The Economic Environment of Business - Essay Example

The Economic Environment of Business

This paper deals with three aspects of an economy – cartel formations, exchange rate and finally recession. All these economic phenomena have their effects upon the economic activities that have been highlighted.

Cartels refer to the formation of an agreement or association among producers or buyers to manipulate the market price in order to earn excess profit. Cartels were formed to maintain monopoly power without a tag of monopoly in order to avoid government’s regulations (Bruneckienė, et al., 2015). Exchange rates refer to the value of currency of home country, with respect to the value of the foreign currency (Evans, 2011). For example, the value of UK’s (United Kingdom) pound sterling in relation to US’s (United States) dollars, will determine the exchange rate between UK and USA. Recession refers to the period during which, the production activities in the economy are curbed, resulting in unemployment due the shrinkage of aggregate demand (Hubbard, 2007).

• Cartels

According to the scholarly works, cartels have been defined as the free or voluntary association of producers to attain monopoly power in the market (Gillespie, 2007). However, cartels are sometimes formed by buyers, so they can have strong negotiating power over the suppliers. Such an association goes back in history, when they were not known as cartels (Connor, 2007). In 1916, Ripley was able to identify ‘pools’ and ‘corners’, where independent sellers were formulating contracts, jointly agreeing to sell their products at a fixed price, so as to obtain higher profits in terms of price and quantity. According to the author, U.S. cordage cartel was one of the first documented U.S.’s ‘pools’ which was formed in the year 1860 (Connor, 2007).

According to the extract, hotel owners in UK had instructed their travel agents that they should not provide rooms to the tourists at discounted rates. Thus the main objective behind forming cartel was to fix the tariff of hotel rooms at higher level so that the owners can earn more profit. According to the investigation carried out by the UK’s Competition and Markets Authority (CMA), these tendencies of the hotels to form cartels by maintaining ‘rate parity’ among the entrepreneurs in the hotel industry, lead to a rise in cost of family holidays, not in the terms of some tens but by hundreds and thousands of pounds.

Figure 1: Cartels' Profit Maximising Outcome for an Industry

(Source: Dwivedi, 2009)

The firms or entrepreneurs who decide to form cartels, also notes what would be each’s share in the total output production. In the above diagram, part ‘c’, the profit maximising output and price of a cartel has been illustrated. Now this quantity Q is to be divided among the firms A and B (for the sake of simplicity there are two firms in the market). A’s production is X1 shown in part ‘a’ while firm B produces X2. Thus, dividing the total industry’s output X[= X1+X2].

Competition policy, refers to the government policies that are meant to prevent formation of monopoly power (Mcconnell, 2013). Competition policies are fomulated to enhance market efficiency through promotion of competitive envirionment in an economy. These policies are aimed to facilitate technological innovation, so that the efficiency can be increased. Competition policies promote price war among suppliers. On the other hand, it also ensure the benefit of getting more in variety but at a cheaper rate to the consumers.

For a market economy, it becomes increasingly important that monopoly power are not allowed to raise its head, because if a firm or a group of companies assumes monopoly over a certain sector, consumers are hard hit. They have no other option but to buy resources at the price charged by the monopolist. For example, the formation of OPEC (Organization of the Petroleum Exporting Countries) led to oil price hike during 1960s and 70s (OPEC, 2016). They almost control 40% of the total world’s crude oil production and have about 80% of crude oil reserves located among the member countries (OPEC, 2015). This provides them with the power of controlling global oil prices. Oil importing countries need to accept OPEC prices; hence, exercising considerable power over economic decisions undertaken by the importing countries’.

When the Competition and Markets Authority’s started their investigation into price fixing by hotels; they found that hotel owners and travel agents together practice a policy of ‘rate parity’, which involves identical rooms across the industry available at same price and the travel agents keep a constant vigilance that there should be no one in the industry to offer any deviation from this price fixing policy, so that all can enjoy considerable profit. These activities with the essence of cartel, increases the travelling expenditure of tourists by hundreds and thousands of pounds. The authority was also not able to provide any fixed minimum charge for hotel rooms, because that would also have been against the competetion laws provided by the constitution of UK.

Cartels have a tendency to breakdown because of the lack of mutual trust and nature to cheat. Producers are driven by profit motive and when they find that by lowering the price below their mutually agreed cartel price, they can attain greater a market share, members of the cartel develop the tendency to cheat. In other words, one firm obtains greater market share at the cost of others by secretly disobeying the mutually agreed cartel price.

If, in the hotel industry, a tourist family visits a hotel to get accomodation during off-season and is not ready to pay the higher cartel price, then in order to keep their business running, the owner and other travel agents are ready to offer discounts. It is also because the entrpreneur will think that if they refuse the customer; another hotel might be tempted in the similar manner and hence, resolve in offering the discount to gain profit at the cost other members in the cartel. Under these circumstantces, they are more likely to break their cartel in the greed of earning greater market share.

• Exchange Rate

In between July 2015 and February 2016, the UK’s pound (Sterling) has fallen down to a seven-year low when compared against US dollars. This is the outcome of the turmoil that is happening in UK because it needs to decide whether to stay or leave the European Union (EU). The election results will provide the verdict of the citizens of UK on June 23.

This has made the investors worried and they are not convinced to keep sterling–denominated assets. Such uncertainties will result in stalling of business and investment in the UK’s economy, though many economists are of the opinion that this decision may be fruitful in the long-run. However, in the currency markets short–run risks and uncertainties attract more focus. Since, this decision to leave EU has been supported by many eminent political personalities like, the mayor of London and justice secretary; there is a chance that around 30% to 40% votes will be in favour of the decision. The borrowing interest rates have been kept low at 0.5% all throughout the beginning of 2016 by the Bank of England (The Guardian, 2016).

Now, the families taking holidays abroad will find their trips to be more expensive since, they will have to pay more pounds with respect to US dollars. All the import items will be costlier for the Britons. The British expats will suffer because their economic return s will provide them with lesser value. However, export sector might be getting a much required boost as the depreciation in the currency has been recorded to ensure improvement in the trade balance with the increase in demand for the cheaper home goods.

Figure 2: Exchange Rate of Pound against Dollar

• (Source: Hubbard, Garnett and Lewis, 2012)

In the above diagram, the depreciation of UK’s pound (Sterling) with respect to US dollar has been shown. The deprivation process has been shown with the fall of the pound to dollar ratio from 1.70 to 1.50, resulting in a decrease in demand for pound, as shown with a leftward shift of the demand curve from D2 to D1. The fall in the quantity demanded, is shown with the reduced Q1 amount of demand for pound. People now do not want to hold assets in pounds; rather they will want them to be converted into some appreciated currency in order to increase their asset value.

Figure 3: Exchange Rate between Pound and Dollar

(Source: Author’s Creation)

Figure 4: Data on Exchange rate between Pound and Dollar (July 2015 to June 2016)

(Source: Pound Sterling Live, 2016)

The hotel industry in UK will be benefitted from the depreciation in the currency because tourists will find the same hotel tariffs lower than the one that they were paying prior to depreciation. This can be illustrated with the use of following numerical example.

Say previously £1 was equal to $2 and as a result of depreciation in the pound, now £1 can only equate to $0.5. So, in the hotel industry, if the price of a room for a day was £10 then it required $20 from the pocket of the American tourists. However, the scenario changes after depreciation, the same room will now cost only £5 per day. This reduced tariff rate will attract more tourists all around the world thus, increasing the business of the hotel industry.

• Recession

According to the business cycle theory, in the process of attaining economic growth, an economy experiences short-run fluctuations, leading to fall in total output produced in the economy causing recession.

Figure 5: Recession as a Business Cycle Phenomenon

(Source: Joseph, 2006)

From the point of view of a layman, a recession occurs when an economy faces lower level of GDP (total output that have been produced and reported in an economy) for two consecutive quarters (Wiegand, 2009). However, the responsibility of claiming a particular situation as ‘recession’ has been bestowed with the National Bureau of Economic research (NBER) (Arnold, 2008). It is a non-profit, private and nonpartisan organisation. According to NBER, “a recession is a significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income and wholesale retail trade.” (Arnold, 2008)

The prime cause of UK’s recession during 2007-08 was deregulation of the financial market, which was later fuelled with oil price hike and unemployment. Financial markets of UK started to deregulate in 1970s and became a popular phenomenon in 1980s, as many regulations and government control were broken down (Learn higher, 2012). It gave leverage to the financial institutions to raise funds from markets situated across the world, leading to tremendous growth of their services. UK’s housing and real estate sector received the greatest benefit and in order to maintain profits, banks in UK had provided loans above the face value of actual property. This generated a sufficient amount of “toxic debts” for the banks.

The oil price hike in the middle of 2007 raised the stakes of business transaction in not only UK, but also in the world. Banks became worried about their sub-prime mortgage and limited their lending due to lack of confidence in the credibility of the institutional projects. This necessitated the support from Bank of England to other commercial banks like, Northern Rock Building Society, which later was nationalized.

UK because of the recession had witnessed a sharp fall in the consumption and investment pattern. There was a sharp fall in the growth of the retail business but ultimately bank’s supports rescued them from going out of business. Furnishing and DIY sectors faced difficulties. Many brands withdraw their association in UK market. Government in certain cases used coercion over banks operating in UK, so that they could issue fresh shares to maintain their capital ratios. Unemployment; specifically in the age group of 18-24, became a big challenge for the UK government. The GDP rates were staggering and during 2009, the economy could only reach 0.3% (Learn higher, 2012).

The financial crisis that led to the recession in UK during 2008 had affected many economies of the world. The debt crisis in US crippled its economic activities. The hotel industry suffered in UK because when people did not have enough money to maintain their daily bread and butter, taking pleasure trip was out of the question. They wanted to reduce their unnecessary expenditures and hence, the hotels were not able to get enough sales. However, products from the food industry consists of a consumer’s autonomous consumption, as a person can live without taking a holiday trip but cannot survive without food. Taking a vacation to the in the face of recession seemed to be a luxury when people’s main concerned was employment.

Economic activities are influenced by cartels, changes in the exchange rates and recessions because of the inter relation between them. Globalisation increased the dependence of one nation on another which not only increase trade relation among them but also multiplied the negative impacts of the economic activities. Any organisation needs to consider the effects of cartels, changing exchange rates and speculation about recession while decision-making. This necessitates clear and complete knowledge about these influencing factors and this paper has presented a glimpse of it.

• Reference List

Arnold, R. A., 2008. Economics. Boston: Cengage Learning. p. 151.

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Hubbard, G., Garnett, A. and Lewis P., 2012. Essentials of Economics. London: Pearson Higher Education AU.

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OPEC, 2015. OPEC Annual Statistical Bulletin. [PDF] Available at: < http://www.opec.org/opec_web/static_files_project/media/downloads/publications/ASB2015.pdf> [Accessed 8 June 2016].

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Wiegand, S., 2009. Lessons from the Great Depression For Dummies. New York: John Wiley & Sons.