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Birmingham Business School
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Programme Of Study: Business Management
Module: Introduction to Business, Economy and Government
Assignment Title: Business in economy
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Economic indicators are facts and statistics which help in determining how the economy of a certain area is about to perform. These facts are released by major financial institution such as the federal reserve and are updated every 3 months. It is very important that business firms use the statistics of indicators because it helps in determining whether the market is going to rise or fall (Discoveroptions.com, 2018). There are three different types of economic indicators based on their timing and are called leading, coincident and lagging indicators. This essay, is divided into three section covering different economic indicators namely, gross domestic product, inflation and employee rates are the three indicators that the business firms need to monitor and should these indicators into consideration before making a business decision. Monitoring these indicators helps business firm to understand the economy under which the market operates better, this will also help in earing higher returns (The Economist guide to economic indicators: making sense of economics, 1998, page 2). These statistics are also used by investors to make new capital investments or make changes the old investments. Investors use data collected from different countries to make international investments. Information collected from the economic indicator also helps in comparing the performance of countries.
1. Real Gross Domestic Product
Gross Domestic Product(GDP) is the total number of good and services produced in an economy over a period of time, it represented in monetary value. “and the GDP growth rate is probably the single best indicator of economic growth.” (Elvis Picardo, 2018). GDP shows the total of all economic activities of a country. GDP is a coincident indicator because the changes in the economy occur at the same time as changes take place in the GDP. The GDP is in direct relation to the countries corporation profits that is why GDP is also called a procyclic economic indicator (Moffatt M, 2018). GDP is a long-term determinant of economic growth of a country and can be measured in various ways such as the output method and the expenditure method. Real GDP is mainly used to measure the economic performance of a country rather than nominal GDP because real GDP takes the prices of the base year (Mulhearn and Vane, 2012)
Figure 1: Gross Domestic Product of United States
Figure 2: Corporate profits of United States
GDP of the United States has seen a constant increase from 2007 to 2018 these also leads to increase in the corporate profits as seen from the above table, but the profits also reduce when the GDP does not increase, the GDP was very low and falling through out 2008 this also led to a decrease in the corporate profits from $1708.9 billion to $1345.5 billion. This table proves the link between the GDP and corporate or business profits. “Economic growth refers to an increase in real GDP, while annual percentage change in real GDP in known as the rate of economic growth.” (Mulhearn and Vane, 2012). This rate of economic growth can be both positive and negative, this rate should neither be to slow or too fast. The business firms need to monitor these rates to make better business decisions, if the rate of economic of growth is too much and unadjusted this means, the firms to produce more products and services leading to an increase in the in wages of the worker and also increase the cost of product leading to inflation (Investopedia, 2018). If the growth of GDP is slowing down it could lead to recession in the market. Slowing GDP indicates that the country has reduced the number of goods and services it produces, this leads companies to cut down costs to prevent loss and fire most of its employees.
Figure 3: GDP growth and unemployment of South Africa
Source: Source: Statistics South Africa.
The above diagram shows us the relation between the GDP and employment rates from 2008 to 2013. There is a very big fall in the GDP through 2008 which caused over millions of employees to lose their jobs within a single year. Real GDP growth is not constant over a year, in tends to fluctuate over a period. These fluctuations are measured with the help of a trend GDP line. These fluctuations can either be positive or negative causing different periods in the business cycle such as boom, recession, peak and so on. In the figure 3 we can see that the GDP fluctuations in South Africa were negative and this caused a recession in the country causing a lot of companies to cut off their employees. Business firms have to great importance to understand business cycles, during booms, the demand for all products go up, production and profits rise leading firms to invest and expand their operations while during a recession the there is less money in the market and the demand for all products goes down. Monitoring the business cycle can help the firm in investing their money at the right time, investing during a recession can only lead to a failure and having less funds during booms forces the business to either miss an opportunity or borrow funds at a very high interest rate (Chrystal and Lipsey, 2010). When the GDP is divided by the total number of population the solution is known as the GDP per capita, this is also the average living standard of the country. This information is used by investors making international investments and is also used to helps in comparing the economic performance of different countries. (FocusEconomics | Economic Forecasts from the World’s Leading Economists, 2018)
Inflation refers to a general increase in price of the good and services in the market. Inflation is caused when there is excess of money in the market and the aggregate demand of goods and services are low. (McAleese, 1997). Increase in the prices of commodities leads to an increase in cost of raw materials, interest rates on borrowings and so on, all of these factors affect the performance of firms. Many economists have come to the conclusion that countries with low inflation rates are performing better than the countries with hyper-inflation (McAleese, 1997). Inflation and growth are negatively related which means as inflation increases the growth of the economy is hindered. The business firms are mainly affected by the consumer purchasing trends, when the prices of commodities the consumer will not buy as many products as before, this can cause a significant loss of revenue (McMahon, 2018). Inflation rates are subtracted from the base year GDP and compared to the past year GDP to calculate actual economic growth. The central banks and other government institutions try and regulate the inflations rates to ensure that the economy is growing as predicted, for example, the Indian government introduced new currency notes to tackle the excess unaccounted money in the market. This currency change made people deposit all the old currency in the banks, this increases the capacity of the banks to lend money at a low interest rate. Change in prices of raw material forces firms to conduct more negotiations with its suppliers or even start looking for new suppliers at a cheaper price this increases the transaction cost (Earl and Wakeley, 2005).
The inflation rates hinder the ability of the business to make investment decisions.
The prices of goods and services do change with the occurrence of inflationary pressure, this confuses the investors to make decisions when entering a different or new market. Inflation also encourages firms to spend more money on acquiring assets instead of investing the money into the business to increase production because the aggregate demand in the market is low and there is no profit in making more products (Earl and Wakeley, 2005). To counter the effects of inflation the central banks increase the rate of interest on borrowing and increase the interest rates on saving, this helps in reducing the money in the market. The value of money of diminishes as the inflation rate increases, holding money when inflation increases tends to no use in the future. Consumer start spending more money as inflation decreases because the value money is decreasing with rise in inflation rates, once the inflation rates reaches very high money starts to lose it value as a unit of exchange (A. Wolla, 2018). Zimbabwe went through a hyperinflation causing the Zimbabwe dollars to lose its value, consumers would have to carry large bags of cash to purchase their daily commodities. Business firms start to deposit more money into the banks as holding money is more expensive and borrow less as interest rates are very high.
High inflations rates reduce the value of the currency of the country, this causes investors from other countries to buy less because the investors now get less goods for the same price (the telegraph, 2018). This mainly affects the import and export industry, most of supply network chains are globally interlinked. If the inflation is high in the United Kingdom, the value of the British Pound will fall and all raw materials that are imported from other countries will become more expensive, and the shifting to a local supplier is not favourable in the short term because the costs will be very high (McMahon, 2018). The supply of raw materials from the UK will also decrease because the investors could get more materials at the same price in a different country.
3.Employment rates an Unemployment rates
The labour and workforce is the prime component of any economy. Employments rates are a coincident indicator, increase in the work force of a country will directly relate to a growth of the economy. Unemployment rates are a lagging indicator, unemployment rates improve after a few quarters of growth in the economy, for example, the financial crises in America in 2008, the recession began in the first quarter while the unemployment rate only rose to its peak 10.2 in October 2009 (Amadeo, 2018). A company is operating with a high level of unemployment it will not be able to adapt and understand the latest market trend, this would result in information asymmetry between competitors and the company also lose opportunities to make more profits (McAleese, 1997). Low unemployment rates would make it very difficult for firms to hire skilled employees while, during high unemployment rates the employees try and negotiate for better job security rather than asking for more salaries or wages. If a company is not hiring new employees, this will make the existing work force presume that they will not be cut off and will affect the productivity of work they do. “Economic growth reflects growth of the labour force plus growth of labour productivity” (The Economist guide to economic indicators: making sense of economics, 1998). High unemployment rates reduce the purchasing power of the consumer, this causes the aggregate demand of good and services to fall. Firms earn more revenue when the demand of the products are high, if the aggregate demand is low the firm will not be able to sell their products and earn revenues. Unemployed workers do not pay any sort of taxes to the government, the governments have to pay of their debts. If the government is not able to pay these debts in time, it has to increase the taxes to pay its debt.
High unemployment rates go hand in hand with recessions, this means when the GDP decrease the unemployment level will increase. Similarly, when the GDP output is high the unemployment rates are low. Employment and unemployment rates are linked with GDP and inflation rates in the short run. Unemployment rates helps business in understanding and confirming what the other indicators are interpreting, for example when the unemployment rates are high the business can correlate that economy is recovering from a recession. Countries set their own natural rate of unemployment depending on many various factors such as incentives, age, labour work force, wages and so on (The Economist guide to economic indicators: making sense of economics, 1998). The rate of unemployment should not go below the natural rate of unemployment, such a low unemployment rate indicates that the workers and consumers now have a very high purchasing power, aggregate demand will rise causing a rise in prices of the goods causing inflation.
All the three indicators are equally important for the business to monitor. GDP, inflation and unemployment rates are interlinked with each other and have significant influence on the development and performance of business organization. Economic indicators are differentiated bases of the timing of the changes in relation to change in the economy as a whole. These indicators not only help in measuring the performance of the business but also help in the making decisions that will help the business perform well in the long run. Economic indicators have a very close relationship with the business cycle. The business cycle helps the business to make critical decisions such as laying off employees during a recession and invest and expand during the ‘boom’ phase. This paper can show that the business firms can benefit and make profit making decisions if they understand the relation between these indicators and also observe how these indicators effect the market.
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