IGCSE Business Studies Ch 27: Economic Issues

Cambridge IGCSE Business Studies

Chapter 27: Economic Issues

This chapter explains how changes in the wider economy affect businesses. It covers the business cycle, GDP, unemployment, inflation, real income, government economic objectives, fiscal policy, monetary policy, interest rates, exchange rates, supply-side policies and how businesses may respond.

Business cycleGDP and growthUnemploymentInflationGovernment objectivesPolicy responses

Topic 1: The business cycle and GDP

Economic growth changes over time, so businesses must understand different stages of the economy.

1. The business cycle

Economic growth does not occur at the same rate every year. Economies move through different stages of the business cycle: growth, boom, recession and slump.

Growth

GDP rises.
Unemployment generally falls.
Living standards rise.
Most businesses experience increasing sales.

Boom

Spending becomes very high.
Inflation rises.
Skilled workers may become difficult to recruit.
Business costs can rise.

Recession

GDP falls.
Consumer demand usually falls.
Business profits may decrease.
Unemployment rises.

Slump

A severe and prolonged recession where unemployment is very high, demand is very low and many businesses may fail.

2. Gross Domestic Product — GDP

Gross Domestic Product (GDP) is the total value of goods and services produced in a country in one year.

Economic growth occurs when a country's GDP increases.

Economic growth generally creates a chain of effects:

Higher GDP→More employment/income→More consumer spending→Higher business sales

Important balance: falling unemployment can make it harder and more expensive for businesses to recruit workers.

Topic 2: Unemployment, inflation and real income

These economic changes can reduce demand, increase costs or change which products consumers buy.

3. Unemployment

Unemployment exists when people who are willing and able to work cannot find a job.

Possible advantage if unemployment rises

Workers may be easier to recruit.

Possible disadvantages if unemployment rises

Household incomes fall.
Consumer spending may fall.
Business sales may decrease.

Application point: businesses selling cheaper alternatives may sometimes gain because consumers switch from more expensive products.

4. Inflation and real income

Economic effects of GDP, unemployment, inflation and real income on businesses

Inflation is an increase in the average price level of goods and services over time.

High inflation can affect businesses because:

raw-material and other costs may rise
businesses may increase prices
higher prices may reduce demand
workers may demand higher wages
consumers have less money available for non-essential products.

Real income refers to what a person's income can actually buy.

If prices rise faster than wages, real income falls.

Example: wages increase by 6%, but inflation is 10%. Real income has effectively fallen because prices rose faster than wages.

Topic 3: Government economic objectives and balance of payments

Governments try to manage economic conditions that affect businesses and consumers.

5. Government economic objectives

Most governments aim for:

Low inflation

Helps make economic conditions more predictable and can improve international competitiveness.

Low unemployment

Can increase national output and improve living standards.

Economic growth

Usually increases living standards because more goods and services are produced.

Balance of payments stability

Helps avoid problems linked to large gaps between exports and imports.

6. Why governments want low inflation, low unemployment and growth

Rapid inflation can

reduce consumers' real incomes
make domestically produced goods less competitive
encourage consumers to buy imports
discourage businesses from expanding.

High unemployment means

fewer goods and services are produced
government spending on unemployment benefits increases
living standards may fall.

If GDP falls

unemployment may rise
incomes and living standards may fall
businesses may delay expansion because customers have less money to spend.

7. Balance of payments

The chapter defines the balance of payments as the difference between a country's exports and imports.

Exports

Goods and services sold to other countries.

Imports

Goods and services bought from other countries.

If the country has a balance of payments deficit, possible consequences include greater need for foreign currency, borrowing from abroad and downward pressure on the exchange rate.

Topic 4: Fiscal policy

Fiscal policy involves changes in taxation and government spending.

8. Government economic policies

Government economic policy diagram showing fiscal policy, monetary policy and supply-side policies

Governments use three main types of economic policy:

Fiscal policyMonetary policySupply-side policies

Fiscal policy involves changes in taxation and government spending.

Important taxes discussed in the chapter include income tax, corporation/profits tax, indirect taxes such as VAT, and import tariffs.

9. Income tax, corporation tax and indirect taxes

Income tax

Income tax is a direct tax on people's incomes.

Higher income tax→Lower disposable income→Less spending→Lower sales

Luxury and non-essential products are likely to be more affected than essential goods.

Corporation/profits tax

A tax on company profits.

profit after tax falls
less retained profit may be available for expansion
dividends to shareholders may fall
investment may become less attractive.

Indirect taxes

Indirect taxes, such as VAT, are added to the prices of goods and services.

Higher indirect tax→Higher prices→Lower demand

Workers may also demand higher wages because their real incomes have fallen, increasing business costs further.

Disposable income is income remaining after income tax has been paid.

10. Import tariffs, quotas and government spending

Import tariff

An import tariff is a tax on imported products.

Benefits

imported products become more expensive
domestic businesses competing with imports may gain sales.

Problems

businesses using imported raw materials/components face higher costs
other countries may retaliate by placing tariffs on exports from the country.

Import quota

An import quota is a physical limit on the amount of a product that can be imported.

It can protect domestic industries from foreign competition.

Government spending

Governments spend money on areas such as education, healthcare, defence, roads and railways.

Increasing government spending→Increase demand→Create jobs→Increase GDP

Businesses supplying the public sector may particularly benefit. Cuts in government spending can reduce demand for businesses that depend heavily on government contracts.

Topic 5: Monetary policy, interest rates and exchange rates

Interest-rate changes affect borrowing, investment, spending and sometimes currency values.

11. Monetary policy and interest rates

Flow diagram showing higher interest rates, loan costs, investment, spending and exchange rate appreciation

Monetary policy refers to changes in interest rates by the government or central bank.

An interest rate is the cost of borrowing money.

Higher interest rates may affect businesses in several ways.

1. Higher loan costs

Businesses with loans may pay more interest.

Higher costs→Lower profit

2. Less business investment

Businesses may postpone borrowing to expand, build factories or buy equipment.

3. Lower consumer spending

Consumers with loans or mortgages have less disposable income.

4. Lower demand for expensive goods

Consumers may be less willing to borrow to buy cars, houses and other expensive goods.

12. Interest rates and exchange rates

Higher interest rates can attract money from overseas. This may increase demand for the country's currency and cause exchange rate appreciation.

Exchange rate appreciation

A rise in the value of a currency compared with other currencies.

This tends to make imports cheaper and exports more expensive.

Exchange rate depreciation

A fall in the value of a currency compared with other currencies.

Topic 6: Supply-side policies and business responses

Supply-side policies aim to make businesses and the economy more efficient and competitive.

13. Supply-side policies

Supply-side policies aim to make businesses and the economy more efficient and internationally competitive.

Privatisation

Using private ownership and the profit motive to try to improve efficiency.

Education and training

Improving workers' skills and productivity.

Increasing competition

Reducing controls or taking action against monopolies to encourage competition.

14. How businesses may respond to economic changes

Businesses cannot control government policies, but they can change their decisions.

Table showing possible business responses to changes in tax, tariffs, interest rates and government spending

Economic change	Possible business response
Higher income tax	Reduce prices or introduce cheaper products.
Higher import tariffs	Buy more materials locally.
Higher interest rates	Reduce borrowing/investment or repay loans.
Higher government spending	Try to win more government contracts.

Important: every response can have disadvantages. For example, introducing cheaper products may damage a premium brand image.

15. Important exam point: effects depend on the business

Economic changes do not affect every business in the same way. Students should consider the type of product or service when explaining the effects of tax or interest-rate changes.

Luxury jewellery business

Higher income tax may cause a large fall in demand because customers can postpone the purchase.

Food business selling essential products

The fall in demand may be much smaller because essential products are still needed.

Topic 7: Key definitions and exam checklist

Use the definitions and checklist to revise the whole chapter quickly.

16. Key definitions

Term	Meaning
GDP	Total value of goods and services produced in a country in one year.
Economic growth	Increase in a country's GDP.
Recession	Period of falling GDP.
Inflation	Increase in the average price level over time.
Unemployment	People willing and able to work cannot find jobs.
Real income	Income measured by what it can actually buy.
Disposable income	Income remaining after income tax.
Fiscal policy	Changes in taxes and government spending.
Monetary policy	Changes in interest rates.
Import tariff	Tax on imported products.
Import quota	Limit on the quantity that can be imported.
Exchange rate appreciation	Rise in the value of a currency.
Exchange rate depreciation	Fall in the value of a currency.
Supply-side policies	Policies designed to improve economic efficiency and competitiveness.

17. What students must know for the examination

Explain the four stages of the business cycle.
Define and explain GDP and economic growth.
Explain how changes in unemployment, inflation and GDP affect businesses.
Identify the main government economic objectives.
Distinguish between direct and indirect taxes.
Explain the effects of changes in income tax, corporation tax, indirect taxes, import tariffs and government spending.
Explain how interest-rate changes affect businesses and consumers.
Understand briefly how interest rates may affect the exchange rate.
Explain the purpose of supply-side policies.
Recommend how a business could respond to economic-policy changes.
Always apply the effect to the type of business and product in the case study.