge) which may lead to an increase in
profits (1 mark analysis) which will not necessarily be spent
on increasing the wages of staff (1 mark evaluation).
Sample question 5
• The value of the £ (pound sterling) fell against the euro in
late 2008 and 2009.
• This change would have most likely benefited British:
• A tourists holidaying in France and Spain
• B exporters who sold their products in countries using the
• C consumers, because overall the inflation rate fell as a
• D importers, because they were able to improve their
profit margins
Answer to question 5
• Answer option B - exporters
• Definition of exchange rate, i.e. the price of one
currency in terms of another (1 mark);
• - Because the relative price of British exports will fall as
a result (1 mark);
• - Which, providing competitiveness is based on price,
will increase demand (1 mark)
• - British tourists abroad will get less foreign currency
for their £ sterling which will make things more
expensive (1 mark)
• Spiced / wpidec
Revision Video

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