What happens in a recession?

A recession is a period of negative economic growth. In a recession, we see falling real GDP, falling average incomes and rising unemployment. This graph shows US economic growth 2001-2016. The period 2008-09 shows the deep recession, where real GDP fell sharply. Other things we are likely to see in a recession 1. Unemployment The …

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Effect of the exchange rate on business

Readers Question: What are the effects of the exchange rate on UK businesses?

The exchange rate will play an important role for firms who export goods and import raw materials. Essentially:

  • A depreciation (devaluation) will make exports cheaper and exporting firms will benefit.
    • However, firms importing raw materials will face higher costs of imports.
  • An appreciation makes exports more expensive and reduces the competitiveness of exporting firms.
    • However, at least raw materials (e.g. oil) will be cheaper following an appreciation.

Effect of depreciation in the exchange rate

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If there is a depreciation in the value of the Pound, it will make UK exports cheaper, and it will make imports into the UK more expensive.

In this example:

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  • At the start of 2007, the exchange rate was £1 = €1.50.
  • By Jan, 2009, the Pound had fallen in value so £1 was now only worth €1.10 (a depreciation of 26%)

Impact on British exporters

Suppose a British car costs £4,000 to build and sells for £5,000 in the UK.

  • In 2007, the European price of this car would be €7,500 (5,000 *1.5)
  • In 2008, the European price of this car would be €5,500 (5,000 *1.1)

The 26% depreciation means that European consumers now find British goods much cheaper. The cost of producing the car stays the same (assuming parts are not imported), but the effective market price in Europe has fallen. This should increase demand for British goods.

Increase profit margin or reduce the foreign price?

A British firm has a choice, it can reduce the European price from €7,500 to €5,500; this should lead to an increase in the quantity sold, and increase UK exports.

Alternatively, the firm could keep the price at €7,500 and just make a bigger profit margin. It is a good choice for exporters to have – reduce European price and sell more or keep price the same and make a bigger profit margin.

Impact on importers of raw materials

The downside of a depreciation is that British firms who import raw materials will see an increase in the cost of buying raw materials. If the British car company imports engines from Germany to make the car, it will have to pay more to buy the engines. This will reduce its profit margin.

Suppose an engine costs €1000 to import from Germany. In 2007, this costs £666 (1,000/1.5). In 2009, with the fall in the value of the Pound, they will have to spend £909 (1,000/1.1) to buy the same German engine.

Impact on incentives

In the long term, it is argued that a depreciation may reduce the incentives for exports to cut costs. The depreciation enables an ‘easy’ increase in their profit margin. As a result, there may be less incentive to cut costs and boost productivity. If a firm is facing an appreciation, then they may face a greater incentive to cut costs.

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Product life-cycle

product-life-cycle

Definition: The product life-cycle (PLC) refers to the different stages a product goes through from introduction to withdrawal. The product life-cycle refers to a likely pathway a product may take. It has implications for the marketing strategy of a firm as it seeks to introduce, grow and maintain market share. In this case, the product …

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Pricing strategies

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A look at different pricing strategies a firm may use to try and increase profitability, market share and gain greater brand loyalty.

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Types of pricing strategies

General strategies

  1. Profit maximisation. One strategy is to ignore market share and try to work out the price for profit maximisation. In theory, this occurs at a price where MR=MC. In practice, it can be difficult to work this out precisely.
  2. Sales maximisation. Aiming to maximise sales whilst making normal profit. This involves selling at a price equal to average cost.
  3. Gaining Market Share. Some firms may have a target to increase market share, this could involve setting prices as low as they can afford, leading to a price war. A similar concept to sales maximisation.

See: Objectives of firms

Pricing strategies to attract customers / increase profit

  • Premium pricing. This occurs when a firm makes a good more expensive to try and give the impression that it is better quality, e.g. ‘premium unleaded fuel’, fashion labels.
  • Loss Leaders This involves setting a low price on some products to entice customers into the shop where hopefully they will also buy other goods as well. However, it is illegal to sell goods below cost, so firms could be investigated by OFT.
  • Price Discrimination. This involves charging a different price to different groups of consumers to take advantage of different elasticities of demand. There are different types of price discrimination from first degree to third degree.
  • Reference Pricing. This involves setting an artificially high price to be able to later offer discounts on previously advertised price.
  • Price Matching. The purpose behind price matching is making a promise to match any price cuts by your competitors. The argument is that this discourages your competitors from cutting price. This is because they know there is little point in cutting prices because you will respond straight away. Very clear price matching stances can thus avoid price wars and give the impression of being very competitive. For example, Tesco is offering £10 voucher to customers who can prove their shopping basket would have been cheaper at other supermarkets.
  • Retail price mechanism RPM – when manufacturers set minimum prices for retailers, e.g. net book agreement.

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The Role of Profit in an Economy

importance-of-profit

Profit is the surplus revenue after a firm has paid all its costs. Profit can be seen as the monetary reward to shareholders and owners of a business. In a capitalist economy, profit plays an important role in creating incentives for business and entrepreneurs. For an incumbent firm, the reward of higher profit will encourage …

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Benefits and costs of Sainsbury – Asda meger

Sainsburys and Asda have announced a plan for a merger. They argue it will lead to lower prices for customers, no job losses and is necessary to deal with the threat of new discounters like Lidl and Aldi and the impending arrival of Amazon. Others are more cautious arguing that the new firm will have …

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Problem of declining industries

Economies are constantly evolving. Industries which once employed thousands of people can later become uncompetitive and unprofitable. The UK has seen the rise and fall of many manufacturing industries. Industries such as cotton, wool, coal and ship-building were once key aspects of the UK economy, employing thousands of people in dense areas, but over time …

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Student discounts – charity or good business?

Companies often offer student discounts – from 10% to 50% off. What is the logic behind this student discount – is it compassionate pricing for hard-up students or is there good economic logic to increase profits for firms? Charging different prices to different groups of consumers is known as price discrimination. The idea is that …

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