How businesses are affected by fluctuations in economic activity
Each stage of the economic cycle will have different implications for a business and they may have to take action as a result. They will have to consider how a fall or rise in the average income level will affect their sales, which is dependent on the income elasticity of demand of their products. In response to this, businesses will have to plan the quantity they want to sell and the price they want to sell their products at.
Boom:
- Output will increase as will investment
- Unemployment is low but so is recruitment as wages must increase
- Consumers have more to spend – feel more confident about future
- New businesses will start up
- Existing businesses will expand
- Sales of income elastic goods e.g. perfume/cars will increase significantly
- Prices and cost rise as resources become scarce
- Demand-pull inflation occurs causing problems
- Some businesses take too many risks – overconfidence leads to downturn
Downturn:
- Sale of income elastic goods (such as jewellery and cars) will fall
- Sales of other goods will fall
- Unemployment begins to rise as firms make employees redundant to recover lost profit
- Consumers feel less confident; they may reduce spending
- Investment slows as expectations of growth diminish
- Output slows and may fall
- Costs and prices may rise more slowly; inflation may ease
Recession:
- Sales of income elastic goods will fall significantly
- Unemployment is high, so consumers will have less disposable income
- Investment and output of normal goods falls
- Businesses cut back on output and some will fail
- Consumers replace normal goods with inferior goods, so output and sales of these products will rise
- Supply exceeds demand, so prices fall
Recovery:
- Sales of income elastic goods begin to recover
- Sales of other goods begin to rise (milk and bread)
- Consumers feel the worst is over and unemployment begins to fall both causing people to spend more
- Investment begins to increase as confidence returns (e.g. savings accounts)
- Output begins to rise
- Early signs of inflation as economic growth returns