BM Unit 1.5

Unit 1.
External Environment
Introduction
► This chapter assesses the importance of
external influences on business performance
and decision-making.
► Businesses depend for their survival on
understanding and responding to external
factors that are beyond their control.
► Many of the factors are ‘constraints’
because they may limit the nature of
decisions that business managers can take.
Introduction
► The legal requirements imposed by
governments, on environmental pollution for
example, are one of the most obvious
constraining influences on business activity.
However, external influences can also
create opportunities and enable a business
to become even more successful –
introducing new technology in advance of
rival firms is one example.
Internal Factors
►Are the constraints and

opportunities (facing a business
in the attempt to achieve its
aims and objectives) within a
firm’s own control
Internal Factors (Constraints)
► Example:
 Finance – most firms lack sufficient sources of
finance
 People – poor working relations, poor
communications can harm a firm’s ability to
achieve its objectives
 Marketing – firms might not have attractive
marketing campaigns as their rivals
 Production – firm may lack the resources or
expertise
External Factors (Constraints)
►Are those issues which either

restrict or aid the performance
of a business but are beyond
its control.
External Factors (Constraints)
► Example:
 Tax rates
 Interest rates
 Recession
 Natural disasters
 Oil crisis
 War
STEEPLE ANALYSIS
► Is an analytical framework used to examine
the opportunities and threats of the external
environment
► Is an acronym for the Social, Technological,
Economic, Environmental, Political, Legal
and Ethical
► STEEPLE analysis is central to business
strategy, such as assessing the feasibility of
an overseas investment project
Key advantages of
STEEPLE analysis
► It is quite simple to use
► It helps managers to be thorough and logical in
their analysis of the external opportunities and
threats faced by the business
► Useful brainstorming and discussion tools
► It promotes proactive and forward thinking
rather than static views based on gut feelings
► Managers will be better informed and prepared
to deal with external shocks
► It helps you to spot business or personal
opportunities, and it gives you advanced warning
of significant threats.
► It reveals the direction of change within your
business environment. This helps you shape what
you're doing, so that you work with change, rather
than against it.
► It helps you avoid starting projects that are likely
to fail, for reasons beyond your control.
► It can help you break free of unconscious
assumptions when you enter a new country,
region, or market; because it helps you develop an
objective view of this new environment.
PEST ANALYSIS
► PEST = Political, Economic, Social and
Technological opportunities and threats of
the external environment within which
businesses operate
► These factors affect all businesses in the
economy and are beyond the control of any
individual organization
► Mainly used at the start of a strategy review
process
Variations of PEST
►STEP – more optimistic name
►PESTLE analysis
 Legal and Environmental
►STEEPLE
 Ethical opportunities and threats
STEEPLE analysis issues
► SOCIAL
 Social, cultural and demographic changes can
also present opportunities and threats
 The values and attitudes of society toward a
wide range of different issues (such as business
ethics, social welfare, women, religion or animal
rights)
► TECHNOLOGICAL
 Advances in technology and work processes
(such as the microchip revolution or the
introduction of just-in-time stock control
system) have improved the efficiency of
businesses
► ECONOMIC
 Inflation, unemployment, economic growth and
international trade
 Consumer and business confidence also affect
the level of economic activity
► ENVIRONMENTAL
 Impacts of business activities on the natural
environment
 External costs of business activity – passive
smoking, air and noise pollution, packaging
waste etc.
► POLITICAL
 Government legislation (employment law,
consumer protection rights, copyright,
trademark regulations) define the boundaries
within which businesses can operate
► LEGAL
 The government imposes rules, regulations and
laws to ensure that the general public is
protected from adverse business activity
► ETHICAL
 Ethical firms act in a socially responsible way
toward their stakeholders (especially their
customers, employees and local community)
Steps to carry out a the analysis
►Brainstorm external factors likely to
affect the business
►Discuss these factors to decide which
ones are most likely to have a significant
impact on the business and hence its
strategy
►Summarize the information in a PEST
analysis template to further the
development of business strategy
A simplified example of a PEST
analysis which examines some of
the opportunities and threats of
foreign businesses operating in
India
PEST analysis of multinationals
operating in India
► POLITICAL
 Political reform in India will encourage better
trade relations with other nations.
 Legislation is less stringent than in developed
nations, thereby placing fewer constraints on
business activity.
 Regarded as less politically stable compared
with many other countries in the region.
 Poor enforcement of patents and copyrights
might discourage technology transfer to India.
operating in India
► ECONOMIC
 Huge growth potential in financial markets.
 Significant economic growth and rising disposable
incomes (spending power) in India.
 Improved infrastructures and market opportunities in
Mumbai and New Delhi.
 Relatively low costs of production (average wage rates
are still very low).
 Infrastructure and economic stability are less attractive
than in other countries such as China.
 The vast majority of the Indian population is still very
poor.
operating in India
► Social
 Potential market of over 1.2 billion people (the
second most populous country in the world and
expected to overtake China as the most
populated nation by 2050).
 Well-educated English-speaking workforce.
 Large yet increasing discrepancies in income
and wealth distribution.
 Language barriers in rural cities and/or a clash
of national cultures.
operating in India
► Technological
 Growing number of technologically aware
population (huge opportunities for firms
providing products such as mobile
phones, personal computers and internet
services).
 Technologies are easily copied due to a
lack of appropriate legislation.
SOCIAL
OPPORTUNITIES AND
THREATS
Social
Opportunities and Threats
► The attitude of society towards a wide range of
different issues (business ethics, social welfare,
women, religion or animals) will affect what
good and services are provided in the economy.
► Demographic changes in developed nations,

such as a more educated and flexible workforce
alongside an aging population, have affected
recruitment practices, marketing strategies and
the products provided by businesses.
Examples of social
opportunities & threats
► The growing support for environmental
protection has altered business behavior
immensely, with many organizations now
reporting the non-financial aspects of their
operations, such as recycling and waste
management.
► With a more liberal and modern social
attitude toward women in most societies,
businesses have benefited from having a
more flexible labor force.
Examples of social
► Migration and the increased awareness and
acceptance of multiculturalism has created
more choice for consumers, e.g. the most
consumed take-out food in the UK is Indian
curry, while the largest non-Asian importer
of Malaysian Laksa (spicy noodle soup) is
Finland.
► Societal pressure for businesses to act more
ethically and socially responsibly can often
result in higher costs.
Examples of social
► Demographic changes in society, such as an
aging population in economically developed
countries, have affected recruitment
practices, marketing strategies and the
products supplied by businesses. Women in
modern societies are opting to have children
at a later age as they give their careers
priority, thereby providing further
opportunities for businesses.
Examples of social
► Language can create opportunities and
threats too. The largest multinational
companies are aware that the most
commonly spoken languages around the
world are Mandarin, English, Spanish and
Hindi. However, it is not always possible to
translate marketing messages and other
communications across different languages
and cultures.
Question 1.5.2
Page 58
Comment on how the
demographic changes below may
present both opportunities and
threats to a business:
1. Growing number of self-employed people.
2. Increasing number of single parent
families.
3. Parents choosing to have fewer children
and at a later stage in their lives.
4. More people graduating with university
degrees.
Growing number of
self-employed people
Increasing number of single
parent families
Parents choosing to have fewer
children and at a later stage
in their lives
More people graduating with
university degrees
TECHNOLOGICAL
OPPORTUNITIES AND
THREATS
Technological
► Technology has affected all aspects of
business functions
► Internet affected:
 Human resources in recruitment process
 Marketing (e-commerce – trading in internet)
 Finance – annual reports online
 Operations Management – access to
benchmarking data
Technological
►Internetpresents opportunities for
businesses: (see page 59)
 Speed of access to information
 Reducing language and cultural barriers
 Reduced cost of production
 Overcome geographical limitations
Technological
► Otheropportunities that technology bring to
businesses include:
 New working practices – working from home,
video conferencing, e-commerce, advertising in
the internet
 Increased productivity and efficiency gains –
use of robots / machines, automation
 Quicker product development time – CAD/CAM
allowed businesses to produce prototypes
quickly and cost-efficiently
Technological
► Other opportunities:
 New products and new markets – technology is
a source of innovation and brings about new
products in the market
 The creation of jobs – increased need for

maintenance and technical support
Technological
►Internetpresents threats for
businesses: (see page 59)
 Price transparency – customers can easily
compare the prices of different businesses
without leaving their home or office
 Online crime – hackers, online banking and
credit card fraud
 Higher cost of production – maintenance and
training costs
 Reduced productivity – access personal email
and social networking during working hours
Technological
► Other Threats:
 Technology is not always reliable or secure
 It can be costly
 Shorter product life cycle
 Automation has led to job losses in primary and

secondary sector industries
Technological
► Factors
to consider when adopting or
implementing technology in the workplace:
 Costs
 Benefits
 Human relations
 Recruitment and training
Question 1.5.3
Nintendo and Apple
Page 60
Nintendo’s Wii games console and Apple’s iPod are
huge hits with customers. Nintendo’s games console
appeals to new market segment such as women and
the elderly. Demand is high in Asia, Europe and the
USA helping Nintendo to outsell its two nearest
rivals, the Xbox 360 and PlayStation 3. In April
2007, announced the sale of its 100 millionth iPod,
making it the most successful music player in
history. Some 300 million iPods were bought within
the first ten years of its launch.
 Explain how the technological environment

can present opportunities for hi-tech firms
such as Nintendo and Apple.
The technological environment can
present a host of opportunities for hi-
tech firms which include:
► The ability to produce more sophisticated
consoles, games and other gadgets (such as
the iPod) to appeal to a larger and wider
market
► Quicker product development times;
essentially in fast-paced industries where
products may have a short product life cycle
The technological environment can
present a host of opportunities for hi-
tech firms which include:
► Marketing opportunities are enhanced with
the use of improved technology, e.g.
purchasing music online through iTunes
► Any other relevant factor that is explained
Rubric
► 3-4 marks: there is good explanation of
how the technological environment can
provide opportunities to organizations.
Examples are used and there is relevant
application to hi-tech firms.
► 1-2 marks: a vague answer that lacks detail
and / or depth. There may be little, if any,
application. Award 1 mark for a list of
factors.
ENVIRONMENTAL
OPPORTUNITIES AND
THREATS
Environmental
► External cost of production or negative
externalities – costs incurred by a third party in
a business transaction (cost borne by society or
the environment rather than by the buyer or
seller)
 Samples of external costs:
►Passive smoking
►Air pollution
►Noise pollution
►Packaging waste
►Global warming
Environmental
► Public concerns and changes in social
attitudes about the environment have meant that
businesses are increasingly reviewing their
operations
 Firms that do not respect the environment face ruining
their reputation and long-term profitability
 If compliance cost are too high, then firms may choose
not to become more environmentally friendly
Environmental
► Changes in weather
 Torrential rain or flooding will affect large number of
businesses
 Indian Ocean Tsunami (SE Asia 2004); Hurricane
Katrina (USA 2005); snow & icy conditions across
Europe (12/2010); floods in Australia (2011) caused
major havoc to businesses
 Extreme weather condition in Russia reduced its GDP by
over 1 percent in 2010
 Japan’s 9.0 earthquake (2011) cost the nation over
$15bn
 Some business might be able to exploit changes in the
season
Environmental
► Health scares and epidemics
 SARS 2003 and bird flu (2006) in SE Asia caused turmoil
in the region with many businesses collapsing
 Mad cow disease (late 1990s), foot and mouth disease
(2001) and swine flu (2009) had similar effects in
Europe
LEGAL
OPPORTUNITIES AND
THREATS
Legal Opportunity & Threats
► The gov’t. imposes rules, regulations and
laws to ensure that the general public is
protected from the negative aspects of
business activity.
► Common legislation affecting businesses
include:
 Consumer protection legislation
 Employee protection legislation
 Competition legislation
 Social and environmental protection
► Consumer protection legislation
 Laws exist that make it illegal for businesses to
provide false or misleading descriptions of their
products and services.
 Products must meet certain quality standards.
 Businesses are held liable for any damage or
injury caused by their defective products.
► Employee protection legislation
 Laws that protect the interests and safety of
workers.
 For example: anti-discrimination legislation
helps to ensure that businesses act fairly toward
their employees, irrespective of their age,
gender, religion or ethnicity.
 See page 67 Box 1.5.f – Legal Employment

rights
► Competition legislation
 Laws ensure that anti-competitive practices are
prohibited to protect customers and smaller
businesses from firms with monopoly power.
 The gov’t. takes action against businesses
deemed to be acting against the public interest,
such as large firms engaging in fixing or
charging unjustifiably high prices.
 Competition laws ie. copyright, trademark,
patent laws give businesses legal protection
against competitors; thus this stimulate
innovation and improving firm’s competitiveness
► Socialand environmental protection
legislation
 Laws to prevent or reduce the consumption of
demerit goods (ie. tobacco, petrol, alcohol,
gambling and illegal drugs).
 Without government legislation, the
consumption of these products would be higher
and therefore the costs to society would be
greater (ie. passive smoking, pollution and
crime)
• Sample case studies:

– Businesses can get into all sorts of
trouble if they do not comply with
employment legislation. In November
2000, Coca-Cola was made to pay out
$192.5 million (worth around 300 million
cans of Coke) in lawsuit allegations that
they treated black workers unfairly.

– In 2013, the Turkish government
introduced a series of strict trading
laws of the sale of alcoholic products:
alcohol cannot be sold within 100
meters of a place of worship or a
school, all forms of alcohol advertising
are banned, and alcohol cannot be
bought or sold between 10 pm and 6
am

– The US state of Colorado legalized
the sale of marijuana (cannabis) in
2014 at regulated retailers. The
psychoactive drug became legally
available for personal and recreational
use for those aged 21 and above.
Entrepreneurs in Colorado cashed in
by attracting tourists to the area.
Critics argued that legalization sends
the wrong message to youth around
the world.
ETHICAL
OPPORTUNITIES AND
THREATS
Ethical Opportunities and Threats
► Business ethics are the moral principles that
are, or should be, considered in business
decision making.
► Benefits of being socially responsible:
 They attract and retain good quality workers
 They attract new customers and retain existing
ones
 It generates good publicity and public relations
► Samples of ethical business behavior:
 Protecting natural environment by using
resources efficiently and minimizing waste
 Firms pay their workers on time
 Firms don’t employ workers below the legal
minimum age or allow their employees to
operate in poor working conditions
 Firms don’t use misleading marketing or deal
with corrupt suppliers, sponsors or governments
► Businesses use external social audits
(external agency who examine and
generates reports) – they report on the
ethical and social stance of a business;
 its external matters (involvement in the
community, levels of pollution) and
 internal issues (efficiency of its waste
management and ability to provide safe working
environments)
ECONOMIC
OPPORTUNITIES AND
THREATS
Economic
► Economic environment refers to the large-
scale economic factors affecting a nation as
a whole, such as the condition of foreign
trade and the levels of business and
consumer confidence.
► Government’s 4 key macro-economic goals:
 Controlled inflation
 Economic growth
 Reduced unemployment
 Healthy international trade balance
Economic
► Controlled rate of inflation
 Inflation is the continual rise in the general level
of prices in the economy
 Causes of inflation:
►Demand Pull Inflation – caused by excessive
aggregate demand in the economy
►Cost Push Inflation – caused by higher cost
production leading to a rise in prices so that firms
can maintain their profit margins
Definitions
► INFLATION is a sustained increase in the
AVERAGE PRICE LEVEL of goods and services in a
nation.
► DEFLATION occurs when the AVERAGE PRICE
LEVEL of goods and services decreases over time.
► KEY WORDS in the definition is the AVERAGE

since inflation does not measure changes in
relative prices of particular goods.
Inflation
► INFLATION
 Causes the value of money to decrease
 Makes money less valuable
 Reduces purchasing power
 Encourages households and firms to
spend now rather than postponing
spending until the future when prices are
higher
History of Inflation
► http://www.youtube.com/watch?v=7rpvxZp
hZZc
GDP
► http://www.youtube.com/watch?v=yUiU_xR
PwMc
+ Aggregate Demand
+ Aggregate Demand and Supply
Introduction
 http://www.youtube.com/watch?v=hTWPrWmPJS0&list=PLF2A369
3D8481F442
+
Aggregate Demand
Is the total demand for the goods and

services of a nation at a given price
level and at a given period of time.
Is the total demand for a nation’s goods
and services from domestic
households, firms, the government and
foreigners.
Average
Price Level
P1
P2
AD
0 Y1 Y2 National Output
(real GDP)
+
Components of AD
 1) Consumption (C) – includes the durable and non-durable goods
and services purchased by private individuals and households
 2) Investment (I) – refers to spending by firms and households
 3) Government spending (G) – spending on government purchases,
which includes salaries for workers as well as capital goods spending
 4) Net Exports (X-M) – count all exports as an inflow and thus an
increase in GDP while subtracting imports as an outflow and a
decrease in GDP.
 AD = C + I + G + (X – M)
+ Determinants of AD or
shifts in the AD curve
 A change in the price level leads to a
movement along a nation’s AD curve and a
change in the national output demanded.
 AD will shift if any of its four components
changes.
 Each components has its own determinants
that may cause it to increase or decrease.
+
What causes changes in
CONSUMPTION?
 Changes in INCOME
 Income is the most significant determinant of
consumption
 As income rise people have more money to
spend on goods and services, so consumption
increases
 Growing economy => national income rising =>
increase in consumption => increase in
aggregate demand
+
CONSUMPTION?
 Changes in INTEREST RATES
 Rise in interest rates (price of borrowed money) will
likely lead to less borrowing => consumption will
fall => fall in AD
 Rise in interest rates makes saving more attractive;
people would prefer to put extra money in the bank
to earn money
 A fall in interest rates will lead to an increase in
consumption, ceteris paribus, as it becomes more
attractive to borrow money to spend on durable
goods and services.
+
CONSUMPTION?
 Changes in WEALTH
 Income is the money that people earn. Wealth is
made up of the assets the people own.
 2 factors that can change the level of wealth:
1. Change in house prices

2. Change in the value of stocks and shares
+
CONSUMPTION?
 HOUSEHOLD INDEBTEDNESS
 Household debt is the amount of money owed
by a household to lenders
 In the short run, an increase in consumer debt
allows households to increase consumption at
each level of household income.
 In the long run, debts must be paid back, which
is only achieved through reduction in future
consumption.
+
CONSUMPTION?
 Changes in EXPECTATIONS/CONSUMER
CONFIDENCE
 If people are optimistic about their economic
future then they are likely to spend more now
 High consumer confidence is likely to lead to
increased consumption
 Economists regularly measure consumer
confidence and put the information together in
the form of a “consumer confidence index” or
“consumer sentiment index”
CONSUMPTION?
1. Changes in INCOME
2. Changes in INTEREST RATES
3. +
Changes in WEALTH
4. Changes in
EXPECTATIONS/CONSUMER
CONFIDENCE
5. HOUSEHOLD INDEBTEDNESS
+
INVESTMENT?
 INTEREST RATES
 If interest rates are high, then firms may prefer to
put their retained profits in the bank to earn higher
returns on savings rather than use them to invest
 Decrease in interest rates will
 decrease the incentive to save
 decrease the cost of borrowing
 likely to lead to an increase in borrowing
 likely to result in an increase in the level of
investment
+
INVESTMENT?
 Changes in the level of NATIONAL INCOME
 Increase in national income leads to an increase
in consumption
 This will encourage firms to invest in new plant
and equipment to meet the increase in demand
 Investment accelerates when national income
rises
+
INVESTMENT?
 BUSINESS CONFIDENCE/EXPECTATIONS
 Future prices
 Technology
 Business taxes
 Inventories
 Degree of excess capacity
INVESTMENT?
1. INTEREST RATES
2. NATIONAL INCOME
+
3. BUSINESS
CONFIDENCE/EXPECTATI
ONS
GOVERNMENT SPENDING?
• Government spending will rise:
• 1. Government made commitment to
financially support a given industry
+
• 2. Government to correct market failure
• 3. A new education or health policy might
require increased public spending on
schools or hospitals
+
NET EXPORTS?
 INCOMES ABROAD
 Household income in trading nations is a major
determinant of a nation’s net exports
 Ex. U.S. and Canada (trading partners)
 As income in the U.S. fall, Canada’s exports
fell
+
NET EXPORTS?
 TASTES AND PREFERENCES OF
CONSUMERS
 Once a country’s producers have developed a
strong reputation in the global marketplace, that
country can count on steady demand from
abroad for its output
 Demand abroad is an important objective of
government and multinational corporations
+
NET EXPORTS?
 EXCHANGE RATES
 Weak currency is likely to contribute to a
country’s net exports
 Weaker currency makes the output cheaper to
consumers abroad
 Weaker currency makes foreign products less
desirable to domestic consumers & may lead to
growth in domestic household consumption
+
NET EXPORTS?
 PROTECTIONISM
 Government actions and policies that restrict or
restrain international trade, often done with the
intent of protecting local businesses and jobs
from foreign competition.
 Typical methods of protectionism are import
tariffs, quotas, subsidies or tax cuts to local
businesses and direct state intervention.
NET EXPORTS?
• 1. INCOMES ABROAD
• 2. TASTES AND PREFERENCES
OF+ CONSUMERS
• 3. EXCHANGE RATES
• 4. PROTECTIONISM
+
Aggregate Supply
+
Aggregate Supply (AS)
Is the total amount of goods and
services that all the firms in all the
industries in a country will
produce at every price level in a
given period of time
+
Aggregate Supply (AS)
AS curve illustrates the
relationship between the average
price level in a nation and the total
output of the nation’s producers.
+
SRAS is horizontal at levels of output
below full employment
PL LR SR
AS AS • Equilibrium
=> AD = AS
PE
AD1
YFE Real
+
• At YFE, the nation
PL LR SR experiences very low
AS AS unemployment, stable
prices (meaning low
inflation), nation’s
resources are being used
efficiently and near their
PE
full capacity towards the
production of G&S
AD1
YFE Real
+
PL LR SR
AS AS
• A fall in AD, small
decrease in price level,
large decrease in output
P
PE1
AD1
AD2
Y1 YFE Real
+
• At Y1, decrease in AD
PL LR SR
caused by a decrease in
AS AS any of the components of
AD, causes a fall in price
level (from PE to P1)
P • As PL falls, firms respond
PE1 by reducing output and
laying off workers
• In the SR, the decrease in
AD1
the PL is proportionally
smaller than the decrease
in the equilibrium output
AD2
Y1 YFE Real
+
• At Y2, as AD continues to
PL LR SR
decrease, firms must
AS AS reduce employment and
output
• Reduce in AD caused the
P PL and output to decrease
• Due to elasticity below
PE1 employment level,
P2 decline in output is
AD1 proportionally greater
than the decline in the PL
AD2
AD3
Y2 Y1 YFE Real
+ SRAS is horizontal at levels of output
• At Y2, as AD continues
to decrease, firms must
PL LR SR reduce employment and
AS AS output
• Reduce in AD caused
the PL and output to
decrease
• Due to elasticity below
PE employment level,
P1 decline in output is
proportionally greater
P2 than the decline in the
AD1
PL
AD3 AD2
Y2 Y1 YFE Real
+
Short – Run: Level of output below full
employment
 Thedecline in the short-run equilibrium output
and employment resulting from a fall in AD is
explained by the fact that in the short run, wages
and prices are downwardly inflexible.
 Firmsfind it difficult or impossible to adjust
workers’ wages due to several rigidities that exist
in many countries’ labor markets.
+
Labor market rigidities that make wages
inflexible in the SR:
Worker contracts
Minimum wage laws
Wage agreements with labor
unions
Government regulations
+
In the SR:
C, I, G, (X-M)
AD
YFE
Employment
+
Shifts in Aggregate Supply
+ Causes of an increase in SRAS
 Lower resource costs (ex. oil, minerals and other raw materials)
 Improvement in the productivity of land or capital
 Reduction in the minimum wage
 Government subsidies to producers
 Investment tax credits (encouraging firms to invest in capital)
 Reduction in trade union power
 Better infrastructure
 Better educated or more skilled workforce
 Strong currency
+ Causes of a decrease in SRAS
 Increasein resource costs (oil shocks, energy
shortages, higher food prices)
 Increase in trade union power
 Increase in the minimum wage
 Higher business taxes
 Weaker currency (makes imported raw materials
more expensive)
+
In Summary
Understanding the interactions of AD and
AS in a nation’s economy helps
governments, households and firms to
respond better to fluctuations in the level of
economic activity, and gives all
stakeholders involved the ability to
understand the appropriate responses to
periods of macroeconomic uncertainty or
prosperity.
DEMAND-PULL INFLATION
LRAS SRAS
PL
P0
AD0
Y0 YFE Real
GDP
LRAS SRAS
PL
P1
P0
AD0 AD1
Y0 Y1 YFE Real
GDP
LRAS SRAS
PL
PE
P1
P0
ADE
AD0 AD1
Y0 Y1 YFE Real
GDP
LRAS SRAS
PL
P2
PE
P1
AD2
P0
ADE
AD0 AD1
Y0 Y1 YFE Y2 Real
GDP
LRAS SRAS
PL
P3
P2
PE
AD3
P1
AD2
P0
ADE
AD0 AD1
Y0 Y1 YFE Y2 Y3 Real
GDP
COST-PUSH INFLATION
LRAS SRAS2 SRAS1

PL
P1
PE
AD
Y1 YFE Real
GDP
Question 1.5.4
Zimbabwe’s hyperinflation
problems (pg. 60)
Outline 3 factors that could have
caused inflation in Zimbabwe
► Cost-push inflation
 Caused by soaring food prices
► Zimbabwean government printing more
money, thereby raising the money supply
and reducing its value
Outline 3 factors that could have
caused inflation in Zimbabwe
► Cost-push inflation
 Caused by soaring food prices
► Zimbabwean government printing more
money, thereby raising the money supply
and reducing its value
► Demand pull inflation
 Citizens getting large pay raises (due to
increasing cost of living), thereby creating pent-
up demand and higher prices
Evaluate the impact of uncontrollable
inflation on the Zimbabwean economy
► Reduces the international competitiveness
of the economy
 This will make it more difficult for Zimbabwe to
sell its exports, thereby hindering the country’s
economic growth
► The level of national output is likely to
decline due to soaring costs of production
 This will have detrimental effects on the
employment level in the economy
Evaluate the impact of uncontrollable
inflation on the Zimbabwean economy
► Investment (including foreign direct
investment) is likely to decline as business
confidence levels fall
 This will hamper future levels of economic
activity in Zimbabwe
► Standards of living is likely to fall
 Causing further social and economic problems
for the poverty-ridden country
UNEMPLOYMEN
T
Economic
►A high level of employment / reducing the
rate of unemployment:
 Types of unemployment (pg. 61)
 Policies to tackle the problems of
unemployment:
►Demand Side Policies - increase the level of AD
►Expansionary Fiscal Policies - reduce taxes/increase
government spending
►Expansionary Monetary Policies - reduce level of
interest rates
►Supply-side Policies - increase the level of AS
TYPES OF UNEMPLOYMENT
 http://www.youtube.com/watch?v=ZckAN1KYB5
I&list=PLF2A3693D8481F442
Types of unemployment
Frictionalunemployment
Seasonal unemployment
Technological unemployment
Regional unemployment
Structural unemployment
Cyclical unemployment
Frictional Unemployment:
Occurs when people change jobs as
there is usually a time lag between
leaving a job and finding or starting
another. As this is temporary, there
is relatively little social hardship. It
is always present in the economy.
Seasonal Unemployment:
Is caused by seasonal changes
in demand for a product
e.g. beach resorts tend to
suffer from a lack of tourists
during the winter months.
Technological Unemployment:
Results in people losing their
jobs due to the introduction of
labor-saving (capital intensive)
technologies, which can cause
mass-scale unemployment.
Regional Unemployment:
Refers to the different
unemployment rates that exist in
different areas of a country.
Remote rural areas tend to have
higher levels of unemployment
than busy urban business districts.
Structural Unemployment:
Occurs when the demand for
products produced in a particular
industry continually falls.
The industry therefore suffers
from structural and long-term
changes.
Cyclical (demand-deficient)
Unemployment:
Is caused by a lack of aggregate
demand in the economy.
It is the most severe type of
unemployment as it tends to
affect each and every industry
(caused by a recession).
Types of Unemployment
Description:
People who are in between jobs or looking
for their first job
Description:
People who are in between jobs or looking
for their first job
Frictional Unemployment
Description:
Workers unable to find work because a
reduction in private and public spending
reduces AD.
Description:
Workers unable to find work because a
reduction in private and public spending
reduces AD.
Cyclical Unemployment
(Demand-Deficient)
Description:
Workers who need to seek other work
between seasons.
Description:
Workers who need to seek other work
between seasons.
Seasonal Unemployment
Description:
Workers unable to find work because their
skills do not match those demanded by
firms.
Description:
Workers unable to find work because their
skills do not match those demanded by
firms.
Structural Unemployment
Description:
People losing their jobs due to the
introduction of labor-saving technologies.
Description:
People losing their jobs due to the
introduction of labor-saving technologies.
Technological Unemployment
Description:
Refers to the different unemployment rates
that exist in different areas of a country.
Description:
Refers to the different unemployment rates
that exist in different areas of a country.
Regional Unemployment
Meaning of unemployment
UNEMPLOYMENT
Is the condition of someone of
working age (16-64) who is
willing and able to work, actively
seeking employment, but unable
to find a job.
Unemployment rate (UR) calculations:
 UR = number of unemployed x 100

labor force
 Unemployment rate is the percentage of the total

labor force in a nation that is unemployed.
Labor Force
 It’sthe sum of EMPLOYED and UNEMPLOYED
persons aged 16-64 (age range may vary from nation to
nation)
 Persons
who are neither employed nor seeking
employment are not in the labor force
 Retired persons
 Students
 Those taking care of children or other family members
 Others who are neither working nor seeking work
Labor force participation rate (LFPR)
 Is the proportion of the working-age population that is
either unemployed or employed. (Ratio of the number of
people in the labor force to the entire working-age
population of a nation.)
 LFPR = labor force x 100

working age population
 Ifthe LFPR drops, it may be because people have

chosen to give up searching for jobs or they have
decided to retire early or go back to school.
 A decline in LFPR can cause the unemployment

rate to understate the true number of people out of
work in a nation.
Examples of people who are
part of the labor force and who
are not part of the labor force
A part-time retail sales clerk who is
also going to college
Part of the labor force because she is

employed
A stay-at-home mother
NOT part of the labor force

because she is not employed nor
seeking employment
A college
graduate who volunteers in
a community center

because although he is working,
he is not formally employed nor
is he seeking employment
A full-time nurse
Part of the labor force because he

is employed
A factoryworker whose plant closed
and who is applying for jobs at other
firms
Part of the labor force because he

is unemployed
A discouraged worker who has been
looking for a job for 18 months but
has given up the job search

because he is no longer seeking
employment
An engineer who goes back to school
to earn a teaching degree

because he is not currently
seeking employment
A recent college graduate
interviewing at different companies
for her first job
Part of the labor force because

she is unemployed
Consequences of unemployment
 Individual consequences of unemployment
Decreased household income and purchasing
power
Increased levels of psychological and physical
illness, including stress and depression
Consequences of unemployment
 Social consequences of unemployment
Downward pressure on wages for the
employed
Increased poverty and crime
Transformation of traditional societies
Economic consequences of
unemployment
1. Lower level of AD
 Unemployment lowers household’s disposable
income
 Reduces consumption
 Reduces level of demand and output in the nation
as a whole
 Leads to more unemployment
 Can pull the economy into a recession
unemployment
2. Under-utilization of the nation’s resource
 Unemployment means a nation is not fully

utilizing its productive resources
 Nation with high unemployment is producing

within its PPC at a level below that which is most
beneficial to an economy
unemployment
3. Brain-drain
 Skilled
workers choosing to leave the country
with high unemployment if job opportunities are
abundant elsewhere
 Thisfurther leads to a fall in the production
possibilities of the nation with high
unemployment
unemployment
5. Increased budget deficits
 High unemployment reduces tax revenues flowing to
a government while increasing public expenditures
on financial support for the unemployed
 Resultin decrease government spending on public
goods (infrastructures, education, defense,
healthcare) or an increase in government borrowing
to finance its budget deficit
unemployment (T/F)
Higher level of AD
FALSE
Lower level of AD
unemployment (T/F)
Over-utilization of the nation’s

resources
FALSE
Under-utilization of the nation’s
resources
unemployment (T/F)
Brain-dead
FALSE
Brain-drain
unemployment (T/F)
Decreased budget deficits
FALSE
Increased budget deficits
ECONOMIC
OPPORTUNITIES AND THREATS
 Economic Growth:
 Increase in a country’s economic activity over

time
 Measured in terms of Gross Domestic Product

(GDP) – change in total output of the economy
per year
 See the trade cycle (pg. 62)

ECONOMIC GROWTH IN THE BUSINESS CYCLE
Recession
• Defined as 2 consecutive quarters of declining
national output
• If the economy contracts over a six-month
period, it is classified as a recession
• Impacts consumer and market confidence and
will cause less economic activity
• Fewer workers required to produce because
less output is demanded
• Raises fear of unemployment
• Policy makers will intervene to help the
economy
Trough
• Lowest point of a recession
• Nobody knows exactly when this is reached
• Economy, hopefully, will enter a recovery
period quickly (recovery – increase in GDP)
Expansion
• Economy grow beyond its previous
level of output
Peak
• Highest point of output before a
recession
ECONOMIC GROWTH
 Improved efficiency in the production process (better use of existing
resources)
 Enhancing the quality of factors of production which requires
investment in:
 Capital Goods – developing an economy’s infrastructure to aid
economic activity and competitiveness
 Education and Training – better educated and trained workforce
becomes a more productive and internationally competitive labor
force
 Health Technology – advances helps to ensure workers are healthy
and therefore more productive; also prevents workers having to take
time off work or retire early due to illness
ECONOMIC GROWTH
 Increased in the quantity of resources
 Discovering new sources of raw materials
 Changes in the labor force
 Changes in demography – a fall in the birth rate in developed
economies has led to an aging population and a smaller workforce.
Conversely, a ‘baby boom’ will lead to a larger workforce in the next
couple of decades.
 Changes in participation rates – gov’t. policies (such as lower rates of
income tax or reduced welfare payments) can boost the participation
rate.
 Changes in net migration – This refers to the difference between
IMMIGRATION (the number of people entering a country for work
purposes) and EMIGRATION (those leaving a country). If the net
migration figure is positive, then the size of the workforce will increase,
thereby helping to raise the productive capacity of the economy.
BARRIERS TO ECONOMIC GROWTH
 Lack of infrastructure (transport and communications networks)
 Countries without basic electricity, road networks, schools, hospitals
and housing will find it difficult to prosper
 Lack the technical knowledge and skilled labor force
 Essential resources for generating sustainable economic growth
 Rapid population growth
 High net birth rate will tend to find that there are too many ‘mouths’
to feed
 High foreign debt repayments
 Highly indebted poor countries are obliged to repay their huge
interest-bearing loans, with little left for domestic investment and
growth
Economic
► Animprovement in the balance of
payments:
 BoP is a record of a country’s money inflows
and outflows, per time period
 It records export earnings and import
expenditures
BOP
► Components:
►Current account
►Capital account
►Financial account
► To correct an imbalance on the BOP,

governments often attempt to alter their
exchange rates, which will have a direct
effect on businesses.
Exchange Rate
► The exchange rate measures the value of
one currency in terms of foreign currencies.
► Appreciation – higher exchange rate means
that export prices will be relatively higher,
thereby reducing the exporter’s price
competitiveness.
► Depreciation – lower exchange rate means
that domestic firms that import raw
materials and components will suffer from
having to pay higher prices, thereby raising
their costs.
Depreciation: Supply increase
EUR
SUSD
Price of USD in terms of EUR
SUSD 1
.749
.66
DUSD
O Qe Q1 Q of USD
Appreciation: Supply decrease
EUR
SUSD 1 SUSD
.80
.749
DUSD
O Q1 Qe Q of USD
Appreciation: Demand increase
EUR
SUSD
.80
.749
DUSD 1
DUSD
O Qe Q1
Q of USD
Depreciation: Demand decrease
EUR
SUSD
.749
.66
DUSD 1 DUSD
O Q1 Qe Q of USD
Consequences of continual & large
fluctuations in the foreign exchange
► Can create difficulties for businesses
 Business planning and forecasting become very
complex and impractical
►Businesses may not be able to accurately forecast
export sales or costs of imported materials due to
exchange rate volatility
►International trade deals could be postponed until
the business can benefit from more favorable
movements in the exchange rate
► Governments can set up international trade
barriers to correct any disparity in its BOP or
to protect their domestic industries.
Protectionism
► Gov’t. policy used to safeguard domestic businesses from
foreign competitors.
 TARIFFS – tax placed on imported products, raising
their price
 QUOTAS – quantitative limits on the volume or value of
imports
 SUBSIDIES – payments made by a gov’t. to domestic
firms as a form of financial aid to reduce the cost of
production of domestic firms
 EMBARGOS – physical bans on international trade with
a certain country
 TECHNOLOGICAL & SAFETY STANDARDS – strict
administration and compliance costs in meeting
industrial and health & safety regulations imposed on
imports
Review question 1.5.5
JKL Jeans
K&Q sell jeans in the UK. They
buy their jeans from an American
supplier and import 10,000 pairs
of jeans per month for a cost of
$30 each. K&Q then sell these to
their customers at a price of 30
GBP each.
Use the various exchange rates to
complete the table below for K&Q Jeans.
Exchange Purchase Purchase Sales Profit or Loss
Rate Cost ($) Cost (GBP) Revenue (GBP)
(GBP)
UK 1 = $1.00
UK 1 = $2.00
UK 1 = $1.50
UK 1 = $2.50
UK 1 = $0.75
Use the various exchange rates to
complete the table below for K&Q Jeans.
Exchange Purchase Purchase Sales Profit or Loss
Rate Cost ($) Cost (UK) Revenue (UK)
(UK)
UK 1 = $1.00 300,000 300,000 300,000 0
UK 1 = $2.00 300,000 150,000 300,000 150,000
UK 1 = $1.50 300,000 200,000 300,000 100,000
UK 1 = $2.50 300,000 120,000 300,000 180,000
UK 1 = $0.75 300,000 400,000 300,000 -100,000

Comment on the relationship
between changes in the exchange
rate and the level of profits.
► There is a positive relationship between the
exchange rate and the level of profits for
K&Q Jeans.
► For example, when the exchange rate (for
sterling) rises from $1 to $2, the profit rises
from zero (break-even) to 150,000 GBP
since K&Q Jeans are able to purchase from
their US supplier at a lower rate.
By engaging in international trade,
explain two other costs that K&Q
Jeans might incur.
► Possible answers with full explanation:
 Tariffs imposed on the import of US jeans
 Transportation costs for the jeans being shipped
in from the USA
 Insurance for the stock being transported
from overseas
Examine how a high exchange rate can
be both an opportunity and a threat to a
business such as K&Q Jeans.
►A high exchange rate can create an
opportunity for K&Q Jeans because
 the costs of importing its stocks of jeans will fall
 K&Q will be able to purchase the same quantity
of stock for a lower cost
 K&Q profit margin will increase
Examine how a high exchange rate can
be both an opportunity and a threat to a
business such as K&Q Jeans.
►A stronger currency can also present threats
 If the business exports its products
 Price of jeans sold overseas will automatically
increase
 K&Q’s exports will become less competitive
POLITICAL
OPPORTUNITIES AND
THREATS
Political
►A government is said to adopt a laissez-faire
(don’t interfere) approach to managing the
economy if it does not intervene
significantly in business activity; this should
stimulate healthy competition and efficiency
and likely to attract FDI (foreign direct
investment)
Political
► Most countries adopt an interventionist

approach to managing the economy by
using legislation and policies to oversee
business behavior and to influence the level
of business activity.
► Government policies such as Fiscal and
Monetary Policies
Fiscal Policy
► Uses taxation and government expenditure
► 2 forms:
 Deflationary (contractionary) fiscal policy –
higher taxes and/or decrease in gov’t.
expenditures
 Expansionary fiscal policy – decrease in taxes
and/or increase in gov’t. expenditures
Direct Taxes
 Taxes imposed on people’s
income or wealth and on
firm’s profit
 Taxes that are paid directly

to the government by those
on whom they are imposed
 Example: Income tax and

Corporation tax
 Unavoidable because
individuals and firms have
to declare their full income
Indirect Taxes
 Taxes paid by households
through an intermediary
such as a retail store
 The intermediary then pays

the government
 Possibly avoidable – you

can choose not to buy the
goods and services
Types of Taxation Systems
 Proportional Tax
 Regressive Tax
 Progressive Tax
Proportional Tax
 A tax for which the percentage remains constant as
income increases
 Many countries are now promoting the idea of
proportional direct taxes or flat taxes
 The same percentage tax is paid at all levels of
income
Regressive Tax
 Tax that decreases in percentage as income increases
 Such a tax places a larger burden on lower income household than
it does on higher income earners since a greater percentage of a
poor household’s income is used to pay the tax than a rich
household’s
 Most indirect taxes are regressive
Regressive Tax
Income of buyer $ Amount of tax paid % of income taxed
$
10,000 100 1%
50,000 100 0.2%
100,000 100 0.1%
 The higher-income consumer pays the same amount of tax as
the lower-income consumer
 Although they appear to be equitable since everyone pays the
same percentage of the price of the goods they consume, placing
a larger burden on those whose ability to pay is lower and a
smaller burden on the higher-income earners whose ability to
pay is greater
 Regressive taxes may be a good source of government revenue
and might discourage the consumption of demerit goods but
they can worsen income inequality
Progressive Tax
 This is a tax for which the percentage
paid in tax increases as income
increases
 Is the most equitable of the 3 types of
taxes a government collects
 Lower income households not only
pay less tax, but they pay a smaller
percentage
Taxable Income of($)their %
income
to be paidin tax as
as tax
0 – 10,000 0
well 10,001 – 25,000 30%
 This 25,001
is a –hypothetical
50,000 example
40% where
there are 4 tax brackets 50%
50,001 and higher
Progressive Tax
If someone earns $56,000 they will pay the following
tax:
 For the first $10,000 = 0
 For the next $15,000 = 4.5k (15k x .30)
 For the next $25,000 = 10k (25k x .40)
 For the next $6,000 = 3k (6k x .50)
 In total they would pay = 17,500

 On average they would be paying 31% tax (17,500 /
56,000)
Progressive Taxation Exercise
How much tax would they pay and what
is their average tax rate if they earned:
a) $7,000
b) $14,000
c) $28,000
d) $77,000
Taxable Income ($) % to be paid as tax
0 – 10,000 0
10,001 – 25,000 30%
25,001 – 50,000 40%
50,001 and higher 50%
Common examples of taxes
 Income tax
 Corporate tax
 Sales taxes
 Capital gains tax
 Inheritance tax
 Excise duties
 Customs duties
 Stamp duty
Monetary Policy
► Designed to control the amount of spending
and investment in an economy by altering
interest rates to affect the money supply and
exchange rates.
► Interest rates refers to the price of money,
both in terms of the price of borrowing money
and the return for saving money in a bank
account.
► If the economy is growing fast (overheating),
the gov’t. or central bank is likely to raise
interest rates to combat the effects of inflation.
4 reasons businesses are charged
varying ‘RATES’ of interest
► RISK – the greater the risk of a business defaulting
on a lone, the higher the interest rate
► ADMINISTRATION COSTS – the higher the admin.
costs involved in lending money to a business, the
higher the interest rate.
► TIME – the longer the period of a loan, the higher the
real interest rate tends to be due to opportunity cost
of money being lent out
► EXPECTATIONS – if the economy is expected to do
well, then it is likely that interest rates will rise to
dampen the effect of inflation.
Interest Rates and Exchange Rates
► Positive correlation – an increase in interest
rates tends to stimulate demand for its
currency since foreign investors are
attracted by better returns on their saving.
► Increase int. rates and appreciation of
currency cause the price of exports to be
relatively higher and likely to reduce the
demand for exports; can be damaging for
domestic businesses in the long run.
China and Korea FTA
► http://thediplomat.com/2015/06/its-official-
china-south-korea-sign-free-trade-
agreement/
3 TYPES OF MACROECONOMIC TOOLS
• Fiscal Policy
• Monetary Policy
• Supply-side Policy
3 TYPES OF MACROECONOMIC TOOLS
• Fiscal Policy
• Government’s use of taxes and spending to influence the
overall level of AD in the economy
• Monetary Policy
• Is the process by which the monetary authority of a country
controls the supply of money
• Supply-side Policy
• Combination of government-led and free market policies
designed to increase the productive capacity of the country
FISCAL POLICY
• http://www.youtube.com/watch?v=1qhJPqyJRo8
DEFINITION OF FISCAL POLICY
• Is a government’s manipulation of TAXES and

EXPENDITURES with the goal of increasing or decreasing
the level of aggregate demand (AD) in an economy.
• Government spending can have powerful effects on the
economic activity in a nation
• Taxation can change the level of consumption and investment
• Either aimed at reducing AD to reduce inflation or increasing
AD to reduce unemployment, FP is used regularly by
government to manage the overall level of economic activity
of a nation
EXPANSIONARY FISCAL POLICY
• Is a decrease in taxes and/or an increase in

government spending aimed at increasing the
level of aggregate demand to close a
recessionary gap and move an economy
towards its full-employment level of output
This will reduce unemployment
Move the economy towards full-employment level of output during a
recession
Expansionary Fiscal Policy
SRAS1
LRAS
Price level AD1
P2
P1
AD2
Y1 YFE
Real gross domestic product
Copyright  2004 McGraw-Hill Australia Pty Ltd 9-
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
221
CONTRACTIONARY FISCAL POLICY
• Is an increase in taxes and/or an decrease in

government spending aimed at decreasing the
level of aggregate demand to close an
inflationary gap and moving the economy to
its full-employment level of output and price
level stability
Reduces inflation
Slow down the economy
Contractionary Fiscal Policy
LRAS SRAS1
P1
Price level
P2
AD1
AD2
YFE Y1
Real gross domestic product
Copyright  2004 McGraw-Hill Australia Pty Ltd 9-
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
223
Intro to Money Market
 Macroeconomics policymakers have 2 general
tools to manage the level of aggregate demand
 Fiscal Policy – changing the levels of taxes and
government spending
 Monetary Policy – changing the supply of money
available in a nation
 Carried out by the central bank of each country
 Note the difference between central bank and commercial

bank
Central bank vs. Commercial bank
 Commercial banks
 are financial institutions whose main functions are
 to hold deposits for their customers (consumers and firms)
 to make loans to their customers
 to transfer funds by check & electronically from one bank to

another
 to buy government bonds
Role of Central Banks
 Central bank
 Is the monetary authority of a country, which performs the
functions of issuing currency, managing the money supply,
and controlling interest rates
 2 largest economies
 European Union – The European Central Bank (ECB)
 United States – US Federal Reserve (the Fed)
 Independent from politics

 Head and governors are appointed by politicians to fixed
terms
Central Bank’s Responsibilities
 Banker to the government
 Banker to commercial banks

 Regulator of commercial banks
 Conduct Monetary Policy

 Banker to the government
 Holds the government’s cash/deposits
 Receives payments for the gov’t and makes
payments for the gov’t
 Manages the government’s borrowing by
selling bonds to commercial banks and the
public
 Acts as an adviser to the gov’t on financial
and banking matters
 Banker to commercial banks
 Holds deposits for commercial
banks
 Loans to commercial banks in
times of need
 Note: central bank does not act as
a banker to consumers and firms
 Regulator of commercial banks
 Central bank regulates and supervises commercial
banks, making sure they operate with appropriate
levels of cash & according to rules that ensure the
safety of the financial system
 This is a very important function, because the
funds that commercial banks use to make loans
are the savings and other deposits that consumers
and firms deposit with commercial banks
 Conduct Monetary Policy
 CB is responsible for monetary policy,
based on changes in the supply of
money or the rate of interest
 Usually responsible for the
determination of exchange rates because
of the close relationship between interest
rates and exchange rates
The Money Market
 Money Demand
 Includes the desire to hold money as an asset and the
demand for money as a means to purchase goods and
services
 Inversely related to the interest rate
 Increases / decreases with the overall level of
national output
 Money Supply
 Is determined by the action of the central bank aimed
at increasing or decreasing the overall supply of
money available in a nation
Equilibrium in the Money Market
Interest
Rate
Money
Supply (Sm)
r1
Equilibrium
interest
rate
r2
Money
Demand (Dm)
0 Md Quantity fixed M2d Quantity of

by the Central Bank Money
Monetary Policy and the Money Market
Money Market Loanable Funds Market
Interest Rate Interest Rate
M0 M1 … an increase in S0
Expansionary loanable funds S1
monetary policy
leads to…
i0 i0
i1 i1
D
D
Q of Q of Loanable
• The decline inMoney Funds
interest rates increases investment spending,
which shifts the aggregate demand curve out to the right
14-234
Monetary Policy
Price level
Monetary policy affects both real
output and the price level
Expansionary
monetary policy
SAS shifts the
P1 AD curve to the
Contractionary
right
P0 AD1
monetary policy
P2
shifts the AD
AD0 curve to the left
AD2 Real output
Y2 Y0 Y1
14-235
Tools for changing the money supply
 Central banks manage the money supply with the
following monetary policy tools:
 Changing the discount rate
 Buying or selling bonds
 Changing the reserve requirement
(1) Changing the discount rate

 Discount rate is the rate charged by central banks
when they make loans to big commercial banks
 Central bank is typically the “lender of last resort”;
commercial banks would try to borrow first from
other commercial banks
 Lower discount rate, increases money supply and
lowering interest rates across the economy
(2) Buying and selling bonds (Open Market Operations –
OMO)
 Central bank buys bonds from private banks
 Puts cash into banks’ reserves, increasing the funds available for banks
to make loans
 Incentive for banks to lower the interest rates they charge private
borrowers
 Increases the level of consumptions and investment in the economy –
Expansionary monetary policy
 Central bank sells bonds to private banks
 Commercials banks’ reserves are taken out of the private banking system
 Less money available for loans which increases interest rates
 Decreases the level of consumption and investment in the economy –

contractionary monetary policy
(3) Changing the reserve requirement
 Reserve requirement is the % of deposits that banks
are required to have available at all times
 Amount held beyond the reserve requirement is
called excess reserves
 If the reserve requirement is lowered, bank will have
more money to loan out. This increases money
supply and lowers interest rate.
Additional info:
http://www.investopedia.com/ask/answers/07/cen
tral-banks.asp
Expansionary Monetary Policy to
Fight a Recessionary Gap
Contractionary Monetary Policy to
Fight an Inflationary Gap
Monetary Policy
 Expansionary monetary policy is a policy that increases
the money supply and decreases the interest rate and it
tends to increase both investment and output
M i I Y
 Contractionary monetary policy is a policy that decreases

the money supply and increases the interest rate, and it
tends to decrease both investment and output
M i I Y
14-243
CUEGIS
Page 69
Key Terms Review
Business Cycle
• Refers to the fluctuation in the level
of business activity over time.
Countries tend to move through the
cycle of booms, recessions, slumps,
recovery and growth.
Deregulation
• Is the removal of government rules
and regulations which constrain an
industry to enhance efficiency and
encourage more competition within
the industry.
Economic growth
• Measures changes in the Gross
Domestic Product of a country over
time. It occurs if there is an increase
in GDP for two consecutive quarters.
Ethics
• Are the moral values and judgements
(of what is right) that society
believes businesses ought to consider
in their decision-making.
Exchange Rate
• Is the value of a country’s currency
in terms of other currencies.
Inflation
• Occurs when the general price of
money in terms of the amount
charged for borrowed funds or how
much is offered on money that is
saved.
Interest Rate
• Is a measure of the price of money in
terms of the amount charged for
borrowed funds or how much is
offered on money that is saved.
Protectionist measures
• Are any measure taken by a
government to safeguard its
industries from overseas
competitors. They are a threat to
businesses trying to operate in
foreign markets.
STEEPLE Analysis
• Is an analytical framework used to
examine the opportunities and
threats of the external environment
on business activity.
Unemployment
• Refers to the number of people in
the workforce who are willing and
able to work but cannot find
employment.

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Unit 1.

►Are the constraints and

►Are those issues which either

► Demographic changes in developed nations,

 The creation of jobs – increased need for

 Shorter product life cycle

 Automation has led to job losses in primary and

 Explain how the technological environment

 See page 67 Box 1.5.f – Legal Employment

• Sample case studies:

• Sample case studies:

• Sample case studies:

► KEY WORDS in the definition is the AVERAGE

Is the total demand for the goods and

1. Change in house prices

 Improvement in the productivity of land or capital

 Reduction in the minimum wage

 Government subsidies to producers

 Investment tax credits (encouraging firms to invest in capital)

 Reduction in trade union power

 Better educated or more skilled workforce

LRAS SRAS2 SRAS1

 UR = number of unemployed x 100

 Unemployment rate is the percentage of the total

 LFPR = labor force x 100

 Ifthe LFPR drops, it may be because people have

 A decline in LFPR can cause the unemployment

Part of the labor force because she is

NOT part of the labor force

NOT part of the labor force

Part of the labor force because he

Part of the labor force because he

NOT part of the labor force

NOT part of the labor force

Part of the labor force because

 Unemployment means a nation is not fully

 Nation with high unemployment is producing

Over-utilization of the nation’s

Decreased budget deficits

 Increase in a country’s economic activity over

 Measured in terms of Gross Domestic Product

 See the trade cycle (pg. 62)

► To correct an imbalance on the BOP,

UK 1 = $2.00 300,000 150,000 300,000 150,000

UK 1 = $1.50 300,000 200,000 300,000 100,000

UK 1 = $2.50 300,000 120,000 300,000 180,000

UK 1 = $0.75 300,000 400,000 300,000 -100,000

► Most countries adopt an interventionist

 Taxes that are paid directly

 Example: Income tax and

 The intermediary then pays

 Possibly avoidable – you

 In total they would pay = 17,500

• Is a government’s manipulation of TAXES and

• Is a decrease in taxes and/or an increase in

• Is an increase in taxes and/or an decrease in

 Note the difference between central bank and commercial

 to make loans to their customers

 to transfer funds by check & electronically from one bank to

 United States – US Federal Reserve (the Fed)

 Independent from politics

 Banker to commercial banks

 Conduct Monetary Policy

0 Md Quantity fixed M2d Quantity of