Economic issues

The business cycle

No economy grows at a steady rate. Output rises for a few years, runs hot, falls back and then recovers. That repeating pattern is the business cycle, and 0264 names four stages of it.

Two things about that table earn marks rather than just filling a page.

Not every business moves with the cycle. A recession is bad news for a car dealer and often good news for a discount supermarket or a repair workshop, because customers trade down instead of stopping buying. A business selling essentials such as bread or bus travel holds up far better than one selling what people can put off, such as kitchens, holidays and new cars. Decide which of those your business is before writing a word.

A stage is a set of conditions, not a single fact. "In a recession sales fall" is one knowledge mark and nothing more. Saying that this restaurant's sales fall because eating out is one of the first things households cut, so it can no longer cover its fixed rent of $4000 a month and has to reduce its opening hours, is the point, the application and the development that a 6-mark part is built from.

Employment, inflation and economic growth

Economic growth is an increase in the total output of a country over a period, usually a year. An older 0450 textbook may describe the same thing as Gross Domestic Product, or GDP; 0264 asks about economic growth, and what it wants is the effect on a business rather than a definition of the measure.

Inflation is a sustained rise in the general level of prices, not a rise in one business's own selling price. Its danger sits in the gap between the two: if a bakery's costs rise by 8% and it can only raise its prices by 3% without losing customers to the shop opposite, the margin is squeezed even though revenue has gone up.

Every row there has two sides, which is why an 8-mark "Do you think ...?" part is set on this content. The evaluation mark comes from saying which side is larger for this business, not from listing both.

Changes in taxes

0264 separates the two routes a tax change takes to a business, and they are marked as different points, so treat them as different points.

Taxes on business profit. A rise in the tax charged on profit takes money straight out of what the owners keep. Take a business with a profit of $400000 before tax:

Tax at 20%: 400000 x 0.2 = $80000, leaving $320000
Tax at 25%: 400000 x 0.25 = $100000, leaving $300000

That $20000 is retained profit the business no longer has, so an expansion it was funding internally may be delayed, dividends may be cut, and the business looks less attractive to an investor comparing it with one in a lower tax country. A cut does the reverse, and is one reason multinationals choose the countries they do.

Taxes on people's income. Income tax and sales taxes do not touch the business's own tax bill at all. They reduce customers' disposable income, the money left to spend after tax, so demand falls. The fall is uneven: a supermarket loses less than a jeweller, because food is bought whatever happens and jewellery is not.

Changes in government spending

Government spending reaches a business by three routes worth naming separately.

• Direct orders. A government that builds hospitals, roads and schools is a customer, so construction firms and their suppliers gain.
• Spending that lands in customers' pockets. Public sector wages, pensions and benefits are spent in shops, so raising them raises demand across the economy.
• Spending that lowers costs. Better roads and ports cut transport costs, state training schemes cut training costs, grants cut the cost of setting up.

Cuts run the same three routes backwards, and the business hit hardest is the one whose revenue depends on a single government contract.

Changes in interest rates

The interest rate is the price of borrowing and the reward for saving, so it hits a business twice.

On its own costs. A business with a $200000 variable rate loan pays a different amount every time the rate moves:

At 4%: 200000 x 0.04 = $8000 of interest a year
At 7%: 200000 x 0.07 = $14000 of interest a year

$6000 has gone from profit before a single unit is sold. Overdrafts move the same way, and a business already close to its overdraft limit feels it first.

On its customers. Households with mortgages and loans have less left to spend, and anything usually bought on credit (cars, furniture, kitchens) is hit hardest, because the monthly repayment rises as well as the price. So a furniture retailer is squeezed from both ends at once: dearer borrowing and fewer customers.

Responding to a change in taxes or interest rates

Marks concentrate on this bullet, and answers are weakest on it, because it is easier to say what happens than to say what the business does about it.

Most of those responses cost something, and that is where an 8-mark part is won: pick the response, then say what it depends on. A business with no borrowing barely notices a rate rise but still loses the customers. How long the change is expected to last matters too, because delaying investment for six months is sensible and delaying it for five years is not.

A 6-mark part is built differently. "Explain two ways a rise in interest rates might affect a furniture retailer" is worth three marks per way, along a single chain.

Borrowing becomes more expensive. [k] The retailer pays more interest on its $200000 loan, so profit falls. [app] With less profit it may have to delay opening the second store it had planned. [an]

Do not put a second reason where the development belongs. "Interest rates also affect customers" is a new knowledge point, not the third mark.

Common mistakes

• Listing the four stages of the business cycle without saying what any of them does to the business in the question.
• Assuming every business suffers in a recession. Discount retailers, repair services and budget brands often gain.
• Treating inflation as a rise in the business's own prices instead of a general rise in prices.
• Saying a tax rise reduces profit without saying which tax. A rise in income tax does not change the business's tax bill, it changes its customers' spending.
• Writing that higher interest rates only affect businesses that borrow, and forgetting the fall in customer demand.
• Answering "how may the business respond" with the effect rather than the action.
• Offering a second effect instead of developing the first one, in a 6-mark part.
• Concluding "there are advantages and disadvantages" on an 8-mark part, which earns no evaluation mark.

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