4. The Economy & Business

What is the economic climate?

The broad peformance of the UK economy, as measured by changes to GDP growth

What happens when GDP growth increases?

Incomes may increase, spending on goods/services increases, inflation may rise and unemployment may fall

What happens when GDP growth decreases?

Incomes may fall, spending on goods/services falls, inflation may fall and unemployment may rise

How do economic changes impact businesses?

• Opportunities & threats: Economic changes can create new chances for growth or potential risks.

• Adaptation is key: Businesses must anticipate and respond to economic shifts.

• Impact on demand: Changes in factors like inflation, interest rates, or unemployment can affect consumer spending.

• Strategic decisions: Businesses may need to adjust prices, reduce costs, or expand into new markets to remain competitive.

What are the key economic variables businesses must consider to maximise chance of success?

• Inflation – Affects costs of raw materials and pricing strategies

• Unemployment – Impacts consumer spending and labour availability

• Exchange Rates – Influences import/export costs and international competitiveness

• Household Income – Determines consumer purchasing power and demand

• Interest Rates – Affects borrowing costs for businesses and consumers

• Government Taxation – Impacts business profits and consumer disposable income

What happens when a households income rises?

The impact on businesses will depend on the nature of the goods/services that they sell

• Firms which sell inferior goods will see a fall in demand and sales revenue will fall

• Firms which sell normal goods and luxuries will see an increase in demand and sales revenue 

What happens when a households income falls?

The impact on businesses will depend on the nature of the goods/service that they sell

• Firms which sell inferior goods will see an increase in demand and sales revenue will rise

• Firms which sell normal goods and luxuries will see a decrease in demand and sales revenue

What are the business challenges cause by inflation?

• Increased business costs - Workers often demand higher wages to compensate for the increase in the cost of living, suppliers increase the cost of raw materials and components. Utilities such as electricity become more expensive

• Higher repayment on loans - Interest rates usually rise which makes business borrowing more expensive

• Consumers change spending habits - Price increases deters consumers from making more luxury type purchases. Consumers focus more of their spending on necessities

What is the exchange rate?

The value of one currency expressed in terms of another

Who are exchange rates important to?

• Businesses that import raw materials and components

• Businesses that export their products

What can happen to a value of a currency over time?

• It can appreciate - when the value of a currency rises making its exports relatively more expensive

• It can depreciate - when the value of a currency falls making its expore relatively more attractive & its import less attractive

What is the impact of appreciation on exporting and importing businesses?

• Exporting Businesses - Sales are likely to fall as products become more expensive when compared to overseas competitors. In order to remain competitive, exporting businesses may need to lower prices and accept lower profit margins (a % of the proportion of revenue that’s converted to profit)

• Importing Businesses - Costs are likely to fall as raw materials from overseas become cheaper

What is the impact of depreciation on exporting and importing businesses?

• Exporting Businesses - Sales are likely to rise as products become cheaper when compared to overseas competitors

• Importing Businesses - Costs are likely to rise as raw materials from overseas become more expensive. Businesses may seek domestic suppliers to reduce costs and maintain profit levels

What is the interest rate?

A percentage reward offered for saving money and the percentage charged for borrowing money

How do lenders set interest rates on borrowing and savings?

Lenders commonly charge interest on borrowing at a higher rate than the rate offered to customers for savings and investments

What happens if interest rates rise?

Businesses will have to pay more on their loan payments which will increase their costs

What is a potential impact of high interest rates on businesses' capital investments?

Businesses may be less willing to make capital investments and instead, choose to save their money

How do high interest rates affect customer purchasing behavior?

Customers are less likely to purchase goods on credit when interest rates are high, leading to a fall in sales

What are direct and indirect taxes imposed by governments on businesses and households?

• Direct taxes are levied on income e.g. Income tax and Corporation Tax)

• Indirect taxes are levied on spending e.g. Value Added Tax - VAT

What is the impact of increased taxation on revenue?

This may fall for many businesses

• Increased income tax will reduce the disposable income of customers and demand for products may fall

• Increased VAT will make products more expensive and customers may switch to alternative products

What is the impact of increased taxation on costs?

Will rise as a result of increased taxes such as VAT and National Insurance contributions

• Higher costs may be offset by charging higher prices

• Higher prices may lead to lower sales and profits may fall

Import costs are increased when customs duties (taxes imposed by a government on imported goods) are raised

What is the impact of increased taxation on business decisions?

May be affected by increases in business rates and taxes related to employing workers

• Businesses may choose to forego business improvement or relocation, or employ fewer workers as a result of increased costs

How does the unemployment rate affect businesses?

• The impact on businesses depends on the type of skills required

• As unemployment falls, businesses must pay more to secure skilled workers

• A lower supply of skilled workers leads to higher salaries

How does a falling unemployment rate affect wages for unskilled workers?

• Businesses may have to pay more to secure unskilled workers

• A lower supply of unskilled workers leads to higher wages

• Wage increases depend on how limited the supply of unskilled workers is

How does the unemployment rate influence a business’s labour costs?

• A higher unemployment rate generally leads to cheaper labour.

• Labour costs are significant for many businesses.

• The unemployment rate can directly impact the profitability of the business.