6.1. Economic issues
- Syllabus
- 0264–2027–2028
- Topic
- 6.1
- Level
- —
Learning objectives
6.1.1Business cycle• main stages of the business cycle: growth, boom, recession, slump• how each stage of the business cycle may affect a business• effects of changes in the levels of employment, inflation and economic growth on a business6.1.2Effects of government policy• effects of changes in taxes on business profit• effects of changes in taxes on people’s income• effects of changes in government spending• effects of changes in interest rates• how businesses may respond to changes in taxes and interest rates
How the business cycle changes decisions
The business cycle is the repeated fluctuation of economic activity over time. Movement through growth, boom, recession and slump changes customer income and demand, the availability and cost of workers, business costs and confidence. A stage therefore creates several connected effects rather than one guaranteed outcome.
| Stage | Typical conditions | Possible effect on a business |
|---|---|---|
| growth | GDP, employment, income and demand rise | sales, output, profit and investment may rise; skilled workers and premises can become harder or costlier to obtain |
| boom | demand and capacity use are very high; unemployment is low; inflationary pressure grows | strong revenue and confidence may support expansion, but wage, material and borrowing pressures can squeeze profit |
| recession | GDP and consumer spending fall; unemployment rises | sales, cash flow and profit may fall, so a business may cut costs, delay expansion or prioritise survival; recruitment may become easier |
| slump | economic activity and confidence remain very low | prolonged weak demand can cause losses, supplier failure and difficulty borrowing, although labour may be more available |
| Change | Demand-side effect | Cost or capacity effect |
|---|---|---|
| higher employment | more household income can raise sales | fewer available workers can raise recruitment difficulty and wages |
| higher inflation | customers may buy less after prices rise | materials and wages may cost more; raising prices can further reduce demand |
| faster economic growth | rising income and confidence can raise demand and encourage investment | competition for labour, sites and inputs can raise costs |
For example, rapid growth may increase a housebuilder's orders and profit, encouraging more output and investment. At the same time, scarce builders may demand higher wages. Whether profit rises depends on whether extra revenue is greater than the extra labour and input costs.
Do not assume every business moves with the economy in the same way. The effect depends on what it sells, how price- or income-sensitive demand is, whether it needs new workers or borrowing, and how long the change lasts.
How government policy reaches a business
Government policy affects a business through four main routes: the profit it keeps, customers' disposable income, government-created demand and the cost of borrowing. Trace the policy change through one of these routes before deciding its likely effect.
| Policy change | Mechanism and likely business effect | Possible business response |
|---|---|---|
| higher tax on business profit | less profit remains for dividends or reinvestment | postpone expansion, seek other finance, reduce costs or reconsider prices |
| higher tax on people's income | disposable income and demand may fall, especially for non-essential products | adjust price or product mix, control costs or target customers less affected |
| higher government spending | government purchases, jobs or infrastructure may raise demand; later tax or inflation effects may raise costs | tender for contracts or add capacity only when the extra demand is credible |
| higher interest rates | loans and overdrafts cost more; household loan payments can reduce spending and sales | delay or reduce borrowing and investment, use retained profit or another finance source |
| lower interest rates | borrowing costs and some household repayments fall, which may increase investment and demand | take a viable loan, expand capacity or invest when expected returns still exceed the cost and risk |
A rise in income tax can reduce customers' disposable income, lowering demand and revenue. A rise in profit tax acts after profit is earned and leaves less retained profit for investment. The two taxes therefore reach the same business through different mechanisms.
An increase in government spending may directly raise orders for suppliers, create jobs and increase consumer spending. It does not benefit every business equally: the spending destination, possible inflation, competition for workers and any future tax increase can change the final result.
A policy change is not automatically good or bad. Its size and timing, the type of tax, whether the business or its customers borrow, the product's demand, and the business's current profit and capacity determine which mechanism dominates.