1.

1 – Business Activity
The Economic Problem
Need: a good or service essential for living. Examples include water and food and
shelter.
Want: a good or service that people would like to have, but is not required for
living. Examples include cars and watching movies.
Scarcity is the basic economic problem. It is a situation that exists when there are
unlimited wants and limited resources to produce the goods and services to
satisfy those wants. For example, we have a limited amount of money but there are
a lot of things we would like to buy, using the money.

Opportunity cost
Opportunity cost is the next best alternative forgone by choosing another item.
Due to scarcity, people are often forced to make choices. When choices are made it
leads to an opportunity cost
SCARCITY → CHOICE → OPPORTUNITY COST

Example: the government has a limited amount of money (scarcity) and must
decide on whether to use it to build a road, or construct a hospital (choice). The
government chooses to construct the hospital instead of the road. The opportunity
cost here are the benefits from the road that they have sacrificed (opportunity cost).

Factors of Production
Factors of Production are resources required to produce goods or services. They
are classified into four categories.

 Land: the natural resources that can be obtained from nature. This includes
minerals, forests, oil and gas. The reward for land is rent.
 Labour: the physical and mental efforts put in by the workers in the production
process. The reward for labour is wage/salary
 Capital: the finance, machinery and equipment needed for the production of goods
and services. The reward for capital is interest received on the capital
 Enterprise: the risk taking ability of the person who brings the other factors of
production together to produce a good or service. The reward for enterprise is
profit from the business.
 Specialization
Specialization occurs when a person or organisation concentrates on a task at
which they are best at. Instead of everyone doing every job, the tasks are divided
among people who are skilled and efficient at them.
Advantages:

 Workers are trained to do a particular task and specialise in this, thus increasing
efficiency
 Saves time and energy: production is faster by specialising
 Quicker to train laborers: workers only concentrate on a task, they do not have to
be trained in all aspects of the production process
 Skill development: workers can develop their skills as they do the same tasks
repeatedly, mastering it.
Disadvantages:

 It can get monotonous/boring for workers, doing the same tasks repeatedly
 Higher labour turnover as the workers may demand for higher salaries and
company is unable to keep up with their demands
 Over-dependency: if worker(s) responsible for a particular task is absent, the
entire production process may halt since nobody else may be able to do the task.

Purpose of Business Activity

So we’ve gone through factors of production, the problem of scarcity and
specialization, but what is business?

Business is any organization that uses all the factors of production (resources)
to create goods and services to satisfy human wants and needs.
Businesses attempt to solve the problem of scarcity, using scarce resources, to
produce and sell those goods and services that consumers need and want.

Added Value
Added value is the difference between the cost of materials bought in and the
selling price of the product.
Which is, the amount of value the business has added to the raw materials by
turning it into finished products. Every business wants to add value to their
products so they may charge a higher price for their products and gain more
profits.
 For example, logs of wood may not appeal to us as consumers and so we won’t
buy it or would pay a low price for it. But when a carpenter can use these logs to
transform it into a chair we can use, we will buy it at a higher cost because the
carpenter has added value to those logs of wood.
How to increase added value?

 Reducing the cost of production. Added value of a product is its price less the
cost of production. Reducing cost of production will increase the added value.
 Raising prices. By increasing prices they can raise added value, in the same way
as described above.
But there will be problems that rise from both these measures. To lower cost of
production, cheap labour, raw materials etc. may have to be employed, which will
create poor quality products and only lowers the value of the product. People may
not buy it. And when prices are raised, the high price may result in customer loss,
as they will turn to cheaper products.

In a practical sense, you can add value by:

 Branding
 Adding special features
 Provide premium services etc.

1.2 – Classification of Businesses

Primary, Secondary and Tertiary Sector
Businesses can be classified into three sectors:

Primary sector: this involves the use/extraction of natural resources. Examples

include agricultural activities, mining, fishing, wood-cutting, oil drilling etc.
Secondary sector: this involves the manufacture of goods using the resources
from the primary sector. Examples include auto-mobile manufacturing, steel
industries, cloth production etc.
Tertiary sector: this consist of all the services provided in an economy. This
includes hotels, travel agencies, hair salons, banks etc.
Up until the mid 18th century, the primary sector was the largest sector in the
world, as agriculture was the main profession. After the industrial revolution, more
countries began to become more industrialized and urban, leading to a rapid
increase in the manufacturing sector (industrialization).
Nowadays, as countries are becoming more developed, the importance of tertiary
sector is increasing, while the primary sector is diminishing. The secondary sector
 is also slightly reducing in size (de-industrialization) compared to the growth of
the tertiary sector . This is due to the growing incomes of consumers which raises
their demand for more services like travel, hotels etc.

Private and Public Sector

Private sector: where private individuals own and run business ventures. Their aim
is to make a profit, and all costs and risks of the business is undertaken by the
individual. Examples, Nike, McDonald’s, Virgin Airlines etc.
Public sector: where the government owns and runs business ventures. Their aim is
to provide essential public goods and services (schools, hospitals, police etc.) in order
to increase the welfare of their citizens, they don’t work to earn a profit. It is funded by
the taxpaying citizens’ money, so they work in the interest of these citizens to provide
them with services.
In a mixed economy, both the public and private sector exists.

1.3 – Enterprise, Business Growth and Size

Entrepreneurship
An entrepreneur is a person who organizes, operates and takes risks for a new
business venture. The entrepreneur brings together the various factors of
production to produce goods or services. Check below to see whether you have
what it takes to be a successful entrepreneur!
 Risk taker
 Creative
 Optimistic
 Self-confident
 Innovative
 Independent
 Effective communicator
 Hard working

Business plan
A business plan is a document containing the business objectives and
important details about the operations, finance and owners of the new
business.
It provides a complete description of a business and its plans for the first few years;
explains what the business does, who will buy the product or service and why;
provides financial forecasts demonstrating overall viability; indicates the finance
available and explains the financial requirements to start and operate the business.
 Some of the content of a regular business plan are:
 Executive summary: a brief summary of the key features of the business and the
business plan
 The owner: educational background and what any previous experience in doing
previously
 The business: name and address of the business and detailed description of the
product or service being produced and sold; how and where it will be produced,
who is likely to buy it, and in what quantities
 The market: describe the market research that has been carried out, what it has
revealed and details of prospective customers and competitors
 Advertising and promotion: how the business will be advertised to potential
customers and details of estimated costs of marketing
 Premises and equipment: details of planning regulations, costs of premises and the
need for equipment and buildings
 Business organization: whether the enterprise will take the form of sole trader,
partnership, company, or cooperative
 Costs: indication of the cost of producing the product or service, the prices it
proposes to charge for the products
 Finance: how much of the capital will come from savings and how much will come
from borrowings
 Cash flow: forecast income (revenue) and outgoings (expenditures) over the first
year
 Expansion: brief explanation of future plans
Making a business plan before actually starting the business can be very helpful.
By documenting the various details about the business, the owners will find it
much easier to run it. There is a lesser chance of losing sight of the mission and
vision of the business as the objectives have been written down. Moreover, having
the objectives of the business set down clearly will help motivate the employees.
A new entrepreneur will find it easier to get a loan or overdraft from the bank if
they have a business plan.

Government support for business startups

According to startup.com, “a startup is a company typically in the early stages of
its development. These entrepreneurial ventures are typically started by 1-3
founders who focus on capitalizing upon a perceived market demand by
developing a viable product, service, or platform”.
Why do governments want to help new start-ups?
 They provide employment to a lot of people
 They contribute to the growth of the economy
 They can also, if they grow to be successful, contribute to the exports of the
country
 Start-ups often introduce fresh ideas and technologies into business and industry
How do governments support businesses?
 Organise advice: provide business advice to potential entrepreneurs, giving them
information useful in staring a venture, including legal and bureaucratic ones
 Provide low cost premises: provide land at low cost or low rent for new firms
 Provide loans at low interest rates
 Give grants for capital: provide financial aid to new firms for investment
 Give grants for training: provide financial aid for workforce training
 Give tax breaks/ holidays: high taxes are a disincentive for new firms to set up.
Governments can thus withdraw or lower taxation for new firms for a certain
period of time

Measuring business size

Businesses come in many sizes. They can be owned by a single individual or have
up to 50 shareholders. They can employ thousands of workers or have a mere
handful. But how can we classify a business as big or small?

Business size can be measured in the following ways:

 Number of employees: larger firms have larger workforce employed

 Value of output: larger firms are likely to produce more than smaller ones
 Value of capital employed: larger businesses are likely to employ much more
capital than smaller ones
However, these methods have their limitations and are not always accurate.
Example: When using the ‘number of employees’ method to compare business size
is not accurate as a capital intensive firm ( one that employs a large amount of
capital equipment) can produce large output by employing very little labour
(workers). Similarly, value of capital employed is not a reliable measure when
comparing a capital-intensive firm with a labour-intensive firm. Output value is
also unreliable because some different types of products are valued differently, and
the size of the firm doesn’t depend on this.

Business growth
Businesses want to grow because growth helps reduce their average costs in the
long-run, help develop increased market share, and helps them produce and sell to
them to new markets.

There are two ways in which a business can grow- internally and externally.

Internal growth
This occurs when a business expands its existing operations. For example, when
a fast food chain opens a new branch in another country. This is a slow means of
growth but easier to manage than external growth.
External growth
This is when a business takes over or merges with another business. It is
sometimes called integration as one firm is ‘integrated’ into the other.
A merger is when the owner of two businesses agree to join their firms together to
make one business.
A takeover occurs when one business buys out the owners of another business ,
which then becomes a part of the ‘predator’ business.
External growth can largely be classified into three types:


 Horizontal merger/integration: This is when one firm merges with or takes
over another one in the same industry at the same stage of production. For
example, when a firm that manufactures furniture merges with another firm that
also manufacturers furniture.
Benefits:
 Reduces number of competitors in the market, since two firms become one.
 Opportunities of economies of scale.
 Merging will allow the businesses to have a bigger share of the total market.

 Vertical merger/integration: This is when one firm merges with or takes over
another firm in the same industry but at a different stage of production.
Therefore, vertical integration can be of two types:
 Backward vertical integration: When one firm merges with or takes over
another firm in the same industry but at a stage of production that is
behind the ‘predator’ firm. For example, when a firm that manufactures
furniture merges with a firm that supplies wood for manufacturing furniture.
Benefits:
 Merger gives assured supply of essential components.
 The profit margin of the supplying firm is now absorbed by the expanded
firm.
  The supplying firm can be prevented from supplying to competitors.
 Forward vertical integration: When one firm merges with or takes over
another firm in the same industry but at a stage of production that is ahead
of the ‘predator’ firm. For example, when a firm that manufactures
furniture merges with a furniture retail store.
Benefits:
 Merger gives assured outlet for their product.
 The profit margin of the retailer is now absorbed by the expanded firm.
 The retailer can be prevented from selling the goods of competitors.
 Conglomerate merger/integration: This is when one firm merges with or takes
over a firm in a completely different industry. This is also known as
‘diversification’. For example, when a firm that manufactures furniture merges
with a firm that produces clothing.
Benefits:
 Conglomerate integration allows businesses to have activities in more than one
country. This allows the firms to spread its risks.
 There could be a transfer of ideas between the two businesses even though they
are in different industries. This transfer o ideas could help improve the quality
and demand for the two products.

Drawbacks of growth
 Difficult to control staff: as a business grows, the business organisation in terms
of departments and divisions will grow, along with the number of employees,
making it harder to control, co-ordinate and communicate with everyone
 Lack of funds: growth requires a lot of capital.
 Lack of expertise: growth is a long and difficult process that will require people
with expertise in the field to manage and coordinate activities
 Diseconomies of scale: this is the term used to describe how average costs of a
firm tends to increase as it grows beyond a point, reducing profitability. This is
explored more deeply in a later section.

Why businesses stay small

Not all businesses grow.Some stay small, employ a handful of workers and have
little output. Here are the reasons why.
 Type of industry: some firms remain small due to the industry they operate in.
Examples of these are hairdressers, car repairs, catering, etc, which give personal
services and therefore cannot grow.
 Market size: if the firm operates in areas where the total number of customers is
small, such as in rural areas, there is no need for the firm to grow and thus stays
small.
 Owners’ objectives: not all owners want to increase the size of their firms and
profits. Some of them prefer keeping their businesses small and having a personal
contact with all of their employees and customers, having flexibility in controlling
and running the business, having more control over decision-making, and to keep
it less stressful.

Why businesses fail

Not all businesses are successful. The main reasons why they fail are:

 Poor management: this is a common cause of business failure for new firms. The
main reason is lack of experience and planning which could lead to bad decision
making. New entrepreneurs could make mistakes when choosing the location of
the firm, the raw materials to be used for production, etc, all resulting in failure
 Over-expansion: this could lead to diseconomies of scale and greatly increase
costs, if a firms expands too quickly or over their optimum level
 Failure to plan for change: the demands of customers keep changing with change
in tastes and fashion. Due to this, firms must always be ready to change their
products to meet the demand of their customers. Failure to do so could result in
losing customers and loss. They also won’t be ready to quickly keep up
with changes the competitors are making, and changes in laws and regulations
 Poor financial management: if the owner of the firm does not manage his
finances properly, it could result in cash shortages. This will mean that the
employees cannot be paid and enough goods cannot be produced. Poor cash flow
can therefore also cause businesses to fail
Why new businesses are at a greater risk of failure
 Less experience: a lack of experience in the market or in business gets a lot of
firms easily pushed out of the market
 New to the market: they may still not understand the nuances and trends of the
market, that existing competitors will have mastered
 Don’t a lot of sales yet: only by increasing sales, can new firms grow and find
their foothold in the market. At a stage when they’re not selling much, they are at a
greater risk of failing
 Don’t have a lot of money to support the business yet: financial issues can
quickly get the better of new firms if they aren’t very careful with their cash flows.
It is only after they make considerable sales and start making a profit, can they
reinvest in the business and support it
1.4 – Types of Business Organizations
Sole Trader/Sole Proprietorship

A business organization owned and controlled by one person. Sole traders can
employ other workers, but only he/she invests and owns the business.
Advantages:
 Easy to set up: there are very few legal formalities involved in starting and
running a sole proprietorship. A less amount of capital is enough by sole traders to
start the business. There is no need to publish annual financial accounts.
 Full control: the sole trader has full control over the business. Decision-making is
quick and easy, since there are no other owners to discuss matters with.
 Sole trader receives all profit: Since there is only one owner, he/she will receive
all of the profits the company generates.
 Personal: since it is a small form of business, the owner can easily create and
maintain contact with customers, which will increase customer loyalty to the
business and also let the owner know about consumer wants and preferences.
Disadvantages:
 Unlimited liability: if the business has bills/debts left unpaid, legal actions will be
taken against the investors, where their even personal property can be seized, if
their investments don’t meet the unpaid amount. This is because the business and
the investors are the legally not separate (unincorporated).
 Full responsibility: Since there is only one owner, the sole owner has to undertake
all running activities. He/she doesn’t have anyone to share his responsibilities with.
This workload and risks are fully concentrated on him/her.
 Lack of capital: As only one owner/investor is there, the amount of capital
invested in the business will be very low. This can restrict growth and expansion of
the business. Their only sources of finance will be personal savings or borrowing
or bank loans (though banks will be reluctant to lend to sole traders since it is
risky).
 Lack of continuity: If the owner dies or retires, the business dies with him/her.
Partnerships

A partnership is a legal agreement between two or more (usually, up to

twenty)people to own, finance and run a business jointly and to share all profits.
Advantages:
 Easy to set up: Similar to sole traders, very few legal formalities are required to
start a partnership business. A partnership agreement/ partnership deed is a legal
document that all partners have to sign, which forms the partnership. There is no
need to publish annual financial accounts.
 Partners can provide new skills and ideas: The partners may have some skills
and ideas that can be used by the business to improve business profits.
 More capital investments: Partners can invest more capital than what a sole trade
only by himself could.
Disadvantages:
 Conflicts: arguments may occur between partners while making decisions. This
will delay decision-making.
 Unlimited liability: similar to sole traders, partners too have unlimited liability-
their personal items are at risk if business goes bankrupt
 Lack of capital: smaller capital investments as compared to large companies.
 No continuity: if an owner retires or dies, the business also dies with them.
Joint-stock companies

These companies can sell shares, unlike partnerships and sole traders, to raise
capital. Other people can buy these shares (stocks) and become
a shareholder (owner) of the company. Therefore they are jointly owned by the
people who have bough it’s stocks. These shareholders then
receive dividends (part of the profit; a return on investment).
The shareholders in companies have limited liabilities. That is, only their
individual investments are at risk if the business fails or leaves debts. If the
company owes money, it can be sued and taken to court, but it’s shareholders
cannot. The companies have a separate legal identity from their owners, which is
why the owners have a limited liability. These companies are incorporated.
(When they’re unincorporated, shareholders have unlimited liability and don’t
have a separate legal identity from their business).
Companies also enjoys continuity, unlike partnerships and sole traders. That is,
the business will continue even if one of it’s owners retire or die.
Shareholders will elect a board of directors to manage and run the company in
it’s day-to-day activities. In small companies, the shareholders with the highest
percentage of shares invested are directors, but directors don’t have to be
shareholders. The more shares a shareholder has, the more their voting power.
These are two types of companies:
Private Limited Companies: One or more owners who can sell its’ shares to only
the people known by the existing shareholders (family and friends). Example: Ikea.
Public Limited Companies: Two or more owners who can sell its’ shares to any
 individual/organization in the general public through stock exchanges (see
Economics: topic 3.1 – Money and Banking). Example: Verizon Communications.
Advantages:
 Limited Liability: this is because, the company and the shareholders have separate
legal identities.
 Raise huge amounts of capital: selling shares to other people (especially in Public
Ltd. Co.s), raises a huge amount of capital, which is why companies are large.
 Public Ltd. Companies can advertise their shares, in the form of
a prospectus, which tells interested individuals about the business, it’s activities,
profits, board of directors, shares on sale, share prices etc. This will attract
investors.
Disadvantages:
 Required to disclose financial information: Sometimes, private limited
companies are required by law to publish their financial statements annually, while
for public limited companies, it is legally compulsory to publish all accounts and
reports. All the writing, printing and publishing of such details can prove to be
very expensive, and other competing companies could use it to learn the company
secrets.
 Private Limited Companies cannot sell shares to the public. Their shares can
only be sold to people they know with the agreement of other shareholders.
Transfer of shares is restricted here. This will raise lesser capital than Public Ltd.
Companies.
 Public Ltd. Companies require a lot of legal documents and investigations before
it can be listed on the stock exchange.
 Public and Private Limited Companies must also hold an Annual General
Meeting (AGM), where all shareholders are informed about the performance of
the company and company decisions, vote on strategic decisions and elect board of
directors. This is very expensive to set up, especially if there are thousands of
shareholders.
 Public Ltd. Companies may have managerial problems: since they are very
large, they become very difficult to manage. Communication problems may occur
which will slow down decision-making.
 In Public Ltd. Companies, there may be a divorce of ownership and control:
The shareholders can lose control of the company when other large shareholders
outvote them or when board of directors control company decisions.
A summary of everything learned until now, in this section, in case you’re getting
confused:
Franchises

The owner of a business (the franchisor) grants a licence to another person or

business (the franchisee) to use their business idea – often in a specific
geographical area. Fast food companies such as McDonald’s and Subway operate
around the globe through lots of franchises in different countries.
ADVANTAGES DISADVANTAGES

TO Rapid, low cost Profits from the

FRANCHISOR method of business franchise needs to be
expansion shared with the
Gets and income from franchisee
franchisee in the form Loss of control over
of franchise fees and running of business
royalties
If one franchise fails,
Franchisee will better it can affect the
understand the local reputation of the
tastes and so can entire brand
advertise and sell
appropriately Franchisee may not
be as skilled
Can access ideas and
 suggestions from Need to supply raw
franchisee material/product and
provide support and
Franchisee will run training
the operations

TO An established brand Cost of setting up

FRANCHISEE and trademark, so business
chance of business No full control over
failing is low business- need to
Franchisor will give strictly follow
technical and franchisor’s standards
managerial support and rules

Franchisor will Profits have to be

supply the raw shared with
materials/products franchisor

Need to pay
franchisor franchise
fees and royalties

Need to advertise and

promote the business
in the region
themselves

Joint Ventures

Joint venture is an agreement between two or more businesses to work together

on a project. The foreign business will work with a domestic business in the same
industry. Eg: Google Earth is a joint venture/project between Google and NASA.
Advantages
 Reduces risks and cuts costs
 Each business brings different expertise to the joint venture
 The market potential for all the businesses in the joint venture is increased
 Market and product knowledge can be shared to the benefit of the businesses
 Disadvantages
 Any mistakes made will reflect on all parties in the joint venture, which may
damage their reputations
 The decision-making process may be ineffective due to different business culture
or different styles of leadership
Public Sector Corporations

Public sector corporations are businesses owned by the government and run by
directors appointed by the government. They usually provide essentials services
like water, electricity, health services etc. The government provides the capital to
run these corporations in the form of subsidies (grants). The UK’s National Health
Service (NHS) is an example. Public corporations aim to:
 to keep prices low so everybody can afford the service.
 to keep people employed.
 to offer a service to the public everywhere.
Advantages:
 Some businesses are considered too important to be owned by an individual.
(electricity, water, airline)
 Other businesses, considered natural monopolies, are controlled by the
government. (electricity, water)
 Reduces waste in an industry. (e.g. two railway lines in one city)
 Rescue important businesses when they are failing through nationalisation
 Provide essential services to the people
Drawbacks:
 Motivation might not be as high because profit is not an objective
 Subsidies lead to inefficiency. It is also considered unfair for private businesses
 There is normally no competition to public corporations, so there is no incentive
to improve
 Businesses could be run for government popularity
1.5 – Business Objectives and Stakeholder Objectives

Business objectives

Business objectives are the aims and targets that a business works towards to help
it run successfully. Although the setting of these objectives does not always
guarantee the business success, it has its benefits.
 Setting objectives increases motivation as employees and managers now have
clear targets to work towards.
 Decision making will be easier and less time consuming as there are set targets to
base decisions on. i.e., decisions will be taken in order to achieve business
objectives.
 Setting objectives reduces conflicts and helps unite the business towards reaching
the same goal.
 Managers can compare the business’ performance to its objectives and make any
changes in its activities if required.
Objectives vary with different businesses due to size, sector and many other
factors. However, many business in the private sector aim to achieve the following
objectives.

 Survival: new or small firms usually have survival as a primary objective. Firms
in a highly competitive market will also be more concerned with survival rather
than any other objective. To achieve this, firms could decide to lower prices, which
would mean forsaking other objectives such as profit maximization.
 Profit: this is the income of a business from its activities after deducting total
costs. Private sector firms usually have profit making as a primary objective. This
is because profits are required for further investment into the business as well as
for the payment of return to the shareholders/owners of the business.
 Growth: once a business has passed its survival stage it will aim for growth and
expansion. This is usually measured by value of sales or output. Aiming for
business growth can be very beneficial. A larger business can ensure greater
job security and salaries for employees. The business can also benefit from
higher market share and economies of scale.
 Market share: this can be defined as the proportion of total market sales achieved
by one business. Increased market share can bring about many benefits to the
business such as increased customer loyalty, setting up of brand image, etc.
 Service to the society: some operations in the private sectors such as social
enterprises do not aim for profits and prefer to set more economical objectives.
They aim to better the society by providing social,
environmental and financial aid. They help those in need, the underprivileged,
the unemployed, the economy and the government.
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A business’ objectives do not remain the same forever. As market situations
change and as the business itself develops, its objectives will change to reflect its
current market and economic position. For example, a firm facing serious
 economic recession could change its objective from profit maximization to short
term survival.

Stakeholders

A stakeholder is any person or group that is interested in or directly affected

by the performance or activities of a business. These stakeholder groups can be
external – groups that are outside the business or they can be internal – those
groups that work for or own the business.
Internal stakeholders:

 Shareholder/ Owners: these are the risk takers of the business. They invest
capital into the business to set up and expand it. These shareholders are liable to a
share of the profits made by the business.
Objectives:
 Shareholders are entitled to a rate of return on the capital they have
invested into the business and will therefore have profit maximization as an
objective.
 Business growth will also be an important objective as this will ensure that the
value of the shares will increase.
 Workers: these are the people that are employed by the business and are
directly involved in its activities.
Objectives:
 Contract of employment that states all the right and responsibilities to and of
the employees.
 Regular payment for the work done by the employees.
 Workers will want to benefit from job satisfaction as well as motivation.
 The employees will want job security– the ability to be able to work without
the fear of being dismissed or made redundant.
 Managers: they are also employees but managers control the work of
others. Managers are in charge of making key business decisions.
Objectives:
 Like regular employees, managers too will aim towards a secure job.
 Higher salaries due to their jobs requiring more skill and effort.
 Managers will also wish for business growth as a bigger business means that
managers can control a bigger and well known business.
External Stakeholders:
 Customers: they are a very important part of every business. They purchase and
consume the goods and services that the business produces/ provides. Successful
businesses use market research to find out customer preferences before producing
their goods.
Objectives:
 Price that reflects the quality of the good.
 The products must be reliable and safe. i.e., there must not be any false
advertisement of the products.
 The products must be well designed and of a perceived quality.
 Government: the role of the government is to protect the workers and
customers from the business’ activities and safeguard their interests.
Objectives:
 The government will want the business to grow and survive as they will bring a
lot of benefits to the economy. A successful business will help increase the
total output of the country, will improve employment as well as increase
government revenue through payment of taxes.
 They will expect the firms to stay within the rules and regulations set by the
government.
 Banks: these banks provide financial help for the business’ operations’
Objectives:
 The banks will expect the business to be able to repay the amount that has been
lent along with the interest on it. The bank will thus have business liquidity as
its objective.
 Community: this consists of all the stakeholder groups, especially the third parties
that are affected by the business’ activities.
Objectives:
 The business must offer jobs and employ local employees.
 The production process of the business must in no way harm the
environment.
 Products must be socially responsible and must not pose any harmful effects
from consumption.

Public- sector businesses

Government owned and controlled businesses do not have the same objectives as
those in the private sector.

Objectives:
 Financial: although these businesses do not aim to maximize profits, they will
have to meet the profit target set by the government. This is so that it can be
reinvested into the business for meeting the needs of the society
 Service: the main aim of this organization is to provide a service to the community
that must meet the quality target set by the government
 Social: most of these social enterprises are set up in order to aid the community.
This can be by providing employment to citizens, providing good quality goods
and services at an affordable rate, etc.
 They help the economy by contributing to GDP, decreasing unemployment rate
and raising living standards.
This is in total contrast to private sector aims like profit, growth, survival, market
share etc.

Conflicts of stakeholders’ objectives

As all stakeholders have their own aims they would like to achieve, it is natural
that conflicts of stakeholders’ interests could occur. Therefore, if a business tries to
satisfy the objectives of one stakeholder, it might mean that another stakeholders’
objectives could go unfulfilled.

For example, workers will aim towards earning higher salaries. Shareholders
might not want this to happen as paying higher salaries could mean that less profit
will be left over for payment of return to the shareholders.
Similarly, the business might want to grow by expanding operations to build new
factories. But this might conflict with the community’s want for clean and
pollution-free localities.

2.1 – Motivating Workers

Motivation

People work for several reasons:

 Have a better standard of living: by earning incomes they can satisfy their needs
and wants
 Be secure: having a job means they can always maintain or grow that standard of
living
 Gain experience and status: work allows people to get better at the job they do and
earn a reputable status in society
 Have job satisfaction: people also work for the satisfaction of having a job
Motivation is the reason why employees want to work hard and work
effectively for the business. Money is the main motivator, as explained above.
Other factors that may motivate a person to choose to do a particular job may
include social needs (need to communicate and work with others), esteem
needs (to feel important, worthwhile), job satisfaction (to enjoy good
work), security (knowing that your job and pay are secure- that you will not lose
your job).
Why motivate workers? Why do firms go to the pain of making sure their
workers are motivated? When workers are well-motivated, they become highly
productive and effective in their work, become absent less often, and less
likely to leave the job, thus increasing the firm’s efficiency and output, leading
to higher profits. For example, in the service sector, if the employee is unhappy at
his work, he may act lazy and rude to customers, leading to low customer
satisfaction, more complaints and ultimately a bad reputation and low profits.

Motivation Theories

 F. W. Taylor: Taylor based his ideas on the assumption that workers were
motivated by personal gains, mainly money and that increasing pay would
increase productivity (amount of output produced). Therefore he proposed
the piece-rate system, whereby workers get paid for the number of output they
produce. So in order, to gain more money, workers would produce more. He also
suggested a scientific management in production organisation, to break down
labour (essentially division of labour) to maximise output
However, this theory is not entirely true. There are various other motivators in the
modern workplace, some even more important than money. The piece rate system
is not very practical in situations where output cannot be measured (service
industries) and also will lead to (high) output that doesn’t guarantee high quality.
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 Maslow’s Hierarchy: Abraham Maslow’s hierarchy of needs shows

that employees are motivated by each level of the hierarchy going from bottom
to top. Mangers can identify which level their workers are on and then take the
necessary action to advance them onto the next level.
 One limitation of this theory is that it doesn’t apply to every worker. For some
employees, for example, social needs aren’t important but they would be motivated
by recognition and appreciation for their work from seniors.

 Herzberg’s Two-Factor Theory: Frederick Herzberg’s two-factor theory,

wherein he states that people have two sets of needs:
Basic animal needs called ‘hygiene factors’:
 status
 security
 work conditions
 company policies and administration
 relationship with superiors
 relationship with subordinates
 salary
Needs that allow the human being to grow psychologically, called the
‘motivators’:

 achievement
 recognition
 personal growth/development
 promotion
 work itself
According to Herzberg, the hygiene factors need to be satisfied, if not they will act
as de-motivators to the workers. However hygiene factors don’t act as motivators
as their effect quickly wear off. Motivators will truly motivate workers to work
more effectively.
 Motivating Factors

Financial Motivators
 Wages: often paid weekly. They can be calculated in two ways:
 Time-Rate: pay based on the number of hours worked. Although output may
increase, it doesn’t mean that workers will work sincerely use the time to
produce more- they may simply waste time on very few output since their pay
is based only on how long they work. The productive and unproductive worker
will get paid the same amount, irrespective of their output.
 Piece-Rate: pay based on the no. of output produced. Same as time-rate, this
doesn’t ensure that quality output is produced. Thus, efficient workers may feel
demotivated as they’re getting the same pay as inefficient workers, despite their
efficiency.
 Salary: paid monthly or annually.
 Commission: paid to salesperson, based on a percentage of sales they’ve made.
The higher the sales, the more the pay. Although this will encourage salespersons
to sell more products and increase profits, it can be very stressful for them because
no sales made means no pay at all.
 Bonus: additional amount paid to workers for good work
 Performance-related pay: paid based on performance. An appraisal (assessing the
effectiveness of an employee by senior management through interviews,
observations, comments from colleagues etc.) is used to measure this performance
and a pay is given based on this.
 Profit-sharing: a scheme whereby a proportion of the company’s profits is
distributed to workers. Workers will be motivated to work better so that a higher
profit is made.
 Share ownership: shares in the firm are given to employees so that they can
become part owners of the company. This will increase employees’ loyalty to the
company, as they feel a sense of belonging.
Non-Financial Motivators
 Fringe benefits are non-financial rewards given to employees
 Company vehicle/car
 Free healthcare
 Children’s education fees paid for
 Free accommodation
 Free holidays/trips
 Discounts on the firm’s products
 Job Satisfaction: the enjoyment derived from the feeling that you’ve done a
good job. Employees have different ideas about what motivates them- it could be
pay, promotional opportunities, team involvement, relationship with superiors,
level of responsibility, chances for training, the working hours, status of the job
etc. Responsibility, recognition and satisfaction are in particular very important.
So, how can companies ensure that they’re workers are satisfied with the job, other
than the motivators mentioned above?

 Job Rotation: involves workers swapping around jobs and doing each specific
task for only a limited time and then changing round again. This increases the
variety in the work itself and will also make it easier for managers to move around
workers to do other jobs if somebody is ill or absent. The tasks themselves are not
made more interesting, but the switching of tasks may avoid boredom among
workers. This is very common in factories with a huge production line where
workers will move from retrieving products from the machine to labelling the
products to packing the products to putting the products into huge cartons.
 Job Enlargement: where extra tasks of similar level of work are added to a
worker’s job description. These extra tasks will not add greater responsibility or
work for the employee, but make work more interesting. E.g.: a worker hired to
stock shelves will now, as a result of job enlargement, arrange stock on shelves,
label stock, fetch stock etc.
 Job Enrichment: involves adding tasks that require more skill and
responsibility to a job. This gives employees a sense of trust from senior
management and motivate them to carry out the extra tasks effectively. Some
additional training may also be given to the employee to do so. E.g.: a receptionist
employed to welcome customers will now, as a result of job enrichment, deal with
telephone enquiries, word-process letters etc.
 Team-working: a group of workers is given responsibility for a particular
process, product or development. They can decide as a team how to organize and
carry out the tasks. The workers take part in decision making and take
responsibility for the process. It gives them more control over their work and thus a
sense of commitment, increasing job satisfaction. Working as a group will also add
to morale, fulfill social needs and lead to job satisfaction.
 Opportunities for training: providing training will make workers feel that their
work is being valued. Training also provides them opportunities for personal
growth and development, thereby attaining job satisfaction
 Opportunities of promotion: providing opportunities for promotion will get
workers to work more efficiently and fill them with a sense of self-actualisation
and job satisfaction
2.2 – Organization and Management
 Organizational Structure

Organizational structure refers to the levels of management and division of

responsibilities within a business. They can be represented on organizational charts
(left).

Advantages:
 All employees are aware of which communication channel is used to reach them
with messages
 Everyone knows their position in the business. They know who they are
accountable to and who they are accountable for
 It shows the links and relationship between the different departments
 Gives everyone a sense of belonging as they appear on the organizational chart

The span of control is the number of subordinates working directly under a

manager in the organizational structure. In the above figure, the managing
director’s span of control is four. The marketing director’s span of control is the
number of marketing managers working under him (it is not specified how many,
in the figure).
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The chain of command is the structure of an organization that allows instructions
to be passed on from senior managers to lower levels of management. In the
above figure, there is a short chain of command since there are only four levels of
management shown.
Now, if you look closely,there is a link between the span of control and chain of
command. The wider the span of control the shorter the chain of
command since more people will appear horizontally aligned on the chart than
vertically. A short span of control often leads to long chain of command. (If you
don’t understand, try visualizing it on an organizational chart).
Advantages of a short chain of command (these are also the disadvantages of a
long chain of command):
 Communication is quicker and more accurate
 Top managers are less remote from lower employees, so employees will be
more motivated and top managers can always stay in touch with the employees
 Spans of control will be wider, This means managers have more people to control
This is beneficial because it will encourage them to delegate responsibility (give
work to subordinates) and so the subordinates will be more motivated and feel
trusted. However there is the risk that managers may lose control over the tasks.

Line Managers have authority over people directly below them in the
organizational structure. Traditional marketing/operations/sales managers are good
examples.
Staff Managers are specialists who provide support, information and assistance to
line managers. The IT department manager in most organisations act as staff
managers.
Management

So,, what role do manager really have in an organization? Here are their five
primary roles:

 Planning: setting aims and targets for the organisations/department to achieve. It

will give the department and it’s employees a clear sense of purpose and direction.
Managers should also plan for resources required to achieve these targets – the
number of people required, the finance needed etc.
 Organizing: managers should then organize the resources. This will include
allocating responsibilities to employees, possibly delegating.
 Coordinating: managers should ensure that each department is coordinating
with one another to achieve the organization’s aims. This will involve effective
 communication between departments and managers and decision making. For
example, the sales department will need to tell the operations dept. how much they
should produce in order to reach the target sales level. The operations dept. will in
turn tell the finance dept. how much money they need for production of those
goods. They need to come together regularly and make decisions that will help
achieve each department’s aims as well as the organization’s.
 Commanding: managers need to guide, lead and supervise their employees in
the tasks they do and make sure they are keeping to their deadlines and achieving
targets.
 Controlling: managers must try to assess and evaluate the performance of each
of their employees. If some employees fail to achieve their target, the manager
must see why it has occurred and what he can do to correct it- maybe some training
will be required or better equipment.

Delegation is giving a subordinate the authority to perform some tasks.

Advantages to managers:
 managers cannot do all work by themselves
 managers can measure the efficiency and effectiveness of their subordinates’ work
However, managers may be reluctant to delegate as they may lose their control
over the work.

Advantages to subordinates:
 the work becomes more interesting and rewarding- increased job satisfaction
 employees feel more important and feel trusted– increasing loyalty to firm
 can act as a method of training and opportunities for promotions, if they do a good
job.

Leadership Styles

Leaderships styles refer to the different approaches used when dealing with
people when in a position of authority. There are mainly three styles you need to
learn: the autocratic, democratic and laissez-faire styles.
Autocratic style is where the managers expects to be in charge of the business and
have their orders followed. They do all the decision-making, not involving
employees at all. Communication is thus, mainly one way- from top to bottom.
This is standard in police and armed forces organizations.
Democratic style is where managers involve employees in the decision-making
and communication is two-way from top to bottom as well as bottom to top.
Information about future plans is openly communicated and discussed with
employees and a final decision is made by the manager.
Laissez-faire (French phrase for ‘leave to do) style makes the broad objectives of
the business known to employees and leaves them to do their own decision-
making and organize tasks. Communication is rather difficult since a clear
direction is not given. The manger has a very limited role to play.

Trade Unions

A trade union is a group of workers who have joined together to ensure their
interest are protected. They negotiate with the employer (firm) for better
conditions and treatment and can threaten to take industrial action if their requests
are denied. Industrial action can include overtime ban (refusing to work overtime),
go slow (working at the slowest speed as is required by the employment contract),
strike (refusing to work at all and protesting instead) etc. Trade unions can also
seek to put forward their views to the media and influence government decisions
relating to employment.
Benefits to workers of joining a trade union:
 strength in number- a sense of belonging and unity
 improved conditions of employment, for example, better pay, holidays, hours of
work etc
 improved working conditions, foe example, health and safety
 improved benefits for workers who are not working, because they’re sick, retired
or made redundant (dismissed not because of any fault of their own)
 financial support if a member thinks he/she has been unfairly dismissed or treated
 benefits that have been negotiated for union member such as discounts on firm’s
products, provision of health services.
Disadvantages to workers of joining a trade unions:

 costs money to be member- a membership fee will be required

 may be asked to take industrial action even if they don’t agree with the union- they
may not get paid during a strike, for example.

2.3 – Recruitment, Selection

and Training of Workers
The Role of the H.R. (Human Resource) Department
 Recruitment and selection: attracting and selecting the best candidates for job posts
 Wages and salaries: set wages and salaries that attract and retain employees as well
as motivate them
 Industrial relations: there must be effective communication between management and
workforce to solve complaints and disputes as well as discussing ideas and suggestions
 Training programmes: give employees training to increase their productivity and
efficiency
 Health and safety: all laws on health and safety conditions in the workplace should be
adhered to
 Redundancy and dismissal: the managers should dismiss any
unsatisfactory/misbehaving employees and make them redundant if they are no longer
needed by the business.

Recruitment
Job Analysis, Description and Specification
Recruitment is the process from identifying that the business needs to employ someone
up to the point where applications have arrived at the business.

A vacancy arises when an employee resigns from a job or is dismissed by the

management. When a vacancy arises, a job analysis has to be prepared. A job
 analysis identifies and records the tasks and responsibilities relating to the job. It
will tell the managers what the job post is for.

Then a job description is

prepared that outlines the responsibilities and duties to be carried out by
someone employed to do the job. It will have information about the conditions of
employment (salary, working hours, and pension scheme), training offered,
opportunities for promotion etc. This is given to all prospective candidates so they know
what exactly they will be required and expected to do.
Once this has been done, the H.R. department will draw up a job specification, a
document that outlines the requirements, qualifications, expertise, skills,
physical/personal characteristics etc. required by an employee to be able to take
up the job.
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Advertising the vacancy

Internal recruitment is when a vacancy is filled by an existing employee of the
business.
Advantages:
 Saves time and money- no need for advertising and interviewing
 Person already known to business
 Person knows business’ ways of working
 Motivating for other employees to see their colleagues being promoted- urging them to
work hard
Disadvantages:
 No new skills and experience coming into the business
 Jealousy among workers
External recruitment is when a vacancy is filled by someone who is not an existing
employee and will be new to the business. External recruitment needs to be
advertised, unlike internal recruitment. This can be done in local/national newspapers,
specialist magazines and journals, job centres run by the government (where job
vacancies are posted and given to interested people; usually for unskilled or semi-
 skilled jobs) or even recruitment agencies (who will recruit and send along candidates
to the company when they request it).
When advertising a job, the business needs to decide what should be included in the
advertisement, where it should be advertised, how much it will cost and whether it will
be cost-effective.

When a person is interested in a job, they should apply for it by sending in a curriculum
vitae (CV) or resume, this will detail the person’s qualifications, experience, qualities
and skills.The business will use these to see which candidates match the job
specification. It will also include statements of why the candidate wants the job and why
he/she feels they would be suitable for the job.
Selection
Applicants who are shortlisted will be interviewed by the H.R. manager. They will also
call up the referee provided by the applicant (a referee could be the previous employer
or colleagues who can give a confidential opinion about the applicant’s reliability,
honesty and suitability for the job). Interviews will allow the manager to assess:
 the applicant’s ability to do the job
 personal qualities of the applicant
 character and personality of applicant
In addition to interviews, firms can conduct certain tests to select the best
candidate. This could include skills tests (ability to do the job), aptitude tests
(candidate’s potential to gain additional skills), personality tests (what kind of a
personality the candidate has- will it be suitable for the job?), group situation tests (how
they manage and work in teams) etc.
When a successful candidate has been selected the others must be sent a letter of
rejection.

The contract of employment: a legal agreement between the employer and the
employee listing the rights and responsibilities of workers. It will include:
 the name of employer and employee
 job title
 date when employment will begin
 hours to work
 rate of pay and other benefits
 when payment is made
 holiday entitlement
 the amount of notice to be given to terminate the employment that the employer or
employee must give to end the employment etc.
Employment contracts can be part-time or full-time. Part-time employment is often
considered to be between 1 and 30-35 hours a week whereas full-time
employment will usually work 35 hours or more a week.
Advantages to employer of part-time employment (disadvantages of full-time
employment to employer):
 more flexible hours of work
 easier to ask employees just to work at busy times
 easier to extend business opening/operating hours by working evenings or at weekends
 works lesser hours so employee is willing to accept lower pay
 less expensive than employing and paying full-time workers.
Disadvantages to employer of part-time employment (advantages of full-time
employment to employers)
 less likely to be trained because the workers see the job as temporary
 takes longer to recruit two part-time workers than one full-time worker
 can be less committed to the business/ more likely to leave and go get another job
 less likely to be promoted because they will not have gained the skills and experience
as full-time employees
 more difficult to communicate with part-time workers when they are not in work- all work
at different times.
Training
Training is important to a business as it will improve the worker’s skills and
knowledge and help the business be more efficient and productive, especially
when new processes and products are introduced. It will improve the workers’ chances
at getting promoted and raise their morale.
The three types of training are:

 Induction training: an introduction given to a new employee, explaining the firm’s

activities, customs and procedures and introducing them to their fellow workers.
Advantages:


 Helps new employees to settle into their job quickly
 May be a legal requirement to give health and safety training before the start of work
 Less likely to make mistakes
Disadvantages:

 Time-consuming
 Wages still have to be paid during training, even though they aren’t working
 Delays the state of the employee starting the job
 On-the-job training: occurs by watching a more experienced worker doing the job
Advantages:

 It ensures there is some production from worker whilst they are training
 It usually costs less than off-the-job training
 It is training to the specific needs of the business
Disadvantages:

 The trainer will lose some production time as they are taking some time to teach the
new employee
 The trainer may have bad habits that can be passed onto the trainee
  It may not necessarily be recognised training qualifications outside the business
 Off-the-job training: involves being trained away from the workplace, usually by
specialist trainers
Advantages:

 A broad range of skills can be taught using these techniques
 Employees may be taught a variety of skills and they may become multi-skilled that
can allow them to do various jobs in the company when the need arises.
Disadvantages:

 Costs are high
 It means wages are paid but no work is being done by the worker
 The additional qualifications means it is easier for the employee to leave and find
another job

Workforce Planning
Workforce Planning: the establishing of the workforce needed by the business for the
foreseeable future in terms of the number and skills of employees required.
They may have to downsize (reduce the no. of employees) the workforce because of:

 Introduction of automation
 Falling demand for their products
 Factory/shop/office closure
 Relocating factory abroad
 A business has merged or been taken over and some jobs are no longer needed
They can downsize the workforce in two ways:

 Dismissal: where a worker is told to leave their job because their work or behaviour is
unsatisfactory.
 Redundancy: when an employee is no longer needed and so loses their work, through
not due to any fault of theirs. They may be given some money as compensation for the
redundancy.
Worker could also resign (they are leaving because they have found another job) and
retire (they are getting old and want to stop working).

Legal Controls over Employment Issues

There are lot so government laws that affect equal employment opportunities. These
laws require businesses to treat their employees equally in the workplace and when
being recruited and selected- there should be no discrimination based on age, gender,
religion, race etc.
 Employees are protected in many areas including

 against unfair discrimination

 health and safety at work (protection from dangerous machinery, safety clothing and
equipment, hygiene conditions, medical aid etc.)
 against unfair dismissal
 wage protection (through the contract of employment since it will have listed the pay
and conditions). Many countries have a legal minimum wage– the minimum wage an
employer has to pay its employee. This avoids employers from exploiting its employees,
and encourages more people to find work, but since costs are rising for the business,
they may make many workers redundant- unemployment will rise.
An industrial tribunal is a legal meeting which considers workers’ complaints of unfair
dismissal or discrimination at work. This will hear both sides of the case and may give
the worker compensation if the dismissal was unfair.
2.4 – Internal and External Communication
Effective Communication
Communication is the transferring of a message from the sender to the
receiver, who understands the message.
Internal communication is between two members of the same organisations.
Example: communication between departments, notices and circulars to workers,
signboards and labels inside factories and offices etc.
External communication is between the organisation and other organisations or
individuals. Example: orders of goods to suppliers, advertising of products,
sending customers messages about delivery, offers etc.
Effective communication involves:
 A transmitter/sender of the message
 A medium of communication eg: letter, telephone conversation, text message
 A receiver of the message
 A feedback/response from the receiver to confirm that the message has benn
received and acknowledged.
One-way communication involves a message which does not require a feedback.
Example: signs saying ‘no smoking’ or an instruction saying ‘deliver these goods
to a customer’
Two-way communication is when the receiver gives a response to the message
received. Example: a letter from one manager to another about an important matter
that needs to be discussed. A two-way communication ensures that the person
receiving the message understands it and has acted up on it. It also makes the
receiver feel more a part of the process- could be a way of motivating employees.
Downward communication: messages from managers to subordinates i.e. from
top to bottom of an organization structure.
 Upward communication: messages/feedback from subordinates to managers i.e.
from bottom to the top of an organization structure
Horizontal communication occurs between people on the same level of an
organization structure.

Communication Methods

Verbal methods (eg: telephone conversation, face-to-face conversation, video

conferencing, meetings)
Advantages:

 Quick and efficient

 There is an opportunity for immediate feedback
 Speaker can reinforce the message- change his tone, body language etc. to
influence the listeners.
Disadvantages:

 Can take long if there is feedback and therefore, discussions

 In a meeting, it cannot be guaranteed that everybody is listening or has understood
the message
 No written record of the message can be kept for later reference.

Written methods (eg: letters, memos, text-messages, reports, e-mail, social media,
faxes, notices, signboards)
Advantages:

 There is evidence of the message for later reference.

 Can include details
 Can be copied and sent to many people, especially with e-mail
 E-mail and fax is quick and cheap
Disadvantages:

 Direct feedback may not always be possible

 Cannot ensure that message has been received and/or acknowledged
 Language could be difficult to understand.
 Long messages may cause disinterest in receivers
 No opportunity for body language to be used to reinforce messages
 Visual Methods (eg: diagrams, charts, videos, presentations, photographs,
cartoons, posters)
Advantages:

 Can present information in an appealing and attractive way

 Can be used along with written material (eg: reports with diagrams and charts)
Disadvantages:

 No feedback
 May not be understood/ interpreted properly.

Factors that affect the choice of an appropriate communication method:

 Speed: if the receiver has to get the information quickly, then a telephone call or
text message has to be sent. If speed isn’t important, a letter or e-mail will be more
appropriate.
 Cost: if the company wishes to keep costs down, it may choose to use letters or
face-to-face meetings as a medium of communication. Otherwise, telephone,
posters etc. will be used.
 Message details: if the message is very detailed, then written and visual methods
will be used.
 Leadership style: a democratic style would use two-way communication methods
such as verbal mediums. An autocratic one would use notices and announcements.
 The receiver: if there is only receiver, then a personal face-to-face or telephone
call will be more apt. If all the staff is to be sent a message, a notice or e-mail will
be sent.
 Importance of a written record: if the message is one that needs to have a written
record like a legal document or receipts of new customer orders, then written
methods will be used.
 Importance of feedback: if feedback is important, like for a quick query, then a
direct verbal or written method will have to be used.
Formal communication is when messages are sent through established channels
using professional language. Eg: reports, emails, memos, official meetings.
Informal communication is when information is sent and received casually with
the use of everyday language. Eg: staff briefings. Managers can sometimes use the
‘grapevine’ (informal communication among employees- usually where rumours
and gossips spread!) to test out the reactions to new ideas (for example, a new shift
system at a factory) before officially deciding whether or not to make it official.

Communication Barriers
Communication barriers are factors that stop effective communication of
messages.

3.1 – Marketing, Competition and the Customer

A market consists of all buyers and sellers of a particular good.
What is marketing?
 By definition, marketing is the management process responsible for identifying,
anticipating and satisfying consumers’ requirements profitably.

The role of marketing in a business is as follows:

 Identifying customer needs through market research
 Satisfying customer needs by producing and selling goods and services
 Maintaining customer loyalty: building customer relationships through a variety
of methods that encourage customers to keep buying one firm’s products instead of
their rivals’. For example, loyalty card schemes, discounts for continuous
purchases, after-sales services, messages that inform past customers of new
products and offers etc.
 Gain information on customers: by understanding why customers buy their
products, a firm can develop and sell better products in the future
 Anticipate changes in customer needs: the business will need to keep looking for
any changes in customer spending patterns and see if they can produce goods that
customers want that are not currently available in the market.
Some objectives the marketing department in a firm may have:
 Raise awareness of their product(s)
 Increase sales revenue and profits
 Increase or maintain market share (this is the proportion of sales a company has in
the overall market sales. For example, if in a market, $1 million worth of toys were
sold in a year and company A’s total sales was $30,000 in that year, company A’s
market share for the year is ($300,000/ $1000000) *100 = 30%)
 Enter new markets at home or abroad
 Develop new products or improve existing products.
Market Changes
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Why customer spending patterns may change:
 change in their tastes and preferences
 change in technology: as new technology becomes available, the old versions of
products become outdated and people want more sophisticated features on
products
 change in income: the higher the income, the more expensive goods consumers
will buy and vice versa
 ageing population: in many countries, the proportion of older people is increasing
and so demand for products for seniors are increasing (such as anti-ageing creams,
medical assistance etc.)
The power and importance of changing customer needs:
 Firms need to always know what their consumers want (and they will need to
undertake lots of research and development to do so) in order to stay ahead of
competitors and stay profitable. If they don’t produce and sell what customers
want, they will buy competitors’ products and the firm will fail to survive.

Why some markets have become more competitive:

 Globalization: products are being sold in markets all over the world, so there are
more competitors in the market
 Improvement in transportation infrastructures: better transport systems means
that it is easier and cheaper to distribute and sell products everywhere
 Internet/E-Commerce: customers can now buy products over the internet form
anywhere in the world, making the market more competitive
How business can respond to changing spending patterns and increased
competition:
A business has to ensure that it maintains its market share and remains competitive
in the market. It can ensure this by:

 maintaining good customer relationships: by ensuring that customers keep

buying from their business only, they can keep up their market share. By doing so,
they can also get information about their spending patterns and respond to their
wants and needs to increase market share
 keep improving its existing products, so that sales is maintained.
 introduce new products to keep customers coming back, and drive them away
from competitors’ products
 keep costs low to maintain profitability: low costs means the firm can afford to
charge low prices. And low prices generally means more demand and sales, and
thus market share.

Niche & Mass Marketing

Niche Marketing: identifying and exploiting a small segment of a larger market
by developing products to suit it. For example, Versace designs and Clique
perfumes have niche markets- the rich, high-status consumer group.
Advantages:
 Small firms can thrive in niche markets where large forms have not yet been
established
 If there are no or very few competitors, firms can sell products at a high
price and gain high profit margins because customers will be willing be willing to
pay more for exclusive products
 Firms can focus on the needs of just one customer group, thereby giving them an
advantage over large firms who only sell to the mass market
 Limitations:
 Lack of economies of scale (can’t benefit from the lower costs that arise from a
larger operations/market)
 Risk of over-dependence on a single product or market: if the demand for the
product falls, the firm won’t have a mass product they can fall back on
 Likely to attract competition if successful

Mass Marketing: selling the same product to the whole market with no attempt to
target groups with in it. For example, the iPhone sold is the same everywhere, there
are no variations in design over location or income.
Advantages:
 Larger amount of sales when compared to a niche market
 Can benefit from economies of scale: a large volume of products are produced and
so the average costs will be low when compared to a niche market
 Risks are spread, unlike in a niche market. If the product isn’t successful in one
market, it’s fine as there are several other markets
 More chances for the business to grow since there is a large market. In niche
markets, this is difficult as the product is only targeted towards a particular group.
Limitations:
 They will have to face more competition
 Can’t charge a higher price than competition because they’re all selling similar
products

Market Segmentation
A market segment is an identifiable sub-group of a larger market in which
consumers have similar characteristics and preferences

Market segmentation is the process of dividing a market of potential customers

into groups, or segments, based on different characteristics. For example, PepsiCo
identified the health-conscious market segment and targeted/marketed the Diet
Coke towards them.

Markets can be segmented on the basis of socio-economic

groups (income), age, location, gender, lifestyle, use of the product (home/
work/ leisure/ business) etc.
Each segment will require different methods of promotion and distribution. For
example, products aimed towards kids would be distributed through popular retail
stores and products for businessmen would be advertised in exclusive business
magazines.
Advantages:
 Makes marketing cost-effective, as it only targets a specific segment and meets
their needs.
 The above leads to higher sales and profitability
 Increased opportunities to increase sales

3.2 – Market Research

Product-oriented business: such firms produce the product first and then tries to
find a market for it. Their concentration is on the product – its quality and price.
Firms producing electrical and digital goods such as refrigerators and computers
are examples of product-oriented businesses.
Market-oriented businesses: such firms will conduct market research to see what
consumers want and then produce goods and services to satisfy them. They will set
a marketing budget and undertake the different methods of researching consumer
tastes and spending patterns, as well as market conditions. Example, mobile phone
markets.
Market research is the process of collecting, analysing and interpreting
information about a product.
Why is market research important/needed?
Firms need to conduct market research in order to ensure that they are producing
goods and services that will sell successfully in the market and generate profits. If
they don’t, they could lose a lot of money and fail to survive. Market research will
answer a lot of the business’s questions prior to product development such as ‘will
customers be willing to buy this product?’, ‘what is the biggest factor that
influences customers’ buying preferences- price or quality?’, ‘what is the
competition in the market like?’ and so on.
Market research data can be quantitative (numerical-what percentage of teenagers
in the city have internet access) or qualitative (opinion/ judgement- why do more
women buy the company’s product than men?)
Market research methods can be categorized into two: primary and secondary
market research.

Primary Market Research (Field Research)

The collection of original data. It involves directly collecting information from
existing or potential customers. First-hand data is collected by people who want to
use the data (i.e. the firm). Examples of primary market research methods include
questionnaires, focus groups, interviews, observation, and online surveys and so
on.

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The process of primary research:

1. Establish the purpose of the market research

2. Decide on the most suitable market research method
3. Decide the size of the sample (customers to conduct research on) and identify the
sample
4. Carry out the research
5. Collate and analyse the data
6. Produce a report of the findings
Sample is a subset of a population that is used to represent the entire group as a
whole. When doing research, it is often impractical to survey every member of a
particular population because the number of people is simply too large. Selecting a
sample is called sampling. A random sampling occurs when people are selected
at random for research, while quota sampling is when people are selected on the
basis of certain characteristics (age, gender, location etc.) for research.
Methods of primary research
 Questionnaires: Can be done face-to-face, through telephone, post or the
internet. Online surveys can also be conducted whereby researchers will email the
sample members to go onto a particular website and fill out a questionnaire posted
there. These questions need to be unbiased, clear and easy to answer to ensure that
reliable and accurate answers are logged in. (The first part of this wikiHow
article will give you the basic idea of how a questionnaire should be prepared.)
Advantages:


 Detailed information can be collected
 Customer’s opinions about the product can be obtained
 Online surveys will be cheaper and easier to collate and analyse
 Can be linked to prize draws and prize draw websites to encourage customers to
fill out surveys
Disadvantages:


 If questions are not clear or are misleading, then unreliable answers will be
given
 Time-consuming and expensive to carry out research, collate and analyse them.
 Interviews: interviewer will have ready-made questions for the interviewee.
Advantages:
 
 Interviewer is able to explain questions that the interviewee doesn’t understand
and can also ask follow-up questions
 Can gather detailed responses and interpret body-language, allowing
interviewer to come to accurate conclusions about the customer’s opinions.
Disadvantages:


 The interviewer could lead and influence the interviewee to answer a certain
way. For example, by rephrasing a question such as ‘Would you buy this
product’ to ‘But, you would definitely buy this product, right?’ to which the
customer in order to appear polite would say yes when in actuality they
wouldn’t buy the product.
 Time-consuming and expensive to interview everyone in the sample
 Focus Groups: A group of people representative of the target market (a focus
group) agree to provide information about a particular product or general spending
patterns over time. They can also test the company’s products and give opinions on
them.
Advantage:


 They can provide detailed information about the consumer’s opinions
Disadvantages:


 Time-consuming
 Expensive
 Opinions could be influenced by others in the group.
 Observation: This can take the form of recording (eg: meters fitted to TV screens
to see what channels are being watched), watching (eg: counting how many people
enter a shop), auditing (e.g.: counting of stock in shops to see which products sold
well).
Advantage:


 Inexpensive
Disadvantage:


 Only gives basic figures. Does not tell the firm why consumer buys them.
Secondary Market Research (Desk Research)
 The collection of information that has already been made available by others.
Second-hand data about consumers and markets is collected from already
published sources.

Internal sources of information:

 Sales department’s sales records, pricing data, customer records, sales reports
 Opinions of distributors and public relations officers
 Finance department
 Customer Services department
External sources of information:

 Government statistics: will have information about populations and age structures
in the economy.
 Newspapers: articles about economic conditions and forecast spending patterns.
 Trade associations: if there is a trade association for a particular industry, it will
have several reports on that industry’s markets.
 Market research agencies: these agencies carry out market research on behalf of
the company and provide detailed reports.
 Internet: will have a wide range of articles about companies, government
statistics, newspapers and blogs.
Accuracy of Market Research Data
The reliability and accuracy of market research depends upon a large number of
factors:

 How carefully the sample was drawn up, its size, the types of people selected etc.
 How questions were phrased in questionnaires and surveys
 Who carried out the research: secondary research is likely to be less reliable since
it was drawn up by others for different purpose at an earlier time.
 Bias: newspaper articles are often biased and may leave out crucial information
deliberately.
 Age of information: researched data shouldn’t be too outdated. Customer tastes,
fashions, economic conditions, technology all move fast and the old data will be of
no use now.
Presentation of Data from Market Research
Different data handling methods can be used to present data from market research.
This will include:
 Tally Tables: used to record data in its original form. The tally table below shows
the number and type of vehicles passing by a shop at different times of the day:

 Charts: show the total figures for each piece of data (bar/ column charts) or the
proportion of each piece of data in terms of the total number (pie charts). For
example the above tally table data can be recorded in a bar chart as shown below:

The pie chart above could show a company’s market share in different countries.
 Graphs: used to show the relationship between two sets of data. For example how
average temperature varied across the year.
 3.3 – Marketing Mix
Marketing mix refers to the different elements involved in the marketing of a
good or service- the 4 P’s- Product, Price, Promotion and Place.
Product
Product is the good or service being produced and sold in the market. This
includes all the features of the product as well as its final packaging.
Types of products include: consumer goods, consumer services, producer goods,
producer services.

What makes a successful product?

 It satisfies existing needs and wants of the customers

 It is able to stimulate new wants from the consumers
 Its design – performance, reliability, quality etc. should all be consistent with the
product’s brand image
 It is distinctive from its competitors and stands out
 It is not too expensive to produce, and the price will be able to cover the costs
New Product Development: development of a new product by a business. The
process:
1. Generate ideas: the firm brainstorms new product concepts, using customer
suggestions, competitors’ products, employees’ ideas, sales department data and
the information provided by the research and development department
2. Select the best ideas for further research: the firm decides which ideas to
abandon and which to research further. If the product is too costly or may not sell
well, it will be abandoned
3. Decide if the firm will be able to sell enough units for the product to be a
success: this research includes looking into forecast sales, size of market share,
cost-benefit analysis etc. for each product idea, undertaken by the marketing
department
4. Develop a prototype: by making a prototype of the new product, the operations
department can see how the product can be manufactured, any problems arising
from it and how to fix them. Computer simulations are usually used to produce 3D
prototypes on screen
5. Test launch: the developed product is sold to one section of the market to see how
well it sells, before producing more, and to identify what changes need to be made
to increase sales. Today a lot of digital products like apps and software run beta
versions, which is basically a market test
6. Full launch of the product: the product is launched to the entire market
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Advantages:

 Can create a Unique Selling Point (USP) by developing a new innovative product
for the first time in the market. This USP can be used to charge a high price for the
product as well as be used in advertising.
 Charge higher prices for new products (price skimming as explained later)
 Increase potential sales, revenue and profit
 Helps spreads risks because having more products mean that even if one fails, the
other will keep generating a profit for the company
Disadvantages:

 Market research is expensive and time consuming

 Investment can be very expensive
Why is brand image important?
Brand image is an identity given to a product that differentiates it from
competitors’ products.
Brand loyalty is the tendency of customers to keep buying the same brand
continuously instead of switching over to competitors’ products.
 Consumers recognize the firm’s product more easily when looking at similar
products- helps differentiate the company’s product from another.
 Their product can be charged higher than less well-known brands – if there is an
established high brand image, then it is easier to charge high prices because
customers will buy it nonetheless.
 Easier to launch new products into the market if the brand image is already
established. Apple is one such company- their brand image is so reputed that new
products that they launch now become an immediate success.
Why is packaging important?
 It protects the product
 It provide information about the product (its ingredients, price, manufacturing and
expiry dates etc.)
 To help consumers recognize the product (the brand name and logo on the
packaging will help identify what product it is)
 It keeps the product fresh

Product Life Cycle (PLC)

The product life cycle refers to the stages a product goes through from it’s
introduction to it’s retirement in terms of sales.

At these different stages, the product will need different marketing

decisions/strategies in terms of the 4Ps.
 Extension strategies: marketing techniques used to extend the maturity stage of a
product (to keep the product in the market):
 Finding new markets for the product
 Finding new uses for the product
 Redesigning the product or the packaging to improve its appeal to consumers
 Increasing advertising and other promotional activities
The effect on the PLC of a product of a successful extension strategy:
 Price
Price is the amount of money producers are willing to sell or consumer are willing
to buy the product for.

Different methods of pricing:

 Market skimming: Setting a high price for a new product that is unique or very
different from other products on the market.
Advantages:


 Profit earned is very high
 Helps recover/compensate research and development costs
Disadvantage:


 It may backfire if competitors produce similar products at a lower price
 Penetration pricing: Setting a very low price to attract customers to buy a new
product
Advantages:


 Attracts customers more quickly
 Can increase market share quickly
Disadvantages:


 Low revenue due to lower prices
 Cannot recover development costs quickly
 Competitive pricing: Setting a price similar to that of competitors’ products
which are already available in the market
Advantage:


 Business can compete on other matters such as service and quality
Disadvantage:


 Still need to find ways of competing to attract sales.
 Cost plus pricing: Setting price by adding a fixed amount to the cost of
making the product
Advantages:


 Quick and easy to work out the price
 Makes sure that the price covers all of the costs
Disadvantage:


 Price might be set higher than competitors or more than customers are willing
to pay, which reduces sales and profits
 Loss leader pricing/Promotional pricing: Setting the price of a few products at
below cost to attract customers into the shop in the hope that they will buy other
products as well
Advantages:


 Helps to sell off unwanted stock before it becomes out of date
 A good way of increasing short term sales and market share
Disadvantage:


 Revenue on each item is lower so profits may also be lower
Factors that affect what pricing method should be used:
 Is it a new or existing product?
If it’s new, then price skimming or penetration pricing will be most suitable. If it’s
an existing product, competitive pricing or promotional pricing will be appropriate.
 Is the product unique?
 If yes, then price skimming will be beneficial, otherwise competitive or
promotional pricing.
 Is there a lot of competition in the market?
If yes, competitive pricing will need to be used.
 Does the business have a well-known brand image?
If yes, price skimming will be highly successful.
 What are the costs of producing and supplying the product?
If there are high costs, costs plus pricing will be needed to cover the costs. If costs
are low, market penetration and promotional pricing will be appropriate.
 What are the marketing objectives of the business?
If the business objective is to quickly gain a market share and customer base, then
penetration pricing could be used. If the objective is to simply maintain sales,
competitive pricing will be appropriate.
Price Elasticity
The PED of a product refers to the responsiveness of the quantity demanded for
it to changes in its price.
PED (of a product) = % change in quantity demanded / % change in price

When the PED is >1, that is there is a higher % change in demand in response to a
change in price, the PED is said to be elastic.
When the PED is <1, that is there is a lower % change in demand in response to a
change in price, the PED is said to be inelastic.
Producers can calculate the PED of their product and take suitable action to make
the product more profitable.

If the product is found to have an elastic demand, the producer can lower prices
to increase profitability. The law of demand states that a fall in price increases the
demand. And since it is an elastic product (change in demand is higher than change
in price), the demand of the product will increase highly. The producers get more
profit.
If the product is found to have an inelastic demand, the producer can raise
prices to increase profitability. Since quantity demanded wouldn’t fall much as it
is inelastic, the high prices will make way for higher revenue and thus higher
profits.
For a detailed explanation about PED, click here

Place
Place refers to how the product is distributed from the producer to the final
consumer. There are different distribution channels that a product can be sold
through.

Distribution Explanation Advantages Disadvantages

Channel
Manufacturer The product is sold – All of the profit is – Delivery costs may
to Consumer to the consumer earned by the be high if there are
straight from the producer customers over a
manufacturer. A – The producer wide area
good example is a controls all parts of – All storage costs
factory outlet where the marketing mix must be paid for by
products directly – Quickest method of the producer
arrive at their own getting the product to – All promotional
shop from the factory the consumer activities must be
and are sold to carried out and
customers. – financed by the
The cost of holding producer
Manufacturer to The manufacturer inventories of the
Retailer will sell its products product is paid by the – The retailer takes
to Consumer to a retailer (who will retailer some of the profit
have stocks of – The retailer will pay away from the
products from other for advertising and producer
manufacturers as other promotional – The producer loses
well) who will then activities some control of the
sell them to – Retailers are more marketing mix
customers who visit conveniently located – The producer must
the shop. For for consumers pay for delivery of
example, brands like products to the
Sony, Canon and retailers
Panasonic sell their – Retailers usually
products to various sell competitors’
Manufacturer to retailers. products as well
Wholesaler – Wholesalers will
to Retailer The manufacturer advertise and promote – Another middleman
to Consumer will sell large the product to retailers is added so more
volumes of its – Wholesalers pay for profit is taken away
products to a transport and storage from the producer
wholesaler costs. – The producer loses
(wholesalers will even more control of
have stocks from the marketing mix
different
manufacturers).
Retailer will buy
small quantities of
the product from the
wholesaler and sell it
to the consumers.
 One good example is
Manufacturer the distribution of
to Agent medicinal drugs.
to Wholesaler
to Retailer – The agent has – Another middleman
to Consumer The manufacturer specialized knowledge is added so even
will sell their products of the market more profit is taken
to an agent who has away from the
specialized producer
information about the
market and will know
the best wholesalers
to sell them to. This
is common when
firms are exporting
their products to a
foreign country. They
will need a
knowledgeable agent
to take care of the
products’ distribution
in another country

 The type of product it is: if it’s sold to producers of other goods, distribution
would either be direct (specialist machinery) or wholesaler (nuts, bolts, screws
etc.).
 The technicality of the product: as lots of technical information needs to be
passed to the customer, direct selling is usually preferred.
 How often the product is purchased: if the product is bought on a daily basis, it
should be sold through retail stores that customers can easily access.
 The price of the product: if the products is an expensive, luxury good, it would
only be sold through a few specialist, high-end outlets For example, luxury
watches and jewellery.
 The durability of the product: if it’s an easily perishable product like fruits, it
will need to be sold through a wide amount of retailers to be sold quickly.
 Location of customers: the products should be easily accessible by its customers.
If customers are located over the world, e-commerce (explained below) will be
required.
 Where competitors sell their product: in order to directly compete with
competitors, the products need to be sold where competitors are selling too.
Promotion
 Promotion: marketing activities used to communicate with customers and
potential customers to inform and persuade them to buy a business’s products.
Aims of promotion:

 Inform customers about a new product

 Persuade customers to buy the product
 Create a brand image
 Increase sales and market share
Types of promotion
 Advertising: Paid-for communication with consumers which uses printed and
visual media like television, radio, newspapers, magazines, billboards, flyers,
cinema etc. This can be informative (create product awareness) or persuasive
(persuade consumers to buy the product). The process of advertising:

 Sales Promotion: using techniques such as ‘buy one get one free’, occasional price
reductions, free after-sales services, gifts, competitions, point-of–sale displays (a
special display stand for a product in a shop), free samples etc. to encourage sales.
 Below-the-line promotion: promotion that is not paid for communication but uses
incentives to encourage consumers to buy. Incentives include money-off coupons
or vouchers, loyalty reward schemes, competitions and games with cash or other
prizes.
 Personal selling: sales staff communicate directly with consumer to achieve a sale
and form a long-term relationship between the firm and consumer.
 Direct mail: also known as mailshots, printed materials like flyers, newsletters and
brochures which are sent directly to the addresses of customers.
 Sponsorship: payment by a business to have its name or products associated with
a particular event. For example Emirates is Spanish football club Real Madrid’s
jersey sponsor- Emirates pays the club to be its sponsor and gains a high customer
awareness and brand image in return.
What affects promotional decisions?
 Stage of product on the PLC: different stages of the PLC will require different
promotional strategies; see above.
 The nature of the product: If it’s a consumer good, a firm could use persuasive
advertising and use billboards and TV commercials. Producer goods would have
bulk-buy-discounts to encourage more sales. The kind of product it is can affect
 the type of advertising, the media of advertising and the method of sales
promotion.
 The nature of the target market: a local market would only need small amounts
of advertising while national markets will need TV and billboard advertising. If the
product is sold to a mass market, extensive advertising would be needed. But niche
market products such as water skis would only need advertising in special sports
and lifestyle magazines.
 Cost-effectiveness: the amount of money put into promotion (out of the total
marketing budget) should be not too much that it fails to bring in the sales revenue
enough to cover those costs at least. Promotional activities are highly dependent on
the budget.
Technology and the Marketing Mix
It is also worth noting that the internet/ e-commerce is now widely used to
distribute products. E-Commerce is the use of the internet and other technologies
used by businesses to market and sell goods and services to customers. Examples
of e-commerce include online shopping, internet banking, online ticket-booking,
online hotel reservations etc.
Websites like Amazon and e-Bay act as online retailers.
Online selling is favoured by producers because it is cheaper in the long-run and
they can sell products to a larger customer base/ market. However there will
be increased competition from lots of producers.
Consumers prefer online shopping because there are wider choices of detailed
products that are also cheaper and they can buy things at their
own convenience 24×7. However, there is no personal communication with the
producer and online security issues may occur.
However, e-commerce means an entire new type of marketing strategy is also
required – online promotions, new channel of distribution, new pricing strategies
(since price competition in e-commerce is very high and demand is very price
elastic). It requires a lot of money to set up – online websites, promotions, web
developers and technicians to run and maintain the system etc.
The internet is also used for promotion and advertising of products in the form of
paid social media ads and sponsors, pop-ups, email newsletters etc. It helps reach
target customers, is relatively cheap and helps the firm respond to market
changes quicker (since online ads can be easily altered/updated rather than
billboards and TV ads). But it can alienate and chase customers away if they see
it too frequently and find it annoying. There is also the risk of the adverts
being publicised negatively if it has annoying or offensive content that customers
quickly criticise (since content is more easily shareable online).
 3.4 – Marketing Strategy
Marketing Strategy

A marketing strategy is a plan to combine the right combination of the four

elements of the marketing mix for a product to achieve its marketing objectives.
Marketing objectives could include maintaining market shares, increasing sales in
a niche market, increasing sale of an existing product by using extension strategies
etc.
Factors that affect the marketing strategy:

Legal Controls on Marketing

There are various laws that can affect marketing decisions on quality, price and
the contents of advertisements.
 laws that protect consumers from being sold faulty and dangerous goods
 laws that prevent the firms from using misleading information in
advertising Example: Volkswagen falsely advertised environmentally friendly
diesel cars and were legally forced to pull all cars from the market
 laws that protect consumers from being exploited in industries where there is
little or no competition, known as monopolising.
 Entering New Markets

Growing business in other countries can increase sales, revenue and profits. This
is because the business is now available to a wider group of people,
which increases potential customers. If the home markets have saturated (product
is in maturity stage), firms take their products to international markets. Trade
barriers and restrictions have also reduced significantly over the years, along with
new transport infrastructures, so it is now cheaper and easier to export
products to other countries.
Problems of entering foreign markets:
 Difference in language and culture: It may be difficult to communicate with
people in other countries because of language barriers and as for culture, different
images, colors and symbols have different meanings and importance in different
places. For example, McDonald’s had to make its menu more vegetarian in Indian
markets
 Lack of market knowledge: The business won’t know much about the market it is
entering and the customers won’t be familiar with the new business brand, and so
getting established in the market will be difficult and expensive
 Economic differences: The cost and prices may be lower or higher in different
countries so businesses may not be able to sell the product at the price which will
give them a profit
 High transport costs
 Social differences: Different people will have different needs and wants from
people in other countries, and so the product may not be successful in all countries
 Difference in legal controls to protect consumers: The business may have to
spend more money on producing the products in a way that complies with that
country’s laws.
How to overcome such problems:
 Joint venture: an agreement between two or more businesses to work together
on a project. The foreign business will work with a domestic business in the same
industry. Eg: Japan’s Suzuki Motor Corporation created a joint venture with
India’s Maruti Udyog Limited to form Maruti Suzuki, a highly successful car
manufacturing project in India.
Advantages:

 Reduces risks and cuts costs
 Each business brings different expertise to the joint venture
 The market potential for all the businesses in the joint venture is increased
 Market and product knowledge can be shared to the benefit of the businesses
Disadvantages:
 
 Any mistakes made will reflect on all parties in the joint venture, which may
damage their reputations
 The decision-making process may be ineffective due to different business
culture or different styles of leadership
 Franchise/License: the owner of a business (the franchisor) grants a licence to
another person or business (the franchisee) to use their business idea – often in
a specific geographical area. Fast food companies such as McDonald’s and
Subway operate around the globe through lots of franchises in different countries.
ADVANTAGES DISADVANTAGES

TO Rapid, low cost method Profits from the

FRANCHISOR of business expansion franchise needs to be
Gets an income from shared with the
franchisee in the form of franchisee
franchise fees and Loss of control over
royalties running of business

Franchisee will better If one franchise fails, it

understand the local can affect the reputation
tastes and so can of the entire brand
advertise and sell
appropriately Franchisee may not be
as skilled
Can access ideas and
suggestions from Need to supply raw
franchisee material/product and
provide support and
Franchisee will run the training
operations

TO Working with an Cost of setting up

FRANCHISEE established brand business
means chance of No full control over
business failing is low business- need to
Franchisor will give strictly follow
technical and franchisor’s standards
managerial support and rules

Franchisor will supply Profits have to be

the raw shared with franchisor
 materials/products
Need to pay franchisor
franchise fees and
royalties

Need to advertise and

promote the business in
the region themselves

4.1 – Production of Goods and Services

Production is the effective management of resources in producing goods and

services.

The operations department in a firm overlooks the production process. They

must:
 Use the resources in a cost-effective and efficient manner
 Manage inventory effectively
 Produce the required output to meet customer demands
 Meet the quality standards expected by customers
Productivity

Productivity is a measure of the efficiency of inputs used in the production

process over a period of time. It is the output measured against the inputs used
to produce it. The formula is:
 Businesses often measure the labour productivity to see how efficient their
employees are in producing output. The formula for it is:

Businesses look to increase productivity, as the output will increase per employee
and so the average costs of production will fall. This way, they will be able to
sell more while also being able to lower prices.
Ways to increase productivity:
 improving labour skills by training them so they work more productively and
waste lesser resources
 introducing automation (using machinery and IT equipment to control production)
so that production is faster and error-free
 improve employee motivation so that they will be willing to produce more and
efficiently so.
 improved quality control and assurance systems to ensure that there are no
wastage of resources
Inventory Management

Firms can hold inventory (stock) of raw materials, goods that are not completed yet
(a.k.a work-in-progress) and finished unsold goods. Finished good stocks are kept
so that any unexpected rise in demand is fulfilled.

 When inventory gets to a certain point (reorder level), they will be reordered by
the firm to bring the level of inventory back up to the maximum level again. The
business has to reorder inventory before they go too low since the reorder supply
will take time to arrive at the firm
 The time it takes for the reorder supply to arrive is known as lead time.
 If too high inventory is held, the costs of holding and maintaining it will be very
high.
 The buffer inventory level is the level of inventory the business should hold at the
very minimum to satisfy customer demand at all times. During the lead time the
 inventory will have hit the buffer level and as reorder arrives, it will shoot back up
to the maximum level.

Lean Production

Lean production refers to the various techniques a firm can adopt to reduce
wastage and increase efficiency/productivity.

The seven types of wastage that can occur in a firm:

 Overproduction– producing goods before they have been ordered by customers.

This results in too much output and so high inventory costs
 Waiting– when goods are not being moved or processed in any way, then waste is
occurring
 Transportation-moving goods around unnecessarily is simply wasting time. They
also risk damage during movement
 Unnecessary inventory-too much inventory takes up valuable space and incurs
cost
 Motion-unnecessary moving about of employees and operation of machinery is a
waste of time and cost respectively.
 Over-processing-using complex machinery and equipment to perform simple
tasks may be unnecessary and is a waste of time, effort and money
 Defects– any fault in equipment can halt production and waste valuable time.
Goods can also turn out to be faulty and need to be fixed- taking up more money
and time
By avoiding such wastage, a firm can benefit in many ways
 less storage of raw materials, components and finished goods- less money and time
tied up in inventory
 quicker production of goods and services
 no need to repair faulty goods- leads to good customer satisfaction
 ultimately, costs will lower, which helps reduce prices, making the business more
competitive and earn higher profits as well
Now, how to implement lean production? The different methods are:

 Kaizen: it’s a Japanese term meaning ‘continuous improvement’. It aims to

increase efficiency and reduce wastage by getting workers to get together in
small groups and discuss problems and suggest solutions. Since they’re the
ones directly involved in production they will know best to identify issues. When
kaizen is implemented, the factory floor, for example, is rearranged by re-
positioning machinery and equipment so that production can flow
smoothly through the factory in the least possible time.

Benefits:


 increased productivity
 reduced amount of space needed for production
 improved factory layout may allow some jobs to be combined, so freeing up
employees to do other jobs in the factory
 Just-in-Time inventory control: this techniques eliminates the need to hold any
kind of inventory by ensuring that supplies arrive just in time they are needed for
production. The making of any parts is done just in time to be used in the next
stage of production and finished goods are made just in time they are needed for
 delivery to the customer/shop. The firm will need very reliable suppliers and an
efficient system for reordering supplies.
Benefits:Reduces cost of holding inventory
 Warehouse space is not needed any more, so more space is available for other
uses
 Finished goods are immediately sold off, so cash flows in quickly
 Cell Production: the production line is divided into separate, self-contained units
each making a part of the finished good. This works because it improves worker
morale when they are put into teams and concentrate on one part alone.
Methods of Production

 Job Production: products are made specifically to order, customized for each
customer. Eg: wedding cakes, made-to-measure suits, films etc.
Advantages:Most suitable for one-off products and personal services
 The product meets the exact requirement of the customer
 Workers will have more varied jobs as each order is different, improving
morale
 very flexible method of production

Disadvantages:Skilled labour will often be required which is expensive
 Costs are higher for job production firms because they are usually labour-
intensive
 Production often takes a long time
 Since they are made to order, any errors may be expensive to fix
 Materials may have to be specially purchased for different orders, which is
expensive

 Batch Production: similar products are made in batches or blocks. A small

quantity of one product is made, then a small quantity of another. Eg: cookies,
building houses of the same design etc.
Advantages:Flexible way of working- production can be easily switched between
products
 Gives some variety to workers
 More variety means more consumer choice
 Even if one product’s machinery breaks down, other products can still be made

Disadvantages:Can be expensive since finished and semi-finished goods will need
moving about
 Machines have to be reset between production batches which delays production
  Lots of raw materials will be needed for different product batches, which can be
expensive.

 Flow Production: large quantities of products are produced in a continuous

process on the production line. Eg: a soft drinks factory.
Advantages:There is a high output of standardized (identical) products
 Costs are low in the long run and so prices can be kept low
 Can benefit from economies of scale in purchasing
 Automated production lines can run 24×7
 Goods are produced quickly and cheaply
 Capital-intensive production, so reduced labour costs and increases efficiency

Disadvantages:A very boring system for the workers, leads to low job satisfaction
and motivation
 Lots of raw materials and finished goods need to be held in inventory- this is
expensive
 Capital cost of setting up the flow line is very high
 If one machinery breaks down, entire production will be affected

Factors that affect which production method to use:

 The nature of the product: Whether it is a personal, customized-to-order product,
in which case job production will be used. If it is a standard product, then flow
production will be used
 The size of the market: For a large market, flow production will be required.
Small local and niche markets may make use of batch and flow production. Goods
that are highly demanded but not in very large quantities, batch production is most
suitable.
 The nature of demand: If there is a fair and steady demand for the product, it
would be more suitable to run a production line for the product. For less frequent
demand, batch and job will be appropriate.
 The size of the business: Small firms with little capital access will not produce
using large automated production lines, but will use batch and job production.
Technology and Production

 Automation: equipment used in the factory is controlled by computers to carry

out mechanical processes, such as spray painting a car body.
 Mechanization: production is done by machines but is operated by people
 CAD (computer aided designing): a computer software that draws items being
designed more quickly and allows them to be rotated, zoomed in and viewed from
all angles.
 CAM (computer aided manufacturing): computers monitor the production process
and controls machines and robots-similar to automation
 CIM (computer integrated manufacturing): the integration of CAD and CAM. The
computers that design the product using CAD is connected to the CAM software to
directly produce the physical design.
 EPOS (electronic point-of-sale): used at checkouts/tills where operator scans the
bar-code of each item bought by the customer individually. The item details and
price appear on screen and are printed in the receipt. They can also automatically
update and reorder stock as items are bought.
 EFTPOS (electronic funds transfer at point-of-sale): the electronic cash register at
the till will be connected to the retailer’s main computer and different banks. When
the customer swipes the debit card at the till, information is read by the scanner
and an amount is withdrawn from the customer’s bank account (after the PIN is
entered).
Advantages of technology in production
 Greater productivity
 Greater job satisfaction among workers as boring, routine jobs are done by
machines
 Better quality products
 Quicker communication and less paperwork
 More accurate demand levels are forecast since computer monitor inventory levels
 New products can be introduced as new production methods are introduced
Disadvantages of technology in production
 Unemployment rises as machines and computers replace human labour
 Expensive to set up
 New technology quickly becomes outdated and frequent updating of systems will
be needed- this is expensive and time-consuming.
 Employees may take time to adjust to new technology or even resist it as their
work practices change.

4.2 – Costs, Scale of Production and Break-even Analysis

Costs

Fixed Costs are costs that do not vary with output produced or sold in the short
run. They are incurred even when the output is 0 and will remain the same in the
short run. In the long-run they may change. Also known as overhead costs.
 E.g.: rent, even if production has not started, the firm still has to pay the rent.
Variable Costs are costs that directly vary with the output produced or sold.
E.g.: material costs and wage rates that are only paid according to the output
produced.
TOTAL COST = TOTAL FIXED COSTS + TOTAL VARIABLE COSTS
TOTAL COST = AVERAGE COST * OUTPUT
AVERAGE COST (unit cost) = TOTAL COST/ TOTAL OUTPUT
A business can use these cost data to make different decisions. Some examples
are: setting prices (if the average cost of one unit is $3, then the price would be set
at $4 to make a profit of $1 on each unit), deciding whether to stop
production (if the total cost exceeds the total revenue, a loss is being made, and so
the production might be stopped), deciding on the best location (locations with
the cheaper costs will be chosen) etc.
Scale of production

As output increases, a firm’s average cost decreases.

Economies of scale are the factors that lead to a reduction in average costs as a
business increases in size. The five economies of scale are:
 Purchasing economies: For large output, a large amount of components have to be
bought. This will give them some bulk-buying discounts that reduce costs
 Marketing economies: Larger businesses will be able to afford its own vehicles to
distribute goods and advertise on paper and TV. They can cut down on marketing
labour costs. The advertising rates costs also do not rise as much as the size of the
advertisement ordered by the business. Average costs will thus reduce.
 Financial economies: Bank managers will be more willing to lend money to large
businesses as they are more likely to be able to pay off the loan than small
businesses. Thus they will be charged a low rate of interest on their borrowings,
reducing average costs.
 Managerial economies: Large businesses may be able to afford to hire specialist
managers who are very efficient and can reduce the business’ costs.
 Technical economies: Large businesses can afford to buy large machinery such as
a flow production line that can produce a large output and reduce average costs.

Diseconomies of scale are the factors that lead to an increase the average costs of a
business as it grows beyond a certain size. They are:
 Poor communication: as a business grows large, more departments and managers
and employees will be added and communication can get difficult. Messages may
 be inaccurate and slow to receive, leading to lower efficiency and higher average
costs in the business.
 Low morale: when there are lots of workers in the business and they have non-
contact with their senior managers, the workers may feel unimportant and not
valued by management. This would lead to inefficiency and higher average costs.
 Slow decision-making: As a business grows larger, its chain of command will get
longer. Communication will get very slow and so any decision-making will also
take time, since all employees and departments may need to be consulted with.
Businesses are now dividing themselves into small units that can control
themselves and communicate more effectively, to avoid any diseconomies from
arising.

Break-even

Break-even level of output is the output that needs to be produced and sold in order
to start making a profit. So, the break-even output is the output at which total
revenue equals total costs (neither a profit nor loss is made, all costs are covered).
A break-even chart can be drawn, that shows the costs and revenues of a business
across different levels of output and the output needed to break even.

Example:
In the chart below, costs and revenues are being calculated over the output of 2000
units.
The fixed costs is 5000 across all output (since it is fixed!).
The variable cost is $3 per unit so will be $0 at output is 0 and $6000 at output
2000- so you just draw a straight line from $0 to $6000.
The total costs will then start from the point where fixed cost starts and be parallel
to the variable costs (since T.C.= F.C.+V.C. You can manually calculate the total
cost at output 2000: ($6000+$5000=$11000).
The price per unit is $8 so the total revenue is $16000 at output 2000.
Now the break-even point can be calculated at the point where total revenue and
total cost equals– at an output of 1000. (In order to find the sales revenue at output
1000, just do $8*1000= $8000. The business needs to make $8000 in sales revenue
to start making a profit).
 Advantages of break-even charts:
 Managers can look at the graph to find out the profit or loss at each level of
output
 Managers can change the costs and revenues and redraw the graph to see how that
would affect profit and loss, for example, if the selling price is increased or
variable cost is reduced.
 The break-even chart can also help calculate the safety margin- the amount by
which sales exceed break-even point. In the above graph, if the business decided to
sell 2000 units, their margin of safety would be 1000 units. In sales terms, the
margin of safety would be 1000*8 = $8000. They are $8000 safe from making a
loss.
Margin of Safety (units) = Units being produced and sold – Break-even output
Limitations of break-even charts:
 They are constructed assuming that all units being produced are sold. In practice,
there are always inventory of finished goods. Not everything produced is sold off.
 Fixed costs may not always be fixed if the scale of production changes. If more
output is to be produced, an additional factory or machinery may be needed that
increases fixed costs.
 Break-even charts assume that costs can always be drawn using straight lines.
Costs may increase or decrease due to various reasons. If more output is produced,
workers may be given an overtime wage that increases the variable cost per unit
and cause the variable cost line to steep upwards.

Break-even can also be calculated without drawing a chart. A formula can be used:

Break-even level of production =Total fixed costs/ Contribution per unit

Contribution = Selling price – Variable cost per unit (this is the value
added/contributed to the product when sold)
In the above example, the contribution is $8 -$3 =$5, so the break-even level is:
$5000/$5 = 1000 units!

4.3 – Achieving Quality Production

Quality means to produce a good or service which meets customer
expectations. The products should be free of faults or defects. Quality is important
because it:
 establishes a brand image
 builds brand loyalty
 maintains good reputation
 increase sales
 attract new customers
If there is no quality, the firm will

 lose customers to other brands

 have to replace faulty products and repeat poor service, increasing costs
 bad reputation leading to low sales and profits
There are three methods a business can implement to achieve quality: quality
control, quality assurance and total quality management.

Quality Control

Quality control is the checking for quality at the end of the production process,
whether a good or a service.
Advantages:
 Eliminates the fault or defect before the customer receives it, so better customer
satisfaction
 Not much training required for conducting this quality check
 Disadvantages:
 Still expensive to hire employees to check for quality
 Quality control may find faults and errors but doesn’t find out why the fault has
occurred, so the it’s difficult to solve the problem
 if product has to be replaced and reworked, then it is very expensive for the firm
Quality Assurance

Quality assurance is the checking for quality throughout the production

process of a good or service.
Advantages:
 Eliminates the fault or defect before the customer receives it, so better customer
satisfaction
 Since each stage of production is checked for quality, faults and errors can be
easily identified and solved
 Products don’t have to be scrapped or reworked as often, so less expensive than
quality control
Disadvantages:
 Expensive to carry out since quality checks have to be carried throughout the
entire process, which will require manpower and appropriate technology at every
stage.
 How well will employees follow quality standards? The firm will have to ensure
that every employee follows quality standards consistently and prudently, and
knows how to address quality issues.
Total Quality Management (TQM)
Total Quality Management or TQM is the continuous improvement of products
and production processes by focusing on quality at each stage of production.
There is great emphasis on ensuring that customers are satisfied. In TQM,
customers just aren’t the consumers of the final product. It is every worker at each
stage of production. Workers at one stage have to ensure the quality standards are
met for the product in production at their stage before they are passed onto the next
stage and so on. Thus, quality is maintained throughout production and products
are error-free.
TQM also involves quality circles and like Kaizen, workers come together and
discuss issues and solutions, to reduce waste ensure zero defects.

Advantages:
 quality is built into every part of the production process and becomes central to the
workers principles
 eliminates all faults before the product gets to the final customer
 no customer complaints and so improved brand image
 products don’t have to be scrapped or reworked, so lesser costs
 waste is removed and efficiency is improved
Disadvantages:
 Expensive to train employees all employees
 Relies on all employees following TQM– how well are they motivated to follow
the procedures?
How can customers be assured of the quality of a product or service?
They can look for a quality mark on the product like ISO (International
Organization for Standardization). The business with these quality marks would
have followed certain quality procedures to keep the quality mark. For services, a
good reputation and positive customer reviews are good indicators of the service’s
quality.
4.4 – Location Decisions
Owners need to decide a location for their firm to operate in, at the time of setting
up, when it needs to expand operations, and when the current location proves
unsatisfactory for some reason. Location is important because it can affect the
firm’s costs, profits, efficiency and the market base it reaches out to.

Factors that affect the location decisions of a manufacturing firm:

 Production Method: when job production is used, the business will operate on a
small scale, so the nearness to components/raw materials won’t be that important.
For flow production, on the other hand, production will be on a large scale- there
will be a huge amount of components and transport costs will be high- so
components need to be close by.
 Market: if the product is a consumer good and perishable, the factories need to be
close to the markets to sell out quickly before it perishes.
 Raw Materials/Components: the factories may need to be located close to where
raw materials can be acquired, especially if the raw material is to be processed
while still fresh, like fruits for fruit juice.
 External economies: the business may locate near other firms that support the
business by provide services- eg: business that install and maintain factory
equipment.
 Availability of labour: Businesses will need to locate near areas where they can
get workers of the skills they need in the factory. If lots of unskilled workers are
needed in the factories firms locate in areas of high unemployment. Wage rates
also vary by location and firms will want to set up in locations where wage rates
are low.
 Government Influence: the government sometimes gives incentives and grants to
firms that set up in low-development, rural and high-unemployment areas. There
 may also be govt. rules and restrictions in setting up, e.g.: in some areas of great
natural beauty. The business needs to consider these.
 Transport & Communication infrastructure: the factories need to be located
near areas where there are good road/rail/port/air transport systems. If goods are to
be exported, it needs to be set up near ports.
 Power and water supply: factories need water and power to operate and a reliable
and steady supply of both should be ensured by setting up in areas where they are
available.
 Climate: not the most important factor but can influence certain sectors. Eg: the
dry climate in Silicon Valley aids the manufacturing of silicon chips.
 Owner’s personal preferences
Factors that affect the location decisions of a service-sector firm:
 Customers: service-sector businesses that have direct contact with customers need
to locate in customer-accessible and convenient places. Eg; restaurants,
hairdressers, post offices etc.
 Technology: today, with increasing use of IT to shop and make payments,
customers do not need direct access to services and proximity to the
market/customer is not a very important factor in location decisions. They locate
away from customers in places where there are low rent and wage rates. Eg: banks
 Availability of labour: if large number of workers are required in the firm, then it
will need to locate close to residential areas. If they want certain types of worker
skills, they will need to locate in places where such skilled workers can be found.
However, with work-from-home and technology, this is not that big of a factor
nowadays.
 Climate: tourism services need to be located in places of good climate.
 Nearness to other business: some services serve the needs of large companies,
such as firm equipment servicing and so they need to be very close to such
businesses. Businesses may also set up where close competitors are to watch them
and snatch away their customers.
 Rent/taxes
 Owner’s personal preferences

Factors that affect the location decisions of a retailing firm:

 Shoppers: retailers need to be located in areas where shoppers frequent, like malls,
to attract as many customers as possible.
 Nearby shops: being located to other shops that are visited regularly will also
attract attention of customers into the shop. Being near competitors also helps keep
an eye on competition and snatch away customers.
 Customer parking availability: when parking is available nearby, more people
will find it convenient to shop in that area.
 Availability of suitable vacant premises: Obviously, there needs to be a vacant
premise available to set up the business. Vacant premises can also help the
business expand their premises in the future.
 Rent/taxes: rents and taxes on the locations need to be affordable.
 Access to delivery vehicles: if the retailer has home delivery services, then
delivery vehicles will be required.
 Security: high rates of crime and theft can happen in shops. Shopping complexes
with security guards will thus be preferred by firms.

Why businesses locate in different countries?

 New markets overseas.
 Cheaper or new raw materials available in other countries.
 Cheaper and/or skilled workers are available overseas.
 Rent/ taxes are lower..
 Availability of government grants and other incentives
 Avoid trade barriers and tariffs: when exporting goods to other countries, there will
be some tariffs, rules and regulations to get by. in order to avoid this, firms start
operating in the country itself, since there is no exporting/importing involved now.

The role of legal controls on location decisions

Governments influence location decisions:

 to encourage businesses to set up and expand in areas of high unemployment and

under-development. Grants and subsidies can be given to businesses that set up in
such areas.
 to discourage firms from setting in areas of that are overcrowded or renowned for
natural beauty. Planning restrictions can be put into place to do so.

5.1 – Business Finance: Needs and Sources

Finance is the money required in the business. Finance is needed to set up the
business, expand it and increase working capital (the day-to-day running
expenses).
Start-up capital is the initial capital used in the business to buy fixed and current
assets before it can start trading.
 Working Capital finance needed by a business to pay its day-to-day running
expenses
Capital expenditure is the money spent on fixed assets (assets that will last for
more than a year). Eg: vehicles, machinery, buildings etc. These are long-term
capital needs.
Revenue Expenditure, similar to working capital, is the money spent on day-to-
day expenses which does not involve the purchase of long-term assets. Eg: wages,
rent. These are short-term capital needs.
Sources of Finance

Internal finance is obtained from within the business itself.

 Retained Profit: profit kept in the business after owners have been given their
share of the profit. Firms can invest this profit back in the businesses.
Advantages:
– Does not have to be repaid, unlike, a loan.
– No interest has to be paid
Disadvantages:
– A new business will not have retained profit
– Profits may be too low to finance
– Keeping more profits to be used as capital will reduce owner’s share of profit and
they may resist the decision.
 Sale of existing assets: assets that the business doesn’t need anymore, for
example, unused buildings or spare equipment can be sold to raise finance
Advantages:
– Makes better use of capital tied up in the business
– Does not become debt for the business, unlike a loan.
Disadvantages:
– Surplus assets will not be available with new businesses
– Takes time to sell the asset and the expected amount may not be gained for the
asset
 Sale of inventories: sell of finished goods or unwanted components in inventory.
Advantage:
– Reduces costs of inventory holding
Disadvantage:
– If not enough inventory is kept, unexpected increase demand form customers
cannot be fulfilled
 Owner’s savings: For a sole trader and partnership, since they’re unincorporated
(owners and business is not separate), any finance the owner directly invests from
hos own saving will be internal finance.
Advantages:
 – Will be available to the firm quickly
– No interest has to be paid.
Disadvantages:
– Increases the risk taken by the owners.
External finance is obtained from sources outside of the business.
 Issue of share: only for limited companies.
Advantage:

 A permanent source of capital, no need to repay the money to shareholders
no interest has to be paid
Disadvantages:

 Dividends have to be paid to the shareholders
 If many shares are bought, the ownership of the business will change hands.
(The ownership is decided by who has the highest percentage of shares in the
company)
 Bank loans: money borrowed from banks
Advantages:

 Quick to arrange a loan
 Can be for varying lengths of time
 Large companies can get very low rates of interest on their loans
Disadvantages:

 Need to pay interest on the loan periodically
 It has to be repaid after a specified length of time
 Need to give the bank a collateral security (the bank will ask for some valued
asset, usually some part of the business, as a security they can use if at all the
business cannot repay the loan in the future. For a sole trader, his house might
be collateral. So there is a risk of losing highly valuable assets)
 Debenture issues: debentures are long-term loan certificates issued by companies.
Like shares, debentures will be issued, people will buy them and the business can
raise money. But this finance acts as a loan- it will have to be repaid after a
specified period of time and interest will have to be paid for it as well.
Advantage:

 Can be used to raise very long-term finance, for example, 25 years
Disadvantage:

 Interest has to be paid and it has to be repaid
 Debt factoring: a debtor is a person who owes the business money for the goods
they have bought from the business. Debt factors are specialist agents that can
collect all the business’ debts from debtors.
Advantages:

 Immediate cash is available to the business
 Business doesn’t have to handle the debt collecting
Disadvantage:

 The debt factor will get a percent of the debts collected as reward. Thus, the
business doesn’t get all of their debts
 Grants and subsidies: government agencies and other external sources can give
the business a grant or subsidy
Advantage:

 Do not have to be repaid, is free
Disadvantage:

 There are usually certain conditions to fulfil to get a grant. Example, to locate in
a particular under-developed area.
 Micro-finance: special institutes are set up in poorly-developed countries where
financially-lacking people looking to start or expand small businesses can get small
sums of money. They provide all sorts of financial services
 Crowdfunding: raises capital by asking small funds from a large pool of people,
e.g. via Kickstarter. These funds are voluntary ‘donations’ and don’t have to be
return or paid a dividend.

Short-term finance provides the working capital a business needs for its day-to-
day operations.
 Overdrafts: similar to loans, the bank can arrange overdrafts by allowing
businesses to spend more than what is in their bank account. The overdraft will
vary with each month, based on how much extra money the business needs.
Advantages:

 Flexible form of borrowing since overdrawn amounts can be varied each month
 Interest has to be paid only on the amount overdrawn
 Overdrafts are generally cheaper than loans in the long-term
Disadvantages:

  Interest rates can vary periodically, unlike loans which have a fixed interest
rate.
 The bank can ask for the overdraft to be repaid at a short-notice.
 Trade Credits: this is when a business delays paying suppliers for some time,
improving their cash position
Advantage:

 No interests, repayments involved
Disadvantage:

 If the payments are not made quickly, suppliers may refuse to give discounts in
the future or refuse to supply at all
 Debt Factoring: (see above)

Long-term finance is the finance that is available for more than a year.
 Loans: from banks or private individuals.
 Debentures
 Issue of Shares
 Hire Purchase: allows the business to buy a fixed asset and pay for it in monthly
instalments that include interest charges. This is not a method to raise capital but
gives the business time to raise the capital.
Advantage:

 The firms doesn’t need a large sum of cash to acquire the asset
Disadvantage:

 A cash deposit has to be paid in the beginning
 Can carry large interest charges.
 Leasing: this allows a business to use an asset without purchasing it. Monthly
leasing payments are instead made to the owner of the asset. The business can
decide to buy the asset at the end of the leasing period. Some firms sell their assets
for cash and then lease them back from a leasing company. This is called sale and
leaseback.
Advantages:

 The firm doesn’t need a large sum of money to use the asset
 The care and maintenance of the asset is done by the leasing company
Disadvantage:

  The total costs of leasing the asset could finally end up being more than the cost
of purchasing the asset!

Factors that affect choice of source of finance

 Purpose: if a fixed asset is to be bought, hire purchase or leasing will be
appropriate, but if finance is needed to pay off rents and wages, debt factoring,
overdrafts will be used.
 Time-period: for long-term uses of finance, loans, debenture and share issues are
used, but for a short period, overdrafts are more suitable.
 Amount needed: for large amounts, loans and share issues can be used. For
smaller amounts, overdrafts, sale of assets, debt factoring will be used.
 Legal form and size: only a limited company can issue shares and debentures.
Small firms have limited sourced of finances available to choose from
 Control: if limited companies issue too many shares, the current owners may lose
control of the business. They need to decide whether they would risk losing control
for business expansion.
 Risk- gearing: if business has existing loans, borrowing more capital can increase
gearing- risk of the business- as high interests have to be paid even when there is
no profit, loans and debentures need to be repaid etc. Banks and shareholders will
be reluctant to invest in risky businesses.

Finance from banks and shareholders

Chances of a bank willing to lend a business finance is higher when:
 A cash flow forecast is presented detailing why finance is needed and how it will
be used
 An income statement from the last trading year and the forecast income statement
for the next year, to see how much profit the business makes and will make.
 Details of existing loans and sources of finance being used
 Evidence that a security/collateral is available with the business to reduce the
bank’s risk of lending
 A business plan is presented to explain clearly what the business hopes to achieve
in the future and why finance is important to these plans
Chances of a shareholder willing to invest in a business is higher when:
 the company’s share prices are increasing- this is a good indicator of improving
performance
 dividends and profits are high
 the company has a good reputations and future growth plans
5.2 – Cash Flow Forecasting and Working Capital
 Why is cash important?
If a firm doesn’t have any cash to pay its workers, suppliers, landlord and
government, the business could go into liquidation– selling everything it owns to
pay its debts. The business needs to have an adequate amount of cash to be able to
pay for all its short-term payments.
Cash Flow

The cash flow of a businesses is its cash inflows and cash outflows over a period
of time.
Cash inflows are the sums of money received by the business over a period of
time. E.g.:
 sales revenue from sale of products
 payment from debtors– debtors are customers who have already purchased goods
from the business but didn’t pay for them at that time
 money borrowed from external sources, like loans
 the money from the sale of business assets
 investors putting more money into the business
Cash outflows are the sums of money paid out by the business over a period of
time. Eg:
 purchasing goods and materials for cash
 paying wages, salaries and other expenses in cash
 purchasing fixed assets
 repaying loans (cash is going out of the business)
 by paying creditors of the business- creditors are suppliers who supplied items to
the business but were not paid at the time of supply.

The cash flow cycle:

 Cash flow is not the same as profit! Profit is the surplus amount after total costs
have been deducted from sales. It includes all income and payments incurred in the
year, whether already received or paid or to not yet received or paid respectfully.
In a cash flow, only those elements paid by cash are considered.
Cash Flow Forecasts

A cash flow forecast is an estimate of future cash inflows and outflows of a

business, usually on a month-by-month basis. This then shows the expected cash
balance at the end of each month. It can help tell the manager:

 how much cash is available for paying bills, purchasing fixed assets or repaying
loans
 how much cash the bank will need to lend to the business to avoid insolvency
(running out of liquid cash)
 whether the business has too much cash that can be put to a profitable use in the
business
Example of a cash flow forecast for the four months:
 The cash inflows are listed first and then the cash outflows. The total inflows and
outflows have to be calculated after each section.

The opening cash/bank balance is the amount of cash held by the business at the
start of the month
Net Cash Flow = Total Cash Inflow – Total Cash Outflow
The net cash flow is added to opening cash balance to find the closing cash/bank
balance– the amount of cash held by the business at the end of the month.
Remember, the closing cash/bank balance for one month is the opening cash/bank
balance for the next month!
The figures in bracket denote a negative balance, i.e., a net cash outflow (outflows
> inflows)

Uses of cash flow forecasts:

 when setting up the business the manager needs to know how much cash is
required to set up the business. The cash flow forecast helps calculate the cash
outflows such as rent, purchase of assets, advertising etc.
 A statement of cash flow forecast is required by bank managers when the
business applies for a loan. The bank manager will need to know how much to
lend to the business for its operations, when the loan is needed, for how long it is
needed and when it can be repaid.
 Managing cash flow– if the cash flow forecast gives a negative cash flow for a
month(s), then the business will need to plan ahead and apply for an overdraft so
 that the negative balance is avoided (as cash come in and the inflow exceeds the
outflow). If there is too much cash, the business may decide to repay loans (so that
interest payment in the future will be low) or pay off creditors/suppliers (to
maintain healthy relationship with suppliers).

How can cash flow problems be overcome?

When a negative cash flow is forecast (lack of cash) the following methods can be
used to correct it:

 Increase bank loans: bank loans will inject more cash into the business, but the
firm will have to pay regular interest payments on the loans and it will eventually
have to be repaid, causing future cash outflows
 Delay payment to suppliers: asking for more time to pay suppliers will help
decrease cash outflows in the short-run. However, suppliers could refuse to supply
on credit and may reduce discounts for late payment
 Ask debtors to pay more quickly: if debtors are asked to pay all the debts they
have to the firm quicker, the firm’s cash inflows would increase in the short-run.
These debtors will include credit customers, who can be asked to make cash sales
as opposed to credit sales for purchases (cash will have to be paid on the spot,
credit will mean they can pay in the future, thus becoming debtors). However,
customers may move to other businesses that still offers them time to pay
 Delay or cancel purchases of capital equipment: this will greatly help reduce
cash outflows in the short-run, but at the cost of the efficiency the firm loses out on
not buying new technology and still using old equipment.
In the long-term, to improve cash flow, the business will need to attract more
investors, cut costs by increasing efficiency, develop more products to attract
customers and increase inflows.
Working Capital

Working capital the capital required by the business to pay its short-term day-to-
day expenses. Working capital is all of the liquid assets of the business– the
assets that can be quickly converted to cash to pay off the business’ debts. Working
capital can be in the form of:
 cash needed to pay expenses
 cash due from debtors – debtors/credit customers can be asked to quickly pay off
what they owe to the business in order for the business to raise cash
 cash in the form of inventory – Inventory of finished goods can be quickly sold off
to build cash inflows. Too much inventory results in high costs, too low inventory
may cause production to stop.
 5.3 – Income Statements
Accounts are the financial records of a firm’s transactions.
Final Accounts are prepared at the end of the financial year and give details of the
profit or loss made as well as the worth of the business.
Profit

Profit = Sales Revenue – Total cost

When the total costs exceed the sales revenue, then a loss is made.

How to increase profit?

 Increase sales revenue
 Cut costs
Why is profit important to a business?
 It is a reward for enterprise: entrepreneurs start businesses to make a profit
 It is a reward for risk-taking: entrepreneurs has to take considerable risks when
they invest capital in a venture, and profits are a compensation/reward to them for
taking these risks (paid in the form of profits or dividends)
 It is a source of finance: after payments to owners, profits are reinvested back into
the business for further expansion (this is called retained earnings)
 It is an indicator of success: more profits indicate to investors that the
business/industry is worth their time and money, and they will invest more either
int he firm or new firms of their own, in the hopes of gaining good returns on their
investment
For social enterprises, profit is not one of their primary objectives, but welfare of
the society is. However, they will also strive to make some profit to reinvest it back
into the business and help it grow.

Profit is not the same as cash flow! Profit is the surplus amount after total costs
have been deducted from sales. It includes all income and payments incurred in the
year, whether already received or paid or to not yet received or paid respectfully.
In a cash flow, only those elements paid in cash immediately are considered.
Income Statement

An income statement is a financial document of the business that records all

income generated by the business as well as the costs incurred by the business and
thus the profit or loss made over the financial year. Also known as profit and loss
account.
A simple Income Statement
Sales Revenue = total sales
Cost of Sales = total variable cost of production + (opening inventory of finished
goods – closing inventory of finished goods)
Gross Profit = Sales Revenue – Cost of Sales
Expenses: all overheads/fixed costs
Net Profit = Gross Profit – Expenses

Profit after Tax = Net Profit – Tax

Dividends: share of profit given to shareholders; return on shares
Retained Profit for the year = Profit after Tax – Dividends. This retained
earnings is then kept aside for use in the business.

Only a
very small portion of the sales revenue ends up being the retained profit. All costs,
taxes and dividends have to be deducted from sales.

Uses of Income Statement

Income statements are used by managers to:
 know the profit/loss made by the business
 compare their performance with that of previous years’ and with that of
competitors’. If profit is lower than that of last year’s why is it falling and what can
they do to correct the issue? If it is lower than that of competitors’ what can they
do to be more profitable and be competitive in the market?
 know the profitability of individual products by preparing separate income
statement for each product. They may decide to stop production of products that
are making losses.
 help decide what products to launch by preparing forecast income statement for
the first few years. Whichever product is forecast to have a higher profit, the
business will choose to launch that product
5.4 – Statement of Financial Position
The balance sheet, along with the income statement is prepared at the end of the
financial year. It shows the value of a business’ assets and liabilities at a
particular time. It is also known as ‘statement of financial position’.
Assets are those items of value owned by the business.
 Fixed/non-current assets (buildings, vehicles, equipment etc.) are assets that
remain in the business for more than a year – their values fall over time in a
process called depreciation every year.
 Short-term/current assets (inventory, trade receivables (debts from customers),
cash etc) are owned only for a very short time.
 There can also intangible (cannot be touched or felt) non-current assets like
copyrights and patents that add value to the business.
Liabilities are the debts owed by the business to its creditors.
 Long-term/non-current liabilities (loans, debentures etc.)- they do not have to be
repaid within a year.
 Short-term/current liabilities (trade payables (to suppliers), overdraft etc.)- these
need to be repaid within a year.
CURRENT ASSETS – CURRENT LIABILITIES = WORKING CAPITAL
This is because the liquid cash a company has with them will be the liquid (short-
term) assets they own less the short-term debts they have to pay.
Shareholder’s Equity is the total amount of money invested in the company by
shareholders. This will include both the share capital (invested directly by
shareholders) and reserves (retained earnings reserve, general reserve etc.).
Shareholders can see if their stake in the business has risen or fallen by looking at
the total equity figure on the balance sheet.
Check whether the equations on the right are satisfied in this balance sheet!

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SHAREHOLDERS EQUITY = TOTAL ASSETS – TOTAL LIABILITIES

TOTAL ASSETS = TOTAL LIABILITIES + SHAREHOLDERS EQUITY

CAPITAL EMPLOYED = SHAREHOLDERS EQUITY + NON-CURRENT
LIABILITIES
This is because non-current liabilities like loans are also used for permanent
investment in the company.
Uses of a statement of financial position
 When the current assets subtotal is compared to the current liabilities subtotal,
investors can estimate whether a firm has access to sufficient funds in the short
term to pay off its short-term obligations i.e., whether it is liquid
 One can also compare the total amount of debt (liabilities) to the total amount of
equity listed on the balance sheet, to see if the resulting debt-equity ratio indicates
a dangerously high level of borrowing. This information is especially useful for
lenders and creditors, (especially banks) who want to know if the firm will be able
to pay back its debt
 Investors like to examine the amount of cash on the balance sheet to see if there is
enough available to pay them a dividend
 Managers can examine its balance sheet to see if there are any assets that could
potentially be sold off without harming the underlying business. For example,
they can compare the reported inventory assets to the sales to derive an inventory
turnover level, which can indicate the presence of excess inventory, so they will
sell off the excess inventory to raise finance
5.5 – Analysis of Accounts
The data contained in the financial statements are used to make some useful
observations about the performance and financial strength of the business.
This is the analysis of accounts of a business. To do so, ratio analysis is employed.
Ratio Analysis

 Profitability Ratios: profitability is the ability of a company to use its resources

to generate revenues in excess of its expenses. These ratios are used to see how
profitable the business has been in the year ended.
 Return on Capital Employed (ROCE): this calculates the return (net profit) in
terms of the capital invested in the business (shareholder’s equity + non-current
liabilities) i.e. the % of net profit earned on each unit of capital employed. The
higher the ROCE the better the profitability is. The formula is:

 Gross Profit Margin: this calculates the gross profit (sales – cost of
production) in terms of the sales, or in other words, the % of gross profit made
on each unit of sales revenue. The higher the GPM, the better. The formula is:

 Net profit Margin: this calculates the net profit (gross profit-expenses) in
terms of the sales, i.e. the % of net profit generated on each unit of sales
revenue. The higher the NPM, the better. The formula is:
 Liquidity Ratios: liquidity is the ability of the company to pay back its short-
term debts. It if it doesn’t have the necessary working capital to do so, it will go
illiquid (forced to pay off its debts by selling assets). In the previous topic, we said
that working capital = current assets – current liabilities. So a business needs
current assets to be able to pay off its current liabilities. The two liquidity ratios
shown below, use this concept.
 Current Ratio: this is the basic liquidity ratio that calculates how many current
assets are there in proportion to every current liability, so the higher the current
ratio the better (a value above 1 is favourable). the formula is:

 Liquid Ratio/ Acid Test Ratio: this is very similar to current ratio but this
ratio doesn’t consider inventory to be a liquid asset, since it will take time for it
to be sold and made into cash. A high level of inventory in a business can thus
cause a big difference between its current and liquidity ratios. So there is a
slight difference in the formula:

Uses and users of accounts

 Managers: they will use the accounts to help them keep control over the
performance of each product or each division since they can see which products
are profitably performing and which are not.
 This will allow them to take better decisions. If for example, product A has a
good gross profit margin of 35% but its net profit margin is only 5%, this means
that the business has very high expenses that is causing the huge difference
between the two ratios. They will try to reduce expenses in the coming year. In
the case of liquidity, if both ratios are very low, they will try to pay off current
liabilities to improve the ratios.
 Ratios can be compared with other firms in the industry/competitors and also
with previous years to see how they’re doing. Businesses will definitely want to
perform better than their rivals to attract shareholders to invest in their business
and to stay competitive in the market. Businesses will also try to improve their
profitability and liquidity positions each year.
 Shareholders: since they are the owners of a limited company, it is a legal
requirement that they be presented with the financial accounts of the company.
From the income statements and the profitability ratios, especially the ROCE,
existing shareholders and potential investors can see whether they should invest
in the business by buying shares. A higher profitability, the higher the chance of
getting dividends. They will also compare the ratios with other companies and
with previous years to take the most profitable decision. The balance sheet will
tell shareholders whether the business was worth more at the end of the year than
at the beginning of the year, and the liquidity ratios will be used to ascertain how
risky it will be to invest in the company- they won’t want to invest in businesses
with serious liquidity problems.
 Creditors: The balance sheet and liquidity ratios will tell creditors (suppliers) the
cash position and debts of the business. They will only be ready to supply to the
business if they will be able to pay them. If there are liquidity problems, they
won’t supply the business as it is risky for them.
 Banks: Similar to how suppliers use accounts, they will look at how risky it is to
lend to the business. They will only lend to profitable and liquid firms.
 Government: the government and tax officials will look at the profits of the
company to fix a tax rate and to see if the business is profitable and liquid enough
to continue operations and thus if the worker’s jobs will be protected.
 Workers and trade unions: they will want to see if the business’ future is
secure or not. If the business is continuously running a loss and is in risk of
insolvency (not being liquid), it may shut down operations and workers will lose
their jobs!
 Other businesses: managers of competing companies may want to compare their
performance too or may want to take over the business and wants to see if the
takeover will be beneficial.
Limitations of using accounts and ratio analysis

 Ratios are based on past accounting data and will not indicate how the business
will perform in the future
 Managers will have all accounts, but the external users will only have those
published accounts that contain only the data required by law- they may not get the
‘full-picture’ about the business’ performance.
 Comparing accounting data over the years can lead to misleading assumptions
since the data will be affected by inflation (rising prices)
 Different companies may use different accounting methods and so will have
different ratio results, making comparisons between companies unreliable.
6.1 – Economic Issues
The Business/ Trade Cycle
 An economy will not always go through an economic growth; there is usually a
cycle, as shown below.

Growth– when GDP is rising,

unemployment is falling and there are higher living standards in the country.
Businesses will look to expand and produce more and will earn high profits.
Boom– when GDP is at its highest and there is too much spending, causing
inflation to rapidly rise. Business costs will rise and firms will become worried
about how they are going to stay profitable in the near future.
Recession– when GDP starts to fall due of high prices, as demand and spending
falls. Firms will cut back production to stay profitable and unemployment may rise
as a result.
Slump– when GDP is so low that prices start to fall (deflation) and unemployment
will reach very high levels. Many businesses will close down as they cannot
survive the very low demand level. The economy will suffer.
(When the government takes measures to increase demand and spending in the
economy to take it from a slump to growth, it is called as the ‘recovery’ period).
The cycle repeats.

Economic Objectives
Here, we’ll look at the different economic objectives a government might have and
how their absence/negligence will affect the economy as well as businesses.

 Maintain economic growth: economic growth occurs when a country’s Gross

Domestic Product (GDP) increase i.e. more goods and services are produced than
in the previous year. This will increase the country’s incomes and achieve greater
living standards.
Effects of reducing GDP (recession):
 As output falls, fewer workers will be needed by firms, so unemployment will
rise
  As goods and services that can be consumed by the people falls, the standard of
living in the economy will also fall
 Achieve price stability: inflation is the increase in average prices of goods and
services over time. (Note that, inflation, in the real world, always exists. It is
natural for prices to increase as the years go by. In the case there is a fall in the
price level, it is called a deflation) Maintaining a low inflation will help the
economy to develop and grow better.
Effects of high inflation:
 As cost of living will have risen and peoples’ real incomes (the value of
income) will have fallen (when prices increase and incomes haven’t, the income
will buy lesser goods and services- the purchasing power will fall).
 Prices of domestic goods will rise as opposed to foreign goods in the market.
The country’s exports will become less competitive in the international market.
Domestic workers may lose their jobs if their products and firms don’t do well.
 When prices rise, demand will fall and all costs will rise (as wages, material
costs, overheads will all rise)- causing profits to fall. Thus, they will be
unwilling to expand and produce more in the future.
 The living standards (quality of life) in the country may fall when costs of
living rise.
 Reduce unemployment: unemployment exists when people who are willing and
able to work cannot find a job. A low unemployment means high output, incomes,
living standards etc.
Effects of high unemployment:
 Unemployed people do not produce anything and so, the total output/GDP in
the country will fall. This will in turn, lead to a fall in economic growth.
 Unemployed people receive no incomes, thus income inequality can rise in the
economy and living standards will fall. It also means that businesses will face
low demand due to low incomes.
 The government pays out unemployment benefits to the unemployed and this
will rise during high unemployment and government will not enough money
left over to spend on other services like education and health.
 Maintain balance of payments stability: this records the difference between a
country’s exports (goods and services sold from the country to another)
and imports (goods and services bought in by the country from another country).
The exports and imports needs to equal each other, thus balanced.
Effect of a disequilibrium in the balance of payments:
 If the imports of a country exceed its exports, it will cause depreciation in the
exchange rate– the value of the country’s currency will fall against other
foreign currencies (this will be explained in detail here).
  If the exports exceed the imports it indicates that the country is selling more
goods than it is consuming- the country itself doesn’t benefit from any high
output consumption.
 Reduce income equality/achieve effective income redistribution: the
difference/gap between the incomes of rich and poor people should narrow down
for income equality to improve. Improved income equality will ensure better living
standards and help the economy to grow faster and become more developed.
Effects of poor income equality:
 Inequal distribution of goods and services- the poor cannot buy as many goods
as the rich- poor living standards will arise.
Government Economic Policies
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Government can influence the economic conditions in a country by taking a variety
of policies.

Fiscal policy is a government policy which adjusts government spending and

taxation to influence the economy. It is the budgetary policy, because it manages
the government expenditure and revenue. Government aims for a balance budget
and tries to achieve it using fiscal policy.
Increasing government spending and reducing taxes will encourage more
production and increase employment, driving up GDP growth. This is because
government spending creates employment and increases economic activity in the
economy and lower taxes means people have more money to consume and firms
have to pay lesser tax on their profits. On the other hand, reducing government
spending and increasing taxes will discourage production and consumption, and
unemployment and GDP will fall.
Monetary policy is a government policy that adjusts the interest rate and foreign
exchange rates to influence the demand and supply of money in the economy, and
thus demand and supply. It is usually conducted by the country’s central bank and
usually used to maintain price stability, low unemployment and economic growth.
Increasing interest rates will discourage investments and consumption,
causing employment and GDP to fall (as the cost of borrowing-interest on loans
– has increased, and people prefer to earn more interest by saving rather than
spend). Similarly, reducing interest rates will boost investment, consumption,
employment, and thus GDP.

Supply-side policies: both the fiscal and monetary policies directly affect demand,
but the policies that influence supply are very different. It can include:
 Privatisation: selling government organizations to private individuals- this will
increase efficiency and productivity that increase supply as well encourage
competitors to enter and further increase supply.
 Improve training and education: governments can spend more on schools,
colleges and training centres so that people in the economy can become better
skilled and knowledgeable, helping increasing productivity.
 Increased competition: by acting against monopolies (firms that restrict
competitors to enter that industry/having full dominance in the market- refer xxx
for more details) and reducing government rules and regulations (often termed
‘deregulation’), the competitive environment can be improved and thus become
more productive.
For more details on government policies, check out our Economics notes.
*EXAM TIP: Remember that economic conditions and policies are all
interconnected; one change will lead to an effect which will lead to another effect
and so on, like a chain reaction in many different ways. In your exams, you should
take care to explain those effects that are relevant and appropriate to the business
or economy in the question*
How might businesses react to policy changes? It will depend varying on how
much impact the policy change will have on the particular
business/industry/economy. Here are a few examples:
 6.2 – Environmental and Ethical Issues
Business’ Impact on the Environment

Social responsibility is when a business decision benefits stakeholders other than

shareholders i.e. workers, community, suppliers, banks etc.
This is very important when coming to environmental issues. Businesses can
pollute the air by releasing smoke and poisonous gases, pollute water bodies
around it by releasing waste and chemicals into them, and damage the natural
beauty of a place and so on.
WHY BUSINESSES WANT WHY BUSINESSES DO NOT
TO BE ENVIRONMENT- WANT TO BE
FRIENDLY ENVIRONMENT-FRIENDLY

Sense of social responsibility It is expensive to reduce and

that comes from the fact that
their activities are contributing
to global warming and pollution
recycle waste for the business.
It means that expensive
machinery and skilled labour
will be required by the business
– reducing profits.

Using up scarce non-renewable Firms will have to increase

resources (such as rainforest
wood and coal) will raise their
prices in the future, so
businesses won’t use them now
prices to compensate for the
expensive environment-friendly
methods used in production-
higher prices mean lower
demand.

Consumers are becoming High prices can make firms less

socially-aware and are willing competitive in the market and
to buy only environment they could lose sales
friendly products.

Governments, environmental Businesses claim that it is the

organisations, even the government’s duty to clean up
community could take action pollution
against the business if they do
serious damage to the
environment
Externalities

A business’ decisions and actions can have significant effects on its stakeholders.
These effects are termed ‘externalities’. Externalities can be categorized into six
groups given below and we’ll take examples from a scenario where a business
builds a new production factory.

Private Costs: costs paid for by the business for an activity.

Examples: costs of building the factory, hiring extra employees, purchasing new
machinery, running a production unit etc.
Private Benefits: gains for the business resulting from an activity.
Example: the extra money made from the sale of the produced goods etc.
External Costs: costs paid for by the rest of the society (other than the business)
as a result of the business’ activity.
Examples: machinery noise, air pollution that leads to health problems among near
residents, loss of land (it could have been a farm land before) etc.
External Benefits: gains enjoyed by the rest of the society as a result of a business
activity.
Example: new jobs created for residents, government will get more tax from the
business, other firms may move into the area to support the firm-helping develop
the region, new roads might be built that can be enjoyed by residents etc.
Social Costs = Private Costs + External Costs
Social Benefits = Private Benefits + External Benefits
Governments use the cost-benefit-analysis (CBA) to decide whether to proceed
with a scheme or not and businesses have also adopted it. In CBA, the government
weighs up all the social costs and benefits that will arise if the scheme is put into
effect and give them all monetary values (this is not easy- what is the value of
losing natural beauty?). They will only allow the scheme to proceed if the social
benefits exceed the social costs, if the costs exceed the benefits, it is not allowed to
proceed.

Sustainable Development

Sustainable development is development that does not put at risk the living
standards of future generations. It means trying to achieve economic growth in a
 way that does not harm future generations. Few examples of a sustainable
development are:
 using renewable energy- so that resources are conserved for the future
 recycle waste
 use fewer resources
 develop new environment-friendly products and processes- reduce health and
climatic problems for future generations

Environmental Pressures

Pressure groups are organisations/groups of people who change business (and

government) decisions. If a business is seen to behave in a socially irresponsible
way, they can conduct consumer boycotts (encourage consumers to stop buying
their products) and take other actions. They are often very powerful because they
have public support and media coverage and are well-financed and equipped by the
public. If a pressure group is powerful it can result in a bad reputation for the
business that can affect it in future endeavours, so the business will give in to the
pressure groups’ demands. Example: Greenpeace
The government can also pass laws that can restrict business decisions such as
not permitting factories to locate in places of natural beauty.
There can also be penalties set in place that will penalize firms that excessively
pollute. Pollution permits are licenses to pollute up to a certain limit. These are
very expensive to acquire, so firms will try to avoid buying the pollution permit
and will have to reduce pollution levels to do so. Firms that pollute less can sell
their pollution permits to more polluting firms to earn money. Taxes can also be
levied on polluting goods and services.

Ethical Decisions

Ethical decisions are based on a moral code. It means ‘doing the right thing’.
Businesses could be faced with decisions regarding, for example, employment of
children, taking or offering bribes, associate with people/organisations with a bad
reputation etc. In these cases, even if they are legal, they need to take a decision
that they feel is right.
Taking ethical/’right’ decisions can make the business’ products popular among
customers, encourage the government to favour them in any future
disputes/demands and avoid pressure group threats. However, these can end up
 being expensive as the business will lose out on using cheaper unethical
opportunities.

6.3 – Business and the International Economy

Globalization

Globalization is a term used to describe the increases in worldwide trade and

movement of people and capital between countries. The same goods and
services are sold across the globe; workers are finding it easier to find work by
going abroad for work; money is sent from and to countries everywhere.
Some reasons how globalization has occurred are:
 Increasing number of free trade agreements– these are agreements between
countries that allows them to import and export goods and services with no tariffs
or quotas.
 Improved and cheaper transport (water, land, air) and communications
(internet) infrastructure
 Developing and emerging countries such as China and India are becoming
rapidly industrialized and so can export large volumes of goods and services. This
has caused an increase in the output and opportunities in international trade,
allowing for globalisation
Advantages of globalisation

 Allows businesses to start selling in new foreign markets, increasing sales and
profits
 Can open factories and production units in other countries, possibly at a cheaper
rate (cheaper materials and labour can be available in other countries)
 Import products from other countries and sell it to customers in the domestic
market- this could be more profitable and producing and selling the good
themselves
 Import materials and components for production from foreign countries at a
cheaper rate.
Disadvantages of globalisation

 Increasing imports into country from foreign competitors- now that foreign firms
can compete in other countries, it puts up much competition for domestic firms. If
these domestic firms cannot compete with the foreign goods’ cheap prices and
high quality, they may be forced to close down operations.
 Increasing investment by multinationals in home country- this could further add to
competition in the domestic market (although small local firms can become
suppliers to the large multinational firms)
 Employees may leave domestic firms if they don’t pay as well as the foreign
multinationals in the country- businesses will have to increase pay and conditions
to recruit and retain employees.
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REPORT THIS AD
When looking at an economy’s point of view, globalisation brings consumers
more choice and lower prices and forces domestic firms to be more efficient (in
order to remain competitive). However, competition from foreign producers can
force domestic firms to close down and jobs will be lost.
Protectionism

Protectionism refers to when governments protect domestic firms from foreign

competition using trade barriers such as tariffs and quotas; i.e. the opposite of free
trade.
Import quota is a restriction on the quantity of goods that can be imported into the
country.
Tariffs are taxes on imports.
Imposing these two measures will reduce the number of foreign goods in the
domestic market and make them expensive to buy, respectively. This will
reduce the competitiveness of the foreign goods and make it easy for domestic
firms to produce and sell their goods. However, it reduces free trade and
globalisation.
Free trade supporters say that it is better to allow consumers to buy imported goods
and domestic firms should produce and export goods and services that they have a
competitive advantage in. In this way, living standards across the globe will
improve.

Multinational Companies (MNCs)

Multinational businesses are firms with operations (production/service) in more

than one country. Also known as transnational businesses. Examples: Shell,
McDonald’s, Nissan etc.
Why do firms become multinationals?

 To produce goods with lower costs– cheaper material and labour may be available
in other countries
 To extract raw materials for production, available in a few other countries. For
example: crude oil in the Middle East
 To produce goods nearer to the markets to avoid transport costs.
 To avoid trade barriers on imports. If they produce the goods in foreign
countries, the firms will not have to pay import tariffs or be faced with a quota
restriction
 To expand into different markets and spread their risks
 To remain competitive with rival firms which may also be expanding abroad
Advantages to a country of a multinational setting up in their country:

 More jobs created by multinationals

 Increases GDP of the country
 The technology that the multinational brings in can bring in new ideas and
methods into the country
 As more goods are being produced in the country, the imports will be reduced
and some output can even be exported
 Multinationals will also pay taxes, thereby increasing the government’s tax
revenue
 More product choice for consumers
Disadvantages to a country of a multinational setting up in their country:

 The jobs created are often for unskilled tasks. The more skilled jobs will be done
by workers that come from the firm’s home country. The unskilled workers may
also be exploited with very low wages and unhygienic working conditions.
 Since multinationals benefit from economies of scale, local firms may be forced
out of business, unable to survive the competition
 Multinationals can use up the scarce, non-renewable resources in the country
 Repatriation of profit can occur. The profits earned by the multinational could be
sent back to their home country and the government will not be able to levy tax on
it.
 As multinationals are large, they can influence the government and economy.
They could threaten the government that they will close down and make workers
unemployed if they are not given financial grants and so on.

Exchange Rates

The exchange rate is the price of one currency in terms of another currency.
For example, €1= $1.2. To buy one euro, you’ll need 1.2 dollars. The demand and
supply of the currencies determine their exchange rate. In the above example,
if the €’s demand was greater than the $’s, or if the supply of € reduced more than
the $, then the €’s price in terms of $ will increase. It could now be €1= $1.5. Each
€ now buys more $.
A currency appreciates when its value rises. The example above is an
appreciation of the Euro. A European exporting firm will find an appreciation
disadvantageous as their American consumers will now have to pay more $ to buy
a €1 good (exports become expensive). Their competitiveness has reduced. A
European importing firm will find an appreciation of benefit. They can buy
American products for lesser Euros (imports become cheaper).
A currency depreciates when its value falls. In the example above, the Dollar
depreciated. An American exporting firm will find a depreciation advantageous as
their European consumers will now have to pay less € to buy a $1 good (exports
become cheaper). Their competitiveness has increased. An American importing
firm will find a depreciation disadvantageous. They will have to buy European
products for more dollars (imports become expensive).
In summary, an appreciations is good for importers, bad for exporters; a
depreciation is good for exporters, bad for importers; given that the goods are
price elastic (if the price didn’t matter much to consumers, sales and revenue
would not be affected by price- so no worries for producers).
Confused? Don’t worry, it is a confusing topic. Check out our more detailed
Economics notes on exchange rates.
6.2 – Environmental and Ethical Issues
Business’ Impact on the Environment

Social responsibility is when a business decision benefits stakeholders other than

shareholders i.e. workers, community, suppliers, banks etc.
This is very important when coming to environmental issues. Businesses can
pollute the air by releasing smoke and poisonous gases, pollute water bodies
around it by releasing waste and chemicals into them, and damage the natural
beauty of a place and so on.
WHY BUSINESSES WANT WHY BUSINESSES DO NOT
TO BE ENVIRONMENT- WANT TO BE
FRIENDLY ENVIRONMENT-FRIENDLY

Sense of social responsibility It is expensive to reduce and

that comes from the fact that recycle waste for the business.
their activities are contributing It means that expensive
to global warming and pollution machinery and skilled labour
will be required by the business
– reducing profits.

Using up scarce non-renewable Firms will have to increase

resources (such as rainforest
wood and coal) will raise their
prices in the future, so
businesses won’t use them now
prices to compensate for the
expensive environment-friendly
methods used in production-
higher prices mean lower
demand.

Consumers are becoming High prices can make firms less

socially-aware and are willing competitive in the market and
to buy only environment they could lose sales
friendly products.

Governments, environmental Businesses claim that it is the

organisations, even the government’s duty to clean up
community could take action pollution
against the business if they do
serious damage to the
environment

Externalities

Advertisements
REPORT THIS AD
A business’ decisions and actions can have significant effects on its stakeholders.
These effects are termed ‘externalities’. Externalities can be categorized into six
groups given below and we’ll take examples from a scenario where a business
builds a new production factory.

Private Costs: costs paid for by the business for an activity.

Examples: costs of building the factory, hiring extra employees, purchasing new
machinery, running a production unit etc.
Private Benefits: gains for the business resulting from an activity.
Example: the extra money made from the sale of the produced goods etc.
 External Costs: costs paid for by the rest of the society (other than the business)
as a result of the business’ activity.
Examples: machinery noise, air pollution that leads to health problems among near
residents, loss of land (it could have been a farm land before) etc.
External Benefits: gains enjoyed by the rest of the society as a result of a business
activity.
Example: new jobs created for residents, government will get more tax from the
business, other firms may move into the area to support the firm-helping develop
the region, new roads might be built that can be enjoyed by residents etc.
Social Costs = Private Costs + External Costs
Social Benefits = Private Benefits + External Benefits
Governments use the cost-benefit-analysis (CBA) to decide whether to proceed
with a scheme or not and businesses have also adopted it. In CBA, the government
weighs up all the social costs and benefits that will arise if the scheme is put into
effect and give them all monetary values (this is not easy- what is the value of
losing natural beauty?). They will only allow the scheme to proceed if the social
benefits exceed the social costs, if the costs exceed the benefits, it is not allowed to
proceed.

Sustainable Development

Sustainable development is development that does not put at risk the living
standards of future generations. It means trying to achieve economic growth in a
way that does not harm future generations. Few examples of a sustainable
development are:
 using renewable energy- so that resources are conserved for the future
 recycle waste
 use fewer resources
 develop new environment-friendly products and processes- reduce health and
climatic problems for future generations

Environmental Pressures

Pressure groups are organisations/groups of people who change business (and

government) decisions. If a business is seen to behave in a socially irresponsible
way, they can conduct consumer boycotts (encourage consumers to stop buying
their products) and take other actions. They are often very powerful because they
have public support and media coverage and are well-financed and equipped by the
 public. If a pressure group is powerful it can result in a bad reputation for the
business that can affect it in future endeavours, so the business will give in to the
pressure groups’ demands. Example: Greenpeace
The government can also pass laws that can restrict business decisions such as
not permitting factories to locate in places of natural beauty.
There can also be penalties set in place that will penalize firms that excessively
pollute. Pollution permits are licenses to pollute up to a certain limit. These are
very expensive to acquire, so firms will try to avoid buying the pollution permit
and will have to reduce pollution levels to do so. Firms that pollute less can sell
their pollution permits to more polluting firms to earn money. Taxes can also be
levied on polluting goods and services.

Ethical Decisions

Ethical decisions are based on a moral code. It means ‘doing the right thing’.
Businesses could be faced with decisions regarding, for example, employment of
children, taking or offering bribes, associate with people/organisations with a bad
reputation etc. In these cases, even if they are legal, they need to take a decision
that they feel is right.
Taking ethical/’right’ decisions can make the business’ products popular among
customers, encourage the government to favour them in any future
disputes/demands and avoid pressure group threats. However, these can end up
being expensive as the business will lose out on using cheaper unethical
opportunities.

6.3 – Business and the International Economy

Globalization

Globalization is a term used to describe the increases in worldwide trade and

movement of people and capital between countries. The same goods and
services are sold across the globe; workers are finding it easier to find work by
going abroad for work; money is sent from and to countries everywhere.
Some reasons how globalization has occurred are:
 Increasing number of free trade agreements– these are agreements between
countries that allows them to import and export goods and services with no tariffs
or quotas.
 Improved and cheaper transport (water, land, air) and communications
(internet) infrastructure
 Developing and emerging countries such as China and India are becoming
rapidly industrialized and so can export large volumes of goods and services. This
has caused an increase in the output and opportunities in international trade,
allowing for globalisation
Advantages of globalisation

 Allows businesses to start selling in new foreign markets, increasing sales and
profits
 Can open factories and production units in other countries, possibly at a cheaper
rate (cheaper materials and labour can be available in other countries)
 Import products from other countries and sell it to customers in the domestic
market- this could be more profitable and producing and selling the good
themselves
 Import materials and components for production from foreign countries at a
cheaper rate.
Disadvantages of globalisation

 Increasing imports into country from foreign competitors- now that foreign firms
can compete in other countries, it puts up much competition for domestic firms. If
these domestic firms cannot compete with the foreign goods’ cheap prices and
high quality, they may be forced to close down operations.
 Increasing investment by multinationals in home country- this could further add to
competition in the domestic market (although small local firms can become
suppliers to the large multinational firms)
 Employees may leave domestic firms if they don’t pay as well as the foreign
multinationals in the country- businesses will have to increase pay and conditions
to recruit and retain employees.
When looking at an economy’s point of view, globalisation brings consumers
more choice and lower prices and forces domestic firms to be more efficient (in
order to remain competitive). However, competition from foreign producers can
force domestic firms to close down and jobs will be lost.
Protectionism

Protectionism refers to when governments protect domestic firms from foreign

competition using trade barriers such as tariffs and quotas; i.e. the opposite of free
trade.
Import quota is a restriction on the quantity of goods that can be imported into the
country.
Tariffs are taxes on imports.
 Imposing these two measures will reduce the number of foreign goods in the
domestic market and make them expensive to buy, respectively. This will
reduce the competitiveness of the foreign goods and make it easy for domestic
firms to produce and sell their goods. However, it reduces free trade and
globalisation.
Free trade supporters say that it is better to allow consumers to buy imported goods
and domestic firms should produce and export goods and services that they have a
competitive advantage in. In this way, living standards across the globe will
improve.

Multinational Companies (MNCs)

Multinational businesses are firms with operations (production/service) in more

than one country. Also known as transnational businesses. Examples: Shell,
McDonald’s, Nissan etc.
Why do firms become multinationals?

 To produce goods with lower costs– cheaper material and labour may be available
in other countries
 To extract raw materials for production, available in a few other countries. For
example: crude oil in the Middle East
 To produce goods nearer to the markets to avoid transport costs.
 To avoid trade barriers on imports. If they produce the goods in foreign
countries, the firms will not have to pay import tariffs or be faced with a quota
restriction
 To expand into different markets and spread their risks
 To remain competitive with rival firms which may also be expanding abroad
Advantages to a country of a multinational setting up in their country:

 More jobs created by multinationals

 Increases GDP of the country
 The technology that the multinational brings in can bring in new ideas and
methods into the country
 As more goods are being produced in the country, the imports will be reduced
and some output can even be exported
 Multinationals will also pay taxes, thereby increasing the government’s tax
revenue
 More product choice for consumers
 Disadvantages to a country of a multinational setting up in their country:

 The jobs created are often for unskilled tasks. The more skilled jobs will be done
by workers that come from the firm’s home country. The unskilled workers may
also be exploited with very low wages and unhygienic working conditions.
 Since multinationals benefit from economies of scale, local firms may be forced
out of business, unable to survive the competition
 Multinationals can use up the scarce, non-renewable resources in the country
 Repatriation of profit can occur. The profits earned by the multinational could be
sent back to their home country and the government will not be able to levy tax on
it.
 As multinationals are large, they can influence the government and economy.
They could threaten the government that they will close down and make workers
unemployed if they are not given financial grants and so on.

Exchange Rates

The exchange rate is the price of one currency in terms of another currency.
For example, €1= $1.2. To buy one euro, you’ll need 1.2 dollars. The demand and
supply of the currencies determine their exchange rate. In the above example,
if the €’s demand was greater than the $’s, or if the supply of € reduced more than
the $, then the €’s price in terms of $ will increase. It could now be €1= $1.5. Each
€ now buys more $.
A currency appreciates when its value rises. The example above is an
appreciation of the Euro. A European exporting firm will find an appreciation
disadvantageous as their American consumers will now have to pay more $ to buy
a €1 good (exports become expensive). Their competitiveness has reduced. A
European importing firm will find an appreciation of benefit. They can buy
American products for lesser Euros (imports become cheaper).
A currency depreciates when its value falls. In the example above, the Dollar
depreciated. An American exporting firm will find a depreciation advantageous as
their European consumers will now have to pay less € to buy a $1 good (exports
become cheaper). Their competitiveness has increased. An American importing
firm will find a depreciation disadvantageous. They will have to buy European
products for more dollars (imports become expensive).
In summary, an appreciations is good for importers, bad for exporters; a
depreciation is good for exporters, bad for importers; given that the goods are
price elastic (if the price didn’t matter much to consumers, sales and revenue
would not be affected by price- so no worries for producers).
Confused? Don’t worry, it is a confusing topic. Check out our more detailed
Economics notes on exchange rates.
6.2 – Environmental and Ethical Issues
Business’ Impact on the Environment

Social responsibility is when a business decision benefits stakeholders other than

shareholders i.e. workers, community, suppliers, banks etc.
This is very important when coming to environmental issues. Businesses can
pollute the air by releasing smoke and poisonous gases, pollute water bodies
around it by releasing waste and chemicals into them, and damage the natural
beauty of a place and so on.
WHY BUSINESSES WANT WHY BUSINESSES DO NOT
TO BE ENVIRONMENT- WANT TO BE
FRIENDLY ENVIRONMENT-FRIENDLY

Sense of social responsibility It is expensive to reduce and

that comes from the fact that
their activities are contributing
to global warming and pollution
recycle waste for the business.
It means that expensive
machinery and skilled labour
will be required by the business
– reducing profits.

Using up scarce non-renewable Firms will have to increase

resources (such as rainforest
wood and coal) will raise their
prices in the future, so
businesses won’t use them now
prices to compensate for the
expensive environment-friendly
methods used in production-
higher prices mean lower
demand.

Consumers are becoming High prices can make firms less

socially-aware and are willing competitive in the market and
to buy only environment they could lose sales
friendly products.

Governments, environmental Businesses claim that it is the

organisations, even the government’s duty to clean up
community could take action pollution
against the business if they do
serious damage to the
environment

Externalities

Advertisements
REPORT THIS AD
A business’ decisions and actions can have significant effects on its stakeholders.
These effects are termed ‘externalities’. Externalities can be categorized into six
groups given below and we’ll take examples from a scenario where a business
builds a new production factory.

Private Costs: costs paid for by the business for an activity.

Examples: costs of building the factory, hiring extra employees, purchasing new
machinery, running a production unit etc.
Private Benefits: gains for the business resulting from an activity.
Example: the extra money made from the sale of the produced goods etc.
External Costs: costs paid for by the rest of the society (other than the business)
as a result of the business’ activity.
Examples: machinery noise, air pollution that leads to health problems among near
residents, loss of land (it could have been a farm land before) etc.
External Benefits: gains enjoyed by the rest of the society as a result of a business
activity.
Example: new jobs created for residents, government will get more tax from the
business, other firms may move into the area to support the firm-helping develop
the region, new roads might be built that can be enjoyed by residents etc.
Social Costs = Private Costs + External Costs
Social Benefits = Private Benefits + External Benefits
Governments use the cost-benefit-analysis (CBA) to decide whether to proceed
with a scheme or not and businesses have also adopted it. In CBA, the government
weighs up all the social costs and benefits that will arise if the scheme is put into
effect and give them all monetary values (this is not easy- what is the value of
losing natural beauty?). They will only allow the scheme to proceed if the social
benefits exceed the social costs, if the costs exceed the benefits, it is not allowed to
proceed.

Sustainable Development
 Sustainable development is development that does not put at risk the living
standards of future generations. It means trying to achieve economic growth in a
way that does not harm future generations. Few examples of a sustainable
development are:
 using renewable energy- so that resources are conserved for the future
 recycle waste
 use fewer resources
 develop new environment-friendly products and processes- reduce health and
climatic problems for future generations

Environmental Pressures

Pressure groups are organisations/groups of people who change business (and

government) decisions. If a business is seen to behave in a socially irresponsible
way, they can conduct consumer boycotts (encourage consumers to stop buying
their products) and take other actions. They are often very powerful because they
have public support and media coverage and are well-financed and equipped by the
public. If a pressure group is powerful it can result in a bad reputation for the
business that can affect it in future endeavours, so the business will give in to the
pressure groups’ demands. Example: Greenpeace
The government can also pass laws that can restrict business decisions such as
not permitting factories to locate in places of natural beauty.
There can also be penalties set in place that will penalize firms that excessively
pollute. Pollution permits are licenses to pollute up to a certain limit. These are
very expensive to acquire, so firms will try to avoid buying the pollution permit
and will have to reduce pollution levels to do so. Firms that pollute less can sell
their pollution permits to more polluting firms to earn money. Taxes can also be
levied on polluting goods and services.

Ethical Decisions

Ethical decisions are based on a moral code. It means ‘doing the right thing’.
Businesses could be faced with decisions regarding, for example, employment of
children, taking or offering bribes, associate with people/organisations with a bad
reputation etc. In these cases, even if they are legal, they need to take a decision
that they feel is right.
 Taking ethical/’right’ decisions can make the business’ products popular among
customers, encourage the government to favour them in any future
disputes/demands and avoid pressure group threats. However, these can end up
being expensive as the business will lose out on using cheaper unethical
opportunities.

6.3 – Business and the International Economy

Globalization

Globalization is a term used to describe the increases in worldwide trade and

movement of people and capital between countries. The same goods and
services are sold across the globe; workers are finding it easier to find work by
going abroad for work; money is sent from and to countries everywhere.
Some reasons how globalization has occurred are:
 Increasing number of free trade agreements– these are agreements between
countries that allows them to import and export goods and services with no tariffs
or quotas.
 Improved and cheaper transport (water, land, air) and communications
(internet) infrastructure
 Developing and emerging countries such as China and India are becoming
rapidly industrialized and so can export large volumes of goods and services. This
has caused an increase in the output and opportunities in international trade,
allowing for globalisation
Advantages of globalisation

 Allows businesses to start selling in new foreign markets, increasing sales and
profits
 Can open factories and production units in other countries, possibly at a cheaper
rate (cheaper materials and labour can be available in other countries)
 Import products from other countries and sell it to customers in the domestic
market- this could be more profitable and producing and selling the good
themselves
 Import materials and components for production from foreign countries at a
cheaper rate.
Disadvantages of globalisation

 Increasing imports into country from foreign competitors- now that foreign firms
can compete in other countries, it puts up much competition for domestic firms. If
 these domestic firms cannot compete with the foreign goods’ cheap prices and
high quality, they may be forced to close down operations.
 Increasing investment by multinationals in home country- this could further add to
competition in the domestic market (although small local firms can become
suppliers to the large multinational firms)
 Employees may leave domestic firms if they don’t pay as well as the foreign
multinationals in the country- businesses will have to increase pay and conditions
to recruit and retain employees.
When looking at an economy’s point of view, globalisation brings consumers
more choice and lower prices and forces domestic firms to be more efficient (in
order to remain competitive). However, competition from foreign producers can
force domestic firms to close down and jobs will be lost.
Protectionism

Protectionism refers to when governments protect domestic firms from foreign

competition using trade barriers such as tariffs and quotas; i.e. the opposite of free
trade.
Import quota is a restriction on the quantity of goods that can be imported into the
country.
Tariffs are taxes on imports.
Imposing these two measures will reduce the number of foreign goods in the
domestic market and make them expensive to buy, respectively. This will
reduce the competitiveness of the foreign goods and make it easy for domestic
firms to produce and sell their goods. However, it reduces free trade and
globalisation.
Free trade supporters say that it is better to allow consumers to buy imported goods
and domestic firms should produce and export goods and services that they have a
competitive advantage in. In this way, living standards across the globe will
improve.

Multinational Companies (MNCs)

Multinational businesses are firms with operations (production/service) in more

than one country. Also known as transnational businesses. Examples: Shell,
McDonald’s, Nissan etc.
Why do firms become multinationals?

 To produce goods with lower costs– cheaper material and labour may be available
in other countries
 To extract raw materials for production, available in a few other countries. For
example: crude oil in the Middle East
 To produce goods nearer to the markets to avoid transport costs.
 To avoid trade barriers on imports. If they produce the goods in foreign
countries, the firms will not have to pay import tariffs or be faced with a quota
restriction
 To expand into different markets and spread their risks
 To remain competitive with rival firms which may also be expanding abroad
Advantages to a country of a multinational setting up in their country:

 More jobs created by multinationals

 Increases GDP of the country
 The technology that the multinational brings in can bring in new ideas and
methods into the country
 As more goods are being produced in the country, the imports will be reduced
and some output can even be exported
 Multinationals will also pay taxes, thereby increasing the government’s tax
revenue
 More product choice for consumers
Disadvantages to a country of a multinational setting up in their country:

 The jobs created are often for unskilled tasks. The more skilled jobs will be done
by workers that come from the firm’s home country. The unskilled workers may
also be exploited with very low wages and unhygienic working conditions.
 Since multinationals benefit from economies of scale, local firms may be forced
out of business, unable to survive the competition
 Multinationals can use up the scarce, non-renewable resources in the country
 Repatriation of profit can occur. The profits earned by the multinational could be
sent back to their home country and the government will not be able to levy tax on
it.
 As multinationals are large, they can influence the government and economy.
They could threaten the government that they will close down and make workers
unemployed if they are not given financial grants and so on.

Exchange Rates

The exchange rate is the price of one currency in terms of another currency.
For example, €1= $1.2. To buy one euro, you’ll need 1.2 dollars. The demand and
supply of the currencies determine their exchange rate. In the above example,
if the €’s demand was greater than the $’s, or if the supply of € reduced more than
the $, then the €’s price in terms of $ will increase. It could now be €1= $1.5. Each
€ now buys more $.
A currency appreciates when its value rises. The example above is an
appreciation of the Euro. A European exporting firm will find an appreciation
disadvantageous as their American consumers will now have to pay more $ to buy
a €1 good (exports become expensive). Their competitiveness has reduced. A
European importing firm will find an appreciation of benefit. They can buy
American products for lesser Euros (imports become cheaper).
A currency depreciates when its value falls. In the example above, the Dollar
depreciated. An American exporting firm will find a depreciation advantageous as
their European consumers will now have to pay less € to buy a $1 good (exports
become cheaper). Their competitiveness has increased. An American importing
firm will find a depreciation disadvantageous. They will have to buy European
products for more dollars (imports become expensive).
In summary, an appreciations is good for importers, bad for exporters; a
depreciation is good for exporters, bad for importers; given that the goods are
price elastic (if the price didn’t matter much to consumers, sales and revenue
would not be affected by price- so no worries for producers).
Confused? Don’t worry, it is a confusing topic. Check out our more detailed
Economics notes on exchange rates.