F1_Session4_notes

Lecture Notes 2010 Session 4 C10, C11, C12 Kris-1 Macro economic factors  Governments shape the external environment or macro economy that they have to operate in.  Governments attempt to influence the nature and condition of their domestic economies.  Fiscal policies , Monetary policies  Note: No policy initiative will have a uniform equal effect across all individuals, households or businesses.  Example: Policies aimed to benefit a country’s importers will work to the detriment of its exporters. Economics?  Definition 1: The study of how society allocates scarce resources, which have alternative uses, between competing ends  Definition 2: The study of wealth creation  Economics is classified into two  Microeconomics: It is the study of economic behavior of individual consumers, firms and industries  Macroeconomics: It considers aggregate behavior and the study of sum of individual economic decisions  Aggregate demand for goods and services  The output of goods and services(national output)  The supply of factors of production  Labor, Land, Capital , entrepreneurship  Total incomes earned by providers of factors of production ( national income)  Laborwages, land rent, capital interest,entrepreneurshipprofit  Money spent in purchasing the national product ( national expenditure)  Government policy Macroeconomic policy  Four macroeconomic policy objectives  Economic growth – how can productive capacity be increased  Inflation – how can we ensure that general price levels do not increase?  Unemployment – how can we ensure that everyone who wants a job has one?  Balance of payments- how should we manage our relationship and trade with other countries? Level of business activity in the economy  It’s industry specific  Generic factors  Confidence : Customer demand for products, business higher investment  Reduced by political instability, disasters, likelihood of unemployment and high inflation  Aggregate demand : Total demand for a country’s output and consists of Consumer spending(c) + investment by firms (I) + Government spending (G) + demand for export(X) – imports(M) AD= C+I+G+X-M  Higher demand leads to increased output Lecture Notes 2010 Session 4 C10, C11, C12 Kris-2  Higher demand can also lead to inflationary pressure  Capital  Greater availability of finance results in higher levels of investment  Lower interest rates will make capital cheaper  Government policy on cheap loans( regional development grants)  Use of resources  New technology and more efficient workings practices can improve productivity and lower costs,Advances in levels of education can also give a more productive workforce  Government policy  Can increase the level of aggregate demand through fiscal policy( Government spending and taxation) , Investment in the infrastructure can attract investment  Exchange rate movements  A strengthening currency will make a country’s exports more expensive which results in the decreased demand for those exports. ,Imports on the other hand get cheaper. Trade cycles  Fluctuations in economic activity over time with an underlying trend of output growth  Role of Government: Smooth out this pattern to avoid ‘boom and bust’ years. Stagnation and economic growth  Governments want economic growth  Growth should result in increased demand for goods and services, income increase for households and more job opportunities.  Problems associated with growth  Growth rates should exceed inflation rate ( real growth has to occur)  Measurement of growth is difficult ( gray market)  Growth may be at an expense of the environment or though exploitation of the poor  Increasing gap between the rich and the poor  Rapid growth means rising incomes and this often ‘sucks in’ imports worsening the balance of trade, rather than benefiting domestic producers. Inflation  Governments want stable prices and low inflation  Inflation causes uncertainty and stifles business investment  Not all income rise in line with inflation ( poor and those on fixed incomes suffer the most)  In extreme cases of inflation, the function of money may break down resulting in civil unrest and even war  Inflation distorts the working of the price mechanism and is thus a market imperfection Lecture Notes 2010 Session 4 C10, C11, C12 Kris-3  High inflation can affect savings in different ways  People who save to spend later( transaction motive) will save less to avoid the purchasing power of their money being eroded  People who save in case something bad happens ( precautionary motive) will save more due to uncertainty inflation creates. Unemployment  Even in a healthy economy some unemployment will arise as people change jobs.  Mass unemployment is a problem due to  Need to pay out benefits to the unemployed at a time when its tax receipts are low. This can result in the government having to raise taxes, borrow money and cut back on services  Results in increased crime, poor health and divorces.  Restrict economic growth  Good for firms as they have high bargaining power(pay low wages) Balance of payments  In the long-term government seeks to establish a broad balance between the value of imports into and export from the country • Trade Surplus: Exports > Imports EX: China • Trade deficit : Exports < Imports EX: US  Persistent surplus/deficit has negative macroeconomic effects. • Trade deficit : Need to be financed, the cost act as a major drain on the productive capacity of the economy • Trade surplus: Cause significant inflationary pressures, leading ultimately to a loss in international confidence in the economy and a lack of international competitiveness. Fiscal policy options  Refers to government’s taxation and spending plans and is usually understood within the context of demands side policies.  In the Medium to long-term government should achieve a balanced budget • Budget Surplus: Government Income > expenditure • Budget deficit : Government Income < expenditure • Balanced Budget : Government Income = expenditure Running a deficit budget  Need to be financed by borrowing(known as Public Sector Net Cash Requirements PSNCR)  Used to promote economic growth and reduce unemployment by closing the ‘deflationary gap’  Deflationary gap: It is said to exist in the economy when the current equilibrium level of national income is too low to provide employment opportunities for all those seeking work.  By running a deficit, the government is injecting more into the economy than it is taking out and can boost aggregate demand and reduce unemployment . This is known as ‘expansionary policy’ Running a surplus budget  If aggregate demand lies above the level necessary to generate full employment, this can lead to inflation . In this situation an ‘inflationary gap’ is said to exist. Lecture Notes 2010 Session 4 C10, C11, C12 Kris-4  Fiscal policy can also be used to control inflation.  If an inflationary gap exists, government can seek to reduce aggregate demand by running a budget surplus, effectively taking money out of the economy. This is known as a ‘contractionary policy’. Monetary policy options  Management of the money supply in the economy.  Changing interest rates • Directly or indirectly through open market operations, setting reserve requirements for bank or trading in foreign exchange markets. • Expansionary policy: Increases total supply of money in the economy • Contractionary policy: Decreases total supply of money  Money supply • M0 : Notes and coins in circulation and balances at the country’s central bank • M4: Notes and coins and all private sector sterling bank/building society deposits  Management of the money supply in the economy.  Reserve requirements • The proportion of deposits retained in cash is known as the reserve asset ratio or liquidity ratio.  Open market operations • By buying bonds and selling its own bonds the government is able to exert some control over the money supply  Buying back its own bonds : release more cash  Sell bonds : Reduce the amount of cash  Interest rates • High interest rates suppress demand for money due to the increased cost of borrowing. ( Responsibility of Central Bank) • Monetarists view interest rate manipulation as a key control over inflation. Demand and supply side policies  Classical view ( do nothing)  Leave it alone  Economy would automatically move to equilibrium with full employment.  Failed in the Great Depression which led to Keynesian view  Keynesian view (demand side) , advocated by John Maynard Keynes  Government’s role to move the economy to a better equilibrium  Stimulate the economy: Borrow and inject it into economy to stimulate economic growth.  Slow down economy: By increasing levels of taxation and reduce the amount of money in the economy.  The monetarist ( supply side)  Monetarist believe that there is only one true equilibrium  Equilibrium will only occur when supply is equal to demand  Economy will gravitate towards this natural equilibrium unless hindered by market imperfections Lecture Notes 2010 Session 4 C10, C11, C12 Kris-5  Role of government is to remove market imperfections  Inflation, government spending and taxation, Price fixing, minimum wage agreements,  Regulation of markets, Abuses of monopoly power Growth  Policies which promote growth  Cutting interest rates • Boosts aggregate demand or monetarism  Running a deficit budget • Classic Keynesian response to recession • Monetarists view that the way government finances the increase will have a negative effect elsewhere. ( high taxation)  Supply-side policies • Increasing availability of skilled labor through training schemes, childcare facilities etc.  Other • Regional development grants, protectionism , creating stable economy to boost confidence. Unemployment  Reducing is not straightforward  Cyclical unemployment : Caused by the fact that aggregate demand in the economy is too small to create employment opportunities • Keynesian solution: boosting aggregate demand • Monetarists solution: appropriate supply-side strategies  Frictional unemployment : Refers to people who are short-term unemployed as they move from one job to another • Reduced by provision of better information and other supply-side policies  Structural and technological unemployment: Caused by structural change in the economy. • Boosting aggregate demand is likely to have little impact of structural unemployment. • Supply-side policies are likely to be more effective  Seasonal unemployment : Caused by seasonal industries.  Real wage unemployment : Likely to occur in highly unionized industries. • Keep wages artificially high by the threat of strike and closed shops. • Monetarists view this as a market imperfection and should be reduced by reducing unions powers and abolish minimum wage agreements. Inflation  Causes and solutions  Demand-pull inflation • Results when demand for goods > supply of goods ( more money chasing fewer goods) • Demand side policies would reduce AD through tax rises, cuts in government spending and higher interest rates.  Cost-push inflation • If the cost of factors increases then price of output will increase  Imported inflation Lecture Notes 2010 Session 4 C10, C11, C12 Kris-6 • Economy which has significant imports, a weakening of the national currency will increase the cost of imports and could lead to domestic inflation. • Reduced by policies to strengthen the national currency  Monetary inflation • Result from an over expansion of the money supply • Controlling tools: reduce money supply through higher interest rates  Expectations effect • Anticipation level of inflation is built into wage considerations and pricing decisions then it is likely that the expected rate of inflation will arise. • Controlled by prices and incomes policy Balance of payments  Records all transactions that have taken place between residents of a country and overseas residents during the period of a year  Inflow of money is positive(credits)  Outflow of money is negative (debits)  Balance of payments deficits( outflow > inflow)  Controlled by expenditure-reducing strategies • Reducing overall demand , increasing interest rates  Controlled by expenditure-switching strategies • Encouraging expenditure on domestically-produced rather than imported goods. – Import controls such as Tariffs and quotas, Boost exports – Lower the exchange rate Social and Technological Factors Demographic trends (PEST/STEP)  Key social and demographic issues  Population – size, location, density and composition  Wealth- income, distribution  Education and training  Health  Social structure, attitudes, values and tastes  Population size  Growth  growing market  Factors : birth rates, death rates, immigration and emigration.  World average fertility rate : 2.59 children per adult woman ( 2.1 is viewed as the replacement rate for a stable population)  Fertility rate  Singapore : 1.06 (Lowest in world)  African countries – Over 6  Population composition and location  Relative sizes of birth and death rats will change the composition of the population Lecture Notes 2010 Session 4 C10, C11, C12 Kris-7  Ireland : 36% of population is aged under 25  UK : 16% of population is aged over 65( pensions time bomb)  Location  50% of world’s population lives in cities(60% - 2030)  Resulting in people living in smaller houses and apartments.  Opportunity for firms specializing in space-saving furniture.  Wealth  Economic growth  higher disposable income  increased demand for products  Fastest growing economies in the word: BRIC  Brazil, Russian , India and China  Education  Educated workforce is a key driver for economic growth.  China 99% of the youth population is not literate  Increased standards of education leas to using internet as a major selling and advertising platform.  Health  Western countries – overweight problem  greater demand for healthcare providers.  Social structure  Increasing population leads to increased housing demand.  UK: population increased by 7.7% between 1971 and 2006 but them number of dwellings grew by 25%  This is partly explained by increasing wealth but also by changes in social structure.  The proportion of one person households may be increasing ( divorce rates)  Values  Increasing concern for greenhouse gases and the ozone layer, testing of products on animals  creates problems for firms which are unwilling to embrace the cultural shift  Many women pursue careers first before having children  Older mothers are wealthier and more demanding of the baby products  Changes in lifestyle  24 hour super market  Online shopping  Flexible work timings  Tastes  Culturally, changes in tastes and fashions can have a damaging effect on organizations that fail to anticipate the changes.  Marks and Spencer  Government responses to social and demographic trends impact firms significantly  Low birth rates: Governments give financial incentives to encourage women to have more children.  Singapore, Canada, Australia  Rapid increasing population: Governments discourage large families  ‘One child’ policy – China Lecture Notes 2010 Session 4 C10, C11, C12 Kris-8  Aging population (>65)  Creates pension crisis in many countries as the income earned from taxes in not enough to pay the pension demands. Government response is by raising the retirement age and encouraging private and occupational pension schemes.  Housing  Increased housing demand lead to government setting out new housing development plans increased demand for builders  Employment  Increased single-parent families often make governments provide childcare vouchers and tax credits increased demand for childcare services and after-school clubs.  Health  Band effects of smoking led to a ban on tobacco advertising  Obesity problem led to regulation of fast food industry  AIDS and sexual health awareness Technological factors(PEST/STEP)  Affect a firm in many ways  Home-working  Product development • Turntables  CD player  mp3  Production changes • Computer aided desin(CAD), Computer aided manufacturing (CAM)  Marketing • Online selling  Impact on organization structure  Some administrative and managerial roles have been replaced by more effective IT systems  Some production riles have been replaced by the use of robots and automated production lines  Improved communication resulting in more flexible work arrangements resulting in downsizing and delayering in firms  Downsizing (Rightsizing)  Reducing no of employees in an organization without necessarily reducing the work of or the output. ( 1980s and 1990s)  Delayering  Linked to downsizing , it is the process of removing layers of management. • Resulting in flatter organization ( team work focused)  Outsourcing  Contracting-out aspects of the work of the organization which was previously done in-house to specialist providers Impact of technological changes on products  Products becoming increasingly sophisticated  mobile  Emergence of substitutes Lecture Notes 2010 Session 4 C10, C11, C12 Kris-9  Cinema vs. Emergence of video  Transformation of business model  Online banking  Outsourced customer support  Due to cost considerations  Usage of robots and automated production lines  IT systems enabled efficient scheduling and monitoring of production, resulting in lower inventory levels, higher quality, elimination of bottlenecks and lower costs. Impact of technological change on marketing  Pricing – Most ‘price watch’ schemes are IT-based  Monitor competitors’ prices to ensure that they are not being undercut.  Promotion  Websites, viral-marketing  Distribution  Sell direct to a wider range of potential customers  Market research –  Customer databases. Impact of technological change on society as a whole  Information age  Key issues  E-commerce • www Ads, online shopping, e-transactions, e-exchange  Home shopping  Home banking  Home learning  Home entertainment  Teleworking /telecommuting Competitive factors Competitive advantage  Choices for firms wishing to obtain a competitive advantage according to Michael Porter  Choice one ( Cost leadership versus differentiation • Cost leadership : Achieving lower costs than its rivals for similar products and services – Achieving economies of scale and learning curve effects – Example: Walmart , Nissan – Note: Cost leadership does not mean reduced quality • Differentiation : Creation of a product or services that is perceived throughout its industry as unique. The company may then charge a premium for its product. – Example: Apple , BMW  Choices for firms wishing to obtain a competitive advantage according to Michael Porter  Choice TWO ( FOCUS) • Focus strategy: The firm concentrates on a select few target markets. • It is also called a segmentation strategy or niche strategy. Lecture Notes 2010 Session 4 C10, C11, C12 Kris-