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Ch 5

Ch 5

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External Economic Influences

Ch 5

Business Constraints  Those factors which limit the business decision making are known as business constraints. Economic constraints are those factors which arise from the economy. Businesses operate in the economy. Due to government economic objectives and policies, they have to face such factors.

The Basic Economic Objectives of Government
Economic Growth (GDP)  Gross Domestic Product (GDP) is the total value of the goods and services produced in a country in one financial year. Increase in GDP leads to Economic Growth. Due to economic growth economies gain these benefits.  High living standards  Reduction in unemployment  Reduction in Poverty  Higher level of revenue for government Methods to Calculate GDP  Calculate total output of the country (Goods and Services Produced in one Year)  Calculate total revenue of the country  Calculate total expenditure of the country The Main Factors Leading To Economic Growth  Increase in output resulting from productivity increases GDP.  Increases in demand for the products made by industry. The Business Cycle  Overheating Boom:- In this Period, there is maximum utilization of economic resources Recession:- This period starts after six month continues decline in GDP  Depression/Slump: - A period low demand for products and investments in economy. (See Table 5.1 on Page 72) Inflation/Deflation  Inflation is the persistent rise in the price of commodities.  Deflation is the persistent decrease in the price of commodities also called negative inflation.  Causes of inflation  Demand pull  Cost push Impact of inflation Benefits of low inflation rates Real value of debts owed will fall Drawbacks of increased inflation rates o Higher wage demands thus industrial disputes. o Consumers become price sensitive & look for bargains  Business Strategies in periods of rapid inflation  Cut back on investment spending  Cut profit margins  Reduce borrowing to levels at which interest payments are manageable.  Reduce labor cost 1

(See Table 5.2 on Page 75)


Unemployment  Unemployment is said to exist when members of the working population are willing and able to work, they search for work but can’t find employment. Types of unemployment  Cyclical unemployment: - This occurs when an economy is in recession.  Structural unemployment: - It occurs with structural changes in economy, which changes demand for labor. This type of unemployment may happen even in boom period of economy.  Frictional unemployment: - This type of unemployment happens when a person loose one Job and find another.  Seasonal unemployment Government policy towards unemployment  In cyclical unemployment, taking measure toward Economic Growth  In structural unemployment, Provide education, training to workers  In Frictional unemployment, providing information about jobs through Jon Centres.  The cost of unemployment (Go to Page 78) Balance of Payments  The balance of payments (or BOP) is a measure of the payments that flow into and out from a particular country from and to other countries. It is determined by a country's exports and imports of goods, services, and financial capital, as well as financial transfers.  Balance of Payments = Current Account + Capital Account + Change in Official Reserve Account  Current Account (Also called Balance of Trade): - It comprises on Exports and Imports of a country. It may be deficit or surplus.  Capital Account: - It shows the investment flow in and out from country.  Change in Official Reserve Account: - The official reserve account records the government's current stock of reserves. Reserves include official gold reserves, foreign exchange reserves, and strategic defense reserves (SDRs), such as the Strategic Petroleum Reserve Exchange Rate The price of one country’s currency expressed in terms of another currency. (See Table 5.3 on page 79)  Fluctuations in Exchange Rates: - A market based exchange rate will change whenever the values of either of the two component currencies change.  A currency will become more valuable whenever demand for it is greater than the available supply. This is called Appreciation of Currency.  A currency will become less valuable whenever demand is less than available supply (this does not mean people no longer want money, it just means they prefer holding their wealth in some other form, possibly another currency). This is called Depreciation of Currency. (See Table 5.4 on page 80)

Macro-Economic Policies
These are policies that are designed to impact on the whole economy. Fiscal Policy  This policy is concerned with decisions about government expenditure, tax rates and Govt. borrowing. Through this policy Govt. control Aggregate Demand. (See figure 5.4 on page 82 when economy is on Recession stage and figure 5.5 on page 83 when economy is on Boom stage) Monetary Policy 3

 This policy is concerned with decisions about the rate of interest and the supply of money in the economy. It is issued by Central Bank.


Exchange Rate Policy  The government strategy regarding the international value of the currency. There are three different approaches a Govt. can take:  Freely floating exchange rate (Demand and supply of currency)  Fixed exchange rate (Govt. control)  Join the common currency

Further Economic Constraints
Labor Market  The labor market, like any other market, involves buyers and sellers. In this case the buyers are employers and the sellers are those people who are prepared to sell their services. Labor market is split up into a number of sub-markets. The market for teachers, doctors etc.  Demand and Supply determine the price of labor. Due to Govt. intervention through Minimum Wage Legislation, employers are forced to pay more. (See figure 5.9 on page 91) Factors That Determine Demand Of Labor Demand of product Technological changes Factors That Determine Supply Of Labor Social structure of country/Social values Population – working population Price rates in different labor markets Skill Shortage When demand of a particular skill is more than supply. Skill Surpluses When supply of a particular skill is more than demand. Market Failure  It is a situation when markets fail to achieve the most efficient allocation of resources and there is under or over production of certain goods or services. (See table 5.6 on page 93)

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