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2.5.1 Economic influences

A) The effect on businesses

Inflation – This is an increase in the general price level of goods/services within an economy. A decrease in the inflation rate is likely to result in a reduction in businesses goods/services. This is likely to result in an increase in consumer’s purchasing power and as a result of this an increase in the demand for businesses goods/services. In addition to this, it will also increase the competitiveness of exporting businesses due to the decrease in domestic goods/services relative to other countries.

Exchange rates – This is the value of one currency expressed in terms of another currency. A depreciation in the domestic country’s currency will result in a decrease in the price of exports and an increase in the price of imports. This is likely to result in an increase in the demand for exporting businesses goods/services. However, it will also result in an increase in the price of raw materials for those businesses that import them. As a result of this, it is likely to increase the costs of production for businesses which may then be passed onto consumers in the form of higher prices. An appreciation in the currency will have the opposite effect.

Interest rates – This is the reward for saving and the cost of borrowing. The interest rates are set by the bank of England. A lower interest rate will reduce the cost of borrowing as well as reduce the reward for savings. As a result of this, businesses are much more likely to borrow money when interest rates are low. Furthermore, it will mean that the amount of money that consumers are paying on loans such as mortgages will be reduced. As a result of this, consumers will have more disposable income resulting in increased consumer consumption. This will cause the demand for businesses goods/services to increase. An increase in the interest rates will have the opposite effect.

Taxation and government spending – Taxation is money paid to the government on various forms of income. The main type of tax affecting businesses is corporation tax. An increase in corporation tax will result in a reduction in businesses profit. Corporation tax is a certain amount of money that is taken away from a business’s profits. Furthermore, if income tax increases then consumers will be left with less disposable income. As a result of this, consumer consumption is likely to decrease. This will result in a reduction in the demand for businesses goods/services.

The business cycle – The business cycle is a measurement of the fluctuations in real GDP in an economy. During a boom there is likely to be high employment, high consumer confidence and high disposable incomes. As a result of this, there is likely to be a high demand for businesses goods/services resulting in high profits. This is in contrast to a recession where there is likely to be a lack of demand for a business’s goods/services.

 

B) The effect of economic uncertainty on the business environment

Uncertainty about the future of the economy can have a big impact on businesses behaviour. In times of uncertainty businesses are likely to reduce their spending. Contingency planning can also help to reduce the risk of uncertainty.

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