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 to 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 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) increases 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 the government will not have 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 need 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:
● Unequal 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, 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 organisations 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 TO BE WHY BUSINESSES DO NOT WANT TO BE

ENVIRONMENT- FRIENDLY ENVIRONMENT-FRIENDLY

It is expensive to reduce and recycle waste

Sense of social responsibility that comes from
for the business. It means that expensive
the fact that their activities are contributing to
machinery and skilled labour will be required
global warming and pollution
by the business – reducing profits.
 Firms will have to increase prices to
Using up scarce non-renewable resources
compensate for the expensive
(such as rainforest wood and coal) will raise
environment-friendly methods used in
their prices in the future, so businesses won’t
production- higher prices mean lower
use them now
demand.

Consumers are becoming socially-aware and

High prices can make firms less competitive
are willing to buy only environment friendly
in the market and they could lose sales
products.

Governments, environmental organisations,

even the community could take action against Businesses claim that it is the government’s
the business if they do serious damage to the duty to clean up pollution
environment

Externalities

A business’ decisions and actions can have significant effects on its stakeholders. These effects are
termed ‘externalities’. Externalities can be categorised 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 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 penalise firms that excessively pollute. Pollution
permits are licences 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,
associating 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

Globalisation

Globalisation 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 globalisation has occurred are:

● Increasing number of free trade agreements– these are agreements between countries that allow 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 industrialised 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.