AQA A-Level Business: Businesses and the external environment (7132) – Revision Notes

These are condensed notes for section 3.1.3, Understanding that businesses operate within an external environment, in the AQA AS and A-level Business specification (7131 and 7132), written for A-level Business 7132. For full explanations and worked examples, use the study guide. To test yourself on exam-style questions, use the practice questions. The wider topic is in the What is business? revision notes, the course hub is AQA A-level Business, the printable list is the Business checklist, and the free diagnostics show where your gaps are.

The one content point

The specification lists a single content point: how the external environment can affect costs and demand. It names six factors that must be covered: competition and market conditions, then incomes and interest rates, then demographic factors, and finally environmental issues together with fair trade.

• External means outside the business’s control. The business responds but cannot decide the factor.
• Costs are what the business pays for inputs, labour, finance and compliance.
• Demand is how much customers want and can afford to buy at a given price.

Key terms

Term	Meaning in one line
Competition	Rivals selling similar products to the same customers
Market conditions	State of the market: growth or decline, seasonality, and the supply and price of inputs
Incomes	The money households have to spend, which drives what they buy
Normal good	Demand rises when incomes rise
Inferior good	Demand falls when incomes rise, because buyers trade up
Interest rate	What it costs to borrow money, and what savers earn
Variable-rate loan	Interest cost moves when the rate moves
Fixed-rate loan	Interest cost stays the same for the fixed period
Demographic factors	Size, age structure, location and movement of the population
Environmental issues	Pollution, waste, emissions and pressure to behave responsibly
Fair trade	Buying on terms that give producers a fair, stable price; usually costs the buyer more

The six factors at a glance

Factor	Effect on costs	Effect on demand	Main thing that changes the size of the effect
Competition	More marketing spend; rivals bid for staff and suppliers	New or cheaper rival cuts volume or forces a price cut	How similar the products are and how loyal customers are
Market conditions	Input shortages raise input prices; gluts lower them	Growth lifts demand; decline and off-peak seasons cut it	Whether the market is growing and how seasonal it is
Incomes	Higher pay pressure when incomes rise generally	Normal goods gain when incomes rise; inferior goods lose	Whether the product is a luxury or a necessity
Interest rates	Higher finance cost on variable-rate debt	Less spending on credit-financed items when rates rise	How much debt the business has and whether customers borrow
Demographic factors	Recruiting and training costs shift with workforce size and age	Different age groups buy different products	Which age group the product targets
Environmental issues and fair trade	Greener inputs, packaging and compliance often cost more	Ethical customers may buy more and accept higher prices; a poor record loses customers	How much customers care and what rivals do

Method for any answer

1. Name the factor and the change.
2. Say whether it hits costs, demand or both.
3. Give the direction and the likely knock-on to price, volume, revenue or profit.
4. Apply it to the business in the case: product, customers, debt, location, staff.
5. Judge the size, timing and the business’s possible response.

Short calculations to know

Percentage change = change ÷ original × 100.

Effect of an input price rise on unit cost. New unit cost = other costs + (input cost × (1 + percentage rise)).

Tormarsh Printers. Paper is 35% of a £20 unit cost. Paper prices rise 10%.

Paper per unit before = 35% × £20 = £7.00
Paper per unit after  = £7.00 × 1.10 = £7.70
New unit cost         = £13.00 + £7.70 = £20.70
Rise in unit cost     = 0.70 ÷ 20 = 3.5%

At a price of £30, margin on price falls from 33.3% to 31.0%. The rise in total unit cost (3.5%) is smaller than the rise in the input (10%) because the input is only part of the cost.

Interest on a variable-rate loan. Interest = loan × rate. A rise from 4% to 5% on £200,000 takes the bill from £8,000 to £10,000, a rise of £2,000 or 25%. One percentage point on the rate became a 25% rise in the bill.

Fair trade premium and the net effect. Larch Row Chocolate sells 50,000 bars at £3.20, with unit cost £2.00 (of which cocoa is 25%, or £0.50) and fixed costs of £30,000. It switches to fair trade cocoa, which costs 12% more, and raises price to £3.35. Demand rises to 53,500 bars.

Cocoa per bar after  = £0.50 × 1.12 = £0.56
New unit cost        = £1.50 + £0.56 = £2.06  (up 3.0%)
Profit before        = 50,000 × (£3.20 − £2.00) − £30,000 = £30,000
Profit after         = 53,500 × (£3.35 − £2.06) − £30,000 = £39,015

Revenue rises from £160,000 to £179,225. The costs rose, yet profit rose by £9,015 (30.1%) because customers accepted the higher price and bought more. That depends on the demand response, which is uncertain. If volume had stayed at 50,000, profit would have been 50,000 × £1.29 − £30,000 = £34,500, still higher than before because the price rise (4.7%) more than covered the cost rise.

Link between income and demand. If incomes rise 4% and sales of a product rise 10%, the ratio of the two changes is 10 ÷ 4 = 2.5. Calling this income elasticity of demand, and interpreting it, is covered in the marketing section (3.3.2). Here you only need to know that products differ in how strongly they respond.

Dunsby Cycles. Real incomes fall 2%. Premium e-bike sales fall 5% and budget bike sales rise 3%.

Premium: 5 ÷ 2 = 2.5 times as large a fall as income (a luxury-type response)
Budget:  sales moved the opposite way to income (an inferior-good response)

Factor notes

Competition

• Cost side: marketing, recruitment and supplier competition.
• Demand side: lost volume or lower price.
• Response options: match the price, hold the price and differentiate, improve service, cut costs.
• Evaluate: a price cut protects volume but cuts the margin on every unit; holding keeps the margin but risks volume.

Market conditions

• Growing market: demand rises for all firms, so rivals may expand capacity.
• Mature or declining market: firms fight for share.
• Seasonal market: idle capacity and cash pressure in quiet months, and a need to hire temporary staff or hold stock in peak months.
• Input market: shortages and poor harvests push input prices up.

Incomes

• Rising incomes help luxuries and premium brands. Falling incomes hit them and can help budget lines.
• Rising incomes across the economy usually raise the pay needed to recruit staff.
• Always say which product you mean.

Interest rates

• Rise: finance costs up on variable-rate debt, credit-financed purchases down, saving more attractive.
• Fall: the reverse.
• Fixed-rate debt delays the cost effect.
• A business with little debt and cash-paying customers is less exposed.

Demographic factors

• Ageing population: more demand for care, health and mobility products; harder to recruit younger workers.
• Young or growing population: more demand for education and housing; larger workforce.
• Always link the trend to the specific product or job role.

Environmental issues and fair trade

• Costs up: certified inputs, recyclable packaging, cleaner production, compliance.
• Costs possibly down over time: less energy and waste.
• Demand: green and fair trade customers may pay more; a poor record can lose customers and reputation.
• Keep legal points general. Say compliance costs money, without quoting detail.

Must-know distinctions

• Cost effect versus demand effect. The same factor can do both. Name both where they apply.
• Percentage point versus percentage. A rate moving from 4% to 5% is a one point change but a 25% change in the interest paid.
• Input rise versus unit cost rise. The unit cost rises by less than the input, unless the input is all of the cost.
• Fixed-rate versus variable-rate. Only the variable-rate bill moves straight away.
• Normal versus inferior. Same fall in incomes, opposite effects on demand.
• Short run versus long run. Green spending may cut profit now and win customers later.

Quick self-test

1. Name the six external factors the specification lists.
2. Which two things does the specification say the external environment can affect?
3. A business has a £200,000 variable-rate loan and the rate rises from 4% to 5%. Find the extra interest in a year and the percentage rise in the interest bill.
4. An input is 20% of a £50 unit cost and its price rises by 25%. What is the rise in unit cost, in pounds and as a percentage?
5. Give one cost effect and one demand effect of a new competitor opening nearby.
6. Define an inferior good and say what happens to its demand when incomes rise.
7. Real incomes rise 4% and sales of a product rise 10%. Find the ratio of the two changes.
8. Give one way an ageing population could raise a business’s costs.
9. Why might switching to fair trade inputs raise costs but also raise profit?
10. Why does a fixed-rate loan delay the effect of a rise in interest rates?

Answers

1. Competition and market conditions; incomes and interest rates; demographic factors; environmental issues and fair trade.
2. Costs and demand.
3. Extra interest £2,000 a year (£10,000 − £8,000); a rise of 25%.
4. Input cost £10 rises to £12.50, so unit cost rises by £2.50, which is 5%.
5. Cost: more spent on marketing, or higher wages as rivals bid for staff. Demand: lost customers, or pressure to cut price.
6. A good whose demand falls as incomes rise because buyers trade up to better products.
7. 10 ÷ 4 = 2.5.
8. Fewer younger workers are available, so recruitment and wage costs may rise.
9. Certified inputs cost more per unit, but ethical customers may buy more or accept a higher price, so extra revenue can outweigh the extra cost.
10. The interest rate on the loan does not change until the fixed period ends, so the finance cost stays the same until then.

Where marks are usually lost

• Listing the factor without saying whether costs or demand change.
• Stopping at “costs rise” without a link to price, volume or profit.
• Using the same effect for every business, ignoring product, customers and debt.
• Treating an input price rise of 10% as a unit cost rise of 10%.
• Mixing up percentage points and percentages in interest rate questions.
• Calling fair trade or green changes only a cost.
• Giving a balanced list with no judgement on which factor matters most and why.
• Forgetting the timing: fixed-rate debt, long-term contracts and slow customer reaction.

Frequently asked questions

Which external factors does AQA 3.1.3 list? Six factors: competition, market conditions, incomes, interest rates, demographic factors, and environmental issues and fair trade. The specification says these can affect a business’s costs and demand.

What is the difference between a normal good and an inferior good? Demand for a normal good rises as incomes rise. Demand for an inferior good falls as incomes rise, because buyers trade up to better products, so the same change in incomes has opposite effects.

Why does a fixed-rate loan delay the effect of a rise in interest rates? The interest rate on a fixed-rate loan does not change until the fixed period ends, so the finance cost stays the same until then. Only the variable-rate bill moves straight away.

Why does unit cost rise by less than an input’s price? Unless the input is the whole of the cost, its price rise applies only to its share of unit cost. For example, a 10% rise in paper that makes up 35% of unit cost raises unit cost by 3.5%.

Official syllabus

AQA, AS and A-level Business (7131 and 7132) specification, section 3.1.3, Understanding that businesses operate within an external environment, under 3.1 What is business?