CAMBRIDGE INTERNATIONAL AS & A LEVEL BUSINESS: TEACHER’S RESOURCE

Exam-style questions and sample answers have been written by the authors. In examinations, the way marks are awarded may
be different.

Coursebook answers
Most of the answers are in ‘outline’ form indicating the appropriate points and skills that learners need
to include in their answers. They provide the necessary guidance to allow learners to develop and extend
the points for a fuller answer that contains the relevant skills. In many instances, there may be other valid
approaches to answering the question.

Chapter 7
Business in context
Learners’ discussion might include:
Benefits from economic growth
• Reduction in unemployment as output increases.
• Reduction in the number of people living in poverty.
• Increasing incomes and living standards.
• Better quality of healthcare.
• Improvements in education and skills of the labour force, which will increase productivity.
Financial support for business will:
• encourage extraction of raw materials to export
• help add value in agriculture by supporting processing industries
• encourage entrepreneurship and make the economy more dynamic
• provide jobs and training.

Activities
Activity 7.1
Learners’ own answers.

Activity 7.2
1 The level of economic activity has a significant impact on the level of spending within an economy
as it affects income. In a recession, unemployment is rising and workers are concerned about losing
their jobs. Consequently, there is a decline in expenditure on luxury goods. This will affect tourism
as consumers seek to save money, leading to a fall in demand for holidays. People are more likely
to holiday in their own country and choose less expensive holiday options. The reverse is true of an
economic boom, as unemployment falls and people are more confident about the future. In these
circumstances, the demand for foreign holidays will grow as people have more money to spend.
2 In a time of rising inflation and slower economic growth, many businesses delay expansion plans due
to the falling real disposable incomes of consumers. Consumers wish to save money by reducing luxury
purchases and are more likely to focus on necessities. The tourist industry, in general, may be adversely
affected. However, there are a number of reasons, suggested in this case, for believing that Mr De
Smit’s strategy of business expansion has merit. These include:

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 CAMBRIDGE INTERNATIONAL AS & A LEVEL BUSINESS: TEACHER’S RESOURCE

• In a recession, as inefficient businesses face bankruptcy due to declining sales and a failure to
control costs, there will be opportunities for takeover at low cost. Mr De Smit will be able to
acquire businesses at very competitive prices. Mr De Smit was able to take over another business
cheaply in the last recession.
• Mr De Smit is also considering the wider market for his safari parks, e.g. even if southern Africa
faces recession, there may still be demand from non-Africans. These tourists can be attracted with
appropriate promotion.
• It is suggested that the safari parks are not expensive holidays and so, as incomes fall, people may
switch to these cheaper holidays.
However, growth may be a high-risk strategy because:
• Taking over businesses that are failing will increase borrowing and increase payments. If Mr De
Smit is unable to turn these businesses around, they will remain unprofitable. He must choose
takeover targets very carefully to ensure that they really do have the potential for profit.
• If the world economy is in recession, tourists from outside southern Africa will face declining
disposable incomes. Therefore, it may be difficult to attract tourists to the safari park.
• The business is also affected by the response of competitors to rising prices and a recession.
Competitors may increase their marketing activity to protect demand. They may limit price
increases to remain competitive even though this will reduce profit margins.
Evaluation: much will depend on the position of the firm in the market. Is it really a low-cost
alternative to expensive hotels?
The severity of the recession will also be significant. Holidays are a luxury, so even low-cost options
will suffer if there is a significant downturn in economic activity. The income elasticity of demand will
be important. If it is negative, a decline in income will lead to an increase in demand.

Activity 7.3
1 To control the rate of inflation by managing aggregate demand in the economy. Excess demand has
caused the price of chicken and vegetables to increase. This is an example of demand-pull inflation.
High levels of consumer demand relative to the economy’s ability to supply lead to price increases
as consumers are effectively competing for limited supply. Higher interest rates will reduce spending
in the economy and therefore reduce inflationary pressure. Increasing interest rates is referred to as
deflationary monetary policy.
2 Learners’ answers might include:
• Consumer spending on luxury goods. As the cost of borrowing rises, consumers will face higher
interest charges on any new borrowing. Therefore, they will reduce their expenditure on luxury
goods that require finance to purchase.
• Business investment. Higher interest rates will reduce the growth of consumer spending and this
will reduce the potential returns from investment. Therefore investment will fall. Further, as some
investment is financed from borrowing, an increase in interest rates will reduce the potential profit
of investment due to the increased repayments needed to service debt.
• The external value of the exchange rate. Two forces will influence the exchange rate. The increase
in interest rates will encourage currency flows into the financial sector, attracted by the higher
rates of interest available. This will create a demand for the currency, leading to an appreciation of
the exchange rate. However, the deflationary impact of increased interest rates will reduce import
growth into the economy. This will cause further upward pressure on the exchange rate.
• Greater uncertainty about the future. High rates of inflation make it more difficult to predict the
revenues and costs associated with long-term investment. Therefore investment is discouraged.
• Employees will demand higher wages and there may be an increase in industrial unrest. A wage-
price spiral may result.
• If inflation is high relative to other countries, businesses will be less competitive over time. This
will lead to a reduction in exports and an increase in imports.

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 CAMBRIDGE INTERNATIONAL AS & A LEVEL BUSINESS: TEACHER’S RESOURCE

• Manufacturing businesses will benefit from increasing demand due to rising incomes. This will lead
to higher levels of profit and reduced pressure to be price competitive.
• Increased growth leading to higher profits will lead to increased investment and technological
change.

Activity 7.4
1 30 000 ÷ 3 = $10 000
2 30 000 ÷ 2.70 = $11 111.11
3 Renard could pass the cost increase onto customers by increasing the price. It could absorb some or all
of the cost increase by accepting a lower profit margin.
4 15 000 × 3 = €45 000
5 15 000 × 2.70 = €40 500
6 If Foxbore leaves the dollar price of its exports unchanged, the euro price paid by the German
importer will be less. Therefore, Foxbore may benefit from increased sales as there is an inverse
relationship between price and the quantity demanded.
Alternatively, Foxbore could actually increase the dollar price to the German importer and enjoy a
higher profit margin without reducing demand. For example, a price of $16 666.66 would leave the
euro price unchanged at €45 000.
7 If Foxbore imported raw materials from Germany, the depreciation would be less beneficial as it would
now be paying more for raw materials, i.e. costs of production would be higher.

Activity 7.5
1 BMWs are exported to the USA, so a depreciation of the dollar will raise the dollar price of a BMW.
This will lead to a reduction in demand for BMWs unless BMW is willing to accept a lower euro
price for its cars. However, a lower euro price will reduce BMW’s profit margins. Analysis could be
demonstrated by the use of an appropriate simple numerical example.
2 Increase production by 60% in US factory
• Benefits: protects BMW from the dollar exchange rate fluctuations affecting sales and profit;
increased US production will encourage Americans to purchase BMWs; reduction in transport
costs to market will benefit BMW’s profits.
• Negatives: if the dollar appreciates, BMW will be worse off as a result of increased US production.
Expand marketing of its products in non-US and non-EU markets such as China
• Benefits: reduced reliance on US and EU markets and an increase in sales and revenue, which
could increase profit.
• Negatives: few can afford the luxury brand; establishing a presence in these new markets will
initially be expensive.
Cut back on its expensive German workforce
• Benefits: more price competitive due to cost savings as high wage costs result in higher average
costs of car production in Germany.
• Negatives: if production is transferred away from Germany, this may affect the company’s image,
which feeds on the perception of German engineering excellence; potential industrial unrest; costs
of redundancy.
Evaluation of these strategies could include an assessment of the likely impact of them on the long-
term profitability of BMW.

Activity 7.6
Learners’ own answers.

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 CAMBRIDGE INTERNATIONAL AS & A LEVEL BUSINESS: TEACHER’S RESOURCE

Exam-style questions
Decision-making questions
1 Pakistan’s economy: a mixture of hope and future problems
1 Supply-side policies aim to improve the conditions of supply. Policies to increase agricultural
productivity will decrease the costs for food processing manufacturers. Improvements to transport
will enable agricultural businesses to get their products to market and reduce wastage of fresh
produce. There will be an increase in profits to farmers. This will also reduce the cost of produce to
businesses supplied by farmers.
2 Deflationary monetary policy will be used to control inflation. This means higher interest rates.
This increases the cost of borrowing and will discourage investment. Households will have less
discretionary income and spending will decrease. Lower demand will reduce business profits and
reduce inflationary pressure as businesses cut prices to attract consumers.
Evaluation could include a consideration that some businesses will be more affected than others.
Businesses with high debts will be more affected than those with no or low debt levels. Businesses
that produce or sell essential products might experience a smaller fall in demand than those that
provide luxury products.
2 Prospects for the economy
1 A recession involves a reduction of demand in the economy. Lower sales put downward pressure
on prices and may mean that businesses are no longer able to cover costs, leading to losses which,
if prolonged, will cause bankruptcy. A recession also leads to some customers defaulting on
payments for goods and services bought on credit. This causes cash flow problems for business and
can lead to bankruptcy as businesses will be unable to pay their debts.
2 Interest rate cuts is reflationary monetary policy. The reduced cost of borrowing boosts consumer
spending on products for which borrowing is required. The fall in interest rates also reduces the
mortgage payments of some households and thus increases their discretionary income. This leads
to increased consumption. The increase in demand raises the rate of economic growth.
Tax cuts and increased government spending is expansionary fiscal policy. The cut in tax rates
increases household disposable income and therefore increases consumer spending. This increases
demand for the goods and services of businesses, which increases output, increasing economic
growth. Increased government spending gives a direct boost to demand in the economy. Some of
the money is spent on the goods and services, increasing economic growth.
Depreciation of the currency makes exports more price competitive, leading to an increase
in demand. Imports become more price uncompetitive and therefore consumers switch to
domestically produced goods.
3 Depreciation will encourage business to export more goods and enter new markets abroad. This
may require businesses to find new channel intermediaries abroad, e.g. agents. Marketing may
also be required and products changed to meet customer tastes. As the cost of imports increases,
businesses may look for domestic suppliers of materials and components. Quality will need to be
monitored to ensure that customer satisfaction is not reduced.
Higher indirect taxes will increase prices. To maintain demand, businesses may have to cut profit
margins. This will depend on price elasticity of demand. If demand is price inelastic, businesses
may be able to pass on the increased costs to consumers.
Evaluation could include a consideration of how responsive demand is to price rises as, for
some essential products, businesses might not have to react much to higher indirect taxes. Also
a currency depreciation will affect businesses that import a high proportion of their inputs,
especially when it might not be easy to find domestic suppliers.

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3 Coaching Inns (CI)

1 Decrease in economic growth: the economy has expanded in recent years. Economic growth will
have created jobs and reduced unemployment, so it will become increasingly difficult for businesses
to recruit staff. This may be a particular problem for hotels if that type of work is perceived to
be low paid. The forecast decrease in economic growth will reverse this trend and therefore, as
demand is reduced, there will be lower capacity utilisation and a fall in profits.
Higher interest rates: as a premium hotel, CI may be adversely affected by increased interest rates as
tourists and businesses switch to cheaper alternatives. CI may have to offer more discounted packages
to maintain occupancy levels. This will negatively affect profits and there will be less retained profit for
re-investment into the business. Further expansion will be made more difficult due to the higher cost
of borrowing. If expansion requires additional borrowing, increased repayments will make expansion
less attractive. Further, the increase in interest rates will dampen demand and thus make expansion
less desirable. The business has borrowed heavily to purchase suitable properties in the past. Higher
interest rates may increase the cost of servicing its existing debt (i.e. paying the interest on the debt it
already has). Interest payments represent an expense to the business and therefore any increase will
reduce profit.
2 Focus expansion downmarket: the premium end of the market may be adversely affected by
higher interest rates, so CI could consider opening lower-priced hotels. However, this may require
establishing a new brand name to avoid contamination of the existing brand, which may be
expensive. The lower end of the market may already have well-established brands and be highly
competitive. The budget end of the market is a segment that CI may have little knowledge of, so
recruitment of suitable managers will be important.
Consolidation, putting expansion on hold and focusing on the existing 23 hotels: expansion is
expensive and places a strain on resources, particularly if funds are borrowed. CI may benefit from
focusing its resources on its current hotels. Higher interest rates may cause a reduction in aggregate
demand and a slowdown of economic growth, so further expansion will be more risky.
Restructure debt: CI has borrowed heavily to finance expansion so, with higher interest rates,
it will face higher interest payments. The business could consider raising more equity finance
by issuing shares, which would be particularly relevant if expansion remains a key objective. CI
may be able to re-negotiate the terms of its existing debt with financial institutions to reduce the
interest burden. Extending the length of commercial mortgages and loans will reduce interest
payments but will cost the business more in the long term.
Evaluation could include an assessment and justification of which decision is most likely to lead to
maintained or even higher profitability for CI.

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