OHT 16.

CHAPTER 16. Government and business

Analysis of the business environment. The principles of state intervention. Macroeconomic policy. Industrial policy. Competition law. Regional policy.

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 16.2 Learning outcomes This chapter will help you to: Appreciate the importance of the wider business environment in the context of developing a business strategy, based on a PEST analysis. Understand the meaning of market failure and the distinction between public goods and private goods. Recognise the importance and role of government in market intervention. Identify the drivers of economic activity and the role of government in influencing the level of economic activity through various policy options. Appreciate the impact of industrial policy on the development of particular industries, sectors of the economy, or firms. Grasp the fundamental principles of competition law and the reasons for regulating monopolies and prohibiting restrictive practices. Understand the role of regional policy in the reversal of regional decline and in the limitation of regional expansion.
J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

Analysis of the business environment

OHT 16.3

A PEST analysis is concerned with identifying and evaluating the Political, Economic, Social and Technological factors likely to impact on the business in the time period under study (Figure 16.1)

Figure 16.1 A PEST analysis

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

The principles of state intervention

OHT 16.4

Market failure occurs where the market price fails to reflect the true social benefit of consuming a good or service and the marginal cost fails to reflect the true social cost of providing the good or service. A normal or private good has no appreciable social costs and benefits. By contrast,a public good is one where such externalities are pervasive. More correctly,a public good is non-excludable and non-rival.

Non-excludable :it is not possible (or possible without prohibitive cost) to exclude non-payers from benefiting from consumption of the good; e.g.those who choose not to be vaccinated against a disease may still benefit because provided others are vaccinated they are less likely to contract the disease. Non-rival :there is little or no social advantage from excluding non-payers from consuming the good or service because consumption by one person does not reduce the amount that can be consumed by others (the good or service is non-rival);e.g.defending an additional person or persons in a locality adds no additional cost to the national defence budget.
J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 16.5

Figure 16.2 Government and external benefits

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

Macroeconomic policy

OHT 16.6

Figure 16.3 Illustrating economic fluctuations

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 16.7

If

I +G +X equals S+T +M then the level of economic activity stays constant. If I +G +X exceeds S+T +M then the level of economic activity will rise . If I +G +X is less than S+T +M then the level of economic activity will fall .

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 16.8

Industrial policy Accelerative industrial policies are designed to speed up the adjustment process,for example by providing soft loans, tax allowances,state subsidies and restructuring grants. By contrast, decelerative policies are intended to slow down the pace of change,usually through financial aid,and are usually directed at industries in serious decline. In both cases the state intervention may either be aimed at one firm or selected firms or spread across an industry or business sector.
J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 16.9

Figure 16.4 Basic types of industrial policy

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 16.10

Competition law

Lower prices. A normal profit level. Lower costs of production. More consumer choice.

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 16.11

Regional policy

Regional policy takes two broad forms aimed at:

Reversing regional decline. Limiting regional expansion.

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 16.12A

Key learning points A PEST analysis is concerned with identifying and evaluating the political,economic, social and technological factors likely to impact on the business in the time period under study. There are four main areas of state intervention in the market:macroeconomic policy,industrial policy, competition law and regional policy. State intervention may be justified from a number of perspectives:to encourage or discourage consumption where there are appreciable external benefits or external costs respectively;to regulate the level of economic activity;to protect consumers and employees;and to alter the free-market distribution of income and wealth. Market failure occurs where the market price fails to reflect the true social costs and social benefits of a transaction.

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

Key learning points

OHT 16.12B

Externalities are a cause of state intervention and arise when some of the benefits or costs of consuming a good or service spill over to others. A public good is one where there is significant market failure resulting from the conditions of non-excludability and non-rivalry. A private good is excludable and rival. A good or service is non-excludable when non-payers cannot be excluded from benefiting from the consumption of the good or service or cannot be excluded except at too high a cost. A good or service is non-rival when its consumption by one person does not reduce anothers ability to consume. The level of macroeconomic activity is affected by the relative size of injections into and leakages out of the economy at any given time,where injections are investment spending,government spending and export revenue,and leakages are savings,taxation and import spending.

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 16.12C Key learning points Accelerative industrial policies are designed to speed up the adjustment process within economies in terms of industrial restructuring,while decelerative policies are intended to slow down the pace of economic change. The various types of industrial policy in relation to accelerative or decelerative objectives may be categorised into four broad areas aimed at a national champion strategy,t he development of sunrise industries, a lame duckstrategy and problem industries. Industrial policy, in general, is faced with the choice between picking winners and supporting losers. Privatisation and market liberalisation policies are pursued so as to increase economic efficiency by replacing state ownership with private ownership and by opening up monopoly markets to competition. Competition policy is concerned with promoting competition in the economy. A high degree of competition leads to a number of benefits, namely: lower prices, normal profit level, lower costs of production and more consumer choice.
J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

Key learning points

OHT 16.12D

Article 81 of the European Treaty prohibits restrictive agreements and practices in so far as they affect trade between member states and restrict or distort competition. Article 82 of the European Treaty prohibits any abuse by one or more undertakings of a dominant position within the common market or a substantial part of itin so far as it affects trade between member states. Regional policy takes two broad forms aimed at (a)reversing regional decline,or (b) limiting regional expansion.

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 17.1

CHAPTER 17. Business and economic forecasting

Interpolation and extrapolation from data. Collecting information on consumer behaviour. Statistical estimation of demand relationships. Forecasting demand.

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 17.2A

Learning outcomes This chapter will help you to: Appreciate the importance of forecasting in the context of strategic planning and development. Distinguish between the estimation of relationships between key business variables and the use of data to forecast future business and market trends. Understand how the demand for a product or service can be estimated and the technical steps involved, using cross-sectional or time series data. Select an appropriate method for collecting information about consumer behaviour in relation to a firms products which form the basis of demand estimation and forecasting. Categorise various methods of market experiments including sales-wave research, simulated store techniques and test marketing.
J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 17.2B

Learning outcomes
Avoid the common pitfalls in business and economic forecasting, particularly concerning the dangers of spurious correlations, data mining and the misinterpretation of statistical results. Grasp the principles of various forecasting techniques, involving trend projection, the use of leading indicators and econometric modelling.

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 17.4

Figure 17.1 Extrapolation and interpolation

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 17.5

Collecting information on consumer behaviour Consumer surveys ;and Market experiments . - Sales-wave research. - Simulated store techniques. - Test marketing.

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 17.6

Figure 17.2 Steps of regression analysis

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 17.7

Figure 17.3 Regression of sales volume against advertising expenditure

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 17.8

Figure 17.4 Plot of sales against price

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 17.9

Figure 17.5 The identification problem

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 17.10

Forecasting demand The various forecasting methods can be grouped conveniently under three headings, namely:

Trend projection (or trend extrapolation). Leading indicators. Econometric modelling.

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 17.11

Trend projection

Figure 17.6 Trend projection forecasting

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 17.12

Decomposition method Trend Seasonal variation (S) Cyclical variation (C) Random shocks (R)

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 17.13

Figure 17.7 Decomposition of sales data over time

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 17.14

The components of the time series may be viewed as an additive model such that the sales data (Q) may be decomposed as: Additive model Q=T+S+C+R where T is the trend value of sales, S represents the seasonal variation component of sales,C the cyclical variation and R the random shocks. Alternatively, the relationship may be stated in terms of a multiplicative model whereby: Multiplicative model Q = T x S x C x R = T.S.C.R
J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 17.15

Leading indicators

New housing starts. Stock Exchange indices. Price-to-unit labour cost ratios. New orders for durable goods. Changes in manufacturing stocks. Changes in consumer credit.

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 17.16

Econometric modelling

Q =a +bP +cA +dY

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

Key learning points Understanding the reactions of consumers to changes in demand conditions involves estimating the nature of demand relationships within the range of observed explanatory variables and forecasting future demand patterns from values of variables which lie beyond the range of observed values.The former is concerned with interpolation and the latter extrapolation . The methods available to help management collect information about consumer behaviour as the basis of demand estimation and forecasting may be broadly categorised under the headings of consumer surveys and market experiments . Consumer surveys seek to discover the future buying intentions of consumers by eliciting their probable reactions to a range of conditions concerning price,advertising spend,product quality and design,and so on. Market experiments seek to test buyers reactions to actual changes introduced, while attempting so far as is possible to keep other market conditions fairly stable or under control.
J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 17.17A

OHT 17.17B Key learning points In general,the different methods of market experimentation fall under one of three headings:sales-wave research , simulated store techniques ,and test marketing . Regression analysis involves five key steps:the identification of variables,compilation of data,specification of the form of the relationship,estimation of the relationship, and evaluation of the estimated relationship. The most commonly used procedure for estimating the relationship between variables is known as the method of least squares regression. In essence, this enables us to find the values of the coefficients of the explanatory variables which minimise the sum of the squared positive and negative deviations of the actual (observed)values of the dependent variable from those predicted by the fitted relationship.This enables us to derive a mathematical relationship providing the best fit between the dependent and explanatory variables, which can be shown graphically.
J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 17.17C

Key learning points Evaluation of the reliability of estimated coefficients is commonly based on the multiple correlation coefficient and the standard error of the estimate. The multiple correlation coefficient measures the proportion of the total variation in the observed dependent variable that is explained by the estimated relationship it is thus an overall measure of the strength of the estimated relationship. The standard error of the estimate allows us to attach a degree of confidence to the estimated value of the dependent variable based on the regression equation. The various forecasting methods may be grouped under three headings,namely: trend projection (or trend extrapolation),leading indicators ,and econometric modelling .

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

Key learning points

OHT 17.17D

The choice of forecasting method depends on how far forward we need to forecast, the degree of accuracy required in the forecasts,how quickly the forecasts are needed,and how accurate and complete the underlying data are which form the basis of the forecasts. The simplest type of forecasting method is a straightforward trend projection (or extrapolation)of past data.This can be particularly useful in arriving at short-term forecasts. Time series data may be broken down into four components:trend (T ),seasonal variation (S ),cyclical variation (C ),and random shocks (R ).

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 17.3

Interpolation and extrapolation from data

At the heart of business and economic forecasting lies two central themes:
The estimation of demand relationships. Forecasting demand.

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 18.1

CHAPTER 18. Business economics - a checklist for managers

Learning outcomes This chapter will help you to: Integrate the many dimensions of business economics and decision-making explained in this book. Better understand the complexity of questions facing management in their pursuit of successful corporate and business strategies. Understand that business economics provides insights into important factors involved in the achievement of sustained competitive advantage, while recognising that the subject rarely provides precise answers.

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 18.2

Understanding the business objectives What are my objectives for each of the products, e.g.short-term profit maximisation, sales maximisation (increasing market share),etc.? Who are my stakeholders? Does my stakeholder analysis suggest pursuit of objectives other than the maximisation of shareholder value or profit maximisation? Are current product prices set at a level to achieve the desired objectives? Is my competitive strategy primarily focused on being the lowest-cost producer or does it rely more on product differentiation? If my products are neither the lowest-cost nor sufficiently differentiated (stuck in the middle, what action might be taken to change the product focus and how might rivals react?

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 18.3A

Understanding the competitive market In what types of markets do I operate (highly competitive,monopolistic,etc.)? What are the implications for setting prices and achieving profits in the short and long run? How do my main competitors set their prices and determine their expenditure on other aspects of the marketing mix. Is there a threat from new competition? What barriers to entry into my markets exist and can be legally reinforced? Do I understand the limitations imposed by domestic and international competition law on my business and the possible strategies that I may pursue? What does new competition imply for my competitive position over the longer term?
J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

Understanding the competitive market

OHT 18.3B

How might I best respond to changes in the market by altering the marketing mix for my products? Would either a penetration or skimmingpricing strategy be advantageous in achieving my desired business objectives? Under what circumstances would a predatory pricing policy make good commercial sense? When might non-price competition be superior to competing purely on price? Under what conditions would cost-cutting not make good business sense?

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 18.4A

Understanding consumer behaviour Do I know how different market factors affect the demand for my products and hence do I know (even in general terms)the demand function for each of my products? Is it likely that my prices will have to be changed in the immediate future and if so what are the own price elasticities of the products? Are the prices of substitute and complementary products likely to change and if so what are the relevant cross-price elasticities of my products? What is the income elasticity of demand for my products and what is the forecast for income changes in the next few years? Is it possible and would it be useful to have a statistician/economist estimate the demand coefficients for my products? Is price set mainly with a view to consumer demand or mainly with a view to covering supply costs (e.g.a cost-plus pricing policy)? Is my pricing strategy consistent with my overall business objectives?
J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 18.5

Understanding the costs of production How elastic is the supply of each of the products I produce and hence how fast could I respond to changes in demand? How might supply elasticity be increased? What is the current marginal cost for each of my products and is it rising or falling and why? What does the nature of my marginal cost structure mean for my future competitiveness? Is there evidence of diminishing returns given current plant size? What does the evidence on diminishing returns imply for my investment programme in my business? Am I getting the maximum economies of scale in production,and if not why not? How do economies of scale affect my competitive position? Is there scope for reducing X-inefficiency in my business and how might such savings be best achieved?
J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 18.6

Understanding business finance and the investment decision What are the various sources of finance available to me to fund my business decisions? What are the implications for the weighted average cost of capital? To what extent would raising capital through the equity markets be preferable to debt financing investment projects? How are investment decisions made within my business? Are discounted cash flow estimates consistently used in investment appraisal? What regional and other government financial incentives might be accessed? What is the opportunity cost of capital investment alternative business investment opportunities or a relatively risk-free return in a bank account? What costs and benefits (internal and external)are taken into consideration in investment appraisal in my business?
J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 18.7

Understanding the employment decision Do decisions on employment take into account the marginal revenue product (i.e.the added value) of labour? What criteria are used to establish wage rates in my business? What factors determine the supply of labour to the business? What are the implications for labour supply of current demographic trends? What action is being taken to anticipate unfavourable movements in labour costs? Are current wage differentials economically justified?

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 18.8A

Understanding the external environment

Is there a regular briefing in my company concerned with developments in the macroeconomic environment and related government policy and their likely impact on the business? Do I know what would be the demand for my products if interest rates rose or fell, or if the exchange rate depreciated or appreciated,or if there was a change in the rate of growth of consumer spending or investment? In developing business plans do I make use of any macroeconomic forecasts prepared by the various forecasting bodies in my country? Are there any likely changes in the political, economic,social and technological (PEST)environment which will impact on my business in the future? How should I respond to these events?

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 18.8B

Understanding the external environment

How does competition policy impact on my business? What are the implications for the business of changes in the market for natural resources including land? What is the effect of environmental legislation? How might our approach to green issuesbe better managed?

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.

OHT 18.9

Figure 18.1 Business success - the wheel of fortune

J. Nellis and D. Parker, Principles of Business Economics. Pearson Education Limited 2002.