A2 - Business - The relationship between business and the economic environment

The main economic factors influencing business activity

Even the most successful and efficient business organisations is influenced by external economic factors. External economic factors can be divided into two groups: those operating within the business organisation's market and those operating in the whole economy.

Economic factors operating within the business organisation's market

These are often referred to as micro-economic factors. For example, the price of diamonds sold by a diamond mining company could be affected:

• the prices of alternative gemstones - if these fall, then the demand for diamonds might be reduced and the price of them too.
• supply problems in other diamond-producing areas - this might lead to higher prices
• reduced demand from the industry for diamon-tipped drills

Economic factors operating in the whole economy

These are often referred to as micro-economic factors. This chapter will focus on this second type of external economic influence on business activity.

The importance of the state of wider economy on business strategy and business success should not be underestimated. The impact of the so-called 'credit crunch' in 2008?09 on world economic prosperity and the reaction of governments and central banks to the threats that it posed is a good example of how all firms can be affected by economic developments beyond their control.

Our analysis of the impact of macro-economic factors on business strategies begins with a study of the trends in the most important indicators of a country's economic performance.

The key economic variables that influence business activity

The economic environment in which organisations operate has a very important influence on business success and failure. The state of the economy can be measured in a number of different ways - often called 'macro-economic indicators' as they measure the performance of the whole economy, not just one industry or one market. These indicators are gross domestic product, economic growth, the rate of inflation, interest rates, unemployment and exchange rates.

Gross domestic product (GDP)

Gross domestic product (GDP) represents the value of a country's national income in oney year. It is usually adjusted for inflation (producing 'real GDP') - so any increase in GDP is caused by a real increase in output, not just inflation. An increase in real GDP almost always means that the population's standard of living is increasing - and this means they have more money to spend. Changed in the growth rate of GDP occur frequently. When they are recorded over time, with the inevitable ups and downs of economic activity, the pattern shown is called the business cycle. 

The four key stages are:

• Boom: A period of very fast economic growth with rising incomes and profits. However, a boom often sows the seeds of its own destruction. Inflation rises due to very high demand for goods and services, and shortages of key skilled workers leads to high wage increases. High inflation makes this economy's goods uncompetitive and business confidence falls as profits are hit by higher costs. The government or central bank often increases intrest rates to reduce…