Please enable JavaScript.
Coggle requires JavaScript to display documents.
Economic Factors - Coggle Diagram
Economic Factors
Interest Rates
Interest Rates = the price paid for borrowed money. The base rate of interest is the rate set by the Bank of England.
Effect of high interest rates on consumers:
- less spending by borrowers - the cost of borrowing increases so people borrow less (as the cost of repaying the loan is more)
- more saving by savers - there is an appeal to saving as they will earn a higher rate of interest on their money and hence spend less money
- less spending - as smaller amount of disposable income (hits those selling luxury items). Also millions of consumers have mortgages - when interest rates rise there is less money to spend on other items
Effect of high interest rates on businesses:
- reduction in the sale of luxury items and items normally bought on credit - businesses selling wants, such as televisions and sofas, may see a substantial fall in sales
- higher overheads for businesses - loans become more expensive due to the increase in interest charges
- reduction in expansion/ growth - firms may decide to postpone decisions to buy new machinery or build new factories.
- no real change in sales for businesses selling 'needs'
- encourages businesses to save more as the returns are greater
- sees firms reducing their levels of stocks (maybe selling at reduced prices) to reduce the need to borrow money
- sees firms reducing production to reduce the costs of credit
- encourages debtors to delay payment in order to earn interest
- sees creditors wanting their money more quickly
The Link Between Interest Rates and Exchange Rates:
- Rise in interest rates - UK becomes a more attractive location for foreign investors - foreign investors purchase pounds to invest in UK banks and demand for pounds increases, raising the price (exchange rate)
- Fall in interest rates - UK becomes less attractive to investors - foreign investors sell pounds to purchase other currencies - supply of pounds increases causing the exchange rate to fall
Monetary Policy
Definition: Since May 1997 the Monetary Policy Committee of the Bank of England has had responsibility for setting interest rates, which is does monthly, with the aim of achieving the government's target for inflation whilst attaining long-term growth in the economy
The objectives of raising interest rates include:
- reducing the level of consumer spending
- reducing inflation
- slowing the level of economic growth (GDP)
- reducing the number of imports
- dampening down an economic boom
The implications of raising interest rates are:
- many businesses may experience falling sales as consumers increase savings
- demand for products purchased on credit may decline significantly
- business cancelling or postponing investment plans
- firms reduce borrowing
- increased value of sterling increasing the prices of exports while reducing import prices
The objectives of reducing interest rates:
- reducing levels of unemployment
- stimulating the level of production in the economy
- promoting exports sales by reducing the exchange rate of the pound
- increasing rates of economic growth in the economy
- assisting in recovering from a slump
The consequences of falling interest rates:
- demand and sales are likely to increase
- production is likely to be stimulated by increasing employment
- export sales of price sensitive products may increase whilst imports become less competitive
Exchange Rates
The price of one currency is expressed in terms of another. There is an important link between the domestic rate of interest and the value of the nation's currency.
Exchange rates between most currencies vary regularly according to the balance of supply and demand for each individual currency. If the demand for pounds increases (for example, more tourism to the UK), the exchange rate goes up; if the supply increases (such as more UK citizens holidaying abroad), the exchange rate fails.
if high: SPICED - Strong Pound Imports Cheaper Exports Dearer
if low: WPIDEC - Weak Pound Imports Dearer Exports Cheaper
Exchange Rates and its effect on imports and exports: changes in the value of currencies affect the prices of exports and import:
Exports
- a rise in the value of the pound means exported goods cost more for overseas customers, so demand falls
- a fall in the value of the pound means imports cost less for overseas customers so demand rises
Imports
- a rise in the value of the pound means imports cost less so more profit can be made or prices can be reduced
- a fall in the value of the pound means imports cost more so less profit is made or prices are increased
Unemployment
Unemployment will always be with us. This may seem a slightly contentious statement, but the fact is that every economy has a natural rate of unemployment. This natural rate of unemployment does alter over time and will depend on such things as mobility of labour, availability of training, trade union power and the skills of labour.
Types of unemployment:
- Structural Unemployment
- Cyclical unemployment
- Frictional Unemployment
Structural Unemployment:
- This appears when there have been large changes in patterns of demand or developments in technology which have caused long-term unemployment in regions or industries.
- These changes mean that the structure of the industry or service has changed, and that jobs in their previous form are unlikely to return.
- A good example would be the high levels of male unemployment in South Wales valleys and regions of Yorkshire which had previously large coal-mining and steel-producing areas.
- In this case, decline in the industries has been caused by cheap imports and by the switch to natural gas for heating and in power stations
- Providing a solution to structural unemployment when it occurs is one of the largest problems facing any government.
- Quite often, families have previously been employed for many generations within the same industry. It is difficult to encourage retraining and mobility of labour from these regions. It is also difficult to encourage businesses to move to the areas which are so depressed.
Cyclical Unemployment:
- Cyclical Unemployment, as its name indicates, appears as part of the business cycle.
- As an economy enters a downturn, unemployment increases; this will peak during any subsequent recessionary period.
- This type of unemployment will fall during recovery and reach a minimum at the peak of the boom period.
- The government has tried to tackle cyclical unemployment in two ways: firstly, by encouraging wage flexibility, for example, by making part of employees' wages relate to profits of the company (profit-related pay). It is then not so expensive to employ workers when there is a downturn in profits.
- Also the government has tried to reduce the nature of the economic cycle and the large variations between boom and bust. One important way of doing this is to encourage investment in labour and so make it more expensive to shed workers during the economic downturn.
Frictional Unemployment:
- This perhaps is the least problematic of the three types of unemployment and occurs when there is a delay in finding a job after losing a previously held job.
- This unemployment is less long-term than structural unemployment; it tends to be temporary.
- Nonetheless, the government still tries to reduce it by increasing information available of vacancies that exist.
- This can be done through job centres and other employment recruitment services.
The impact of high levels of unemployment on UK businesses:
- The major impact of unemployment is reduced demand for goods and services.
- The economic crisis of 2008 saw the unemployment figure reach 3 million and this had a very significant impact on the sales and orders of UK businesses. Sales forecasts were radically revised and survival became the major objective of the majority of enterprises.
- This fall in demand can result in a fall in output and then possible redundancies for some workers if they are not needed.
Inflation
Inflation is the rate at which the general level of prices is rising. Inflation is measured by the Consumer Price Index (CPI) which measures the rate of inflation based on the changes in prices of a basket of goods and services.
For many businesses, a low rate of inflation is not a problem. Inflation only becomes a major problem when it is high, rising rapidly or doing both together.
Inflation occurs in two ways:
- demand pull inflation - the demand for the country's goods and services exceeds its ability to supply the products. Prices rise generally as a means of restricting demand to the available supply.
- cost push inflation - costs rise due to factors such as rising wages or costs of raw materials and components.
The government's main weapon against inflation has been to raise interest rates. The effects of this are:
- consumers are discouraged from spending their money by higher savings rates and are less likely to buy on credit as it is more expensive.
- businesses reduce investment as borrowing becomes more expensive.
- output and sales decline and the inflationary pressure reduces
High rates of inflation affect businesses because:
- rising wages and raw materials costs may force firms to accept lower profit margins or to raise prices.
- firms face menu costs as prices listed have to be frequently updated
- firms face shoe leather costs (businesses frequently need to spend time and money trying to find out which supplier has the cheapest prices)
- overseas firms (with lower inflation rates) may gain a competitive advantage
- some businesses will invest more as the real value of loans falls quickly
- other businesses will hold back on investment because interest rates are likely to rise
- people save more due to uncertainty and because interest rates are frequently raised, so demand falls.
-