M03EFA: Economic Environment of Business

Exam: Referred/ deferred: August sitting 2010

Guidance Notes

SECTION A:

Cowasaki Ltd

Cowasaki Ltd is a small - scale manufacturer of racing motorcycles in Coventry, UK. One
of the main cost components of its racing motorcycles is a basic 1000cc petrol engine.
Currently, Cowasaki Ltd is assembling its own 1000cc petrol engines on site. On the same
industrial estate to Cowasaki Ltd in Coventry is Bike Engines ‘R’ Us Plc, a specialist
motorcycle engine manufacturer who produces very large numbers of 1000cc petrol engines
each year.

Key Concepts and Principles:

a) A detailed understanding of short – term and long –term cost curves and an
appreciation of why different firms may face different cost conditions in the short and
long run.
b) An understanding of transaction costs and the firm’s decision whether to ‘make or
buy’.
c) An in-depth knowledge of scale economies and diseconomies and the ability to
demonstrate how a profit maximising manager might deal with them.

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SECTION B:

UK Investment Volatility Lasts 30 Years

Investment can be highly volatile. It is subject to more violent swings than national income. For
the period between 1976 and 2006 for the UK, the maximum annual rise in GDP was 5.6% and
the maximum annual fall was 3.8%. By contrast the maximum annual rise in investment for the
same period was 19.4% and the maximum annual fall was 10.9%.
If we focus upon investment in the manufacturing sector then the swings were even greater. For
instance, the maximum annual rise in manufacturing investment in plant and machinery was 20%
and maximum annual fall was 28%. Moreover, for this sector of the economy, the maximum
annual rise in investment in new buildings and works was 59% whilst the maximum annual fall
was 39%.
Meanwhile, the upward and downward swings in GDP and investment do not completely match
(i.e. are not closely correlated) because there are additional factors that determine investment
other than simple changes in national income. These factors include a range of tangible as well
as intangible factors, the latter including what J.M. Keynes famously described as ‘animal
spirits’. Understanding the determinants of investment is crucial if governments are to use
expansionary fiscal policy to help reduce the impact of the current global recession.

Key Concepts and Principles:

a) An understanding of the Keynesian perspective on investment.

b) The ability to evaluate Keynes’s concept of ‘animal spirits’.
c) An in-depth knowledge of a wide range of potential determinants or ‘drivers’ of aggregate
investment in macroeconomies.
d) A thorough knowledge of the Keynesian income-expenditure model including the ability
to draw it and demonstrate how it will be affected by changes to key macro variables, e.g.
consumption spending by households.