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Cambridge IGCSE0450

Economic issues

Business Studies 0450 Chapter Notes

What this chapter covers

Economic issues - Business cycleEconomic issues - How government control over the economy affects business activity and how businesses may respond
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Economic issues notes

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In this chapter

  1. 1The business cycle and its four stages
  2. 2Growth and boom
  3. 3Recession and slump
  4. 4Gross domestic product (GDP)
  5. 5Employment levels
  6. 6Inflation
  7. 7Government economic objectives
  8. 8Changes in taxes
  9. 9Changes in government spending
  10. 10Changes in interest rates
  11. 11How a business might respond

1. The business cycle and its four stages

The business cycle has four main stages: growth, boom, recession and slump.

The stages are described by what happens to GDP. It increases in growth, rises rapidly in a boom and falls in a recession. Each stage changes what people earn and spend, so it changes a business's sales.

Do not use the stages of the product life cycle. Only growth is a part of both.

Examiner insight

“A large number of candidates confused the business cycle with the product life cycle or simply listed the terms used in the business cycle chart.”

Worked example 14 marks

Tariq owns Harbour Bakes, a bakery in a coastal town. He has read that his country's economy moves through the business cycle. Identify four stages of the business cycle.

  1. 1

    Knowledge: growth. [1]

  2. 2

    Knowledge: boom. [1]

  3. 3

    Knowledge: recession. [1]

  4. 4

    Knowledge: slump. [1]

2. Growth and boom

In growth, there is an increase in GDP over time. Incomes rise, so demand for a business's products rises with them.

In a boom, GDP is rising rapidly. People have higher levels of income and increased consumer confidence, so higher sales are more likely.

A business may be able to raise its prices in a boom. Its costs of production may rise too.

Examiner insight

“A common mistake was to state gross domestic product (GDP) would increase rather than that GDP would be rising rapidly.” “An error made by weaker candidates was to confuse an economic boom with a recession and state that sales would fall.”

Worked example 14 marks

Siena owns Bella Bikes, a shop that sells electric bicycles. Her country is in a boom. Explain one way the boom may affect Bella Bikes.

  1. 1

    Knowledge: in a boom, incomes are higher and consumers are more confident. [1]

  2. 2

    Application: customers have more money to spend on a bicycle that costs a lot. [1]

  3. 3

    Analysis: so demand for electric bicycles rises. [1]

  4. 4

    Analysis: Bella Bikes sells more, so its sales revenue rises. [1]

3. Recession and slump

A recession is a sustained fall in GDP or output. Consumers cut their spending, so a business sells less. Sales fall for goods that are not basic needs. More people are looking for work, so labour can be cheaper.

A slump follows a recession. It brings rising unemployment and lower disposable income. Demand for luxury goods falls, revenue is likely to fall, and a business may need to cut prices or costs.

Examiner insight

“The majority of candidates were aware of this term but were not clear that it specifies a sustained fall in GDP or output.” “There were a significant number of candidates who incorrectly thought that in a recession inflation would rise and with it the price of raw materials and products.”

Worked example 16 marks

Jade owns Peak Gear, a shop that sells skiing equipment. She takes on extra shop assistants every winter. Her country has just entered a recession. Explain two ways the recession may affect Peak Gear.

  1. 1

    Knowledge: in a recession, consumer spending falls. [1]

  2. 2

    Application: skiing equipment is not a basic need, so fewer customers buy it. [1]

  3. 3

    Analysis: demand falls, so Peak Gear's sales revenue falls. [1]

  4. 4

    Knowledge: in a recession, more people are looking for work, so labour is cheaper. [1]

  5. 5

    Application: Jade can take on her winter shop assistants at lower wages. [1]

  6. 6

    Analysis: her labour costs fall, which helps her profit while sales are weak. [1]

4. Gross domestic product (GDP)

Gross domestic product is a measure of the value of goods produced in a country within a specified time period. It is a technical term, so give it precisely.

For a business, the direction of change matters. A rising GDP means more output and more income in the economy, so demand tends to rise. A falling GDP has the opposite effect.

Say whether GDP is rising or falling. Do not write only ‘low GDP’.

Examiner insight

“A number of candidates confused the term with concepts such as gross profit or GDP per capita.” “Some considered the effects on the whole economy rather than businesses so gave answers linked to unemployment or taxation.”

Worked example 14 marks

Lumen Lamps makes lamps in a country where GDP has fallen for two years. Explain how falling GDP may affect Lumen Lamps.

  1. 1

    Knowledge: falling GDP means the value of goods produced in the country is decreasing. [1]

  2. 2

    Application: households have less income, so they spend less on lamps. [1]

  3. 3

    Analysis: demand for Lumen Lamps falls, so its sales revenue falls. [1]

  4. 4

    Analysis: lower revenue cuts its profit unless it cuts costs. [1]

5. Employment levels

Unemployment means people do not have a job. When employment rises, unemployment falls.

Lower unemployment means more people earn, so there may be higher demand. It may be difficult to recruit employees, so wage rates may rise.

Higher unemployment means customers have lower disposable income and may not afford the product. It is easier to recruit workers.

Write ‘an increase in unemployment’ or ‘a fall in unemployment’, not only ‘unemployment’. A change in the country's employment level is not a change in the number of employees the business has.

Examiner insight

“A minority of responses incorrectly stated that a reduction in unemployment would lead to fewer customers.” “However, high unemployment would make it less likely for customers to afford fast food because the average disposable income would be quite low.”

Worked example 14 marks

Kenzo owns Spice Hut, a fast-food restaurant. Unemployment in his town is high and rising. Explain one way this may affect Spice Hut.

  1. 1

    Knowledge: high unemployment means many people have no job, so their disposable income is low. [1]

  2. 2

    Application: fewer customers can afford a meal at Spice Hut. [1]

  3. 3

    Analysis: so the number of meals sold falls. [1]

  4. 4

    Analysis: Spice Hut's sales revenue falls, so Kenzo may need to cut costs or prices. [1]

6. Inflation

Inflation is an increase in the general price of goods and services over time. Write ‘price’, not ‘cost’, and do not write about a single product.

It reaches a business through its costs. Suppliers charge more for materials, so there is an increase in costs. The business may raise its own prices. Higher prices may then reduce demand and sales revenue.

Do not say inflation raises revenue and profit. Do not confuse it with the interest rate.

Examiner insight

“The weakest responses stated that inflation would increase revenues and profit for the business as prices would rise.” “A common error was to identify actions the business might take such as ‘close shops’ or ‘reduce the number of workers,’ but these are not direct consequences of an increase in inflation.”

Worked example 14 marks

Marta runs Oasis Soaps, which makes soap bars from palm oil and lavender bought from suppliers. Inflation in her country is rising. Explain one way this may affect Oasis Soaps.

  1. 1

    Knowledge: inflation is an increase in the general price of goods and services, so suppliers charge more. [1]

  2. 2

    Application: Oasis Soaps pays more for palm oil and lavender, so its costs rise. [1]

  3. 3

    Analysis: Marta may have to raise the price of a soap bar. [1]

  4. 4

    Analysis: customers may buy fewer bars, so sales fall. [1]

Recap

  • The business cycle has four stages: growth, boom, recession, slump. It is not the product life cycle.
  • Growth: GDP is increasing over time. Boom: GDP is rising rapidly, sales are higher.
  • Recession: a sustained fall in GDP or output. Slump: rising unemployment, lower disposable income, falling demand.
  • GDP: the value of goods produced in a country in a specified time period.
  • Falling unemployment: higher demand, harder recruitment, higher wages. Rising: the reverse.
  • Inflation: an increase in the general price of goods and services over time. It raises costs, then prices, then may cut demand.

7. Government economic objectives

A government has economic objectives for the whole country. One is economic growth: an increase in gross domestic product (GDP) over time. GDP refers to the output of the country.

Another is to reduce unemployment. A third is to increase competition between businesses.

These objectives matter to a business. If unemployment falls, more people earn an income, so demand can rise. It can also become harder to recruit employees.

Examiner insight

“Such responses recognised that economic growth involved an increase in gross domestic product (GDP) and that this increase occurred over time.” “Candidates frequently described signs of economic growth, such as falling unemployment, rather than providing the precise definition required.”

Worked example 14 marks

Tariq's Tyres is a new tyre garage in Country P. It has hired 6 workers who did not have jobs. The government gives free training to new businesses like this one. Outline two economic objectives the government might meet by supporting new businesses.

  1. 1

    Knowledge: to reduce unemployment [1]

  2. 2

    Application: Tariq's 6 workers had no jobs before, so the unemployment rate falls [1]

  3. 3

    Knowledge: to increase competition [1]

  4. 4

    Application: Tariq's Tyres is one more garage for drivers in Country P to choose from [1]

8. Changes in taxes

Income tax is a tax on people's incomes. A tax on business profits is paid by the business itself. They affect a business in different ways.

If income tax rises, customers have less disposable income. They spend less, so demand falls, most of all for luxury goods. If income tax falls, demand can rise.

If the tax on profits rises, the business keeps less retained profit. That means lower investment, for example in a new factory.

Examiner insight

“There are still many who confuse income tax with corporation tax and therefore related their answers to profit of the business paid to the government rather than reduced disposable income for employees and consumers.” “Responses should have made specific reference to a fall in retained profit followed by an explanation of the impact.”

Worked example 14 marks

Selim's Sofas sells handmade leather sofas to families in Country Q. The government raises income tax. Explain one way this could affect Selim's Sofas.

  1. 1

    Knowledge: higher income tax reduces households' disposable income [1]

  2. 2

    Application: families in Country Q have less to spend on handmade leather sofas [1]

  3. 3

    Analysis: sofas are a luxury, so demand falls by more than for basic goods [1]

  4. 4

    Analysis: sales revenue falls, so Selim's profit is lower [1]

9. Changes in government spending

The government spends its tax revenue on things such as health, education and infrastructure. It also spends on grants and subsidies to support businesses.

A grant does not have to be repaid and carries no interest. It can lower start-up costs and reduce the amount a business needs to borrow. There may be restrictions on how the money is used.

Government spending can also raise demand. If farmers receive larger grants, a business that sells farm equipment is likely to sell more. A cut in spending works the other way.

Examiner insight

“Many wrongly assumed that the grant would need to be repaid.” “A grant might lower start-up costs for the new factories and reduce the amount that PH would need to borrow.”

Worked example 14 marks

Greenleaf Ltd grows vegetables for local shops. It needs a textdollar20 000 watering system and planned to borrow all of the money. The government now offers grants to farms that buy water-saving equipment. Explain one way this could affect Greenleaf Ltd.

  1. 1

    Knowledge: a grant is money from the government that does not have to be repaid [1]

  2. 2

    Application: Greenleaf can borrow less than textdollar20 000 for its watering system [1]

  3. 3

    Analysis: a smaller loan means lower repayments and less interest, so its costs are lower [1]

  4. 4

    Analysis: lower costs leave Greenleaf more profit from the vegetables it sells [1]

10. Changes in interest rates

The interest rate is the cost of borrowing money, and the reward for saving it. When it rises, loans cost more to repay, so a business with a loan has higher costs.

Customers also save rather than spend, and are less likely to take out bank loans to make purchases. Demand falls, most of all for goods bought with a loan.

When the interest rate falls, the effects reverse. An interest rate is not a tax, and a rise does not by itself raise the cost of materials.

Examiner insight

“Common correct answers included people saving rather than spending, and the increased cost of borrowing to fund expansion.” “Some candidates incorrectly saw interest rates as some form of revenue for the government or thought it meant inflation increased.”

Worked example 14 marks

Dunmore Cars sells new cars, and most customers pay with a bank loan. The interest rate rises from 2% to 6%. Explain one way this could affect Dunmore Cars.

  1. 1

    Knowledge: a higher interest rate makes borrowing more expensive [1]

  2. 2

    Application: customers' monthly loan repayments on a new car rise [1]

  3. 3

    Analysis: fewer customers can afford the cars, so demand falls [1]

  4. 4

    Analysis: Dunmore's sales revenue and profit fall [1]

11. How a business might respond

A business can respond to each change. If demand falls, it may need to reduce prices or cut costs. If borrowing costs more, it may delay expansion, or pay for it from retained profit, which carries no interest.

A response must be linked to the change and to the business. A rise in interest rates matters most to a business that has a loan or plans to borrow.

Weigh the response too. All businesses are affected by the same change, so competitors face it as well and the fall in demand may not be big.

Examiner insight

“Other better responses linked the increase in interest rates to the expansion of the business.” “Few suggested that as competitors’ prices would also rise, therefore there might not be a big fall in demand.”

Worked example 16 marks

Pixel Print is a small printing business in Country R. It has a bank loan for its first machine and plans to borrow again for a second. The interest rate rises from 3% to 7%. Do you think Pixel Print should delay buying the second machine? Justify your answer.

  1. 1

    Knowledge: a higher interest rate raises the cost of borrowing [1]

  2. 2

    Application: repayments on the loan for the first machine rise [1]

  3. 3

    Analysis: a second loan at 7% adds more repayments, so Pixel Print has less cash for its other costs [1]

  4. 4

    Analysis: but without the second machine it cannot take on more printing orders, so it misses revenue [1]

  5. 5

    Evaluation: yes, it should delay [1]

  6. 6

    Evaluation: its costs have already risen, and other printers face the same 7%, so it is unlikely to lose customers by waiting [1]

Recap

  • Economic objectives: economic growth (GDP rising over time), lower unemployment, more competition.
  • Income tax up: customers have less disposable income, so demand falls. Profit tax up: less retained profit, so lower investment.
  • A grant is not repaid. It lowers start-up costs and the amount a business needs to borrow.
  • Interest rate up: borrowing costs more and customers save rather than spend. It is not a tax and not inflation.
  • Apply each point to the business, develop it to a result, then weigh the response.

End-of-chapter exercise

Test yourself on the whole chapter. Work through these before moving on.

  1. Asha runs a grocery shop. Her suppliers say that inflation is rising. Define inflation.2 marks
  2. Carlos makes carpets. A newspaper reports that gross domestic product (GDP) is falling. Define gross domestic product.2 marks
  3. Yuki owns a toy shop and wants to know how the business cycle may affect her sales. Identify two stages of the business cycle.2 marks
  4. Dara runs Zest Juice, a juice bar that buys fresh oranges from a market. His country is in a boom. Outline two ways the boom may affect Zest Juice.4 marks
  5. Omar owns Stone & Co, which makes patio tiles from clay bought from suppliers. Inflation is rising. Explain one way this may affect Stone & Co.4 marks
  6. Lena owns Trail Shack, which sells hiking boots. Two of her shop assistants have just left. Her country is in a recession. Explain two ways the recession may affect Trail Shack.6 marks
  7. Ravi owns Gold Leaf, a shop selling luxury chocolates. The economy has moved into a slump. Explain two ways this may affect Gold Leaf.6 marks
  8. Mira owns Fix It Fast, a phone repair shop with 6 technicians. She needs to recruit 2 more. Unemployment in her country is falling. Do you think the fall in unemployment is good for Fix It Fast? Justify your answer.6 marks
  9. Rosa owns Clean Wave, which makes washing powder from chemicals bought from suppliers. It has 30 factory workers and needs to recruit 5 more. The table gives two changes in her country. Explain how each change may affect Clean Wave's profit. | | Last year | This year | | --- | --- | --- | | Inflation | 9% | 6% | | People of working age who have a job | 88% | 95% |8 marks
  10. Velour makes handmade sofas that sell for textdollar3 000 each. It will open one new factory with 80 skilled workers and sell its sofas in the country where it builds the factory. The table gives forecasts for two countries. Justify which country Velour should choose. | | Country A | Country B | | --- | --- | --- | | Business cycle stage | boom | recession | | GDP | rising rapidly | falling for a year | | Unemployment | falling, now 3% | rising, now 14% | | Inflation | rising, now 8% | steady at 1% |12 marks
  11. Nadia's Bikes sells bicycles in Country Z. The government reports that Country Z has economic growth. Define 'economic growth'.2 marks
  12. Okoro Stores is a new shop in Country Z. The government supports new businesses because it wants to reduce unemployment. State two other economic objectives a government might have.2 marks
  13. Maya's Salon in Country Z charges textdollar30 for a haircut. The government raises income tax. Explain one effect on Maya's Salon.2 marks
  14. Orchard Hotel in Country Z has a bank loan of textdollar80 000. The interest rate rises. Explain one effect on Orchard Hotel.2 marks
  15. Lund Toys makes plastic toys and sold textdollar200 000 of toys last year. It wants a new moulding machine. The government cuts the tax on business profits. Explain one way the tax cut could help Lund Toys.4 marks
  16. Kofi's Kitchen supplies school lunches. The government gives a grant to every business that employs young people from the town. Explain one way the grant could affect Kofi's Kitchen.4 marks
  17. Beacon Furniture sells expensive sofas, which many customers buy on credit. The interest rate rises from 4% to 8%. Explain one way this affects Beacon Furniture.4 marks
  18. Mehta Tours runs coach day trips in Country Z. It has a loan for its first coach and planned to borrow for a second. The interest rate rises from 2% to 6%. Explain two ways Mehta Tours might respond.6 marks
  19. Harrow Ovens makes bread ovens in Country Z. It sells only to bakeries and cafés, never to households. It plans to pay for a new factory out of its own profit. The government cuts income tax and raises the tax on business profits. Explain one effect of each change on Harrow Ovens.8 marks
  20. Hopkins Gym has 600 members in Country Z. Each pays textdollar400 a year. It plans a swimming pool costing textdollar50 000 and has textdollar50 000 of retained profit in a savings account. The interest rate has risen from 2% to 6%. The government has cut income tax, and it gives a textdollar10 000 grant to any business that builds a sports facility. Evaluate whether Hopkins Gym should build the pool now with a bank loan, build it now with its retained profit, or delay. Justify your decision.12 marks

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