The business cycle and government economic policy

Last time

Before we start: last time, in Globalisation, multinational companies and exchange rates, you learned these points. Here they are again on one card. Keep them in mind, because today builds on them.

The world outside the business

A business can do everything right and still see sales fall, because the whole economy is slowing. The business cycle and government policy affect every firm. This lesson covers the stages of the cycle and how taxes, interest rates and spending change business decisions.

The business cycle

The business cycle is the regular rise and fall of economic activity, measured by GDP. Growth: output and incomes rise. Boom: demand is very high, prices rise fast, and skilled workers become scarce. Recession: output falls and unemployment rises. Slump: a deep, long recession with very high unemployment.

The cycle and business

Each stage affects businesses differently. Here are the main effects.

A boom

In a boom, customers have more money, so sales rise, and businesses may expand. But costs rise: wages go up as workers become scarce, and suppliers raise prices. And the government may raise interest rates to stop inflation, making loans dearer.

A recession

In a recession, incomes fall, so sales fall, especially of luxury goods. Businesses cut costs, reduce output, make workers redundant, and may close branches. Some do well: discount shops and cheaper brands gain customers.

Interest rates

Higher interest rates make loans and overdrafts dearer, so businesses invest less. Customers also spend less, especially on goods bought on credit, such as cars and houses. Lower interest rates do the opposite: cheaper loans, more investment, and more spending by customers.

Taxes

Higher income tax leaves customers less to spend, so sales fall. Higher taxes on profits leave less for owners and for investment. Higher sales taxes raise prices. Higher import tariffs protect home businesses, but raise the cost of imported materials.

Government spending

Government spending on roads, schools and hospitals creates orders for businesses, such as builders. Better infrastructure lowers transport costs for all businesses. Cuts in spending reduce demand, and may cost firms their contracts.

Government aims

Low unemployment, low and stable inflation, economic growth, and a balance of payments without large deficits. Inflation raises costs and makes planning hard; unemployment cuts customers' spending. So businesses watch government policy closely and plan around it.

Responding to change

In a recession: cut costs, offer cheaper products, and focus on loyal customers. When interest rates rise: repay loans, delay expansion, and use retained profit instead. In a boom: expand capacity, but control costs and avoid borrowing too much.

Mistakes that lose marks

Mistake one: saying lower interest rates make borrowing dearer. Mistake two: describing the stage of the cycle without its effect on the business in the case. Mistake three: giving only one effect, when a boom brings both higher sales and higher costs. The fix: the change, the chain, and the effect on this business.

The full-marks tip

The full-marks tip: write the chain: the policy change, its effect on costs or customers, then the effect on the business. For a boom or recession, give one effect on sales and one on costs.

On one card

So, on one card: the economy and government policy. Keep it for revision.