The impact of the economic environment

Unit 1 – Exploring Business Activity


Assignment 3 – The impact of the economic environment on business


Task 1 (P5)

The impact of the economic environment



Introduction to the Economy

Economics is known to be a science that studies human behaviour regarding their requirements and needs. One of the things it looks at is the demand for services and goods and the effects of what happens when that changes. It looks at how businesses try to supply services and goods in order to meet that demand, and they also look at the problems and difficulties they face in doing so. It includes studying how businesses relate and react to their customers, to each other and to what the government actions are and inactions.


All over the world there are people living in different economic environments. Some countries, particularly in the West are the ones that are quite rich. They have a high standard of living, housing, medicines, education etc. for the majority of people. However, the opposite of this is in third world countries, they can only imagine such luxuries. There are many reasons for the numerous and different economic systems all over the world. Some of this is partially because of the amount of money, or capital, which the country has. It also has something to do with the resources it has available to its country in terms of raw materials and the quality and quantity of labour. Governments worldwide also greatly impact of the economy by making laws, having taxes and controlling the flow of money etc. these factors can either help the country develop or restrict that development. The ways land, resources and capital are used are the key elements in determining the type of economic environment that we live in.


There are three different sectors that a business operate in, a business will only operate in one of the three – Primary (to do with the extraction of raw materials); Secondary (to do with the manufacture of those raw materials) and tertiary (to provide services, including retailing the finished products). These are the important economic categories, as businesses that are in the poorer economic countries of the world are the ones that are usually in the primary sector, whereas businesses in the richest countries are usually in the tertiary and knowledge sectors.



The Importance of Stability

There are always going to be economic problems in the world, regardless of where we live. Decisions have to be made on:


·        The types of goods and services to be produced – should we be concentrating on farming and agriculture, or maybe on housing and education, or even on tourism?

·        How should these goods use vast areas of land (instead of meeting housing needs). Perhaps we should try using high-tech methods which would cost a lot of money (they could be used for schools and hospitals)?

·        Who should be getting the services and goods that we produce? Should everyone be getting an equal share? May be the people that work the hardest and most should be getting the most? But what about the people who cannot work e.g. are full time carers for a relative?



However these questions that are answered will dictate the economy in which we are currently living in. Providing that the economy problem fairly constant output in respect of services and goods, and providing the prices of those goods and services are affordable to the people who will use them.

When the economy becomes unstable, that’s when problems will occur, when services and goods start to become in short supply or the price of the goods and services go so high that people are not able to afford them anymore.  A rise in unemployment could mean that the production and supply of goods decrease and the amount of money to purchase the available goods decreases as well – due to wages being reduced. As there are less people in employment, the taxes being paid to the government are less (they need the taxes to fund services such as housing, health e.g. and education, etc.).


An unstable economy can lead to:

 ·        A shortage of services and goods – in the poverty stricken countries this could even mean food and medicines etc

·        Loss of income and jobs – so even if there were services and goods available, no one could afford to purchase them

·        Lack of income for the government to spend on important public services such as housing, education and health care




The impact on Business of Changes in the Economic Environment

A business has to make lots decisions, which includes:


·        What to produce

·        How to produce it

·        For whom


In deciding what services to offer or what to produce, it will have to take into account many factors –the costs and supply of raw materials, improvements and upgrades on technology and how these have a big effect on products, prices and packages of competitors, strength of the competition, loyalty of their customers/consumers, etc.


In determining how to make the products the business will have a lot of factors to consider. The resources it has access to which includes money (capital), premises, equipment, labour (the number and skills of the workforce), etc.


In determining for whom exactly the services and goods will be made for, the business will have to carefully consider both their present and potential future customers. These may either be consumers, or other businesses – in this country or abroad. The nature of the product, and what competition is doing, will help to determine the price to charge for the product, the package to offer, and the typical customer to aim for (the products target audience).


A business has many decisions to make. However, these decisions will be affected greatly by the economy in which the firm operates. Even if the economy is quite stable, the business always has to monitor its own operations, those of the opposition and any changes to customers’ habits or even lifestyles. Where there is instability in the economy the decisions of the business will be even harder and difficult and even more important. Changing economic conditions can cause:


·        A inadequate amount of raw materials

·        Inflation – where all costs of materials, labour and other resources will go up in price

·        A growth in interest rates where it becomes even more expensive to buy things and it also becomes harder for people to borrow money

·        A growth in unemployment – which means potential/future customers will have less money to spend

·        An increase in restrictions the government has made, making it  more difficult for people to trade

·        Opposition to become fiercer and more competitive as they too struggle to cope with the changing conditions to their business environment


 There are numerous reasons why the above may occur:



When there is a period of growth in the economy – businesses are doing better as they’re becoming more constructive through the use of technology and making greater profits for the owners. Wages are increased as there is an increased output. Inflation and costs increase because of this. As people earn more they have more and more to spend, despite inflation, because they have more money they demand a bigger range of services and goods – perhaps spending on luxury items which they were no able to afford previously. The standards of people get increase more and people demand a better style of life – the basic packages are no longer enough as they are now able to afford luxuries. The leisure and tourism industries grow as people are able to afford to spend money on the latest technology or on their holidays abroad etc. As all these industries are growing, more and more people are able to get jobs and then the process continues.


Unlike a growth period in the economy a recession is the opposite of it. Here businesses struggle to sell their services and goods to people. As sales continue to fall and the business and find it difficult to make a profit, they have to make some of their workers redundant and many businesses, and individuals, will eventually go bankrupt. As unemployment grows, household incomes fall. Businesses cut prices to try to attract customers – which causes inflation to fall too. Consumers have to cut back their spending – concentrating on the basic goods and constantly looking fir bargains. There is little money available for savings.


The Ripple Effect

We have now witnessed how decreased productivity can make a decrease in spending and eventually lead to fewer jobs – which in turn reduce profits and the essential productivity for those sales. The impact of this does not just affect one industry. The ripple effect is where an event has an impact on one industry which spreads to other industries. When housing sales start to slow down, in the housing market, demands for mortgages slows down too – this has an impact on the financial markets. Car sales usually need finance, this too is hit. For example, the car industry, if and when the car industry starts slowing down, employees of the firm will not have as much overtime as they did before and this leads to less money to spend. Instead of eating at a café, they would be more economical and bring a sandwich to work instead – which would affect the businesses that the employee used to go to. Instead of going to a pub to buy beer they would go to a supermarket as it would be cheaper – once again these firms and businesses are affected by the ripple effect of the car industry slowing down.



How Changes in the Economy Affect a Business

If there is a change in the economy there a numerous other fields the business/firm has to answer to:

·        Inflation levels

·        The availability and cost of credit

·        Labour

·        Government policy changes




Inflation is known as an overall rise in prices. 10 years ago if you went into a supermarket and bought 10 they probably would have cost you £3. If you went into the supermarket nowadays and purchased the same product the price of them would have increased – maybe to £5. This is because of the increase in inflation – which is caused by many different factors which includes an increase in the costs of manufacturing goods and products. Inflation increases when there is an economic growth period. In 2006 if inflation was 5% and in 2007 it was 7%, the costs of goods would have risen by over 12% during a period of two years (an increase by 5% followed by an increase by 7% on top of all of that)!


During a period of recession, inflation will slow down. For instance, from one year it could go form 3% to 2%, this is a decreased increase from the year before. In harsh situations prices may decrease – this is known as ‘deflation’.


From the view of a business/firm, rises in inflation, and certainly a slowdown in inflation, need to be thoroughly expected and taken into account in preparation. Many positions of the business could be included in this:

·        Menu costs – changing the prices and labels and goods/products, catalogues and brochures, etc.

·        Customers – where customers/consumers have fixed incomes which means that it may be harder for them to afford any passed on prices.

·        International trading – harder to trade with other countries as UK costs are higher than the costs for other countries.



The Availability and Cost of Credit


Businesses and consumers often have the necessity to finance large items by borrowing money. When it comes to customers this could be either a car loan or a mortgage on their house. For a business/firm, if they are low on money and going through a difficult period it could just be to tide them over, or it could be the case that they want to upgrade apparatus/utensils or expand on their premises. No matter who borrows money, they will end up having to pay interest charges – the cost of borrowing money. In most cases banks who have loaned people money make a profit from lending it people, some of their profits also go to people who have invested their savings into the bank (and therefore provided the sufficient amount of funds to be lent out to people).


The Bank of England sets interest rates in order to sustain a stable economy. If and when the country is in a growth cycle of the economy, people will tend to spend more money – this in turn causes inflation to go up and prices to rise. The Bank of England needs to increase interest rates in order to reduce inflation. By making goods/products more costly to purchase – because of the increased cost of the interest, people will afford to buy less and this will then make inflation go down. The opposite is true in a recession – In order to encourage people buying things, which would give the economy a boost and the Bank of England do this by reducing interest rates.


 In the growth cycle of the economy, therefore, businesses find it difficult to acquire credit because interest rates are high – this makes development and modernisation harder to accomplish. It is also difficult for their customers/consumers to get hold of credit – sales high priced items/products such as cars and houses will be affected. A recession makes interest rates drop lower – nonetheless numerous businesses/firms may still be cautious of borrowing as they are finding it hard sell their goods and products. It’s easier for customers/consumers to borrow money but a lot of them are still out of work. It is hard to get out of a recession, once you are in one.




 A vital decision in a business/firm is the quantity and quality of the labour force that is necessary. Business would clearly favour an exceedingly trained and capable labour force, as this would make productivity and sales rise. During a period of growth, the business/firm could invest deeply in training its workers – nonetheless the more expertise and skill full they become, which means that they can demand more pay. In order to make sure that their employees stay with their company and don’t decide to leave for another job, businesses can offer a range of incentives and perks to keep their employees where they are such as holidays, company cars, travelling by business class when going having to go to another country, help with housing and even crèches for employees who need help with childcare facilities. During a period growth businesses/firms compete in order to get the best experienced and skilled workers – so wages become high.


When a business/company goes into a recession, the amount of people out of work grows as lots businesses/firms go bankrupt. Existing businesses/firms will not give out perks or incentives or even pay large bonuses to their employees anymore, spending/funding training for employees become very limited too. With numbers of people out of work increasing, and more and more people in jobs scared of losing their jobs, wages become lower and the demand for it decreases as well.


Changes in Government Policy


Government brings out numerous new laws, policies and regulations, which businesses/firms are told they have to follow, or are stimulated to follow. These may be:


Legal – new regulations and laws


Fiscal – changes in government spending or taxation


Monetary - changes in credit controls, interest rates and the amount of cash in the economy


A few examples are:


1.    A government can change laws which means that they can bring in complex and informative criteria which makes it hard for a business/firm to acquire credit

2.    The government controls VAT which means they can increase it which makes goods and products costly, therefore less affordable for the ordinary person

3.    Competition laws like monopolising are illegal which means they can stop a large business/firm expanding too much – In effect this can slow down prices increasing