External Influences

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External Influences

• By Richard Grover

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The Business Cycle

• If you were to study a graph of economic growth
  over time it is clear that it fluctuates but in a
  fairly routine pattern.
• This pattern of recession and boom is known as
  The business cycle.
• The next section will outline the stages of the
  cycle and the effect on the firm.

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Recession

• Characterised by decreasing output and gloomy
  outlook.
• Firms may experience falling demand and so cut
  prices and dismiss staff losses are made
  investment falls some go out of business.

4
Recovery

• The economy begins to expand again, expectations
  begin to rise although they are limited.
• The firm will find demand increases again, they
  may review employment and investment positions
  but may still be cautious.

5
Boom

• Rapid growth in output, confidence is high but
  fear of inflation.
• Firms tend to increase investment, hire more
  staff, however skill shortages may occur,
  increase in prices and profit margins.

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Downturn

• Cycle returns to beginning, growth starts to slow
  again.
• Demand falls and reductions in output and
  investment can be expected.

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Effect on firms

• In the cycle personal consumption usually
  fluctuates less than business investment so
  different firms are affected in different ways
  when a slump occurs.
• Firms producing capital equipment (e.g.
  machinery) will be badly affected due to reduced
  investment undertaken by other firms.

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Effect on firms (Episode two)

• Firms selling durables will be badly hit as
  people put off buying these items until an upturn
  when their confidence in employment and income is
  higher.
• Firms selling basic necessities will experience
  less of a fall, it may even increase as people
  switch expenditure from luxuries onto these
  items.

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Benefits of Recession

• Firms are forced to examine its weaknesses in
  product range, organisation etc and to become
  more lean.
• This can lead to improved efficiency and if
  competitors have gone bust the firm may get a
  chance to increase its market share.

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Interest Rates

• Interest rates are a key tool of economic policy.
  They determine the cost of borrowing and
  therefore also the level of spending.
• This means that they have huge impacts upon
  individuals (e.g. mortgage repayments) as well as
  firms (cost of loans, highly geared firms
  affected more).

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Interest Rates (continued)

• If interest rates go up firms are hit twice as
  cost of borrowing increase but in addition
  spending will usually be reduced so demand for
  its products may also fall.
• Low interest rates may be used to stimulate
  growth in an economy (e.g. interest rates after
  9/11 kept low to curb downturn). High interest
  rates may be used to curb growth and inflation as
  too faster growth can be dangerous.

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Interest Rates (UK examples)

• Interest rates are currently 4 and are expected
  to rise in the near future. But this is typically
  very low. Long-term average is 5.
• As recently as 1998 interest rates were as high
  as 7.5 and in the depression of the late 80s
  were sky high as 15 (duepartly to incompetent
  Tory government)

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Exchange Rates

• Exchange rates are constantly fluctuating this
  depends on demand and supply of currencies.
• If demand is high i.e. there is a lot of
  investment in that country then the currency will
  increase in value. In turn if the market is
  flooded with a particular currency it will
  decrease in value.

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Exchange Rates (series 2)

• A rising exchange rate means
• For an importer, lower costs for imported items.
• For an exporter, reduced price competitiveness
  and profit margins.
• Similarly falling exchange rates benefit
  exporters but disadvantage importers.

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Exchange Rates

• Multinationals are in a stronger position to
  deal with these fluctuations, compared to firms
  based in one country, as they can move resources
  and accounting procedures in order to take
  advantage of these fluctuations.

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Inflation Causes

• Cost-push inflation occurs when production costs
  increase, perhaps due to pay rises or through
  exchange rate changes on imports, that are not
  supported by productivity increases.
• Demand-pull occurs when demand exceeds supply.
  This can be controlled by limiting credit or
  increased taxation to reduce spending power.

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Inflation Measuring it.

• The most common measure of inflation is the
  retail price index (RPI). The prices of a typical
  sample of purchases or a typical shopping
  basket are weighted by importance and recorded.
  The index is calculated against a base year has a
  figure of 100.

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Inflation Importance

• Firms and entrepreneurs have inflationary
  expectations, their business plans are affected
  by what they expect to happen to inflation. For
  example in R of I is expected to increase then
  they may buy large quantities of goods now thus
  increasing demand-pull inflation, their workers
  may demand a rise due to the expected increase in
  cost of living thus producing cost push
  inflation. This is known as a self-fulfilling
  prophecy as their actions actually make what they
  expected to happen to be true.

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Inflation Importance

• Inflation affects firms behaviour and chances of
  survival. Long-term planning becomes more
  difficult, profit margins may be squeezed as the
  firm cannot always pass on rises in costs to the
  customer. Increased interest rates during high
  inflation periods makes it doubly difficult for
  firms.

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Unemployment Types

• Structural - is where industries are in
  structural decline through lack of
  competitiveness. Mining is a good example of
  this, huge job losses occurred in the late 80s.
  Steel and shipbuilding are other examples.
• Frictional caused by time lag between one job
  and the next.
• Seasonal found in sectors such as agriculture
  and tourism.
• Cyclical due to downturn in the business cycle.

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Unemployment

• Seasonal, frictional and cyclical unemployment
  will always occur and these are not usually too
  greater threat to an economy.
• Structural unemployment causes major problems for
  government and society as it is often large
  numbers it can be difficult to re-train people
  and find them new jobs, whole areas can go into
  decline etc. A declining industry needs to be
  managed to reduce its impacts. (A good example of
  how not to do this is Thatchers approach to
  mining in the late 80s)

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Macroeconomics Its all related!

• All macroeconomic issues are interrelated
  inflation affects interest rates which affect
  exchange rates and so on.
• Nothing can be viewed in isolation when studying
  an economy all macroeconomic data must be looked
  at together.

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They think its all over!

• IT IS NOW!

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Thank you for Listening