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TOPIC 6. EXTERNAL INFLUENCES ON BUSINESS ACTIVITY

6.1 Economic issues

6.1.1 Business Cycles

 It refers to variation in the national output (GDP) of a country over time. (w19p13)
 Gross Domestic Product (GDP) is the total value of output all businesses in an economy have
produced in a given year.

THE MAIN STAGES OF A BUSINESS CYCLE

Boom

 It is a period when GDP will be rising quickly

 when there will be an upturn in the level of economic activity

Features

1. High level of demand

2. Low levels of unemployment
3. High demand for raw materials and finished products
4. Rising prices or inflation in the late stages of a boom
5. High investment and high demand for capital
6. Rising profits
7. New business start - ups/rising competition

Effects on businesses: Positive – consumer disposable income will increase, so sales will increase.
Negative - too much demand can lead to inflation, shortages of raw materials and labour force, leading
to higher costs of production.
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Recession

 It is a sustained decrease in GDP of a country

 a period of declining national output (down turn)

Features

1. Low sales
2. Rising unemployment
3. Low demand for raw materials and finished products
4. Low investment (and high inflation rates)

Effects on businesses - Domestic sales will decrease because of low disposable income and inflation
HOWEVER, exports may not be affected

6.1.2 How government control over the economy affects business activity and how businesses may
respond

Government economic objectives:

LOW INFLATION

 Inflation is the increase in the average price level of goods and services over time.

Impact of rapid/high rate of inflation on businesses: - Worker’s wages will buy less goods and services
than before, so they demand wage increases. - Prices of that country’s exports will become expensive
compared to those in other countries, so, exporting firms lose sales to foreign competitors. -Uncertainty
will increase, so businesses may cancel plans to expand. Impact of low rate of inflation on businesses: -
Can encourage businesses to expand. - It makes it easier for a country to sell its goods and services
abroad

LOW UNEMPLOYMENT

 Unemployment is a situation where people are willing and able to work, but cannot find jobs
 When unemployment is high, it means employment is low, and the opposite is true

Impact high unemployment on businesses: - Can lead to low sales because people will be having no or
little disposable income. - The businesses can pay low wages and benefit low labour costs

Low levels of unemployment may lead to higher sales and enable firms to grow

ECONOMIC GROWTH

 It is when a country’s Gross Domestic Product increases

 More goods and services are produced than in the previous year.
 Gross Domestic Product (GDP) is the total money value of output of goods and services in a
country in one year
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 When GDP is falling, there is no economic growth

IMPACT OF FALLING GDP ON:

The economy:

 As output is falling, fewer workers are needed and unemployment will occur
 Standards of living will fall, so people will afford to buy fewer goods and services per year
 Businesses will not expand as people will have less money to spend on goods and services
produced

Businesses (s19p12)

 Lower demand / sales

 More difficult to raise prices / may need to reduce prices
 Less likely to invest / expand
 Lower profits
 Spare capacity increases
 Reduce levels of inventory / stock / less output
 BUT, easier to recruit employees / may need to make workers redundant

Economic growth will: - Raise living standards and make people afford more goods and services. - Sales
for luxury products will rise

CHARACTERISTICS OF ECONOMIC GROWTH (S18P12)

 Lower unemployment OR more jobs created

 More businesses opening OR improved business confidence OR
 increased capital investment
 Higher living standards OR more disposable income OR rising incomes OR increase
in demand / sales
 Higher rates of economic growth OR increase in GDP OR Level of
 output increases
 Increased tax revenue
 Higher business profits
 Higher inflation OR higher prices

ACHIEVE A BALANCE OF PAYMENTS EQUILIBRIUM

Balance of Payments (BOP) = Exports – Imports

 If exports are greater than imports, it is called a trade surplus which means the country would
have benefited from trade.
 If exports are less than imports, it is called a trade deficit

Problems of a BOP deficit: - A country may run out of foreign currency and it may have to borrow from
abroad. - The exchange rate is likely to fall
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Impact of changes in taxes:

Taxation

 It is a levy charged by the government on incomes and imports.

 It is used in the government’s fiscal policy (the budget)
 Fiscal policy is any change by government in tax rates or public sector spending
 Taxes are meant to:

a) generate revenue for the government

b) redistribute income by charging taxes on the haves to give the have not’s
c) to reduce imports
d) to control inflation

Types of taxes

Direct taxes: - these are paid directly from incomes e.g.

1) Income tax
 It is charged on salaries earned by employees
 An increase in income tax will reduce the disposable income of workers
 Disposable income is the level of income a taxpayer has after paying income tax
 This will lead to low sales

Higher rate Individual tax payers have Businesses see Businesses produce Unemployment
of tax falling sales fewer goods
less disposable income increase

NB: Businesses selling luxury goods are the most affected whereas those selling essential goods and
services will be less affected

2) Profits tax (or corporation tax)

 It is charged on profits made by businesses – usually limited companies

High rates of profit tax will: - Reduce profits after tax, leaving managers with less finance to put into the
business for expansion purposes. - Reduced profits means owners will get less money from the
business.

3) Customs Duty/Import Tariffs and quotas: is a tax on an imported product

An increase in import duties will: - Increase sales of home produced goods if they are competing with
imported goods. Tariffs make imported goods expensive. Make importing businesses will suffer because
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the cost of production will be increased. This can reduce their profits. Make other countries retaliate.
Businesses trying to export to these countries will sell fewer goods than before

Import quota - It is a physical limit on the quantity of a product that can be imported

Impact of quotas on businesses: - reduce the amount of materials a business can import, so it becomes
difficult to meet demand. Can make the business look for supplies elsewhere, which may reduce quality
or raise costs.

Indirect taxes: - these are added to the prices of goods and taxpayers pay the tax as they purchase the
goods e.g.

4) Value added tax (VAT) – Indirect Tax

An increase in VAT/expenditure tax will: - Cause prices of goods in the shops to rise. Consumers may buy
fewer items as a result and demand for products made by businesses will fall. Sales for luxury items will
be affected most. - Workers notice that their wages buy less in shops, so they push for higher wages,
forcing costs of making products up.

Impact of changes in government spending:

 If government increase its spending, it will create more demand in the economy, more jobs and
GDP will increase

MONETARY POLICY - INTEREST RATES

 Monetary policy is a change in interest rates by government or central bank e.g. RBZ

Impact of a rise in interest rates:

 Higher costs of interest on loan, reducing profits

 Consumer’s incomes available to spend fall
 Could lead to higher exchange rate
 Businesses may be less willing to borrow to pay for investment/expansion
 Less consumers borrowing to buy expensive items

6.2 ENVIROMENTAL AND ETHICAL ISSUES

6.2.1 Environmental concerns and ethical issues as both opportunities and constraints for businesses

Impact of business activity on the environment examples:

 Aircraft jet engine emissions damage the atmosphere

 Pollution from factory chimneys reduces air quality
 Waste disposal can pollute river and seas
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 Transport of goods by ship and trucks burns fossil fuels such as oil which create carbon
emissions and may be linked to ‘global warming’ and climate change.

Social responsibility: - It is when a business decision benefits stakeholders other than shareholders

Environment refers to our natural world

SHOULD BUSINESSES BE MORE SOCIALLY RESPONSIBLE OR NOT? – see business ethics

EXTERNALITIES

These are spill - over effects to thirds parties who were not initially involved in a business decision

THE DIFFERENCE BETWEEN PRIVATE COSTS AND BENEFITS AND EXTERNAL COSTS AND BENEFITS

Private Costs (PC) - It refers to costs paid for by a business in undertaking an activity

Examples:

 Depreciation
 Insurance costs
 Rent/cost of buying land
 Labour costs i.e. wages/salaries
 Transport costs etc.

Private Benefits (PB) - It refers to gains to a business out of an activity

Examples: - Money made of sale of the product produced

External Costs (EC) - It refers to costs that are paid for by the rest of the society, other than the business,
as a result of business activity.

Examples:

 Displacement of local residents

 Noise pollution
 Waste products causing land, water and air pollution damaging the environment, peoples’ and
animals’ health
 Parkland that can no longer be used by local residents
 Loss of natural beauty etc.

External Benefits (EB) - It refers to gains to the rest of the society, other than the business, resulting
from business activity

Examples:

 Jobs created
 Agglomeration where other firms locate in the area
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 Taxes paid to the government that might lead to building of more hospitals etc.
 Infrastructural development

Social Costs (SC) = Private Costs (PC) + External Costs (EC)

Social Benefits (SB) = Private Benefits (PB) + External Benefits (EB)

 The government will try to give the value to all of these costs and benefits

RECOMMENDATION AND JUSTIFICATION: The project should go ahead if SB are greater than SC. If SC are
greater than Sb, the project will not be approved.

Sustainable Development - It is development that does not put at risk living standards of a future
generation

Ways business activity can contribute to sustainable development

 Use renewable energy – e.g. by using solar, wind or tidal energy

 Recycle waste – e.g. by re – using water, paper or plastics that could have been disposed and get
wasted
 Use of fewer resources – lean production
 Development of new ‘environmentally friendly’ products or production methods – e.g. using
biodegradable packaging

PRESSURE GROUPS - It refers to a group of people who come together with a common reason trying to
change business decisions.

 Examples are ILO, Greenpeace and friends of the earth etc.

HOW PRESSURE GROUPS MAY ACT IN ORDER TO INFLUENCE BUSINESS DECISIONS

 Organizing consumer boycotts so that consumers don’t buy from businesses that are not socially
responsible
 Demonstrations in order to attract publicity on a business’s unethical behavior
 Lobbying the government so that it can become harsh on a socially irresponsible business

The role of legal control over business activity affecting the environment

 Government can make business activities illegal. For example:

 Locating in environmentally sensitive areas such as national parks
 Dumping waste products into rivers and seas
 Making products that cannot be easily re-cycled

ETHICAL ISSUES A BUSINESS MIGHT FACE

 Ethical decisions are based on a morale code

 Businesses acting ethically should never:
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 Take or offer bribes to government officials or people working for other firms
 Employ child labour
 Buy in supplies that have led to damage to the environment
 Agree to fix high prices with competitors
 Pay directors large bonuses and owners large profit payouts at the same time reducing
the workforce etc.

ETHICAL DILEMMA: CONFLICTS BETWEEN PROFITS AND ETHICS

Reasons why businesses should act ethically (s19p12, w18p12)

 Good image/reputation so may be willing to pay higher prices leading to higher revenue
 Help employee recruitment / retention, so saving cost of recruitment.
 Opportunity for new sources of finance would allow increased capital from ethical
investors who do not want to be linked with businesses using child labour
 Higher demand which can help increase revenue
 Less opposition from pressure groups

Limitations of being ethical

 Ethical suppliers are likely to charge more leading to higher variable costs as not able to
use low cost materials
 Could lose sales to competitor
 Materials purchased from unethical sources may be cheaper
 May not be able to find suitable (ethical) suppliers
 Shareholders OR owners may want higher profit

6.3 BUSINESS AND THE INTERNATIONAL ECONOMY

6.3.1 THE IMPORTANCE OF GLOBALISATION

 The process by which countries are connected with each other because of the trade of goods and
services [2]
 OR The process of countries becoming more interconnected [2]

REASONS FOR GLOBALISATION

 Reduced protection for industries due to Increasing number of free trade agreements and
economic unions
 Easier transportation of goods globally due to cheaper travel and communication links world
wide
 Emerging market countries which are industrializing and exporting goods in large quantities e.g.
China, Brazil, India, Russia, South Africa - BRICS

Opportunities:

 access to wider markets which helps spread risk

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 Cheaper materials which could lower total cost

 Easier to relocate to other countries so a business can get closer to its markets in other
countries
 Become better known, which may increase market share or credit rating of the business
Threats:

 Increased competition from imports could result in lower sales.

 Loss of employees to other companies could make small firms lose skills to large
employers

WHY GOVERNMENTS MIGHT INTRODUCE IMPORT TARIFFS AND IMPORT QUOTAS

 To raise revenue for the government

 To product domestic industries from foreign competition
 To counter dumping practices
 To improve the balance of payments position

6.3.2 MULTINATIONAL BUSINESSES

 It refers to businesses with factories, production or service operations in more than one country
 Examples: General Motors, Barclays Bank, Total, Econet wireless, British American Tobacco,
Uniliver etc.
 The country where its headquarters is located is called the parent company whereas, a branch is
based in the host country

Reasons why firms go multinational: (w18p11)

 Obtain cheaper raw materials

 Lower labour costs
 Reduce transport costs
 Spread risk
 Avoid barrier to trade
 Access to more markets / more sales opportunities
 Access government grants / support

Advantages of multinational operating in a country

 Jobs are created, which reduces the level of unemployment

 New investment in buildings and machinery increases output of goods and services in the
country
 Some extra output maybe sold abroad, which will increase exports of the country
 Taxes are paid by multinationals, which increases the funds to the government
 There is variety of products, which widen consumer choices
 Increased competition may make consumers pay lower prices for better quality

Disadvantages of multinationals operating in a country

 Local labour is usually exploited by being offered low paid jobs with poor working conditions
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 Local firms may be forced out of business, so MNCs may become monopolies that overcharge
consumers
 MNCs usually quickly exhaust, scarce non – renewable resources in the primary sector, leaving
the host country importing resources it formally possessed
 They may end up interfering in the local politics leading to political instability
 They usually repatriate profits to mother countries, leaving the host country underdeveloped

6.3.3 IMPACT OF EXCHANGE RATE EXCHANGE CHANGES

 It is the value of a currency as compared to another country’s currency, for example USD1 = R9
 The exchange rate can change from time to time depending on the demand and supply of the
currency.
 The exchange rate can either appreciate or depreciate

Calculation

 The exchange rate in 2010 was USD1 = R10

 In 2012 the exchange rate moved to USD1 = R12
a) Describe the exchange rate movement
b) Suppose diamond ore has a value of USD1 000/kg. Calculate the value in rands for both years.

Appreciation

 It is when a currency gains value relative to the other, for example, a movement of USD1 = R12.
 This is also known as an exchange rate rise.

Effects of Appreciation

 When a currency appreciates, it becomes cheaper to import goods from other countries. This is
because less of a currency will be required than before. HOWEVER, appreciation can cause
problems like:
a) exports will decrease because foreigners will need more of their currency to buy the other
currency
b) locals will prefer to import, which means domestic industries will sale less
c) Dividends from other countries will be less such that shareholders will not get adequate return
on investment

Depreciation

 It is when a currency losses value as compared to the other, for example a movement from
USD1 = R9 to USD1 = R6
 This means the USD has lost value relative to the Rand.
 It is also known as an exchange rate fall.

Effects of Depreciation
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 Effects are likely to increase if demand is elastic. This is because foreigners will find it cheap to
buy goods from a country with a falling currency.
 HOWEVER, importing will be expensive and this can lead to an increase in the prices of products
(inflation)
 Those who would have invested in other countries may receive high dividends. BUT, new
investment will be difficult to make.