External influences on business
Businesses are affected by the economy, government policies, environmental and ethical issues, globalisation and exchange rates, which create both opportunities and threats.
📌 Key points
- The business cycle has four stages: growth, boom, recession and slump. In a recession, sales and profits usually fall and unemployment rises.
- Government economic objectives: economic growth, low unemployment, low and stable inflation and balance of payments stability.
- Fiscal policy (taxes and government spending): higher income tax reduces consumers’ spending; higher corporation tax reduces profits available to reinvest; import tariffs protect domestic firms.
- Monetary policy (interest rates): higher interest rates raise the cost of loans and reduce consumer spending, especially on goods bought on credit.
- Supply-side policies such as training, privatisation and better infrastructure help businesses become more efficient and competitive.
- Business activity can cause external costs (e.g. pollution, congestion) and external benefits (e.g. jobs, training); sustainable development meets present needs without harming future generations.
- Governments control pollution with laws, fines and permits; pressure groups and consumer boycotts can push firms to act responsibly. Ethical decisions (e.g. no child labour) may raise costs but improve reputation.
- Globalisation brings new markets and cheaper supplies but more foreign competition; governments may use tariffs and quotas to protect domestic firms.
- Multinational companies bring jobs, investment and technology to host countries, but may send profits abroad and force local firms out of business.
- An appreciation of the currency makes exports dearer and imports cheaper; a depreciation makes exports cheaper and imported materials dearer.
📖 Key terms
- Recession
- A period of falling GDP, with falling sales and rising unemployment.
- Inflation
- The increase in the average price level of goods and services over time.
- Corporation tax
- A tax on the profits of companies.
- External costs
- Costs of a business activity paid for by the rest of society, not the business.
- Sustainable development
- Development that meets present needs without reducing the ability of future generations to meet their needs.
- Pressure group
- A group of people with a common interest who act together to change the behaviour of businesses or governments.
- Multinational company
- A business with factories, production or service operations in more than one country.
- Exchange rate depreciation
- A fall in the value of a currency compared with other currencies.
✏️ Worked example
A UK firm buys components from the US that cost $500. The exchange rate falls from £1 = $2.00 to £1 = $1.60. What happens to the cost of the components in pounds?
- Before: $500 ÷ 2.00 = £250.
- After: $500 ÷ 1.60 = £312.50.
- The pound has depreciated: each pound buys fewer dollars.
- Increase in cost = £312.50 − £250 = £62.50.
- Answer: the components cost £62.50 more, which raises the firm’s costs.
Always explain the chain of effects: e.g. higher interest rates → loans cost more → consumers spend less on cars → the car dealer’s sales fall.
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