The Business Cycle
The business cycle shows the changes in the level of economic activity in an economy over time.
→ Economic activity does not remain at the same level.
→ Periods of increasing economic activity are followed by periods of slower activity or decline.
The four main stages are:
→ Growth
→ Boom
→ Recession
→ Slump
Growth
Growth is a period when economic activity and output are increasing.
→ Businesses generally experience rising demand for goods and services.
→ Consumer spending is likely to increase.
Effects on Businesses
→ Sales and revenue may increase.
→ Profits may increase.
→ Businesses may increase production.
→ More workers may be employed.
→ Businesses may invest in new machinery and equipment.
→ Businesses may open new branches or enter new markets.
→ Competition for workers may increase, causing wages to rise.
Example:
→ If an economy is growing, consumers may have higher incomes and spend more on clothing, restaurants and entertainment.
→ Businesses supplying these products may experience higher sales.
Boom
A boom is a period of very high economic activity and rapid growth.
→ Demand is often very strong.
→ Employment is generally high.
→ Businesses may operate close to full capacity.
Effects on Businesses
→ Sales and revenue may increase significantly.
→ Profits may rise.
→ Businesses may increase production.
→ Investment may increase.
→ Businesses may find it easier to expand.
→ Shortages of skilled workers may occur.
→ Wages may increase because businesses compete for workers.
→ Costs of raw materials and other resources may increase.
→ Strong demand may allow businesses to increase prices.
→ Inflationary pressure may increase.
Recession
A recession is a period when economic activity declines.
→ Demand for goods and services is likely to fall.
→ Businesses may experience lower sales.
→ Consumer confidence may decrease.
Effects on Businesses
→ Sales and revenue may fall.
→ Profits may decrease.
→ Businesses may reduce production.
→ Investment may be postponed.
→ Businesses may reduce the number of employees.
→ Some businesses may close if losses continue.
→ Businesses may reduce prices or increase promotional activity to maintain sales.
→ Businesses may look for ways to reduce costs.
Example:
→ During a recession, consumers may postpone buying cars, furniture and other expensive products.
→ Businesses selling these products may experience a significant fall in demand.
Slump
A slump is a period of very low economic activity and prolonged decline.
→ Demand and production may be very low.
→ Unemployment is likely to be high.
→ Consumer and business confidence may be weak.
Effects on Businesses
→ Sales may fall significantly.
→ Profits may fall or businesses may make losses.
→ Production may be reduced.
→ Businesses may reduce their workforce.
→ Investment may be postponed.
→ Businesses may close.
→ Businesses may offer discounts to encourage customers to spend.
→ Businesses may focus on reducing costs and protecting cash flow.
Comparing the Stages of the Business Cycle
| Stage | Economic Activity | Likely Business Effects |
|---|---|---|
| Growth | Increasing | Rising sales, production and investment |
| Boom | Very high | Strong demand but possible higher costs and wages |
| Recession | Decreasing | Falling sales, lower profits and reduced investment |
| Slump | Very low | Very weak demand, losses and possible business closures |
Employment and Businesses
Employment refers to the number of people who have jobs.
High Employment
→ More people have incomes.
→ Consumer spending may increase.
→ Businesses may experience higher demand.
→ However, businesses may face higher wages because skilled workers are in greater demand.
Example:
→ A restaurant may have difficulty recruiting chefs and waiters during a period of high employment.
→ It may need to increase wages to attract workers.
High Unemployment
→ Fewer people have incomes from employment.
→ Consumer spending may decrease.
→ Businesses may experience lower demand.
→ Businesses may find it easier to recruit workers.
→ Wage costs may increase more slowly or even decrease.
Inflation and Businesses
Inflation is a general increase in the prices of goods and services over time.
Effects of Higher Inflation
→ Raw material costs may increase.
→ Wages may increase.
→ Transport and energy costs may increase.
→ Business operating costs may rise.
→ Profit margins may fall if businesses cannot increase their prices sufficiently.
→ Customers may reduce spending because their purchasing power has fallen.
→ Businesses may need to increase prices.
Example:
→ A bakery faces higher prices for flour, electricity and transport.
→ Its production costs increase.
→ The bakery may increase the price of bread, reduce costs or accept a lower profit margin.
Effects of Lower Inflation
→ Costs may increase more slowly.
→ Businesses may find it easier to plan future costs.
→ Customers’ purchasing power may be more stable.
→ However, lower inflation may occur during a period of weak demand, which could reduce sales.
Economic Growth
Economic growth is an increase in the output of goods and services produced by an economy over time.
Effects of Economic Growth on Businesses
→ Consumer incomes may increase.
→ Demand may increase.
→ Sales and revenue may increase.
→ Businesses may increase production.
→ Profits may increase.
→ Investment may increase.
→ Businesses may employ more workers.
→ Businesses may expand into new markets.
Effects of Low or Negative Economic Growth
→ Demand may fall.
→ Sales may decrease.
→ Businesses may reduce production.
→ Investment may be postponed.
→ Employment may fall.
→ Businesses may focus more heavily on reducing costs.
Effects of Government Policy
Government policies can affect businesses by changing:
→ taxes
→ government spending
→ interest rates
These changes can influence consumer spending, business costs, investment and demand.
Changes in Taxes on Business Profit
Businesses may have to pay taxes on their profits.
Increase in Business Profit Tax
→ The business keeps a smaller proportion of its profit.
→ Retained profit available for investment may decrease.
→ Expansion may be delayed.
→ Businesses may look for ways to reduce costs.
→ Some businesses may increase prices if market conditions allow.
Example:
→ A business makes $500,000 profit.
→ If the amount of tax paid increases, less of the profit remains available for reinvestment.
Decrease in Business Profit Tax
→ Businesses keep more of their profits.
→ Retained profit increases.
→ Businesses may have more finance available for:
→ expansion
→ new technology
→ machinery
→ recruitment
→ product development
Changes in Taxes on People’s Income
Income taxes affect the amount of income consumers have available to spend.
Increase in Income Tax
→ Consumers have less disposable income.
→ Consumer spending may decrease.
→ Businesses selling goods and services may experience lower demand.
→ Businesses may reduce production or delay expansion.
Example:
→ If consumers have less disposable income, they may reduce spending on restaurants, holidays and entertainment.
Decrease in Income Tax
→ Consumers have more disposable income.
→ Consumer spending may increase.
→ Businesses may experience higher demand.
→ Sales and revenue may increase.
Changes in Government Spending
Government spending includes spending on areas such as:
→ infrastructure
→ education
→ healthcare
→ transport
→ public services
Increase in Government Spending
→ Businesses supplying goods and services to the government may receive more orders.
→ Construction businesses may benefit from infrastructure projects.
→ More employment may increase household incomes.
→ Higher incomes can increase consumer spending.
→ This may increase demand for businesses across the economy.
Example:
→ The government builds a new railway network.
→ Construction companies receive contracts.
→ Suppliers of steel, machinery and construction materials may also experience increased demand.
Decrease in Government Spending
→ Businesses dependent on government contracts may experience lower demand.
→ Employment may decrease in affected industries.
→ Lower incomes may reduce consumer spending.
→ Businesses may experience lower sales.
Changes in Interest Rates
Interest rates affect the cost of borrowing and the return from saving.
Increase in Interest Rates
→ Borrowing becomes more expensive.
→ Businesses with loans face higher interest costs.
→ Investment may decrease.
→ Consumers may reduce spending because borrowing becomes more expensive.
→ Businesses may experience lower demand.
→ Businesses may delay expansion or purchases of machinery.
Example:
→ A business planning to borrow $1 million to build a new factory may postpone the investment if the interest cost becomes too high.
Decrease in Interest Rates
→ Borrowing becomes cheaper.
→ Businesses with loans may have lower interest costs.
→ Investment may increase.
→ Consumers may borrow and spend more.
→ Demand for goods and services may increase.
→ Businesses may find expansion more attractive.
How Businesses May Respond to Changes in Taxes
If Taxes Increase
Businesses may:
→ reduce costs
→ improve efficiency
→ delay investment
→ reduce dividends
→ increase prices where possible
→ find alternative suppliers
→ reduce unnecessary spending
→ improve productivity
If Taxes Decrease
Businesses may:
→ increase investment
→ purchase new technology
→ expand production
→ recruit employees
→ develop new products
→ increase marketing
→ retain more profit
How Businesses May Respond to Changes in Interest Rates
If Interest Rates Increase
Businesses may:
→ delay borrowing
→ postpone expansion
→ use retained profit instead of loans
→ reduce unnecessary spending
→ repay existing loans more quickly if financially possible
→ focus on improving efficiency
If Interest Rates Decrease
Businesses may:
→ borrow to finance expansion
→ purchase machinery
→ invest in technology
→ open new branches
→ increase production capacity
→ take advantage of lower borrowing costs
Making Business Decisions During Economic Changes
Businesses should consider how economic conditions affect both demand and costs.
Example
A business is considering opening a new factory.
→ Interest rates have increased.
→ The cost of borrowing will be higher.
→ The business may postpone the investment or use retained profit instead of taking a large loan.
However:
→ If demand for the product is also rising rapidly, the expected increase in sales may make the investment worthwhile.
→ The decision therefore depends on the size of the interest-rate change, the expected demand, the cost of finance and the financial position of the business.
Overall Impact of Economic Issues on Businesses
→ Economic growth → generally increases demand and creates opportunities for expansion.
→ Boom → strong demand but potentially higher wages and input costs.
→ Recession → lower demand, sales and investment.
→ Slump → very weak demand and greater risk of losses and business failure.
→ High employment → greater consumer spending but potentially higher wage costs.
→ High inflation → higher business costs and pressure to increase prices.
→ Higher business taxes → lower retained profit.
→ Higher income taxes → potentially lower consumer spending.
→ Higher government spending → can increase demand and create opportunities for businesses.
→ Higher interest rates → higher borrowing costs and potentially lower investment and consumer spending.
→ Lower interest rates → cheaper borrowing and potentially higher investment and demand.