AQA BUSS4 Course Companion Edition 1

AQA A2 Business Studies

Unit 4 The Business Environment and

Managing Change Course Companion

AQA Business Studies Unit 4 The Business Environment and Managing Change

Tutor2u (www.tutor2u.net) 2009/10 P a g e | 2

CONTENTS

CORPORATE AIMS AND OBJECTIVES ........................................................ 3 Understanding Mission, Aims and Objectives............................................................................. 4

BUSINESS AND THE ECONOMIC ENVIRONMENT......................................... 13 Introduction to the Macroeconomy .......................................................................................... 14

Interest Rates .............................................................................................................................. 22

Inflation ........................................................................................................................................ 25

Unemployment ........................................................................................................................... 30

Exchange Rates ............................................................................................................................ 38

European Union & Business ....................................................................................................... 46

Globalisation of Markets ............................................................................................................ 49

Emerging Markets ....................................................................................................................... 54

BUSINESSES AND THE POLITICAL AND LEGAL ENVIRONMENT ........................ 57

Business & Government Economic Policy ................................................................................. 58

Business Legislation .................................................................................................................... 67

BUSINESSES AND THE SOCIAL ENVIRONMENT ........................................... 73 Business Ethics ............................................................................................................................ 73

Corporate Social Responsibility .................................................................................................. 78

BUSINESSES AND THE TECHNOLOGICAL ENVIRONMENT ............................... 82 Technology .................................................................................................................................. 82

BUSINESSES AND THE COMPETITIVE ENVIRONMENT ................................... 87

Competitive Environment - Five Forces .................................................................................... 87

Business & Environmental Issues ............................................................................................... 94

MANAGING CHANGE ......................................................................... 97

Causes of Change Acquisitions ................................................................................................ 97

Causes of Change Retrenchment .......................................................................................... 103

Change Process Culture ......................................................................................................... 106

Change Process Implementation and Management ........................................................... 110

Change Process Leadership ................................................................................................... 116

Planning for Change Corporate Planning ............................................................................. 121

Planning for Change Managing Risk ..................................................................................... 124

Planning for Change SWOT Analysis ..................................................................................... 127



Corporate Aims and Objectives



Understanding Mission, Aims and Objectives

Introduction to business objectives

You will remember business objectives from your studies in BUSS3. They play a key role in business management by providing a measurable statement of what a business wants to achieve, from the top (corporate) level of the firm right down to the detailed functional activities of the business.

Objectives can be defined in several ways. Here are some possibilities:

The specific intended outcomes of business strategy

The anticipated end results of a programme of activities

Targets which the business adopts in order to achieve its primary aims

The words targets and objectives are often used in the same way in business studies. Objectives have several roles in a business. They are used to:

Implement the mission

Provide a clear focus for decision making and a guide to what needs to be achieved

Provide a target

Motivate employees (assuming the objective is achievable)

Facilitate control of actual performance

Provide criteria for evaluating performance

Reduce uncertainty

Provide a sense of unity

Objectives play a key part in successful business. Objectives exist and operate at different levels in a business the classic hierarchy is illustrated below:



The objectives cascade down from the mission getting progressively more specific and

detailed. For example, a corporate objective of achieving company revenue growth of 10%

per year would be translated into detailed sales targets for individual business units, product

groups and markets.

A key advantage of the hierarchy is that it ensures that at each level the objectives are

consistent with the objectives above them. Functional objectives should not be inconsistent,

or work against, higher level corporate objectives.

How are objectives used in business? To:

How do objectives fit in with other relevant terms such as mission and aims? The distinction

is as follows:

Mission A qualitative statement of why the business exists, how it does business etc

Aim A long term target from which business objectives are derived

Objective A target which must be achieved in order to realise the stated aim

A time assigned targets derived from the goals and set in advance of strategy

Corporate objectives and their role in business strategy

Put simply, corporate strategies are essentially about what the business wants to achieve.

Business strategy is about how those corporate objectives are to be achieved.

Business strategy is concerned with deciding which markets and activities the business should

be involved in; where it wants to be; and how it is going to get there. Strategy is about

making high-level decisions and forms the management game plan for

Satisfying customers (meeting customer needs)

Running the business (organising resources in the most efficient and effective way)

Beating the competition (strategies and tactics to gain competitive advantage)

Achieving corporate objectives

Corporate (or business) objectives are set at the high level and are quite distinct from any

more detailed functional objectives set for the functional areas of a business.

Examples of corporate objectives would include targets for:

Sales revenue (a traditional measure of the size and strength of a business if

revenue is growing then the business is growing)

Profit (both the absolute level of profit and the profit margin i.e. return on sales)



Return on investment (e.g. ROCE, ROI: particularly important for capital-intensive

businesses)

Growth (sales volume, revenue, profit, earnings per share)

Market share (the proportion of markets and industries owned by the business or its

products)

Cash flow (this can be similar to a profit objective, but with the focus on maximising

the net cash inflow of the business)

Shareholder value (particularly important for publicly-quoted businesses where senior

management are tasked with growing the value of the business)

Corporate image & reputation (increasingly important links closely with corporate

social responsibility, product and customer service quality, and business ethics)

Many factors will influence the corporate objectives that are set. Precisely which factors

depends on the nature of the business and its markets, and the business ownership. Some

examples of those factors include:

Factors Influencing Corporate Objectives

Age of the business

Size and legal status

Ownership (e.g. privately owned; stock exchange quoted)

Views of owners and managers

Market conditions

Legislation

State of the economy

Competition

Risk and attitude to risk

Corporate culture

Political factors

Social attitudes

Corporate objectives can also be considered the main or primary objectives of a business. The

set the agenda for the secondary objectives:

Primary Objectives Secondary Objectives

The ultimate, long term goals of the business

(3-10 years typically)

These are the key strategic objectives such

as profit growth or shareholder returns

Make a direct contribution to meeting

primary objectives

E.g. sales growth will help business achieve

profit target

Also known as tactical objectives

Usually focused on the short or medium-term

(1-3 years)

A similar distinction can also be made between strategic (corporate) and tactical (functional)

objectives:



Strategic Tactical

Focused on long-term Focused on short-term

Set by the Board Set by line management

Involve higher risk & uncertainty Relatively low-risk

Likely to involve significant investment / business resources

Limited resources invested

Difficult to change in the short-term Relatively easy to change at minor financial cost

Stretching & challenging Realistic & achievable

Mission statements

Mission statements are they an exercise in public relations or a key part of providing the

direction that management and employees need as they go about their business? The debate

about the relevance and usefulness of mission statements has raged for many years.

A mission statement attempts to put into words what a business or organisation is all about.

It attempts to define in a punchy, understandable phrase:

The overriding goal of the business

The reason for its existence

A strategic perspective

A vision for the future

Here are some examples:



What makes an effective mission statement? Here are some characteristics of good ones. A

good mission statement:

Differentiates the business from its competitors

Defines the markets or business in which the firm wants to operate

Is relevant to all major stakeholders - not just shareholders and managers

Excites, inspires, motivates & guides

Research has found that effective mission statements tend to be:



Brief in length

Flexible they should be able to accommodate change

Business specific and distinctive

Effective at communicating key values

Realistic and achievable

Supported by senior management

Unfortunately, many mission statements are ineffective and this has led some commentators

to question their role. Common criticisms levied are that mission statements are:

Not always supported by actions of the business

Often too vague and general

Often merely statements of the obvious

Often nothing more than a compulsory public relations exercise

Sometimes regarded cynically by staff

Sometimes not a true reflection of reality

Introduction to Stakeholders

Lets start with a definition of stakeholders, which are:

Groups / individuals that are affected by and/or have an interest in the operations and

objectives of the business

Most businesses have a variety of stakeholder groups which can be broadly categorised as

follows:

Stakeholder groups vary both in terms of their interest in the business activities and also their

power to influence business decisions. Here is a useful summary:



Stakeholder Main Interests Power and influence

Shareholders Profit growth, Share price growth, dividends

Election of directors

Banks & other Lenders

Interest and principal to be repaid, maintain credit rating

Can enforce loan covenants

Can withdraw banking facilities

Directors and managers

Salary ,share options, job satisfaction, status

Make decisions, have detailed information

Employees Salaries & wages, job security, job satisfaction & motivation

Staff turnover, industrial action, service quality

Suppliers Long term contracts, prompt payment, growth of purchasing

Pricing, quality, product availability

Customers Reliable quality, value for money, product availability, customer service

Revenue / repeat business

Word of mouth recommendation

Community Environment, local jobs, local impact Indirect via local planning and opinion leaders

Government Operate legally, tax receipts, jobs Regulation, subsidies, taxation, planning

Stakeholder power is an important factor to consider whenever you are asked to write about

the relationship between a business and its stakeholders. In the context of strategy, what is

important is the power and influence that a stakeholder has over the business objectives.

For stakeholders to have power and influence, their desire to exert influence must be

combined with their ability to exert influence on the business. The power a stakeholder can

exert will reflect the extent to which:

The stakeholder can disrupt the business plans

The stakeholder causes uncertainty in the plans

The business needs and relies on the stakeholder

The reality is that stakeholders do not have equality in terms of their power and influence.

For example:

Senior managers have more influence than environmental activists

A venture capitalist with 40% of the companys share capital will have a greater

influence that a small shareholder

Banks have a considerable impact on firms facing cash flow problems but can be

ignored by a cash rich firm



A customer that provides 50% of a business revenues exerts significantly more

influence than several smaller customer accounts

Businesses that operate from many locations across the country will be less relevant

to the local community than a business which is the dominant employer in a town or

village

Governments exercise relatively little influence on many well-established and

competitive business-to-business markets. However their power is much stronger

over businesses in markets which are regulated (e.g. water, gas & electricity) or where

the public sector has a direct stake (e.g. retail banking)

Employees have traditionally sought to increase their power as stakeholders by

grouping together in trade unions and exercising that power through industrial action.

However, in the last two decades the level of union membership has declined

significantly as has the total time lost to industrial action

How should a business handle stakeholders?

How should a business respond to these variations in stakeholder power and influence? The

matrix below provides some guidance on the approaches often taken:

High level of interest Low level of interest

High level of power Key players

Take notice of them

Keep them satisfied

Low level of power Communicate regularly with them

Can usually be ignored

In handling its stakeholders, a business also has to accept that it will have to make choices. It

is rare that win-win solutions can be found for key business decisions. Almost certainly the

business cannot meet the needs of every stakeholder group and most decisions will end up

being win-lose: i.e. supporting one stakeholder means another misses out.

There are often areas where stakeholder interests are aligned (in agreement) where a

decision can benefit more than one stakeholder group. In other cases, there is a clear conflict

of interest. Here are some common examples:

Where Stakeholder Interests are Aligned Where Stakeholder Interests Conflict

Shareholders and employees have a common interest in the success and growth of the business

High profits lead not only lead to good

Wage rises might be at the expense of lower profits and dividends

Managers have an interest in organisational growth but this might be at the expense of



dividends but also greater investment (retained) in the business

Suppliers have an interest in the growth and prosperity of the business

Local community, employees and shareholders benefit from business involvement in the community

short term profits

Expansion of production activity might cause extra noise and disruption in local community

There are two main approaches to handling the often conflicting needs of stakeholders:

Shareholder Approach Stakeholder Approach

The traditional approach

Business (management) acts in best interest of shareholders / owners

Principal aim is to maximise shareholder returns

Main focus is on growth & profit

Increasingly popular

Business takes much more account of wider stakeholder interests

Approach based on consultation, agreement, cooperation

E.g. social and environmental concerns become more important

Over the years various techniques and organisational models have been developed which

help businesses handle their relationships with key stakeholder groups. Some of the most

important are summarised below:

Approach Description

Workers Councils Compulsory for some larger firms in the EU

Brings worker representatives from across departments & activities for regular discussion of business issues

Stakeholder Directors

Outside representatives who hold a non-executive position on the Board Many UK plcs particularly those selling direct to consumers and households, have taken steps to reflect customer interests on the Boards

Arbitration / Conciliation

Formal processes of resolving conflicts between employer and employees (e.g. ACAS)

Also applies to settling disputes between firms and their suppliers (e.g. negotiating agreement on contractual disputes rather than resorting to legal action)

Share options & other performance-related pay

Widened participation of share ownership amongst all employees, helps align interests of shareholders and employees



Business and the Economic Environment



Introduction to the Macroeconomy

Macroeconomic and economic growth

All businesses operate within a competitive environment. However, the nature of competition varies from industry to industry.

All businesses also operate in the economic environment. It is something they can do nothing about but they must understand and respond to changes in economic conditions.

A key part of the economic environment is the strength of the macro-economy. Macroeconomics is mainly concerned with:

The total level of spending (or demand) in the economy

Levels of employment and unemployment

The total investment made by businesses and government

The general level of prices

The rate of interest and exchange rates

The strength of the economy is always changing, although broad movements take time to occur. The level of activity in an economy can be measured in several ways, but the most common way is to look at the value of gross domestic product (shortened to GDP) (the main measure of economic activity) in each period.

GDP is commonly used to measure economic growth and is made up of several parts:

The formula for is: GDP = C + I + G + (X M)

where

C (Consumption)

I (Investment)

G (Government spending)

and X M (Net Exports)

Economic growth is an increase in the value of goods and services produced by an economy over time.

There are two main ways to measure economic growth:



Actual growth (GDP) Potential growth (trend growth)

The percentage annual increase in a countrys real gross domestic product over a period of time

The long run expansion of an economys productive potential

The % annual increase in national output The increase in the capacity of the economy to produce

Caused by an increase in aggregate demand Caused by an increase in aggregate supply

Potential output is that which could be produced if there was full employment of resources

Economic growth is a vitally important measure for several reasons:

Economic growth is about an increase in production within the economy

It is important because our living standards are influenced by our access to goods and

services

Without growth, individuals can only enjoy rising living standards at the expense of

others in society

With economic growth we can all (potentially) be better off



The Business Cycle

Introduction to the Business Cycle

Economies go through a regular pattern of ups and downs in the value of GDP. This is known as the business cycle (sometimes you also see it referred to as the economic cycle).

The business cycle is characterised by four main phases:

Boom: high levels of consumer spending, business confidence, profits and investment. Prices and costs also tend to rise faster. Unemployment tends to be low as growth in the economy creates new jobs

Recession: falling levels of consumer spending and confidence mean lower profits for businesses which start to cut back on investment. Spare capacity increases + rising unemployment as businesses cut back and reduce stocks

Slump / depression: a prolonged period of declining GDP - very weak consumer spending and business investment; many business failures; rapidly rising unemployment; prices may start falling (deflation)

Recovery: things start to get better; consumers begin to increase spending; businesses feel a little more confident and start to invest again and build stocks; but it takes time for unemployment to stop growing

The stages of the classic business cycle can be illustrated as follows:

Looking at the data for UK economic growth, you can see the recent elements of the UKs business cycle:



The timing and shape of the business cycle is affected by many factors, including:

Changes in the level of business and consumer confidence

Alternating periods of stocking and de-stocking

Changes in the value of consumer spending and business investment

Changes in government policy which can induce a change in the economy (refer to later notes on monetary and fiscal policy)

Importance of Trend Growth

In the chart above you can see some fairly significant short-term fluctuations in the annual economic growth rate. A key issue for an economy in the longer-term is achieving a sustainable level of growth. Economists often calculate and refer to the trend growth rate to help assess and compare the relative growth rates of different economies.

Trend growth refers to the smooth path of long run national output - an estimate of how fast the economy can be expected to grow without creating an unsustainable increase in inflation. The figures for the UK economy are illustrated below:

Annual percentage change in GDP at constant prices

The Economic Cycle - Growth in UK National Output

Source: UK Statistics Commission

80 82 84 86 88 90 92 94 96 98 00 02 04 06 08

-5

-4

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Is economic growth good news for business? In general yes. There is a long list of upsides for businesses operating in economies that are growing, including:

Increased profits

A rise in average living standards

The creation of new jobs

Lower unemployment

Increased tax revenues for government - used to fund more spending on government services

Improved business confidence

Increased capital investment

Greater technological innovation

There are, however, some drawbacks for an economy that is growing rapidly:

The risk of demand pull inflation if actual growth exceeds potential growth

Increased inequality if the benefits of growth are not evenly distributed

Increased demand for imports and a trade deficit

Source: OECD World Economic Outlook

UK - Potential GDP and Trend Growth

Source: OECD World Economic Outlook

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

thousa

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0.80

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(th

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0.80

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1.00

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1.20

1.25

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1.35 Potential GDP

1.50

1.75

2.00

2.25

2.50

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3.00

Perc

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1.50

1.75

2.00

2.25

2.50

2.75

3.00

Estimated UK Trend Growth Rate



How businesses are affected by the business cycle

Every business is affected by the stage of the business cycle, but some businesses are more vulnerable to changes in the business cycle than others.

For example, a business that relies on consumer spending for its revenues will find that demand is closely related to movements in GDP. During a boom, such businesses should enjoy strong demand for their products, assuming that the products are actually what customers want! But during a slump, the business has to ride out the storm suffering a sharp drop in demand.

You can see lots of examples of this in the UK economy currently.

During the housing-market inspired boom of the early 2000s, many retail and consumer goods businesses took advantage of the boom. Consumers were prepared to take on significant personal debt in order to finance their purchases. However, the sharp economic downturn during 2008 and 2009 saw many businesses suffer sales falls of between 10-30%. Some did not survive their fixed costs were just too high to be able to remain viable.

Businesses whose fortunes are closely linked to the rate of economic growth are referred to as cyclical businesses. Examples include:

Fashion retailers

Electrical goods

House-builders

Restaurants

Advertising

Overseas tour operators

Construction and other infrastructure firms

By contrast, some businesses actually benefit from an economic downturn. If their products are perceived by customers as representing good value for money, or a cheaper alternative than more expensive products, then consumers are likely to switch. Good examples that were featured in the UK media during the recession of 2008/09 included:

Value retailers (e.g. Aldi, Lidl, Netto)

Fast-food outlets (e.g. Dominos, Subway)

Domestic holidays (e.g. B&Bs and holiday cottages)

Chocolate for some reason, chocolate sales always increase strongly during an

economic downturn!



The Credit Crunch of 2008/9

The global economic problems experienced as a result of the financial crises of 2008 and subsequent credit crunch provided a rich source of examples of how businesses had to respond to a sudden deterioration in economic growth. As you can see from the chart below, the credit crunch contributed to a sharp slowdown in GDP:

To understand the business effects of the credit crunch, you first have to remember what the crunch is! The key issues are liquidity and business confidence.

A credit crunch is essentially a liquidity crisis. Banks become nervous about lending money to each other and to personal and business customers. Where they are prepared to lend, they



charge higher rates of interest to cover their risk. The result is a big fall in the supply of credit and an increase in the cost of borrowing.

The credit crunch hit consumer-serving businesses badly:

The credit crunch made it harder for householders to get loans mortgage loan approvals collapsed contributing to a steep decline in property demand and house prices

A large negative wealth and confidence effect from falling property prices and a large fall in consumer spending on new durable products such as cars, furniture and household appliances

Because consumption is such a high percentage of aggregate demand, the decline in household spending was a key factor driving the UK into recession during 2009

Business confidence also plummeted during the 2008/9 crisis. Why is that important?

Confidence in the future is an important element in business decision-making; especially about investment

Firms will only invest if they are confident about future demand for their products (note the important link to revenue and profit assumptions in investment appraisal)

But business confidence can be a self fulfilling prophecy

An optimistic view of the future leads to investment in equipment and in stock. This rise in aggregate demand brings about a boom

Conversely, pessimism about future prospects will lead to low investment with the danger of provoking a downturn in the economy

The key in business studies is to consider the relationship between business and the economic slowdown. How did businesses respond? In many cases, lack of liquidity and reduced business confidence prompted businesses to:

Cut back production capacity (e.g. longer factory holidays, reduced shifts, short-time working)

Reduce headcount (redundancies are inevitable during a downturn)

Postpone investment (despite interest rates falling to a record low)

Conserve cash (pay suppliers later; push customers to pay earlier)

Intensify sales promotional activity (e.g. discounts, different promotional methods)

De-stock (i.e. reduce the quantity and value of inventories held)



Interest Rates

Credit and why businesses need it

Some small businesses trade in cash and nothing else. Customers pay in cash and the expenses and costs of the business are settled in cash. There is no need for credit.

However, most businesses cannot survive simply with the cash they have in the bank. They need to borrow or lend from banks, suppliers and others in order to trade.

So in business, credit is about borrowing owing money to others for a period of time.

For example, credit arises when:

A business makes use of a bank overdraft facility e.g. the bank account goes 50,000 into the red or overdrawn

A business takes out a bank loan e.g. 500,000 loaned over five years

A business buys goods or services from a supplier and agrees to pay for them in 30 days this is known as trade credit

The amount of credit that a business can raise will depend on several factors such as:

Whether the business is profitable and is likely to remain so in the future

The ability of the business to generate a positive cash flow to allow it to repay credit

The strength of the relationship between the business and its creditors

The industry or market in which the business operates

You may have heard about the credit crunch during 2008 and 2009. The credit crunch was about a reduction in the availability of credit for businesses. As lenders struggled to stay in business, they lost confidence in the ability of businesses to repay credit. So many businesses found themselves in financial trouble due to:

Banks withdrawing or lowering overdraft facilities

Banks refusing to provide bank loans, or making the repayments and interest charges worse

Suppliers insisting on earlier payment of invoices

Customers taking longer to pay their bills

The effects of the credit crunch notably an increase in failed businesses show just how important credit is to the business community.

Interest rates

An interest rate is the cost of borrowing money or the return for investing money.

For example, a bank charges interest on amounts loaned out or on the balance of an overdrawn bank account.

A bank will also pay interest to the owner of an account with a positive balance.



Interest rates vary depending on the type and provider of borrowing.

The base interest rate in the UK economy is set by the Bank of England. Each month, the Monetary Policy Committee of the Bank of England meets to decide what the base rate should be.

During the credit crunch, the base interest rate has fallen sharply to as low as 0.5%, as shown in the chart below:

The base interest rate set by the Bank of England affects other interest rates in the economy because it is the rate at which banks can themselves lend from the Bank of England.

In theory, a lower base rate will lead to lower interest rates on borrowings paid by businesses but not necessarily.

The effect of a change in interest rate will be affected by whether borrowing is at a variable or fixed rate:

With a variable rate, the interest charged varies in relation to the base rate. So a fall in the base rate to 0.5% in early 2009 should mean that businesses with variable-rate overdrafts pay lower interest.

A fixed interest rate means that the interest cost is calculated at a fixed rate which doesnt change over the period of the credit, whatever happens to the base rate.

How businesses are affected by changes in interest rates

The effect of a change in interest rates will depend on several factors, such as:

Percentage - set by the Bank of England Monetary Policy Committee

Monetary Policy Interest Rates in the UK

Source: Reuters EcoWin

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The amount that a business has borrowed and on what terms

The cash balances that a business holds

Whether the business operates in markets that depend on consumer spending

Lets look at the third factor listed above to examine the implications a little more closely.

Consider the example of households and consumers who like to pay for their goods and services using borrowing such as credit cards or a bank overdraft or loan. Also think about households who have substantial balances outstanding on a mortgage used to finance a house purchase.

An increase in interest rates will mean that the cost of borrowing rises.

In theory, a higher bank base rate will mean that credit card companies such as Visa and MasterCard will also raise the rate they charge borrowers on amounts that are outstanding.

A higher interest rate will also mean an increase in the monthly mortgage payments that are made by home-owners who have mortgages which are charged at a variable rate.

In both cases, the disposable income of consumers and households will fall.

The monthly mortgage payment might rise from say 500 to 550, which means that the household has 50 less disposable income available to spend or save.

If consumers and households think that the rise in interest rates is temporary or short-term, they may simply continue to spend as before. In this case, there will be little effect on demand. However, it might also prompt them to cut back on spending, which would result in lower demand.

Some businesses operate in markets which are very sensitive to changes in interest rates. These markets often involve goods and services where the purchase is financed by debt and where the price paid is relatively significant compared with the customers income. For example:

Housing (mortgages)

Motor vehicles

Holidays

Major purchases of consumer goods e.g. new kitchen equipment, audio-visual systems



Inflation

Defining and measuring inflation

Inflation is a sustained increase in the average price level of a country.

The rate of inflation is measured by the annual percentage change in the level of prices.

A sustained fall in the general price level is called deflation in this situation, the rate of inflation becomes negative.

In the UK there are two measures of general price inflation, the preferred measure being the Consumer Price Index (CPI):

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

The recent history of UK inflation (as measured by the CPI) is shown in the chart below:

After a long period of low inflation, the UK suffered higher inflation during 2008. However, the recession of 2009 has reduced inflationary pressures and may even lead to a period of deflation.

Interest rates are used by the Bank of England as a key weapon to control inflation. The Base Rate fell to a low of 0.5% in 2009 as fears of deflation and prolonged recession grow

Annual percentage change in the Consumer Price Index

Consumer Price Inflation for the UK Economy

Source: UK Statistics Commission

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09

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stronger. You can see the relationship between interest rate decisions and the CPI inflation rate in this chart:

Causes of inflation

There are two main causes of inflation:

Demand-pull (when there is excess demand), and

Cost-push (when costs rise)

Demand-pull inflation

This occurs when there is excess aggregate demand in the economy (overall) or in a specific market or industry. Businesses respond to high demand by raising prices to increase their profit margins. Demand-pull inflation is often associated with the boom phase of the business cycle

The main causes of demand pull inflation are

A weaker exchange rate which increases the price of imports and reduces the foreign price of UK exports

A reduction in direct or indirect taxation - consumers have more disposable income causing more demand

Rising consumer confidence and an increase in the rate of growth of house prices

Faster rates of economic growth in other countries providing a boost to UK exports overseas

Annual percentage change in the UK Consumer Price Index, the inflation target is 2%

Consumer Price Inflation and Interest Rates for the UK


97 98 99 00 01 02 03 04 05 06 07 08 09

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Consumer Price Inflation

Base Interest Rates



Cost-push inflation

This occurs when costs of production or operation are increasing

The key causes include:

External shocks (e.g. commodity price fluctuations)

A depreciation in the exchange rate (weaker pound = more expensive imports)

Acceleration in wages

What happens when faced with cost-push inflation?

Firms raise prices to protect their profit margins better able to do this when market demand is price inelastic

Wages often follow prices

A rise in inflation can lead to rising inflationary expectations

Examples of cost-push inflation are shown in the chart below:

A great example to use of cost-push inflation which affects almost every industry is that of rising oil prices also illustrated below:

Index 2003=100, source: Monthly Digest of Economic Statistics

Index of UK Import Prices

Goods, excluding oil, Non-EU Fuels

Finished manufactures: SITC 7 8


01 02 03 04 05 06 07 08

50

100

150

200

250

300

350

400

Index

50

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300

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Total Import Price Index

Import Prices for Fuels

Finished Manufactured Goods



Costs and consequences of inflation

Inflation has many important costs and consequences for both society and business. These include:

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. This is known as a wage-price spiral.

Consumers and businesses on fixed incomes lose out because the their real incomes fall - employees in poor bargaining positions also lose out

Inflation can favour borrowers at the expense of savers because inflation erodes the real value of existing debts

Inflation can disrupt business planning and lead to lower capital investment

Inflation is a possible cause of higher unemployment in the long term because of a lack of competitiveness

Rising inflation is associated with higher interest rates - this reduces economic growth

Is inflation good or bad news for business?

You might be wondering how on earth inflation can be good news for business. But the truth is it can! For example, with a sensible, low level of general price inflation:

Annual percentage change in the Consumer Price Index and monthly average for Brent Crude

UK Inflation and Crude Oil Prices

Source: UK Statistics Commission and IPE

00 01 02 03 04 05 06 07 08 09

0.5

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Industry-wide price rises enable revenues to grow

Growing revenues + a constant gross margin = higher gross profits

Inflation makes using debt as a source of finance cheaper in real terms

The two key issues to consider in relation to the adverse effects of inflation are:

Price elasticity of demand

Responding to cost-push inflation

You will recall that price elasticity refers to the responsiveness of demand to changes in price

When demand is elastic, a price rise leads to a more than proportionate fall off in quantity demanded

When demand is inelastic, a price rise leads to a less than proportionate fall off in quantity demanded

Firms with inelastic price elasticity of demand will be less affected by a rise in inflation

Some firms will be able to absorb price increases by becoming more efficient

Remember that price inflation will vary from industry to industry be careful about making generalisations!

Thinking about the effect of rising costs on a business: with a rise in general inflation:

Sales revenue should rise

But workers likely to demand higher pay to compensate for consumer price inflation

Labour intensive industries more at risk

Cost-push inflation will vary from industry to industry

Firms that need to buy significant commodity raw materials may find profit margins squeezed if they cannot pass on increased costs to customers

Further study links on inflation

Here are some good web links that help you build your understanding of inflation:

BBC Recession Tracker Inflation

Chicken in the basket of UK goods used to measure inflation (BBC news, March 2009)

First UK deflation for fifty years (BBC news, April 2009)

Inflation articles (Guardian)

Two figures, two inflation stories (BBC news, March 2009)

Understanding inflation a users guide (The Times, June 2009)



Unemployment

What is unemployment?

Unemployment arises when the supply of those making themselves available for work is

greater than the demand for workers. Unemployment is, therefore, the excess supply of

labour in the labour market.

You will read much about unemployment when looking at business news stories currently.

But who are the unemployed and how is the total number of unemployed people

calculated?

The unemployed are registered as able, available and willing to work at the going wage rate

but cannot find a job despite an active search for work. This last point is important for to be

classified as unemployed, one must show evidence of being active in the labour market.

There are two main measures of the unemployment total in the UK:

The Claimant Count measure of unemployment includes people who are eligible to claim the

Job Seeker's Allowance. The Claimant Count is a head-count of people claiming

unemployment benefit.

The Labour Force Survey covers those who are without any kind of job including part time

work but who have looked for work in the past month and are able to start work in the next

two weeks. The figure also includes those people who have found a job and are waiting to

start.

Measuring the number of people unemployed at any one time is quite tricky! That is because

there is a constant flow of people entering and leaving the labour market, moving between

jobs, or changing the nature of their employment. You can see this illustrated below:



What has happened to unemployment in the UK?

The most recent changes in claimant count and labour force survey measures of UK

unemployment are summarised in the chart below:

Unemployed people aged 16-59 (women) / 64 (men), seasonally adjusted

Unemployment in the UK Economy

Source: Labour Force Statistics

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09

0

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Labour Force Survey



Looking at the data, you should be able to see:

A long period of falling and then low unemployment from 1992 (recession peak) until

2008

A steep increase in unemployment following credit crunch and global slump in

2008/09

Economists and business commentators expect that UK unemployment is likely to increase

further during 2010.

It is also worth considering the link between economic growth (as measured by growth in

GDP) and unemployment. The recent UK data for these two connected economic variables is

shown below:

Looking at the chart above:

Between 1992 and 2008, almost 4 million extra jobs were created in the UK economy

There is a strong link between sustained economic growth (2-4% p.a.) and

employment creation

The recession of 2008/9 reversed the trend; employment fell by at least 0.5million

Total employment (bottom pane) and the annual growth of real GDP (top pane)

GDP Growth and Jobs for the UK Economy

Growth of Real GDP [ar 12 months] Employment - millions, All aged 16 and over, seasonally adjusted


90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09

millio

ns

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Causes of Unemployment

There are four main causes of unemployment:

Seasonal unemployment

Seasonal unemployment happens due to regular and predictable seasonal changes in

employment / labour demand. Seasonal unemployment affects certain industries more than

others. For example it is a common feature of employment in these industries:

Catering and leisure

Construction

Retailing

Tourism

Agriculture

Frictional unemployment

Frictional unemployment is transitional unemployment due to people moving between jobs:

For example, redundant workers or people joining the labour market for the first time such as

university graduates may take time searching to find the work they want at an acceptable

wage or salary.

Imperfect information in the labour market may make frictional unemployment worse if the

jobless are unaware of the available jobs. Incentives problems can also cause some frictional

unemployment as some people looking for a new job may stay out of work if they believe the

tax and benefit system will reduce the net increase in income from taking work. When this

happens there are disincentives for the unemployed to accept work this is known as the

unemployment trap.

Structural unemployment

Structural unemployment occurs when there is a long run decline in demand in an industry

leading to a reduction in employment because of international competition. Globalisation is a



fact of life and inevitably it leads to changes in the patterns of trade between countries Over

time.

For example, the UK has probably now lost forever, its cost advantage in manufacturing goods

such as motor cars, household goods and audio-visual equipment. Indeed UK manufacturing

industry has lost over 500,000 jobs in the last five years alone as production has shifted to

lower-cost centres in Eastern Europe and emerging markets in Far East Asia. Many of these

workers may suffer from a period of structural unemployment, particularly if they are in

regions of above-average unemployment where job opportunities are scarce.

You can see the effect of structural unemployment on the UKs manufacturing sector in the

chart further below.

Structural unemployment exists where there is a mismatch between the skills of the

workforce and the requirements of the new job opportunities. Many of the unemployed from

manufacturing industry (e.g. in coal, steel and engineering) have found it difficult to find new

work without an investment in re-training.

Cyclical unemployment

Cyclical unemployment is due to a lack of demand for goods and services. When there is a

recession or a slowdown in economic growth, we see a rising unemployment because of

factors such as:

Plant closures and other actions to reduce production capacity

Millions, seasonally adjusted

Employment in UK Manufacturing Industry


80 82 84 86 88 90 92 94 96 98 00 02 04 06 08

mill

ions

3.0

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Business failures

Redundancies

Outsourcing to reduce costs

This is due to a fall in demand leading to a contraction in output across many industries.

An important evaluation point to note is that the economy does not have to go into recession

for cyclical unemployment to start rising. Many jobs can be lost even in a mild slowdown

phase and one reason for this is because of rising productivity.

How businesses are affected by unemployment

Businesses are affected in a variety of ways depending on whether unemployment is high or

low.

Some business implications of rising / high unemployment:

Lower consumer spending = lower demand for income-elastic products

Demand for inferior goods (lower price, quality) may increase

Greater supply of labour potentially lower wage/salary levels

Unemployment creates insecurity in the workforce; potentially a cause of lower

morale and de-motivation

Danger of lost skills for industries as a whole

Business may be impacted by social problems associated with high unemployment

(e.g. rising crime)

Recruitment (in theory) becomes easier there should be more applicants for each

vacancy

Lower staff turnover employees less likely to be able to find other jobs, or want to

move in an uncertain economic climate

Some business implications of falling / low unemployment:

Consumers have more income = higher demand for income elastic goods



Labour market tightens increased upward pressure on wages / salaries

Harder to recruit or expand without offering better worker packages potentially

affects ability to increase capacity

Greater sense of job security and motivation in the workforce if the business is doing

well

The appropriate response to changes in unemployment will depend on several factors,

including:

The nature / cause of unemployment (e.g. cyclical, structural, seasonal)

The labour-intensity of the business

The ability of the business to respond (resources, management structure etc)

Some typical responses are as follows:

Low Unemployment High Unemployment

A chance to expand capacity to take advantage of higher demand

Reduced production capacity if demand falls

Adjust remuneration packages to remain competitive to attract staff

Headcount reductions (redundancy, recruitment freeze)

Invest in training to meet skills gap and help retain key staff

Reduce working capital (particularly inventories)

Offer more flexible working options to attract larger labour pool

Postpone or cancel investment projects

Consider outsourcing to access specialist skills where recruitment is tough

Potentially diversify into new markets

An important evaluation point to remember is that many appropriate businesses actions will

take place before a significant change in unemployment becomes apparent. A business that

is anticipating structural or cyclical changes in its business will ideally take action before those

changes take full effect.

Further study links on unemployment

There are lots of great online resources that can help you consider the implications of

unemployment on businesses. Here is a selection:

Blue-collar workers bear the brunt of the recession (Guardian, July 2009)

BT to shed a further 15,000 jobs (BBC news, May 2009)

Corus steel to cut 2,000 UK jobs (BBC news, June 2009)



Job losses hit the under 25s (BBC news, July 2009)

Microsoft slashes 5,000 jobs as recession bites (The Times, January 2009)

Nearly half of UK jobless are under 25 (BBC news, June 2009)

School-leavers suffer as UK unemployment rises to highest since 1971 (The Times, July 2009)

Shadow of youth unemployment returns to blighted cities of the 1980s (Guardian, June 2009)

The jobless map of Great Britain (Guardian)

Tough market for UK graduates (BBC news, January 2009)

UK economy jobs tracker (BBC news)

UK unemployment jumps by record 281,000 (Guardian, July 2009)

UK unemployment since 1984 (Guardian interactive guide)

Unemployment articles from the Guardian

Unemployment and employment statistics for the UK economy (Guardian)



Exchange Rates

What is an exchange rate?

An exchange rate is the price of one currency expressed in terms of another currency.

The exchange rate determines how much of one currency has to be given up in order to buy a specific amount of another currency.

For example, look at the exchange rates in the following table:

1 buys May September

US Dollars ($) $1.60 $1.45

Euros () 1.15 1.05

In the table above, you can see that in May, 1 would buy $1.60, if you wanted to convert some pounds into US dollars. Alternatively, 1 would buy 1.15 euro.

Exchange rates change constantly as currencies are bought and sold (traded) on the global currency markets. Let any commodity, a currency has a value or price expressed in terms of what it could buy that is the exchange rate.

Look at the table and see what happened to the exchange rate for the pound between May and September.

The value of 1 fell against both the US dollar and the Euro. For example, by September, 1 would only buy you $1.45, a fall of $0.15 from May.

That means that the pound weakened against the dollar (and the euro).

Putting it another way, the value of the US dollar strengthened against the pound. If you were holding dollars, you would need less of them to convert into 1.

Causes of movements in exchange rates

An exchange rate is a price of a currency. The price is determined by the forces of demand and supply in the currency markets.

Just like the commodity markets for wheat, oil and coffee, the price of a currency will reflect the amount of the currency that consumers and businesses want to buy (demand) and sell (supply).

Currencies are traded on in international currency markets 24 hours a day. Many billions of pounds and other currencies are traded every hour, to service the needs of governments, businesses and millions of individuals.

For example, here are some reasons why there is demand for a currency:



Businesses need to pay for invoices from overseas suppliers (e.g. a US supplier sending goods to the UK and pricing the invoice in dollars)

Businesses needing to convert payments they have received from customers in one currency into another (e.g. a customer in Italy pays a UK business in Euros which it wants to convert into pounds before putting it in the bank)

Consumers and business people buying currency before taking a trip or holiday overseas.

Businesses sending back profits (cash) from their overseas operations to the base currency

Currency markets are also affected by speculative demand and supply. Currency traders bet on which way they think exchange rates will move. If they think that there will be excess demand for a currency and that it will strengthen, then they may buy that currency and then look to sell the currency when the exchange rate has risen (making a profit)

A currency is also affected by interest rates. For example if interest rates in the UK rise, then holders of other currencies may swap them into pounds in order to gain access to a higher interest rate.

Finally, you should also consider the implications of fluctuating exchange rates on inflation.

Consider the effects of a weaker pound ():

A weaker makes imports more expensive

Higher import prices: o Drive up firms costs (cost-push inflation) o Feed directly into the consumer price index o Wages may rise in response to the rise in prices - thus triggering off a wage-

price spiral

A weaker also leads to a rise in aggregate demand since exports rise and imports fall

Depending on the extent of spare capacity in the economy, the rise in aggregate demand could increase inflationary pressure

Implications for UK businesses if the pound strengthens

A good way to look at what happens if a currency strengthens (an increase in the exchange rate) is to work through an example.

1 buys January June

US Dollars ($) $1.40 $1.60

Brandon Ltd imports electronic goods from the US for sale via a UK website. These goods are invoiced in US$ - and that is the currency that Brandon must use to settle the invoices. Each month they pay their American suppliers approximately $100,000 for goods imported into the UK.



What is the effect of the strengthening pound in the table above on Brandon Ltd?

Lets convert the monthly US dollar payment to suppliers ($100,000) into pounds to see how much Brandon has to pay:

1 buys January June

US Dollars ($) $1.40 $1.60

$100,000 converted into 71,428 62,500

In June, Brandon Ltd needs to spend 62,500 to pay for their $100,000 of imported goods from the US. This is 8,928 less than in January. That means, for Brandon ltd, the cost of imports has gone down. A strengthened pound has led to cheaper imported goods thats good news for Brandon Ltd (they should be able to make a better profit margin on those imported electrical goods).

If a strengthened exchange rate is good news for an importer like Brandon, what about a business that sells from the UK to the USA an exporter?

Take the example of Huntington Plastics Ltd. Huntington exports moulded plastic components to customers in the US, invoicing in US dollars. What would the effect of a strengthened exchange rate be for Huntington?

1 buys January June

US Dollars ($) $1.40 $1.60

$100,000 converted into 71,428 62,500

If Huntington received $100,000 in sales in January, they could be converted into 71,428.

But in June, the same $100,000 of sales would only be worth 62,500. Thats bad news for Huntington. A strengthened pound has resulted in lower sales.

If Huntington were to invoice their exports in pounds rather than dollars, then they might not be directly affected by the changed exchange rate since there are no foreign currency receipts to convert back into pounds. However, the business might still suffer, since the price of Huntington products would be more expensive for US customers, who might then buy less (perhaps buying from a cheaper domestic supplier).

Lets summarise:

A stronger pound leads to:

Imports being cheaper

Exports dearer (more expensive)

Here is an acronym that can help you remember that: SPICED



S - Stronger

P - Pounds

I - Imports

C - Cheaper

E - Exports

D - Dearer

What happens if the pound weakens (i.e. falls in value against other exchange rates)?

The answer is the opposite of a stronger pound:

Imports become more expensive for UK importers

Exports become cheaper in overseas markets

Factors that determine the effect of exchange rates on business

Businesses are affected by exchange rate fluctuations in different ways. Here is a summary of

the main factors involved:

Low effect on business High effect on business

No export sales turnover all in domestic (UK) market

Significant export sales, perhaps in many currencies

All business activities located in UK Overseas operations, earning profits in foreign currency

Raw materials and other supplies bought in UK

Significant purchases from overseas suppliers

Demand predominantly from domestic (UK) customers

Substantial demand from overseas visitors to UK

Demand is price inelastic Demand is price elastic

Higher costs can be passed on to customers to maintain margin

Higher costs usually have to be absorbed via a lower margin

An important concept to consider when evaluating the effect of changes in exchange rates on

business is price elasticity of demand. For example:

A stronger (higher) exchange rate will increase selling price for export customers (e.g.

they have to use more US$ for each 1)



This is likely to result in greater reduction in quantity demanded + overall reduction in

export sales

There are two other key issues for businesses to address:

There are transaction costs involving from one currency to another Think of it in terms

of the commission tourism have to have when buying foreign currency but on a

much larger scale

Currency movements add to the risks involved in business. The profitability of

business contracts or overseas subsidiaries can be undermined by adverse movements

in an exchange rate

To illustrate the above, lets look at two worked examples:

Stronger pound effect on the revenues of an exporter

Weaker pound effect on the margins of a UK importer

Example 1: Stronger Pound & Export Revenue

Here are the budgeted export sales of a business in the UK that exports to the USA:

Exchange rate: 1 = $1.50

Selling price in export market Per unit $1,500.00

UK production cost Per unit 300.00

Selling price (revenue) in Per unit 1,000

Production cost () Per unit 500

Gross profit () Per unit 500

Units sold per year in US Market Qty 2,500

Budgeted revenue for year '000 2,500

If the US selling price remains the same in terms, what happens to annual revenue if

exchange rate rises to 1 = $1.75?

The data becomes:



Exchange rate: 1 = $1.75

Selling price in export market Per unit $1,750.00

UK production cost Per unit 300.00

Selling price (revenue) in Per unit 1,000

Production cost () Per unit 500

Gross profit () Per unit 500

Units sold per year in US Market Qty 2,000

Revenue per year '000 2,000

Evaluating the changes above:

The US$ price rises the UK product becomes less competitive in the US market

(domestic US products will appear better value)

Quantity demanded in the US falls the % fall depends on price elasticity of demand

The exporters revenue falls from 2.5m to 2.0m

Example 2: Importer & Weaker Pound

In this example, the importer makes a 50% gross margin at a rate of 1 = 1.20 at a selling

price of 50 per unit. This is shown in the following data:

June

Selling price in UK per unit 50.00

Imported cost per unit 30.00

Exchange rate 1 = 1.20


Quantity sold per month 5,000



Revenue 250,000

Cost of Sales 125,000

Gross Profit 125,000

Gross Margin 50.0%

Now consider this question?

What happens to gross profit and gross margin if the Pound () falls in value against the Euro

() to parity? i.e. 1 = 1.00

The table below shows the effect of that change:

October Selling price in UK per unit 50.00


Exchange rate 1 = 1.00


Quantity sold per month 5,000

Revenue 250,000

Cost of Sales 150,000

Gross Profit 100,000

Gross Margin 40.0%

What has happened?

A weaker pound makes it more expensive to buy imports in Euros

The bought-in cost per unit rises from 25 to 30

The gross profit per unit falls from 30 each to 25

Gross margin falls from 50% to 40%



How businesses can manage exchange rate risks

If a business is affected by exchange rate fluctuations, there are several steps it can take to

manage the risks posed, including:

Monitor and try to anticipate exchange rate movements

Used sensitivity analysis to calculate profitability at different exchange rates

Pre-buy and pre-sell currency at favourable exchange rates (hedging / currency

options)

Set up bank accounts in different currencies to reduce currency transactions and

offset the effects of currency movements

Web links for further study

Here are some useful web links for you to investigate the business effects of exchange rate

movements further:

Guardian special reports on currencies

China manipulates currency to soften the downturn (Tutor2u Blog, August 2008)

Sterling leaves the exchange rate mechanism in 1992 (You Tube video)

How pound's rise or fall hits prices (The Times, November 2006)

Sterling challenge for UK shops (BBC news, January 2009)

Sterlings slump has a silver lining (Economics UK, February 2009)

Pound rises above $1.70 (BBC news, August 2009)

Explaining how the exchange rate can affect inflation (Tutor2u blog)



European Union & Business

Introduction to the European Union (EU)

The EU is an important part of business life in the UK.

For many years fellow members of the EU have been the UKs largest trading partners.

Rising European incomes and living standards, and the enlargement of the EU, offer huge

opportunities for the UK to increase exports of goods and services. The UK has also attracted

substantial inward investment from European businesses, which helps boost output and

employment in the UK.

The impact of EU-related legislation is covered elsewhere in these notes. In this section, well

look at two key aspects of EU operation which directly impact on UK businesses:

EU enlargement

The single currency

Enlargement

Europe has added new members periodically. There have been six main waves of EU

enlargement:

1973 (UK, Ireland and Denmark)

1981 (Greece)

1986 (Portugal and Spain)

1995 (Austria, Finland and Sweden)

2004 (Ten new countries)



2007 (Bulgaria and Romania)

As with all significant developments in the EU, there are potential upsides and downsides for

UK businesses to address:

The main benefits of EU enlargement to the UK include:

Greater export potential (more consumers that UK businesses can reach without trade

barriers). The addition of 10 new countries in 2004 added 70 million extra adult

consumers to the EU

The potential for greater exploitation of economies of scale

UK consumers benefit from cheaper and a wider choice of imports, enabling them to

spend more on other goods and services.

Foreign Investment and incomes and profits

More diverse and flexible European labour market

A cleaner environment (as high-polluting nations are brought into EU legislation)

A catalyst for further structural reforms in the EU

Reforms to the agricultural sector (CAP)

Spur to countries to reform their labour markets in the face of lower labour cost

competition

The downsides to the UK are commonly thought to be:

Extra budgetary costs for the EU (increasing the cost of EU membership)

Do new member countries meet stricter EU environmental standards?

Long-term need for higher regional subsidies loss of some regional funding for

established EU countries

Social concerns from increased labour migration

Perhaps not surprisingly, the current UK governments view (Labour) is that enlargement has

been a significant net positive for UK businesses. They point to a view that:

EU enlargement has brought down barriers to trade and business. UK companies have

benefited from access to the largest single market for trade and investment in the

world.

The economic reforms adopted by the new members increase their purchasing power

and thus the demand for EU goods and services, opening new markets for UK business

Single currency (the Euro)

The first thing to remember is that Britain does not currently use the Euro! Britain has an opt-

out from the single currency. However, even though the UK is outside of the Euro Zone, the

UK is not isolated from the effects of the Euro.



When it was introduced, the EU had several long-term aims for the Euro. It was intended to

support the aims of:

Sustained non-inflationary growth

Lower long-term interest rates

Lower unemployment

Expansion of the EU single market

Amongst the potential gains for consumers in the Euro Zone were:

For Consumers For Businesses

Lower prices because of increased competition/ greater price transparency

Reduced transactions costs of travelling within Europe (e.g. costs of currency exchange)

Cheaper mortgages if interest rates are lower and home-buyers can take out mortgages at longer fixed term rates

Invoicing can be done with just one currency

Lower transactions costs some people argue that staying out of the Euro is equivalent to exporters facing a tariff when they trade inside the EU

Gains for the tourist industry in attracting overseas visitors

Businesses might be able to fund their capital investment at lower real interest rates

The UK has recognised that, despite the potential upsides, there are some significant

potential economic and political downsides. For example:

Changeover Costs from joining the Euro:

o Costs of changing accounting systems

o Menu Costs (vending machines, catalogues, franking machines, postage

Installation of new payments systems

o Customer confusion

o Higher prices

Suppliers might increase prices when converting from sterling to euro

Loss of control over macroeconomic policy

UK interest rates would be set by the ECB

Would have to comply with Euro membership criteria



Globalisation of Markets

Introduction to globalisation

Globalisation is arguably the most important factor currently shaping the world economy. Although it is not a new phenomenon (waves of globalisation can be traced back to the 1800s) the changes it is bringing about now occur far more rapidly, spread more widely and have a much greater business, economic and social impact than ever before.

There are several definitions of globalisation. Here are two official examples:

First, from the OCED

The geographic dispersion of industrial and service activities, for example research and

development, sourcing of inputs, production and distribution, and the cross-border

networking of companies, for example through joint ventures and the sharing of assets

And here from the International Monetary Fund:

The process through which an increasingly free flow of ideas, people, goods, services and

capital leads to the integration of economies and societies

Globalisation is best thought of as a process that results in some significant changes for

markets and businesses to address: for example

An expansion of trade in goods and services between countries (an opportunity for

many businesses; a threat for others)

An increase in transfers of financial capital across national boundaries including

foreign direct investment (FDI) by multi-national companies and the investments by

sovereign wealth funds (e.g. Middle Eastern governments buying assets in the UK)

The internationalisation of products and services and the development of global

brands such as Starbucks, Nike, Sony and Google

Shifts in production and consumption e.g. the expansion of outsourcing and

offshoring of production and support services, which has traditionally benefitted

countries with lower labour costs & skilled labour markets such as India, at the

expense of jobs in developed economies like the UK

Increased levels of labour migration which has the effect of lowering wage costs in

many industries, but for others is a problem (e.g. a loss of skilled workers leaving an

economy)

The emergence of countries playing a bigger role in the global trading system including

China, Brazil, India and Russia

A key result of globalisation is the increasing inter-dependence of economies. For example:



Most of the worlds countries are dependent on each other for their macroeconomic

health

Many of the newly industrialising countries are winning a growing share of world

trade and their economies are growing faster than in richer developed nations

All countries have been affected by the credit crunch and decline in world trade, but

many emerging market countries have slowed down rather than fall into a full-blown

recession

Main drivers of globalisation

Influential commentator Hamish McRae has stated that businesses are the main driver of

globalisation. Why is this?

Multinationals (businesses that operate in more than one country) want to increase

sales, profits and shareholder value. Globalisation provides that opportunity

The barriers to internat

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