CHAPTER 6: EXTERNAL INFLUENCES ON BUSINESS ACTIVITY

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.

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 (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.

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  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.

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 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

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,

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 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:

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 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 TO BE WHY BUSINESSES DO NOT WANT

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 ENVIRONMENT- FRIENDLY
Sense of social responsibility that
comes from the fact that their
activities are contributing to global
warming and pollution
Using up scarce non-renewable
resources (such as rainforest wood
and coal) will raise their prices in
the future, so businesses won’t use
them now
Consumers are becoming socially-
aware and are willing to buy only
environment friendly products.
Governments, environmental
organisations, even the community
could take action 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
TO BE ENVIRONMENT-FRIENDLY
It is expensive to reduce and
recycle waste for the business. It
means that expensive machinery
and skilled labour will be required
by the business – reducing profits.
Firms will have to increase prices to
compensate for the expensive
environment-friendly methods
used in production- higher prices
mean lower demand.
High prices can make firms less
competitive in the market and they
could lose sales
Businesses claim that it is the
government’s duty to clean up
pollution
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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.

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 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.

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 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

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 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.

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 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

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 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 $.

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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).

CHAPTER 6

Economic objectives

Governments pursue various economic objectives to promote the well-being of their

citizens and ensure the stability and growth of their economies. These objectives can vary

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based on the specific circumstances of a country, but some common economic objectives
include:

1. Economic Growth: Governments aim to achieve sustained and stable economic

growth to increase the overall standard of living. Policies that encourage
investment, innovation, and productivity are often implemented to foster economic
expansion.
2. Full Employment: Governments seek to attain full employment, meaning that a
large majority of the working-age population is employed. This objective helps
reduce poverty, inequality, and social unrest.
3. Price Stability: Controlling inflation and deflation is a crucial objective to ensure
price stability. Moderate and predictable levels of inflation are often targeted, as
excessive inflation erodes purchasing power, while deflation can lead to economic
downturns.
4. Balance of Payments: Governments aim to maintain a balance between exports
and imports to avoid large trade deficits or surpluses. A stable balance of payments
contributes to overall economic stability.
5. Income Distribution: Governments may work to achieve a more equitable
distribution of income and wealth. This objective is pursued to reduce poverty and
enhance social cohesion.
6. Global Competitiveness: Governments may strive to enhance the competitiveness
of their industries in the global market. This involves fostering innovation,
improving infrastructure, and creating a conducive business environment.

Government Economic Policies

Governments implement various economic policies to achieve their economic objectives

1. Fiscal Policy:

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 Government Spending: Governments use fiscal policy to influence the economy by
adjusting the level of government spending. Increased government spending,
especially on infrastructure, education, and healthcare, can stimulate economic
activity and job creation.

Taxation: Changes in tax rates and structures can impact consumer spending,
business investment, and overall economic activity. Governments may use tax cuts
to stimulate economic growth or tax increases to cool down an overheating
economy and reduce inflationary pressures.

Budget Deficits and Surpluses: Fiscal policy also involves managing the
government's budget. Running a budget deficit (when expenditures exceed
revenues) can stimulate economic growth, while a budget surplus (when revenues
exceed expenditures) can be used to pay down debt or prepare for future economic
downturns.

2. Monetary Policy:

Interest Rates: Central banks use monetary policy tools, such as adjusting interest rates, to
influence the money supply and control inflation. Lowering interest rates can encourage
borrowing and spending, while raising rates can cool down an overheating economy and
control inflation.

Open Market Operations: Central banks conduct open market operations to buy or sell
government securities, influencing the money supply. Buying securities injects money into
the economy, while selling securities withdraws money.

Reserve Requirements: Central banks may set reserve requirements, dictating the
proportion of deposits that banks must hold in reserve. Adjusting these requirements can
impact the money supply and, consequently, economic activity.

3. Supply-Side Policies:

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Regulatory Reforms: Governments may implement reforms to reduce regulatory burdens
on businesses, encourage competition, and foster innovation. This can improve overall
economic efficiency.

Labor Market Policies: Reforms in labor markets, such as changes in labor laws, can
impact employment, productivity, and wages.

Education and Training: Investing in education and training programs can enhance the
skills of the workforce, contributing to long-term economic growth.

4. Trade Policies:

Tariffs and Trade Agreements: Governments may use trade policies to protect domestic
industries through tariffs or negotiate trade agreements to facilitate international trade.
These policies can impact exports, imports, and the overall balance of payments.

5. Environmental and Social Policies:

Environmental Regulations: Governments may implement policies to address

environmental concerns, such as emissions standards and sustainable development
initiatives.

Social Welfare Programs: Policies related to social welfare, healthcare, and poverty
alleviation can have economic implications by affecting income distribution and overall
well-being.

Some terms to be familiar with……..

i. Labour force – the working population of an economy, i.e. all people of working age

who are willing and able to work.

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 ii. Dependent population – people not in the labour force and thus depend on the

labour force to supply them with goods and services to fulfill their needs and wants.

E.g students, retired people, stay at home parents, prisoners or those choosing not

to work.

iii. Employment is defined as an engagement of a person in the labour force in some

occupation, business, trade, or profession.

iv. Unemployment is a situation where people in the labour force are actively looking

for jobs but are currently unemployed.

v. Full Employment is the situation where the entire labour force is employed. That

is, all the people who are able and willing to work are employed – unemployment

rate is 0%.

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