Materials to use with your OCR GCSE Business Studies students relating to the Aaron Furniture Ltd (AFL) Case Study. This includes extracts from several sections taken from our Complete Revision Buddy on AFL. These extracts specifically focus on the talk of interest rates rising and how this might impact on AFL.
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An extract from our ‘Explanation of Key Terms, Concepts and Issues’ Section – p.43-44 of our Complete Revision Buddy for OCR A293 GCSE Business Studies…
The Concern over Rate of Growth in the UK and Talk of Interest Rates Rising
P.4 – Marketing Director’s Report, Extract 7 – lines 89-90.
What the Case Study says
The case study tells us that the Bank of England is concerned about the rate of growth in the UK and that there is talk of interest rates rising.
Why might the Bank of England be concerned about the rate of growth?
The aim of the UK government is to have steady, long-term growth because if demand increases too quickly, supply cannot meet demand, and this leads to inflation (ie the continuous and sustained rise in the general level of prices), and inflation can have several negative effects on an economy:
- Increased uncertainty – the ability to predict future demand, costs and profit is made more difficult by inflation, because inflation distorts values.
- Increased administration / menu costs – the cost of changing price lists, brochures, accounts.
- Reduction in profit margins – as costs increase (through cost push inflation), firms in competitive markets might not be able to pass such cost increases on to customers, hence profit margins will fall because prices must remain competitive.
- Labour force – unions tend to become more active during periods of inflation, to ensure members achieve an increase in real wages.
- Reduced competitiveness – an economy will become less competitive if prices are rising at a faster rate than a competing economy. This might then result in lost orders (unless the business is able to settle for lower profit margins).
In the UK, in recent years, macro-economic policy has essentially been used to control inflation, improve competitiveness and promote strong and sustainable economic growth. Macro-economic policy includes:
- Fiscal policy, which concerns the level of taxation and government spending.
- Monetary policy, which concerns the money supply, ie notes and coins in circulation, interest rates and the amount of credit available.
Since 1997, monetary policy has been managed by the Bank of England’s Monetary Policy Committee (MPC), and not the government. As stated above, if economic growth becomes too excessive, ie supply cannot meet demand, this might lead to inflation. This usually causes the Bank of England’s MPC to increase interest rates, thus putting downward pressure on inflation. (This is explained further below).
How might a rise in interest rates affect consumers and businesses such as AFL?
Higher interest rates would mean that it costs more to borrow and that mortgage holders have more interest to pay, and thus, less discretionary income ie money to spend on non-essential items.
Consumers are also more likely to save rather than spend, as there is more reward for saving.
Both of the above could reduce demand and, thus, the sales and, thus, revenue of businesses, particularly those selling non-essential items.
In the case of AFL, consumers might be less able and / or willing to spend money on home improvements / refurbishment. In which case, AFL could negatively be affected by falling demand for the furniture it sells and, thus, suffer reduced sales and, thus, revenue, and this could exacerbate its current loss making situation.
Higher interest rates would also increase AFL’s costs (business expenses) in terms of interest payments on current borrowing, which could further increase its loss making situation. This would especially be the case if AFL decided to buy rather than lease a new factory and financed the purchase through a mortgage. This would increase the time it would take for AFL to recoup the original cost of such an investment.
An extract from our ‘Mock Exam Paper’ Section – p.198 of our Complete Revision Buddy for OCR A293 GCSE Business Studies…
(e) Extract 7 states that employment and real incomes are expected to continue to grow throughout 2016, and there is talk of UK interest rates rising.
(i) Explain how rising employment might affect the demand for bedroom furniture.
……………………………………………………………………………………………………
………………………………………………………………………………………………..[2]
(ii) Explain how rising incomes might affect the prices that Aaron Furniture Ltd’s retail customers charge.
……………………………………………………………………………………………………….
………………………………………………………………………………………………….[2]
(iii) Assess the extent to which Aaron Furniture Ltd may be affected by rises in interest rates.
.……………………………………………………………………………………………………
.……………………………………………………………………………………………………
An extract from our ‘Mark Schemes and Model Answers’ Section – p.212 of our Complete Revision Buddy for OCR A293 GCSE Business Studies…
(e) Extract 7 states that employment and real incomes are expected to continue to grow throughout 2016, and there is talk of UK interest rates rising.
(i) Explain how rising employment might affect the demand for bedroom furniture. [2]
One mark for correctly stating the effect on demand, one mark for a point explaining this effect.
Possible responses include: The demand for bedroom furniture might increase (1) because more people are earning an income from working and have money to spend on goods and services (1).
(ii) Explain how rising incomes might affect the prices that Aaron Furniture Ltd’s retail customers charge. [2]
One mark for correctly stating the effect on price, one mark for a point explaining this effect.
Possible responses include: Furniture retailers may be able to charge a higher price (1) because people have more money available to spend, and so can afford to pay higher prices (1).
(iii*) Assess the extent to which Aaron Furniture Ltd may be affected by rises in interest rates. [8]
Level 3 (6–8 marks): Evaluation: Consideration of the extent of the impact of a rise in the interest rate on AFL. NB It will be possible to gain all the evaluation by developing one line of argument. Straightforward ideas have been expressed with some clarity and fluency. Arguments are generally relevant, though may stray from the point of the question. There will be some errors of spelling, punctuation and grammar but these are unlikely to be intrusive or obscure meaning.
Level 2 (3–5 marks): Analysis. Up to 3 marks for analytical points. Relatively straight forward ideas are expressed relatively clearly, legibly and appropriately. There will be some errors of spelling, punctuation and grammar which will be noticeable and intrusive.
Level 1 (1–2 marks): Knowledge and Application. One mark for a statement of how a rise in the interest rate may affect consumers and / or businesses in general. One mark for applying this to AFL. Some simple ideas have been expressed. There will be errors of spelling, punctuation and grammar which will be noticeable and intrusive.
Possible responses:
A rise in interest rates increases the cost of borrowing [L1] and would increase the cost of servicing Aaron Furniture Ltd’s (AFL) current level of debt, which has recently increased [L1]. Hence, all things remaining equal, it would reduce profits or, in the case of AFL, make it more difficult for the business to return to profitability [L2], but only if current rates are variable as opposed to fixed. [L3] Obviously, the bigger the rise in the interest rate, the bigger the impact on AFL’s costs and the more difficult it would be for AFL to return to profitability. [L3]
A rise in interest rates would also increase the cost of borrowing to finance further expansion [L1] and, thus, the cost to purchase a new, bigger factory [L1] – if AFL’s directors did decide to move and to buy instead of lease the new factory, and to purchase this through a mortgage. [L2] A rise in the interest rate could, in fact, influence the directors to lease instead of buy the factory, especially if the rise resulted in the interest payments being higher than the leasing payments. [L3]
AFL could also suffer from reduced demand for its bedroom furniture [L1] as mortgage holders would have more interest to pay and, thus, less discretionary income ie money to spend on non-necessities such as the bespoke, luxury furniture made by AFL. [L1] They might also be reluctant to borrow to fund spending, due to the higher cost [L1] and, thus, decide to postpone investment in moving house and / or refurbishment, which could significantly reduce the demand for new bedroom furniture. [L2] Consumers might also be more inclined to save rather than spend – as there is greater reward for saving [L1] which would also lead to a fall in demand for and, thus, sales of AFL’s bedroom furniture. [L2] The bigger the interest rate rise, the bigger the impact on the demand for new bedroom furniture and, thus, the bigger the impact on AFL’s sales, revenues and, ultimately, its ability to return to profitability. [L3]
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