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.
(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

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 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

ENVIRONMENT- FRIENDLY BE ENVIRONMENT-FRIENDLY

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

Using up scarce non-renewable resources Firms will have to increase prices to

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

Consumers are becoming socially aware High prices can make firms less competitive
and are willing to buy only environment in the market and they could lose sales
friendly products.
Governments, environmental Businesses claim that it is the government’s
organisations, even the community could duty to clean up pollution
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 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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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.