3.7.5 Analysing the external environment to assess opportunities and threats: economic change


    3.7.5 Analysing the external environment to assess opportunities and threats: economic change

    The impact of changes in the U.K. and the global economic environment on strategic and functional decision making

    Economic factors include:

    • GDP
    • Taxation
    • Exchange rates
    • Inflation
    • Fiscal and monetary policy
    • More open trade v protectionism


    Gross Domestic Products (GDP) = a measure of economic activity (the total value of a countries output) over a given period of time, usually provided as quarterly or annual figures

    • The difference between GDP and real GDP is that on its own, GDP is nominal, whereas real means that the effect of inflation has been removed


    Direct and Indirect Tax = taxes that firms pay in the UK



    Corporation tax:

    • This is a form on direct taxation, which is a tax on the trading profits made by a business over the course of their financial year as well as any profit from investments and disposal of assets


    Value added tax:

    • This is a form of indirect taxation, collected by businesses for the government. It is a tax placed on the sale of goods and services in the UK – it is a type of ‘consumption tax’


    The business cycle:

    Causes of the business cycle:

    • Changes in business confidence
    • Periods of inventory building and then de-building (usually due to seasons factors such as Christmas or Halloween; or due to expansion of the firm)
    • Irregular patterns of expenditure on consumer durables
    • Confidence in the banking sector



    • Investment
    • Government expenditure
    • Exports



    • Savings
    • Taxes
    • Imports





















    Exchange Rates = the rate between two distinct countries

    • Currency demand – demand from currency comes from a need to purchase the currency of a particular economy
    • Sources of demand include:
      • Exports of goods
      • Exports of services
      • Inflows of foreign investment
      • Speculative demand
      • Official buying of sterling by the Bank of England
    • Currency supply – supply of currency comes from economic agents needing to demand overseas currency in exchange for their own
    • Sources of demand include:
      • Imports of goods
      • Imports of services
      • Outflows of foreign investment
      • Speculative selling
      • Official selling of sterling by the Bank of England


    Free floating exchange rates:

    • Rate determined purely by market demand and supply
    • No government intervention
    • Current finds its own value
    • Means that businesses need to be concerned about how the ER may change when international sales and imports of materials occur
    • For large transactions, firms may need to use the futures market
    • If the pound is weak, it is good for exporters but bad for importers


    Managed exchange rates:

    • Government may seek to influence the market value of the currency
    • Intervention is done by the Bank of England
      • Uses stocks of gold and other foreign currencies
      • May change short erma interest to manage the external value of the pound
    • Increasingly difficult to manage the exchange rate fine the size and power of the FOREX market
    • Provides stability for businesses but means they neither benefit nor lose out


    Fully fixed exchange rates:

    • Central target for the exchange rate (currency peg)
    • No fluctuations permitted
    • Occasional revaluation or devaluation when economic fundamentals demand one
    • Central bank intervention to maintain the currency
    • Illegal to trade away from the currency peg
    • Eurozone countries ‘locked’ their exchange rates together from 1999-2002 before the introduction of the euro


    Inflation = a measure of how much the price of goods and services have gone up over time


    Consumer Price Index (CPI):

    • The main measure of inflation for the UK
    • The Government has set the Bank of England a target for inflation (using the CPI) of 2%
    • The aim of this target is to achieve a sustained period of low and stable inflation
    • Low inflation is also known as price stability
    • Inflation has remained at a relatively low level in the UK in recent years


    Effect of inflation on consumers:

    • As prices rise (inflation) money loses its value and people lose confidence in money as the value of savings is reduced
    • Inflation can get out of control – price increases lead to higher wage demands as people try to maintain their living standards
    • Consumers on fixed incomes (e.g. pensioners) lose out because the their real incomes fall


    Positive effects of inflation on businesses:

    • Industry-wide price rises enable revenues to grow
    • Growing revenues + constant gross margin = higher gross profit
    • Makes using debt as a source of finance cheaper in real terms


    Negative effects of inflation on businesses:

    • If costs are rising due to inflation, a business may not be able to pass them onto customers (PED)
    • Inflation can disrupt business planning and lead to lower investment
    • Rising inflation is associated with higher interest rates – this reduces economic growth and can lead to a recession


    Government Polices = economic policies are the actions taken by the chancellor of exchequer and the government in order to meet their economic objectives


    Fiscal policies :

    • Expansionary – this means that they are aiming to increase economic activity by borrowing more than the government gets in tax and using it to inspire growth
    • Contractionary – this means they are aiming to decrease economic activity by spending less than the government gets in tax and using it to slow down economic growth
    • Neutral – this means they are trying to balance the books and spend what it taxes


    Monetary polices (interest rates):

    • This refers to the availability of money, credit, and the price of credit
    • In the UK, it is done through the Bank of England and the Monetary Policy Committee (MPC)
    • Every month, the MPC meets to look at the state of the economy, and the governments policy to set the interest rate

    Quantitative Easing = a tool that central banks use to inject digital money directly into the economy should it be weak or failing – create digital money and use it to buy government debt in the form of bonds


    Supply side polices:

    • The government tries to improve the supply of goods and services from firm in the UK, including:
      • Privatisation
      • Nationalisation
      • Deregulation
      • Freeing up labour laws
      • Incentives to work
      • Immigration
      • Education and training
      • Transport infrastructure


    Protectionism = this involves any attempt by a country to to impose restrictions on the open trade in goods and services

    • The main aim of protectionism is to cushion domestic businesses and industries from overseas competition and prevent the outcome resulting solely from the interplay of free market forces of supply and demand


    Open Trade = this involves the removal or reduction of barriers to international trade


    Main forms of protectionism:

    • Tariffs – these are a tax or duty that raises the price of imported products and causes a contraction in domestic demand and an expansion in domestic supply
    • Quotas – these are quantitative (volume) limits on the level of imports allowed or a limit to the value of imports permitted into a country in a given time period. Quotas do not normally bring in any immediate tax revenue for the government although if they cause domestic production and incomes to expand, there will be a beneficial impact on taxes paid.
    • Export subsidies – this is a payment to encourage domestic production by lowering their costs (loans can be used to fund the dumping of products in overseas markets)
    • Domestic subsidies – these involve government help (state aid) for domestic businesses facing financial problems


    Why governments protect:

    • Develops new trade advantages
    • Improves the balance of trade
    • Response to dumping
    • Employment protection
    • Desire to increase government revenue


    Reasons for greater globalisation of a business

    Globalisation = the process through which an increasingly free flow of ideas, people, goods, services, and capital leads to the integration of economies and societies

    • The main driver of globalisation are businesses as multinationals was to increase sales, profit, and shareholder value; and the government wants to encourage domestics firms to expand further


    What globalisation involves:

    • An expansion of trade in goods and services between countries
    • And increase in FDI by multinational countries (MNC)
    • The development of global brands
    • Shifts in production
    • Increased levels in labour migration
    • The entry of countries into the global trading system


    The importance of globalisation for business

    Drivers of globalisation:

    • Rising living standards
    • Less protectionism
    • Lower transport costs
    • Digital communication
    • Diverging consumer cultures
    • Market liberalisation


    Advantages of globalisation:

    • Opportunities for trade and investment overseas
    • Access to cheaper goods and services
    • Lifted millions out of poverty
    • More intense competition
    • Bigger export markets (economies of scale)
    • Opportunities to live, study, and travel overseas


    Disadvantages of globalisation:

    • Increased unemployment for firms that lose demand to lower cost competition
    • Rising income and wealth inequality
    • Surge of inward migration of labour has brought economic and social tensions
    • National governments gave less control
    • Globalisation of brands means there is a loss of cultural diversity
    • Environmental damage


    The importance of emerging economies for business

    Features of less developed economies:

    • Low incomes and levels of productivity in terms of labour and capital
    • Often endowed with rich natural resources
    • Higher dependency of export incomes from primary commodities/low export diversification
    • Much of the population works in agriculture and lives in rural areas
    • Limited support provided
    • Distant from technological frontiers
    • Relatively fast growth of population and a younger average age
    • Rapid urbanisation and large scale rural-urban migration
    • Weaknesses in infrastructure such as telecommunications, transport, ports, water, and sanitation
    • Higher tariffs and other import controls
    • Lower access to advances country markets


    Potential business opportunities from emerging economies:

    • They tend to have relatively high rates of economic growth compared with more mature developed economies like the UK, US, Japan and Europe.
    • Many emerging economies have seen the rapid growth of a “middle class” with rising disposable incomes that might simulate demand for the products of businesses located in developed economies.
    • Emerging economies may be a suitable location for international operations – either as a location for production and/or to sell into the domestic market


    Potential business challenges from emerging economies:

    • Many domestic businesses based in emerging economies are now actively pursuing expansion into developed economies
    • Doing business in emerging economies is not straightforward – an increased risk of intellectual property theft, restrictions on the methods of doing business and competitive challenges from established domestic businesses are threats that need to be overcome



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