The impact of the economic climate
The economic climate is the general state of the economy, and no business controls it. What a business can do is understand how each factor affects it, and respond — which is what 1.5.5 covers next.
The specification names six factors.
Interest rates deserve a second look, because they hit a business twice. Directly, a rise makes existing loans and overdrafts more expensive to service and new borrowing less attractive, so planned expansion may be postponed. Indirectly, customers with mortgages have less money left each month, so they spend less — and businesses selling non-essentials feel that first.
- Economic climate
- the general state of the economy, which no business controls but every business is affected by
- Interest rates
- the cost of borrowing money, which affects both what a business pays on its loans and what its customers can afford to borrow and spend
Exchange rates
Exchange rates are the factor students most often get backwards, so it is worth a rule rather than an example to memorise.
When the pound is strong, it buys more foreign currency. Imports become cheaper, because a pound goes further abroad. Exports become more expensive for foreign buyers, because they need more of their currency to buy each pound's worth of goods.
When the pound is weak, the opposite: imports cost more, and exports become cheaper and so more competitive abroad.
Worked example
A UK furniture maker imports timber from Europe and sells about a third of its output to customers in France. The pound weakens. Analyse the impact.
- Take the imports first: a weaker pound means imports cost more, so the timber becomes more expensive.
- That raises variable costs, which raises the break-even output and squeezes profit per unit.
- Now the exports: a weaker pound makes UK goods cheaper for French buyers.
- So the furniture becomes more competitive in France and export sales are likely to rise.
- Weigh the two, because the answer depends on which effect is larger.
Answer: Costs rise because imported timber is dearer, squeezing profit margins — but exports become cheaper for French customers, so sales there should rise. The overall effect depends on the balance: with a third of output exported, higher export sales may well outweigh the extra material cost, though the business could also consider a UK timber supplier.
- Exchange rate
- the value of one currency in terms of another; a strong pound makes imports cheaper and exports more expensive for foreign buyers
Boom and recession
The six factors tend to move together, in a pattern worth recognising.
In a boom, incomes rise, unemployment falls and confidence is high, so sales rise — particularly of non-essentials. But wages and materials cost more, and recruiting becomes harder because there are fewer people looking for work.
In a recession, incomes fall and unemployment rises, so sales fall and customers switch to cheaper alternatives. Some businesses suffer badly, while budget retailers and repair services can do well — because customers trade down rather than stopping spending altogether.
That last point is what separates a good answer from a general one: a recession does not affect every business the same way, and which way it goes depends on what the business sells.
- Boom
- a period when incomes rise, unemployment falls and confidence is high, so sales rise — particularly of non-essentials
- Recession
- a period of falling output when incomes fall, unemployment rises and consumers spend less
Before you practise
- The six factors: unemployment, changing consumer income, inflation, interest rates, government taxation, exchange rates.
- High unemployment lowers sales but makes recruitment easier and cheaper.
- Inflation raises costs, and forces a choice between raising prices and losing profit.
- Higher interest rates raise borrowing costs and leave customers with less to spend.
- Higher taxes reduce profit, or reduce what customers can spend.
- SPICED: Strong Pound, Imports Cheap, Exports Dear.
- A booming economy raises sales but also wage and material costs.
- A recession hurts sellers of non-essentials, but budget retailers can benefit as customers trade down.