Unit-6 External Influences on Business Activity

  Unit 6.1

ECONOMIC ISSUES

How government controls over the economy affect the business activity?

ECONOMIC OBJECTIVES OF GOVERNMENT (Oct/Nov-2019 Q.No.1b) (May/June 2021 Q.No-4b)

1. Positive Balance of payments

            The difference between the value of exports and imports of a country is called balance of payments. Governments try to achieve a surplus balance of payment by increasing exports and reducing imports. A deficit balance of payment may occur,

1. If the country imports more than the exports.

2. Due to exchange rate depreciation.

3. Poor industry and lower production

4. Inadequate utilization of resources in the country.

2. Reduce unemployment:

            Unemployment is the situation where the people are ready to work but unable to find the right job. Increased rate of unemployment may bring the following issues to the country,

1. Unemployed people do not work so national output will be lower than it should be.

2. Government will have to pay benefits for unemployed peoples, this increases govt expenses.

3. Unemployment results lower standard of living among the people.

3. Reduce inflation: (Feb/Mar 2023 Q.No-1a)

Inflation is financial condition where the value of money decreases so the price of essential goods increases than before. Inflation brings the following issues to the country, (Oct/Nov 2020 Q.No-4c) (May/June 2020 Q.No.4b P-2)

1. Prices of local goods will rise more than that of other countries with lower inflation.

2. People may start buying foreign goods instead of local goods- BOP deficit

3. Workers may demand higher wages due to hike in price of goods results falls in their real income.

4. It results increased cost for starting or expanding business.

5. Employees may lose the job due to redundancy so it adds unemployment.

6. People’s standards of living will fall.

4. Promote Economic growth

            An economy is said to grow when it’s GDP (Gross Domestic Product) (May/June 2019 Q.No-3a) is increasing. This is the total value of goods and services produced in the country in a year. The standards of living of people tend to increase with economic growth. If GDP decreases, the country may face the following issues,

1. Lower production and limited employment opportunity so it results unemployment.

2. The average Standards of living of people will decline.

3. No expansion for business firms as people will have less money to spend on the products they make.

THE BUSINESS CYCLE

The business cycle represents the changes in the economic activity as the economy grows up and down over a number of years. It plays a vital role in developing the economic policies of the government.

Stages of Business cycles (Oct/Nov-2015 Q.No4b) (March 2022 Q.No-3a) (May/June 2023 Q.No3c)

The business cycle has four main stages. Each stage may last for months or even years.

1. Growth

2. Boom

3. Recession

4. Slump                 

1. Growth  

Growth stage is when the economy recovers or grows. It has the following key characteristics:

1. A positive outlook for new businesses

2. Existing businesses grow and make profits

3. Growth in economic activity so increase in GDP

4. Lower unemployment as there are more jobs due to businesses doing well

5. Increased standards of living as more are employed

2. Boom (Oct-Nov 2020, Qno-1a) (Mar-2018. Q.No-2a) (May/June 2017 Q.No-3a) (Oct/Nov-2015 Q.No4a).

Boom stage is the peak of the business cycle. It has the following key characteristics:

1. Business investments and profits are at their highest levels

2. Rapid growth of GDP

3. Most sectors of the economy are performing at their best

4. High levels of demand for goods and services causing prices to rise (inflation)

5. Very low unemployment rates and people have better jobs to choose from; this leads to increased wage costs for businesses as well as a shortage of skilled people.

3. Recession (Mar 2016. Q.No.1a)

Recession is when the economy showing the movement downward in size. It has the following key characteristics:

1. Business confidence falls leading to less investment in new and existing businesses

2. Decline in GDP until it reaches a minimum (slump)

3. Falling demand by consumers leads to falling profits

4. Unemployment rises as businesses are not doing well and have to cut costs; workers are made redundant and some businesses even close down.

4. Slump

Slump is when the recession stage of the economy reaches at its worst. It has the following key characteristics:

1. Very low business confidence with very little investment in new and existing business

2. Low production of goods and services – many businesses close down

3. Low demand for goods and services

4. High unemployment due to low business activity

5. Inflation

HOW CHANGES IN TAXES AND GOVERNMENT SPENDING AFFECT BUSINESS ACTIVITY

            Governments want to achieve their economic objectives so the government influences the economic activities timely by implementing economic policies. The main ways in which governments can influence business activity are called economic policies. They are:

1. Fiscal policy- Change by the government in tax rates and public sector spending

2. Monetary policy- Change in interest rates by the government and central bank

3. Supply side policies- Interfering in economic activities

1. Fiscal policy

      Fiscal policy highlights the income and expenditure of the government.

A. Government spending

            Government spending could benefit some business such as:

1. Construction firms (Road, arbour, airport construction, etc.)

2. Defence industries

3. Bus manufacturers (public transport)

4. Subsidies on tax for newly started business.

Benefits to the business from an increase in government spending (Oct/Nov 2022, Q.No-3e)

a. Increase more business opportunities as the development of road links would ensure more customer access.

b. It can create more jobs to undertake the government projects.

Problems to the business from an increase in government spending

a. Business has to pay higher taxes (to pay for spending) which increases costs of business.

b. It may affect to get government grants to the business.

c. Can increase competition

B. Government Income

TAXES

            Taxes are the amount collected by the government from individuals or business as source of revenue.

Types of taxes:

1. Direct taxes

Direct taxes are tax collected directly from the incomes. Direct taxes are of two types.

a. Income tax

            Income tax is charged based on a percentage of income of individuals. The rate of tax may rise according to the income rises.

Impacts of high-income tax

1. People will have less disposable income (Amount of income left after taxes have been paid).

2. Sales decrease because people have less money to spend.

3. Management may cut costs for more profit. Workers might be made redundant and unemployed.

4. Businesses producing luxury goods will lose the most, while others producing everyday needs will get less affected.

b. Corporation tax (Profit Tax) 

            This is the tax charged on the profit of the business. Higher the corporation tax rate results the smaller profit to the business.

Impacts of high corporation tax (Oct/Nov 2017 Q. No-4c)

1. Businesses will have lower profits after tax, thereby, less money to finance the business,

2. Business will have more difficult to expand and start new projects.

3. Lower profits lead to low return to the investors.

2. Indirect taxes

Indirect taxes are charged on the price of goods, so it makes the products more expensive. This is the main source of revenue of government.

Impacts of high indirect tax

1. Price of goods rises so people buy less but they would still spend money on essential goods.

2. As real income falls, costs will rise when workers demand higher wages.

Types of indirect taxes

a. Value added tax (VAT)

b. Import tariffs/customs duty

c. Sales tax

d. Excise duty

a. Value added tax (VAT) or GST

            Value added tax (VAT) is added to the prices of some goods and services we buy. This makes those goods and services expensive and harder to buy, so the government does not put VAT on essential items.

Effects on business if VAT/GST increases

Effect on consumers

1. Price increases

2. Demand for goods decreases

Effect on businesses

1. Business make fewer sales

2. Decrease in revenue and profit

3. Less production due to decreased demand.

4. Businesses will have to become more competitive in price

b. Import tariffs / Customs duty (May/June 2023 Q.No3a)

            Governments may impose a charge on imported goods to protect local products and to reduce imports. It is known as import tariffs.

Impacts on increasing import tariffs, (Oct/Nov 2021 Q.No-3c) (Feb/Mar 2023 Q.No-1e)

1. Imported goods become expensive so importing become expensive

2. Sales of local goods become cheaper than imports, leading to increased sales.

3. Protect local industries without competition.

4. Businesses which import raw materials will suffer higher costs.

c. Sales Tax

      Sales tax is the tax paid by consumers on the purchase of some items. Sales tax is collected by the retailer when the final sale is made to the end consumer. There will be different rates of sales tax depending on the types of items.

d. Excise Duty

      This is the tax paid by the manufacturers on the production of certain goods within the country. Normally government charges different rates for different classes of goods.

GOVERNMENT BORROWINGS

            In order to rise fund, government may borrow funds from the public in the forms of issuing treasury bills and bonds. So, the public gets return through this investment. Besides these, the government may borrow money from other countries or international organizations such as IMF.

2. MONETARY POLICY AND INTEREST RATES (May/June 2016 Q.No-4a P-2) (Oct/Nov-2015 Q.No4c). (Feb/Mar 2023 Q.No-1d)

             Central bank changes the interest rate according to the changes in the economy on behalf of the government. Interest rate or bank rate at which bank offers loans to public. Interest rates affect people who borrow from the bank.

The business will have the following impacts if interest rate increases,

1. Businesses have to pay high rate of interest which would reduce the profit.

2. People hesitate to start new businesses or expand due to high rate of interest burden.

3. Consumers reduce the purchases due to low disposable income.

4. Demand will fall for businesses who produces luxury or expensive goods such as cars because people are less willing to borrow.

5. Higher interest rates will encourage other countries to deposit money into local banks and earn higher profits.

6. Difficult to expand or start new business as capital is expensive

3. SUPPLY SIDE POLICIES

These policies aim to make the country’s economy more efficient so that they can produce more goods and compete in the international economy. By doing so, their GDP will rise. Here are some policies:

1. Privatization: To increase efficiency by changing ownership to private sectors.

2. Improve training and education: This helps to improve efficiency of business and increases GDP in the country.

3. Increase competition: Competition causes companies to be more efficient to survive. Governments need to remove any monopolies.

How does the government controls over business activity?

Government can have impact on businesses by changing economic policies. But business activity is also controlled more directly by the government. Following are some of the main areas that are often controlled by government activities:                                                             

1. What goods can be produced- Legal and illegal categories

2. Responsibilities to employees and working conditions- Fair wages or salary

3. Responsibilities to consumers- To offer high quality goods and services

4. Responsibilities to the natural environment- To protect environment

5. Location decisions- Based on types of industries

6. Reduce monopoly- To increase competition to cut price.

7. Correct information- To ban misleading advertising

8. To ensure fair profit- To ban in making abnormal profit by imposing high price.

Unit 6.2

ENVIRONMENTAL AND ETHICAL ISSUES

Environmental concerns and ethical issues

            Business activities have impacts on environment. It may be positive or negative. If the business ignores the negative impacts, it may affect the business inversely with bad image. So each and every business must be aware about the role of environmental factors and try to bring positive impacts in the country.

HOW BUSINESS ACTIVITY CAN IMPACT ON THE ENVIRONMENT?

Negative impacts

1. Increased use of natural resources.

2. Increased pollution through littering, noise and air pollution.

3. Construction of buildings can lead to soil erosion and loss of habitat for animals.

Positive impacts

1. Spreads awareness and helps in the conservation of wildlife and natural resources.

2. Employment generated through tourism may help in reducing other activities such as overfishing that are bad for the environment.

3. Additional work for local construction businesses.

Business activity can affect the environment in these following ways,

1. Pollution

            Pollution is the main issue faces almost all the developing countries. Air pollution and water pollution are the most affecting pollutions. Improper waste disposal of manufacturing units makes these situations worse. Increased use of plastics also leads to land pollution.

2. Waste

            Chemical and toxic wastes are to be processed properly in order to reduce the pollution. Recycling of waste should be the alternate solution to reduce the pollution.  Commercial wastes, paper waste, IT wastes, packaging waste and chemical wastes are the common waste left in the countries.

3. Emission of greenhouse gases

            Emission of green-house gases such as carbon dioxide and methane cause the global warming. Factories consuming fossils fuels cause increase in greenhouse gases. Business units with air conditioned also release greenhouse gases.

4. Use of energy

            Increased number of business equipped with lighting and air-conditioned would consume high range of energy sources such as coals, gas, fuels etc. to produce electricity. High usage of fuels for transportation and delivery leads to the imbalance in natural resources.

5. Use of natural resources

            Usage of non-renewable resources is to be reduced and alternate sources should be used. Fossil fuels and coals are limited in supply so business should make proper plans to reduce the usage of such resources properly. 

EXTERNALITIES (May/June 2018 Q.No-2a.P-2) (Mar 2023. Q.No-4a.P-2)

            Externality is the effect of the business activities on unrelated parties. These effects may be positive or negative.

Positive externalities (External Benefits) (Oct/Nov 2016 Q.No-1b)

1. New production techniques bring better products at low cost.

2. Improving infrastructure of business so develop backward areas

3. Better facilities for employees so reduces accident or injury during working

4. Provides employment opportunities so improves standard of living of society

Negative externalities (External Costs)

1. Increased use of fuels or energy

2. Increased pollution

3. Natural resources might be damaged.

4. Lose of natural beauty of the place and affects tourism

5. Damage to the ecology and result pollution

External cost and external benefit analysis (Oct/Nov 2017. Q.No-2b) (May/June 2021 Q.No-4c)

            External costs are the costs paid by the rest of society, other than the business, as a result of a business decision. For example, smoke and fumes of the factories may damage the health of residents etc.      External Benefits are the gains to the rest of society, other than the business, resulting from a business decision such as creating jobs or providing quality goods.

            Private costs are the costs of a business decision actually paid for by the business. For example, cost of land and construction etc.

            Private Benefits are the financial gains made by a business as a result of a business decisions. It includes money made from the sale of the products

Role of government in external cost and benefit analysis

            Social cost is the addition of the private and external costs of a business decision. Social Benefit is the addition of the private and external benefit of a business decision. If the total social benefit is greater than the total social cost, the scheme is likely to be accepted. If, however, the total social cost is greater than the total social benefit, the government will probably refuse permission.

• Social costs = private costs + external costs.
• Social benefits = private benefits + external benefits.

SUSTAINABLE DEVELOPMENT (Mar-2021 Q.No-2e) (March 2022 Q.No-1e.) (Feb/Mar 2023 Q.No-1a)

            A business is said to be sustainable if it contributes towards the economic growth of the country and makes profits while obeying the law, being ethical and environmentally friendly.

Steps to be sustainable:

1. Use renewable source of energy.

2. Avoid unnecessary travel by promoting work by home policy (telecommuting)

3. Avoid or reduce use of chemicals that produce toxic waste.

4. Use packaging that is made of recycled materials.

5. Use packaging that can be reused or recycled.

6. Use energy efficient process and equipment to minimise the use of energy.

7. Reduce waste or find a market where it can be used as a raw material.

8. Work with employees, customers and suppliers fairly.

Indicators of sustainable development

For environmental development. (Oct/Nov 2017. Q. No.2c)

1. Conservation of natural resources

2. Conservation of habitats for endangered animals and plants.

3. Use of renewable sources of energy like solar and wind power for business activity

4. Reduced greenhouse gas emissions by using greener sources of energy

5. Proper waste management. Example-recycling.

For social development

1. High life expectancy by generating less pollution

2. Gender equality by having relevant human resources policies in place.

3. Ethical business decision by conducting a social cost-benefit analysis of a project.

4. Fair compensation to employees

For economic development

1. Low unemployment by providing more work opportunity to people

2. High literacy rates by setting up training and knowledge-sharing programmes for employees

3. Growing GDP by generating products and services.

4. Improved standards of living by paying employees fairly and improving working conditions.

Arguments against the environmental protection (May/June 2018 Q.No-3e) (May/June 2016 Q.No-4e) (Oct/Nov 2021 Q.No-2d)

1. Protecting the environment can be expensive. Reducing waste, recycling waste and reducing polluting smoke all cost businesses money and this reduces profits.

2. Firms might have to increase prices to pay for environmentally friendly policies.

3. This could make firms uncompetitive and they could lose sales to businesses, perhaps in other countries, that are not environmentally friendly.

4. Consumers will buy less if they have to pay higher prices.

5. If pollution is a problem, then government’s expenditure may increase to clean it up.

Arguments for environmental protection. (Oct/Nov 2021 Q.No-2d)

1. Global warming and global pollution affect us all and businesses have social responsibility to reduce these problems.

2. Using scarce natural resources, such as rainforest timber, leaves less for future generations and increases prices.

3. Improves business image, if people demanding products from environmentally friendly firms and this can become a marketing advantage.

4. If business damages the environment, then pressure groups (pressure groups are formed by people who share a common interest and who will take action to try to change government policy or business decisions) could take action to harm the firm’s reputation and sales.

Ways to make business more environment friendly

As per law, the following business activities are illegal:

1. Locating in environmentally sensitive areas.

2. Dumping waste products into rivers or the sea, though it is sometimes difficult to prove which firm is responsible for this.

3. Making products that cannot easily be recycled.

MEASURES TO PROTECT ENVIRONMENT

1. Legal control (Oct/Nov 2020 Q.No-4b P-2) (May/June 2021 Q.No 4b P-2)

Government can make rules and laws regarding the protection of environment.

a. Government may impose penalties against illegal practices.

b. Government may charge levy or tax on the commercial use of energy.

c. Government may set standard for business for using natural resources

d. Business may not be permitted in certain areas.

e. Organization for sharing awareness about environmental protection. - Pollution control board.

f. Proper waste management programme such as collection and recycling

g Government may offer incentives such as tax credits for environmentally friendly business.

h. Tax exemption for using renewable energy sources.

i. Assurance of minimum wage for workers

j. Action against the misleading advertisements/promotions.

2. Environmental Pressure Groups (Oct-Nov 2020, Q.No-2a)

            Pressure group is a group of individuals who join together with common interest to stand against the issues which is affecting environment by the business or government policies. These are non-profit organizations working globally against environmental and ethical issues. Eg:- Greenpeace - 55 countries (Headquarters The Netherlands), Environmental Justice Foundation(EJF) -London, UK, etc.

Activities of pressure groups against ethical and environmental issues. (Oct-Nov 2019 Q.No1c)

1. Demonstrations- Rally, campaign, Protests against the organization, etc.

2. Boycotting- Discouraging consumers to buy products or services from such business.

3. Petitioning- Making oral or written complaint to the government or authorities.

4. Lobbying- Attempt to influence the law-making authority or government.

5. Negative Publicity- Through social media, newspapers, websites and public supports, etc.

6. Take legal actions through national or international courts

Ethical issues faced by businesses (Mar 2020 Q.No-3e) (May/June 2023 Q.No4b P-2)

            Business must protect the interest of stakeholders whether they are individuals, organizations or community.

Business Ethics

            Business or corporate ethics are the code of practice to be followed by every business to accomplish their responsibility in healthy ways.

Examples of unethical business practices in different sectors

1. Finance sector

a. Failing to tell customers about extra or hidden costs.

b. Insider trading (trading of company’s stock by individuals having knowledge of non-public information)

2. Marketing sector.

a. False advertising of their products and services

b. Providing products and services that are unsafe for use.

c. Non-disclosure of risk associated with the product or service.

d. Hoarding (Artificially creating shortage to the products by holding more quantities)

3. Human Resource sector

a. Unfair payment to employees,

b. Use of child Labour.

c. Production in sweatshops.

d. Discrimination of employees based on gender, ethnic group, religion and age.

4. Operation sector

a. Dumpling (Selling products at very low cost intentionally so drive out competitors)

b. Improper waste disposal.

c. Exceeding of pollution limits set by the government                                                      

Conflicts between profit and ethics

            Businesses may find that achieving ethical objectives increases their costs. Greater costs mean lower profits, so businesses often face a conflict between profits and ethics. For example, an increase in production levels may lead to economies of scale and possibly more sales, but it also causes an increase in pollution. Paying employees higher salaries rather than earning higher profits is another example of an ethical decision.

It is important that the right balance is found, as earning profit by unethical means is not good for the long-term survival of a business.

The outsourcing industry is good example of the conflict between profit and ethics. Outsourcing is the relocation of business functions (such as finance or manufacturing operations) to other countries. This means that jobs may be lost in one country, and gained in another.

How business responds to ethical issues?

            When faced with an ethical issue, a business has to consider the interests of the various stakeholders. When stakeholders have conflicting interests, decision making may not be easy. Both the advantages and disadvantages of ethical behavior need to be considered.

Advantages/Importance of business ethics (Oct/Nov-2018 Q.No-2d) (Mar 2017 Q.No-3c) (Mar 2016 Q.No-4c) (Oct/Nov 2022 Q. No-1e)

1. Improved image and reputation of business

2. Attracting new investors, which can help a business grow.

3. It would motivate the employees and their productivity.

4. It helps the business to recruit experienced employees

5. Customers may demand eco-friendlier products that have been made fairly. Business can use this to improve their brand awareness and recognition.

6. Increase relationship with the stakeholders so it would reduce the opposition from the pressure groups.

Disadvantages of following business ethics

1. High costs may be involved when choosing raw materials ethically (recyclable materials) as opposed to choosing the one with the lowest price, leading to lower profits.

2. Hard to get raw material with ethical standards results delay in production.

3. Cost of production may be increased by improving working conditions.

4. High wages and salaries of employees, this leads to lower profits.

Legal controls against unethical business practices towards employees (May/June 2016 Q.No-1b P-2) (Mar 2023. Q.No-3a.P-2)

1. Health and safety training for all employees.

2. Legal minimum wage

3. Protection from unfair dismissal

4. Healthy and comfort working environment

Legal controls against unethical business practices towards consumer

1. Ban on misleading advertisement

2. Ban on unfair or abnormal price hike

3. Ban on unhealthy or dangerous product

4. Customer satisfaction

 

Unit 6.3

Business and the International Economy

Globalisation (Mar 2020 Q.No-3a) (Oct/Nov 2022, Q.No-4a)

            Globalization is the concept of one market -worldwide market. Here all the countries are connected with one another due to increased trade of goods and services.

Reasons for globalisation (March 2022 Q.No-1a.)

1. Growth of information and communications technology has helped in international expansion easier for many companies by minimising language barriers.

2. Efficient methods of transportation have helped to break down geographical barriers. For example, perishable food items such as fruits and vegetables can be shipped anywhere in the world in short period of time.

3. Growth of Trading blocs: Trading bloc is a group of countries make agreement to trade without much trade restrictions.

4. Free trade agreements also assist business operations by improving economic and technical co-operation. Free trade agreements are considered to be an important way of opening up foreign markets.

5. Growth of MNC results increased exchange of resources among the countries. It helps to bring development in technology and infrastructure from home countries to host countries.

6. International relationships help the countries to export and import more goods and services beyond the boundaries.

Opportunities and threats of globalisation (International Trade) (Oct/Nov-2018 Q.No-3e) (Mar 2018 Q.No-2d) (May/June 2021 Q.No-2a P-2) (Oct/Nov 2022, Q.No-1b.P-2)

Opportunities of Globalization (International trade) (Mar 2017 Q.No-3d)

1. Businesses can access worldwide markets, which may lead to an increase in sales.

2. Labour may be cheaper in host nations and so businesses can earn more profit from lower costs.

3. Due to increased competition, businesses operate more efficiently and reduce costs due to cost effective innovations and economies of scale.

4. Reduction in costs will lead to greater profits. They can also offer their products at reduced prices, encouraging sales.

Threats to Globalization

1. Local businesses in the host country may suffer as foreign companies start to sell their products at a cheaper price.

2. Exchange rate fluctuations may cause lowering of profits.

3. Increased competition for both local and international businesses.

4. The marketing and distribution costs for the international business will increase. 

Trading bloc

Trading bloc is a group of countries which have made a trade agreement to trade with each other without imposing any trade restrictions such as customs duties, exchange control, etc.

ASEAN (Association South East Asian Nations)

EU (European Union)

SADC (South African Development Council)

NAFTA (North American Free Trade Agreement)

Free trade

            Free trade means trade among the member countries of a trading bloc without imposing customs duties and other strict control. There are free movement of money, capital, people and services among the member countries.

Impacts of increased imports or globalization (Why governments introduce import tariffs and quotas or trade restrictions?) (May/June 2020 Q.No-1b)

Increased imports may bring the following problems to the countries

1. Loss of the revenue for the government due to lack of duties.

2. Home industries get affected due to increased imports.

3. Infant industries become staled due to high competition from other members

4. It causes unemployment due to slow growth of industries.

5. It causes imbalance of resources among the countries.

6. It may lead to deficit BOP.

Measures to reduce the imports

1. Import Tariffs or Duties. (May/June 2016 Q.No-4a)

A tariff is a tax applied to the value of imported and exported goods. These are taxes payable on goods imported into the country. If the duty is increased, product’s price also increases, consequently sales and import decreases so it helps the home producers to sell more. It also increases the revenue of government to ensure surplus BOP.

2. Quota.

            It is the method of limiting the imports by fixing an upper limit on the quantity of foreign goods brought into a country. It also helps to protect the local business by limiting the supply in the country. Eg:- 500 Cars in an year.

3. Embargo.

            It is the complete ban of the imports of certain goods. Carrying of such goods will be punishable offence in that country. Eg:- Drugs, explosive items, arms and ammunition, certain meats. Etc.

4. Exchange control.

             The government can limit the imports of goods by limiting the amount of foreign currency to be payable to the exporters. Eg:- $ 2000 per month, $10,000 per year.

6. Legal restrictions.

            The government tightens up the importing procedures for certain goods. It results to a decrease in imports of such goods. Eg:- Increased documentation.

How business is affected due to import restrictions (Mar 2020 Q.No-3c) (May/June 2021 Q.No-4e)

1. Import cost increases so price of imported goods increase

2. Demand for imported goods decrease and demand for home products increase

3. Import depending industries become stale due to high price of imported raw materials.

4. Difficult to get home suppliers at low cost.

Importance of multinational companies (MNCs)

Multinational Company (MNC) (May/Jun 2015, Q.No.2a)

            An organisation that has operations in more than one country is known as MNC. The parent company or head branch locates in home countries and the branch or subsidiary companies locate in host countries.

Why do firms become multinational? Benefits to a business of becoming an MNC (Mar 2019 Q.No-4c) (Oct/Nov 2016 Q.No-1c) (Mar-2021 Q.No-2d) (May/June 2015 Q.No-4b P-2)

1. To produce goods in countries with low costs. Energy costs, Labour costs and rental of business location may be cheaper in host countries.

2. To extract raw materials which firm may need for production. Some times in Home countries the cost of production may be higher due to shortage of raw materials.

3. To produce goods nearer the market to save transport cost. Importing raw materials and exporting goods may increase transport cost.

4. To avoid trade barriers or restrictions. It helps to reduce risk related with the imports of goods.

5. To expand market into different market areas. Access to worldwide market.

6. To gain from economies of scale. By producing and selling in many countries, MNC can get more revenue at lower cost.

Threats to the growth of MNC

1. Shortage of labour

2. Lack of information about local market and small industries

3. Language difference and communication problems

4. Cultural differences

5. Trade restrictions policies of the counties

6. Expensive labour cost

7. Threat from pressure group

8. Lower brand image or publicity

9. Currency fluctuations

10. Political instability in host countries

Advantages of MNC to the host countries (May/Jun 2015, Q.No.2e)

1. MNC creates employment opportunities in host countries.

2. MNC provides greater choice and quality of goods and services due to high competition.

3. MNC increases income and wealth of the countries, in the form of taxes or duties, due to increased exports.

4. MNC ensures the worldwide market for the products.

5. MNC helps to the development of countries by ensuring the free flow of capital and technologies in host countries.

6. MNC helps to the free movement of human resources.

7. MNC helps to improve the balance of payments.

Disadvantages of MNC to the host countries (May/Jun 2015, Q.No.2e)

1. Large exploitation of scarce natural resources or non-renewable resources of the host countries.

2. Increased environmental pollution.

3. Concentration of wealth in home countries.

4. Increased competition to the small business in the host countries may decreases employment opportunities.

5. Difficult to control the business due its large size.

6. Monopolistic control so products may be charged high price.

7. Exploitation of labour.

The impact of exchange rate changes (Oct/Nov 2019 Q.No-4a) (May/June 2017,Q.No-1b P-2)

Exchange rate

            Exchange rate is the rate at which one country’s currency can be exchanged with other country’s currency. Eg:- 1US$ = 15.42MVR

Exchange rate Depreciation: (March 2022 Q.No-1b)

            if the value of the currency goes down with respect to another currency, it is known as currency depreciation. Eg: 1US$ = 17MVR

Exchange rate Appreciation:

            If the value of the currency increases with respect to another currency is known as currency appreciation. Eg: 1US$ = 12MVR

How exchange rate is determined?

Most currencies are allowed to vary or float on the foreign exchange market according to the demand and supply for each currency just as the prices of goods can vary according to supply and demand in a free market. Some countries exchange rates are fixed by the government.

How businesses are affected by changing exchange rates? (Mar 2019 Q.No-2e) (May/June 2016 Q.No-4c)

1. Impacts on Exporting Businesses if currency depreciate,

            Exports are cheaper so increase the demand of goods

            Business can export more so which increases the sales revenue.

2. Impacts on Importing Businesses if currency depreciate,

            Imports will be expensive

            Price of goods increases in foreign market

            Importers have to pay more than before.

3. Impacts on country or economy if currency depreciate,

            Increases demand for the currency so value of the currency rises -Appreciation

            More exports lead to the increase in balance of payment.

            It is not good if the country importing raw materials or semi-finished goods

4. Impacts on Exporting Businesses if currency appreciate,

            Exports become expensive

            Demand for goods decreases due to high cost of exports

            Business may cut price so it may lead to employee redundancy and decrease in output

5. Impacts on Importing Businesses if currency appreciate,

            Imports will be cheaper

            Business selling imported goods will have more revenue.

6. Impacts on country or economy if currency appreciate,

            More imports may lead to deficit balance of payment

            Local business needs to compete with imported goods so it reduces price.

            A fall in exports may result to the fall in GDP and unemployment.