The business cycle
The business cycle describes the phases an economy moves through over time.
- Growth — Rising GDP
- Boom — Highest GDP
- Recession — Falling GDP
- Slump — Low employment levels and low GDP value
Impacts on businesses if there is a change in economic conditions
Four key economic indicators can affect business activity: unemployment levels, inflation, GDP, and the balance of payments.
Definitions
- Unemployment levels — The percentage of people who are looking for work but are not employed.
- Inflation — The sustained increase in the price level of goods/services due to a rise in demand.
- GDP (gross domestic product) — The total value of goods and services produced in a country in a duration of time (1 year).
- Balance of payments — The record of all financial transactions by a country (includes the balance of trade; the difference between the value of imports and exports).
Impact of each indicator
| Indicator | Impact on businesses |
|---|---|
| Unemployment levels | As employment levels increase, inflation may occur due to more disposable income. Employees can also push for pay raises due to the lack of labour availability, as most people are already employed. This increases production costs. |
| Inflation | Purchasing power of the public decreases as goods and services are now too expensive (cost of living rises). Businesses begin to struggle, which may cause a rise in unemployment. |
| GDP | As GDP increases, this means there is a high level of country output and spending, suggesting high employment. A falling GDP may be a result of inflation, and results in unemployment and reduced spending. |
| Balance of payments | The balance of payments should aim to be equal. For IGCSE, the balance of trade is important. If export value exceeds imports (trade surplus), a country's currency will strengthen — however, this means they become less globally competitive, as foreign importers find their goods more expensive. Similarly, if imports exceed exports, a depreciation in the country's exchange rate may occur, meaning locals cannot afford foreign goods. Therefore, a balance is needed. |
The balance of payments should aim to be equal. A trade surplus strengthens the currency but reduces global competitiveness; a trade deficit can cause the exchange rate to depreciate, making foreign goods unaffordable for locals.
Government objectives over the economy
Governments use fiscal and monetary policy to influence the economy. The table below shows why each measure is used and how businesses might respond.
Increase in taxes and decrease in government spending
- Why? Taxes are usually increased to reduce spending in an economy and to discourage high production. This may cause unemployment to rise. However, this is often used to mitigate rises in inflation, and spending rises exponentially.
- How businesses might respond — They may reduce the level of output to prevent overproduction and to cut inventory costs. As profit falls, plans for expansion must also be halted. Prices of products may also be lowered.
Decrease in taxes and increase in government spending
- Why? Reducing taxes will increase spending in an economy, and by investing more in the country (increasing government spending), this encourages production for an increased GDP value. Employment will increase.
- How businesses might respond — Output levels may increase in order to meet demand.
Change in interest rates
- Why? Interest rates may increase, which will cause GDP and employment to decrease. This is often done to reduce inflation, discouraging spending.
- How businesses might respond — Decrease spending and decrease/increase production in accommodation to demand.
Summary of government measures
| Government measure | How businesses might respond |
|---|---|
| Increase in taxes and decrease in government spending | Reduce output to prevent overproduction and cut inventory costs; halt expansion plans as profit falls; may lower product prices. |
| Decrease in taxes and increase in government spending | Increase output levels to meet rising demand. |
| Change in interest rates | Decrease spending and decrease/increase production in accommodation to demand. |