Business: Economic Issues: An Introduction

8/18/2019 Business: Economic Issues: An Introduction

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Scottish Qualifications Authority 4HN Assessment Exemplar/F7J8 34/AEX002 V1Business: Economic Issues: An Introduction December 2011

Assessment task 1

Outcome covered 1

Assessment task instructions

Prior to undertaking this assessment you will be allowed to prepare the equivalentof 250 words of your own summary notes. You are free to consult your preparednotes during the assessment, but they must be submitted with your answer script.

This assessment will be completed under controlled conditions, which means thatyou will work independently in a supervised environment.

Read the following case study and answer the questions which follow.

Case study

WJE is an independent British manufacturer of quality sports cars based in Dumfries.

The company manufactures lightweight sports cars with powerful engines and hasbecome the only specialised sports car manufacturer in Scotland, offering a selectrange of performance cars, built to a high standard. Most vehicles use the WJEengine which is highly regarded for speed and reliability. WJE performance sportscars are constructed from tubular steel frames, cloaked in fibreglass or carbon fibrebodywork.

The company began its life in 1960 in the old Rubber factory, in Dumfries. The

factory though old was of a suitable size to allow for the production of several cars atany one time. In 1962 the company launched their highly successful WJE Tigerwhich quickly gained a strong reputation for power and reliability. Sales for the Tigerquickly reached 100 units per year, and in 1967 WJE were selling 145 units per year.By 1970 sales were beginning to drop and the second model to be known as thePanther was introduced. The Panther saw the company progress well outside itsScottish roots with around 60% of the sales being exports to Europe and the US.This strong reliance on foreign exports has stayed with the company throughout itsexistence.

The 80’s saw the introduction of harsher safety regulations, which meant major re-

engineering to the Panther and the rushed introduction of the Lynx.

The Lynx unlike the previous two cars was not an instant success and salesperformance for the company dropped by 40% in year one and a further 20% insubsequent years. In this period the company was running at a loss, withredundancies and a freeze on investment.

In 1990 the company launched the Tiger2; this was an attempt to get back to theircore customers with a nostalgic harking back to the original Tiger. This strategyproved to be a great success and sales figures rose well beyond expectations withsales demand for 300 units per year.


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Throughout the early part of the millennium sales continued to grow and thecompany remained profitable.

Today the company is producing 500 Tiger2s and profits are strong, but the company

is concerned that this will be sustained in the long term.

One option available would be to introduce a new model — the Puma — which willtake five years to develop, or alternatively the Tiger2 could be upgraded at a modestcost. The company recognises that they do not have the managerial resources,physical resources or enough money to pursue both options.

Management is also concerned about the impact the present economic climate mighthave on their sales, given that the car is a luxury item.

Research carried out into sport car sales shows that the sector is going through

difficult times. Figures show that sales of rival producer company A’s car — the 370R— are down 34% from the previous year. WJE’s other competitor company B’s GX7has not fared much better with sales down 25%.

WJE have commissioned consultants to look into the potential market for theirproposed new car the Puma. The outcome of this research can be seen in thefollowing demand and supply schedule in Table 1.

Table 1— Potential demand and supply figures for the Puma

Price Demand (Sales per year) Supply (Sales per year)

£20000 800 0

£25000 700 200

£30000 500 500

£35000 400 600

£40000 300 700

£45000 200 800

£50000 100 900

Looking ahead the company is keen to retain their strong export base; however theyare highly aware of factors which might impact on this, such as exchange rates andpolitical stability.


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Answer the following questions in relation to WJE

1 Economics revolves around the nature of choice and the availability ofresources. With reference to WJE’s current situation, explain what is meant bythe ter m ‘the basic (central) economic problem’.

2 In relation to WJE’s current situation explain what is meant by the termopportunity cost.

3 Figure 1 shows the demand and supply curves for performance sports carssimilar to those offered by WJE. The quantity demanded is illustrated by line D,and the quantity firms are prepared to supply is illustrated by line S.

Figure 1— World Market for Performance Sports Cars

Quantity Demanded and Supplied

(a) In figure 1 identify which curve would best depict the likely outcome foreach of the following situations.

(i) New legislation significantly increases safety requirements, requiring asubstantial and expensive redesign of sports cars.

(ii) The launch of a successful television programme which featuresperformance sports cars.

(iii) A significant technological advancement in the manufacture of carbonfibre as used in WJE’s cars, which will reduce material costs by 25%.

(iv) Research uncovers greatly increased risks of serious injury in accidentsinvolving sports cars.

Price(£)

S2

S

S1

D2 D

D1


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(b) For each situation in part (a), indicate whether your selected curverepresents an increase or decrease in demand, or an increase or decrease insupply at every possible price in the market.

4 Using the demand and supply figures for the Puma contained in Table 1,construct a suitably labelled demand and supply diagram, and clearly identify theequilibrium price and quantity.

5 It has been forecast that, in future, insurance costs for sports cars will risesharply. This will have an adverse affect on the demand for WJE’s Puma car withan estimated fall in sales of 100 Puma cars per year at each market price.

(a) Draw and label the new Demand Curve on the diagram that you have

constructed in question 4.

(b) Explain how market forces would act to return the market to a state of

equilibrium at the new equilibrium position.

(c) Identify the new equilibrium price and quantity.

6 Using the demand figures in Table 1 in the case study, calculate the price

elasticity of demand for a Puma sports car if the price changed from £30,000 to

£40,000.

7 Referring to your calculation in Question 6, explain the concept of ‘price elasticity

of demand’ and its relevance to WJE if market pr ice were to change from

£30,000 to £40,000 per car.

8 ‘The demand for WJE cars has, to date, proven to be relatively income elastic.’

With reference to this statement, explain the concept of ‘income elasticity ofdemand’.


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Assessment task 1

Outcome covered 1

Suggested solution and making an assessment decision

1 Economics revolves around the nature of choice and the availability ofresources. With reference to WJE’s current situation, explain what is meantby the term ‘the basic (central) economic problem’.

The basic economic problem is one of scarcity and choice, in the case study theexample that the candidate should identify concerns whether the companyshould develop a new car design or modify its current model. Managerial,physical and financial resources are limited, with the finance required for the newdesign and manufacture being substantial; however it would give them a freshnew product to offer to their customers. An alternative option which may be more

prudent would be to extend the lifecycle of their current successful model whichrequires considerable less financial resources. The candidate should emphasisethe three basic decisions of which (which product to produce), how (how much toproduce) and who (who gets the product).

2 In relation to WJE’s current situation explain what is meant by the termopportunity cost.

In question one the candidate identified the economic problem of whether to useits resources to produce a new model or to upgrade their current model. Only one

choice can be made and choosing one will automatically mean rejecting theother. Opportunity cost is not a financial measure but refers to the missedopportunity as a result of how scarce resources are used. If WJE opts for the newdesign then the opportunity cost is missing out on modification of their currentmodel.

3 (a) (i) New legislation significantly increases safety requirements,requiring a substantial and expensive redesign of sports cars.

The cost of the redesign will mean that the company is less willing tosupply at the current price level so the supply curve will move to the leftat S1.

(ii) The launch of a successful television programme which featuresperformance sports cars.

The result of this change will be an increase in demand at all price levelsso the demand curve is likely to move to the right, to D1.


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(iii) A significant technological advancement in the manufacture ofcarbon fibre as used in WJE’s cars, which will reduce material costsby 25%.

This reduces the company’s overall cost so they are more willing to

supply at all price levels. This will mean that the supply curve will move tothe right, ie S2.

(iv) Research uncovers greatly increased risks of serious injury inaccidents involving sports cars.

This could put consumers off buying a sports car in favour of other cars,and the demand curve for sports cars will move to the left to D2.

(b) For each situation in part (a), indicate whether your selected curverepresents an increase or decrease in demand, or an increase or

decrease in supply at every possible price in the market.

(i) A decrease in supply(ii) An increase in demand(iii) An increase in supply(iv) A decrease in demand

4 Using the demand and supply figures for the Puma contained in Table 1,construct a suitably labelled demand and supply diagram, and clearlyidentify the equilibrium price and quantity.


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5 It has been forecast that in future, insurance costs for sports cars will risesharply. This will have an adverse affect on the demand for WJE’s Pumacar with an estimated fall in sales of 100 Puma cars per year at each marketprice.

(a) Draw and label the new Demand Curve on the diagram that you haveconstructed in question 4.

(b) Explain how market forces would act to return the market to a state of

equilibrium at the new equilibrium position.

The fall in demand at each possible market price would lead to an excess ofsupply by 100 Puma cars at what had been the old equilibrium position. Theresult would be that market forces would exert downward pressure upon themarket price until eventually the market returned to an equilibrium position atthe new equilibrium position.

(c) Identify the new equilibrium price and quantity.

The new equilibrium price is approximately £28500, and the equilibrium

quantity is approximately 450 Puma cars.


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6 Using the demand figures in Table 1 in the case study, calculate the priceelasticity of demand for a Puma sports car if the price changed from£30,000 to £40,000.

Elasticity of demand refers to the behaviour of demand for a product against

changing price conditions. Calculate the price elasticity of demand under thefollowing condition:

Price rises from £30,000 to £40,000

Price elasticity of demand = % change in quantity demanded% change in price

%change in quantity demanded = (500 - 300/500) x100 = 40%%change in price = (3000 - 4000/3000) x100 = 33.3%Price elasticity of demand = 40%/33.3% = 1.2

The demand for WJE cars is said to be elastic as the price elasticity of demand ( PED) is greater than one. This means that the percentage change in demand isgreater than the percentage change in price.

7 Referring to your calculation in Question 6, explain the concept of ‘priceelasticity of demand’ and its relevance to WJE if market price were tochange from £30,000 to £40,000 per car.

Candidates should demonstrate a clear understanding of price elasticity ofdemand. A numerical example or just providing the formula would not besufficient without an explanation. Candidate evidence should include anexplanation that price elasticity of demand measures the extent to which demandchanges when there is a change in market price.

The response should make reference to WJE. Candidates should recognise thatthe situation is elastic, and the rise in price impacts upon revenue. At £30,000sales are 500 cars per year, giving revenue of £1,500,000. If the market pricerose to £40,000 sales would fall to 300 cars, giving revenue of only £1,200,000. Agood submission should question the validity of this option and consider ways in

which WJE can hold their price down, such as a change of materials ormanufacturing source or process.


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8 ‘The demand for WJE cars has, to date, proven to be relatively incomeelastic.’ With reference to this statement, explain the concept of ‘incomeelasticity of demand’.

Candidates should demonstrate a clear understanding of income elasticity of

demand. A numerical example or just providing the formula would not besufficient without an explanation. Candidate evidence should include anexplanation that income elasticity of demand measures the extent to whichdemand changes when there is a change in income. A satisfactory explanation ofelasticity versus inelastic situations would be likely to assist in clearly explainingthe concept. An excellent response could include differentiation between normaland inferior goods, and referring to how these can be identified through thepositive or negative elasticity values.

The response should make reference to WJE. Candidates should recognise thatin WJE case it would appear that demand has been adversely affected by thereduction in income, in other words the situation is likely to be relatively incomeelastic.


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Assessment task 2

Outcome covered 2

Assessment task instructions

Prior to undertaking this assessment you will be allowed to construct theequivalent of 250 words of their own summary notes per Outcome. You are freeto consult your prepared notes during the assessment, but they must besubmitted with your answer script.

This assessment will be completed under controlled conditions, which means thatyou will work independently in a supervised environment.

Read the following case study and answer the questions which follow!

Case study

WJE is an independent British manufacturer of quality sports cars based in Dumfries.

The company manufactures lightweight sports cars with powerful engines and hasbecome the only specialised sports car manufacturer in Scotland, offering a selectrange of performance cars, built to a high standard. Most vehicles use the WJEengine which is highly regarded for speed and reliability. WJE performance sportscars are constructed from tubular steel frames, cloaked in fibreglass or carbon fibrebodywork.

The company began its life in 1960 in the old Rubber factory, in Dumfries. Thefactory though old was of a suitable size to allow for the production of several cars atany one time. In 1962 the company launched their highly successful WJE Tigerwhich quickly gained a strong reputation for power and reliability. Sales for the Tigerquickly reached 100 units per year, and at its peak in 1967 WJE were selling 145units per year. By 1970 sales were beginning to drop and the second model to beknown as the Panther was introduced. The Panther saw the company progress welloutside its Scottish roots with around 60% of the sales being exports to Europe andthe US. This strong reliance on foreign exports has stayed with the companythroughout its existence.

The 80’s saw the introduction of harsher safety regulations, which meant majorreengineering to the Panther and the rushed introduction of the Lynx.

The Lynx unlike the previous two cars was not an instant success and salesperformance for the company dropped by 40% in year one and a further 20% insubsequent years. In this period the company was running at a loss, withredundancies and a freeze on investment.


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In 1990 the company launched the Tiger2; this was an attempt to get back to theircore customers with a nostalgic look back to the old Tiger. This strategy proved to bea great success and sales figures rose well beyond expectations with sales demandfor 300 units per year.

Throughout the early part of the millennium sales continued to grow and thecompany remained profitable.

Today the company is producing 500 Tiger2’s and profits are strong, but thecompany is concerned that this will not last forever.

One option available would be to introduce a new model which will take five years todevelop or alternatively they could upgrade the Tiger2 at a modest cost. Thecompany recognises however that they do not have the managerial resources,physical resources or enough money to pursue both options.

Management is also concerned about the impact the present economic climate mighthave on their sales, given that the car is a luxury item.

Research carried out into sport car sales shows that the sector is going throughdifficult times. Figures show that rival producer company A’s car the 370Z, sales weredown 34% from the previous year. WJE’s other competitor company B’s RX7 has notfared much better with sales down 25%.

WJE have commissioned consultants to look into the potential market for theirproposed new car which they propose to call the Puma. The outcome of thisresearch can be seen in the following demand and supply schedule in Table 1.

Table 1— Potential demand and supply figures for the Puma

Price Demand ( Sales peryear)

Supply( Sales per year)

£20000 800 0

£25000 700 200

£30000 500 500

£35000 400 600

£40000 300 700

£45000 200 800

£50000 100 900


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Looking ahead the company is keen to retain their strong export base; however theyare highly aware of factors which might impact on this, such as exchange rates andpolitical stability.

In order to get a better understanding of the economic factors affecting their

business, the management have requested that you provide some guidance on theworkings of the economy. Your report should provide information on how theeconomy works which will enable the management to understand the likely impact ofeconomic changes on the business.

You have been requested to report back to the management answering the followingquestions.

1 The management want to understand the circular flow of income and theprinciples of withdrawals and injections. Construct a circular flow of incomediagram, with labels showing injections and withdrawals.

2 With reference to your diagram constructed in question 1:

(a) Explain how the Circular Flow of Income operates making reference to theinjections, withdrawals, and physical and monetary flows.

(b) Describe three injections and three withdrawals, providing a specificexample for each one.

3 Explain the multiplier principle in relation to the circular flow of income. In youranswer you should explain how the multiplier can substantially raise the level ofnational income.

4 There are many problems in comparing National Income figures betweendifferent countries, identify and explain four such reasons.


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Assessment task 2

Outcome covered 2

Suggested solution and making an assessment decision

1 The management want to understand the circular flow of income and theprinciples of withdrawals and injections. Construct a circular flow ofincome diagram, with labels showing injections and withdrawals.

Each candidate is expected to construct a circular flow of income model.Diagrams may differ in their structure; this will be acceptable provided theprinciple elements are accurately portrayed.

Households

Firms

Income Y Consumption

Expenditure C

InjectionsInvestment I Government Spending GExports X

Factor IncomesWages, Rent, Profit,Interest

Factor ServicesLabour, land,Entrepreneurship, Capital

Withdrawals/Leakages Savings STaxation TImports M


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2 With reference to your diagram constructed in question 1:

(a) Explain how the Circular Flow of Income operates making reference to

the injections, withdrawals, and physical and monetary flows.

Each candidate should explain that the monetary flow goes from the firms tothe households by way of payment for labour and the other factors ofproduction, whilst consumption expenditure represents a monetary flow fromthe household to the firms by way of purchases for goods and services.Therefore households provide the factors of production whilst firms provide lgoods and services. Withdrawals should be identified in general terms asfactors which take money from the circular flow and include Savings,Taxation and imports. The candidate should also identify the injections andexplain that they represent new money going into the circular flow by way ofInvestment, Government Spending and Exports of goods.

Where injections exceed withdrawals the level of economic activity willincrease, helping to boost the level of national income and employment. Thereverse will happen when withdrawals exceed injections. The economy issaid to be in equilibrium when withdrawals are equal to injections.

(b) Describe three injections and three withdrawals, providing a specificexample for each one.

Each candidate should identify the three injections within the model:

Investments, this will be investments from firms, for example in new capitalequipment, premises or perhaps even in new business creation itself.

Government spending utilises money gained through taxation andborrowing to improve the general wellbeing of the country, for examplehospitals, schools, the Police service, defence and infrastructure, etc.Exports are goods and services which are sold abroad, examples couldinclude physical products such as Tweed or Whisky, or financial services,etc.

Each candidate should identify the three withdrawals within the model:

Savings represent money which the households hold back for a rainy day,and are often kept in an interest earning account in a bank or buildingsociety.

Taxation is money withdrawn from the economy by the government andcan be direct taxation such as personal taxation or indirect such as VAT.

Imports are a leakage where we spend money outwith the domesticmarket on goods and services produced abroad, examples could includecars from Germany or Japan, olive oil from Italy, manufactured productsfrom China.


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3 Explain the multiplier principle in relation to the circular flow of income. Inyour answer you should explain how the multiplier can substantially raisethe level of national income.

Each candidate must explain the nature of the multiplier where an injection of

money into the circular flow will have subsequent additional positive affect. Forexample a new factory opening up will generate jobs, with jobs comes a salary,workers have to spend their salary so more money is spent at the local stores,local stores will need to stock more goods and therefore buy more. Themultiplication affect of the initial new injection therefore leads to a greater impacton national income. The candidate may use figures to help illustrate the multipliereffect and they should highlight that moneys pass from one person to another,some money will tend to leak out of the circular flow through the factors indicatedpreviously. The sum of all the additions will be greater than the initial investment,the actual amount with depend on how strong the leakages are from the circle.

4 There are many problems in comparing National Income figures between

different countries, identify and explain four such reasons.

Each candidate is expected to identify four reasons and explain why they cause

difficulties in making comparisons, acceptable examples could include:

inaccuracies in the data gathering either through human error orcomputation.

double counting for example where a product may go through different

processes it may end up being counted twice. Different countries may treatdouble counting in different ways

different methods of calculating national income figures may differ from onecountry to another

black market economy activity

population size unless the national income figures are given on a per capitabasis it is difficult to make direct comparisons of the wealth of differentcountries

unequal distribution of income making it difficult to compare one nation toanother

national income does provide an indication of wealth; however this does notindicate what the quality of life is in a country

Business: Economic Issues: An Introduction

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