You may have heard of the term economic climate before
but wondered what exactly is the economy and how does its climate impact businesses?
Well, believe it or not you are part of your country’s economy
and play a role in its economic climate.
In business, what’s happening in the economy really matters,
it impacts how much money consumers like yourself and businesses have available
to spend and invest, as well as how many people are available to work.
In simple terms, the economic climate relates to the performance of the economy,
it’s a measure which can be used to aid the government, businesses,
and consumers to make better decisions.
For example, if the UK enters a recession, the economic climate could be described as negative.
When the economic climate is negative, the country is likely to experience higher rates
of unemployment, lower wages and incomes, alongside lost opportunities more generally.
This is not good for the average person and business,
as people won’t have as much financial security and therefore as a result,
will limit their spending which impacts the profitability of businesses.
In turn, businesses will then have to cut costs which often leads to reducing the workforce,
leading to higher rates of unemployment and even less money to spend in the economy.
It’s a very vicious circle.
This is where the government tries to step in with its strategies to boost the economy,
save jobs, and increase consumer spending.
In relation to the economic climate, there are six key ways in which it can impact businesses,
these are: • Unemployment
• Changing levels of consumer income • Inflation
• Changes in interest rates • Government taxation
• Changes in exchange rates Let’s look at each one of these
with some supporting examples.
First up, it’s unemployment. The rate of unemployment is based
on the amount of people who are of working age and able to work but are not currently working.
At its highest, just under 12% of people were classed as unemployed in the UK
back in 1984 and when the rate of unemployment is high,
it means that the economy is not making the most of the people who are available to work, which
negatively impacts household incomes, decreases consumer spending, and slows down the economy.
But, unemployment has been as low as 3.4% in the past and when the rate of unemployment is low,
this also impacts businesses because less people are available for work
which makes it harder to attract new employees and retain current employees.
Essentially, the job market becomes very competitive, and businesses typically need
to increase wages and other perks to attract and retain the best employees possible.
On the plus side, more people are in work, meaning they have greater financial security
and more money to spend on the products and services that businesses offer,
which helps to boost the economy. Next up, it’s changing levels of consumer income
Consumer income refers to the amount of money that people receive from working
or from any investments they have made. Put simply, the higher the level of consumer
income, the more financial security they are likely to have, which leads
to increased consumer confidence and spending. This is good news for most businesses, especially
those who produce and sell premium products or provide premium services, because customers have
increased confidence in their personal finances and are likely to purchase higher quality goods
at a higher price or even just upgrade their existing products because they can afford too.
But, when levels of consumer income are low, consumer confidence drops
as they have less financial security which impacts the buying behaviour of most consumers as they
look to cut back on the amount they purchase and will often look for cheaper alternatives.
For example, when consumer income is low, discount retailers such as Primark and Aldi
often see sales increase as customers switch from more high-end competitors to save money.
We now move onto Inflation. which is the term used to
describe the increase of prices over time and can have a serious impact on businesses.
It is measured using an index, with the Consumer Prices Index being one
of the most common measures used. The Consumer Prices Index works by
measuring how the price of a common collection of consumer goods changes over a set period of
time and is represented as a percentage. For example, in 2022 inflation rose by
7% in the 12 months to March, which is the fastest for 30 years and according to the
Office for National Statistics, the largest contributors to this growing inflation were
increased fuel prices and energy bills. This 7% rate of inflation means that the
price of the average good or service has increased by 7%. For example, if a product
was £1 last year, it would now be £1.07. Unless income rises at the same rate,
inflation will negatively impact the purchasing power of money, this is because
consumers now need more money on average to purchase the same products and services.
Rising inflation can have a negative impact on the profitability of businesses as overall
consumer spending is likely to decrease, whilst at the same time, employees may be asking for a pay
rise to help with the increased cost of living. In addition, if inflation is higher in the UK
than it is in other countries, the cost of UK goods becomes comparably more expensive,
which can lead to a fall in demand for the goods of UK businesses that operate on a global scale.
Up next, its changes in interest rates The base rate of interest is set by the
bank of England and is used by all other banks and lenders in the UK.
Put simply, interest is the amount of money that a person or business is charged for borrowing
or the amount of money that is paid for saving. It is usually represented as a percentage,
for example if the interest rate was 5%, for every £1 that is borrowed,
5p will be charged and for every £1 that is saved, 5p will be paid.
When interest rates are high, consumers are encouraged to save their money and
are less likely to borrow money, which leads to lower consumer spending overall, with the
opposite being true for low rates of interest. Government taxation is another key factor.
In order to spend money to pay for public services and support individuals and businesses,
the government either has to borrow money or raise it from taxes.
Tax is charged on personal income, businesses profits, and the costs of consumer goods
through a wide range of taxes which are implemented by the government.
These include: • Income tax
• National insurance • VAT
• Corporation tax • And Council tax
Government taxation impacts businesses in a number of ways,
essentially the higher the taxation on consumers, the lower their spending power,
which results in lower sales, and businesses needing to reduce their costs
and potentially halt any investment plans. The government can also use taxation to boost
business, for example, in the past during tough economic climates, they have lowered
the VAT charged on products and services. This strategy effectively reduces the price
that consumers pay which boosts sales without impacting the profit margins of businesses.
Last up, its changes in exchange rates. The exchange rate is a measure used to express the
value of one currency against another currency. For example, the exchange rate between the
British £ and the euro is currently £1 to €1.18 but any significant changes to this exchange
rate could impact the costs and profits of the businesses involved in the overseas transactions.
In today’s global business world, UK businesses often trade and operate with lots of different
stakeholders who use a variety of currencies all around the world, so it is crucial that exchange
rates are constantly monitored and factored in to any business decisions or agreements.
If for example, a UK business buys its supplies such as raw materials from a supplier which is
based in another country or exports its goods to customers in other countries
the exchange rate will determine the costs and profitability of these transactions.
So that’s it, a quick introduction to the economic climate and the key ways it can impact businesses.
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