External influences on business activity

Business A2 · Business and its environment. The idea in plain words, the rules to remember, the mistake to avoid and a worked example, written and checked by Mega Lecture.

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The idea

No business controls the world it works in. External influences are changes outside the firm that create opportunities or threats: political and legal, economic, social and demographic, technological, competitors and suppliers, international, and environmental.

Governments pass laws (on employment, health and safety, wages, marketing, competition and location), change ownership through privatisation or nationalisation, and manage the economy to reach low unemployment, low inflation and economic growth.

In a question, name the change, follow it through to the firm's costs, demand or risk, and then to a decision. The size of the effect depends on the firm: higher interest rates hurt a firm that sells on credit far more than a bakery.

Rules to remember

Privatisation = selling a state-owned business to the private sector (profit motive, pressure to cut costs). Nationalisation = taking a private business into state ownership (social objectives, but losses fall on taxpayers).
Monetary policy = changes in interest rates and the money supply. Fiscal policy = changes in taxation and government spending. Supply-side policy = measures that raise the economy's ability to produce, e.g. training, competition.
A fall in the exchange rate makes exports cheaper abroad and imports dearer at home. A rise does the opposite.
Market failure, e.g. pollution not paid for by the polluter, is dealt with by taxes, fines, regulation or subsidies.
Corporate social responsibility (CSR) = a business taking account of the effects of its decisions on society and the environment, beyond what the law demands.
Social audit = a report on how well a business has met its social targets. Environmental audit = a check of its environmental impact against its targets and the regulations.
Multinationals bring jobs, skills, investment and tax revenue to a host country, but profits may be sent home, local firms may be squeezed and the firm may later relocate.

Common mistake

Students state the external change and stop. Marks come from the chain: change, then effect on costs, demand or competitiveness, then the firm's likely decision. With exchange rates, work out whose currency has fallen before deciding who gains.

Worked example

A UK retailer imports toys priced at $30 each. The exchange rate changes from £1 = $1.50 to £1 = $1.20. What happens to the cost of each toy in pounds?

Before: cost in pounds = $30 ÷ 1.50 = £20.
After: cost in pounds = $30 ÷ 1.20 = £25.
Rise = £25 − £20 = £5, and £5 ÷ £20 × 100 = 25%.

Answer: The cost rises from £20 to £25 per toy, a rise of 25%, because a weaker pound makes imports dearer.

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