Business and the Economic Environment

Business and the Economic Environment

  1. a) What are the four stages of the business cycle?

4 Phases of business cycle

 Expansion

As business starts to improve, customers increase their spending powers and companies gain more certainty leading to reinvestments and building of stocks up. Nevertheless, it takes time for unemployment to stop growing.

 Recession

The period is marked by reduced levels of both customer confidence and spending. In this regard, the organization attains lower benefits including the decrease of ventures in the future. Normally, organizations are bound to decrease their stock thus leading to unemployment.

 Boom

There is a high amount of buyer spending, increased confidence as well as investments and profits. Moreover, the period witnesses a rise in expenses and costs. The outcomes of the boom lead to lower unemployment levels due to emergence of new occupations.

 Depression

This is a delayed time of decreasing GDP characterised by high business speculation and poor consumer spending. The occasional failures in business failures may lead to deflation.


The economic cycle is the alternating ascension and descending development of gross domestic product (GDP) along a long term pattern of development. The fluctuations ordinarily consist of shifts between periods of generally fast financial progress (expansions or booms), and periods marked by decline (recessions or depression). There are four phases to the business cycle shown in figure 1.


Although all businesses conform to all the stages of the economic cycle, some are more vulnerable to changes in the economic cycle than others.


What is the current rate of growth of the UK economy?

How does this compare to Germany, the USA and China?

Which phases of the business cycle do you think the UK economy is in?

Why is the most important event in recent UK Economy history the financial crises of 2008?

Although the UK economy witnessed a slow growth in 2015, the relatively lowers oil prices ensured a stronger internal demand growth. Elsewhere, there are mixed outlooks with the Eurozone and US witnessing gradual pick-up and China facing a slowdown. In both Russia and Brazil there is continued recession while emerging economies face increased volatility.

It is largely expected that the UK will increase its GDP by between 2.2 and 2.3% in both 2016 and 2017. The main drivers are vouched to be business investment and consumer spending. Still, the short term risks to growth will be considerably low owing to the influence of international risks coupled with the EU referendum and its uncertainties. However, accelerated growth rates within the UK as well as favourable global environments would result in higher growth rates.

The growth trends of 2015 are bound to continue into 2016 where leading economies had modest growths. Overall, the fastest growing G7 economy is the US with UK narrowly coming into second position. In addition, the growth rate in the Eurozone is on a general pick up in part due to the rebound of Ireland and Spain. That notwithstanding, the three economies of France, Italy and Germany maintained modest growth rates last year.

The recessions in Russia and Brazil coupled with the slowdown in China point to a loss in growth momentum in the emerging countries. However, India is an exception which has gained due to lower oil prices. Overall, the international GDPs are touted to maintain moderate growths in 2016 at PPP and MER weights of 3.2% and 2.7% respectively.



In 2016, the Gross Domestic Product (GDP) of Germany increased by 1.30 percent in the first quarter compared to the previous year’s first quarter. Since 1992, Germany has had annual average growth rates of 1.33%, with the first quarter of 2011 witnessing an all time high of 6 percent. The Federal Statistical Office has reported Annual Growth Rates in Germany over the years.

Germany is the largest European economy and the fifth largest internationally. The country is a leading exporter of chemicals, machinery, household equipment and vehicles, reaping from benefits of a highly skilled labour force. Importation of goods covers about 39% of the German economy while exports of services and goods cover around 46% of the economy. Household consumption accounts for 55 percent of the GDP while gross capital formation amounts to 20 percent and government expenditure forming about 19 percent.


In the first quarter of 2016, China’s economy grew by 1.1% compared to a 1.5% growth in the previous quarter. The rate is the weakest since 2010 when data collection started and is below the 1.5% market consensus growth. Since 2010, the average GDP Growth Rate in China was 1.89% with the second quarter of 2011 recording an all time high of 2.50%. In contrast, the first quarter of 2016 recorded an all time low of 1.10%.

With the slowing down of construction and manufacturing which was the country’s traditional growth engines, services have risen to be the new frontiers. In fact, stronger consumption and services in the last few quarters have helped in offsetting the weaknesses in exports and manufacturing.


In the US, the first quarter of 2016 recorded an annualized 0.8% growth relative to an estimated increase of 0.5%. The main boost was consumption with increased spending in home building while the drag from inventories and net trade remained smaller. On the other hand, the fall in business investment ensured the lowest ever first quarter growth rate. From 1947, annual growth rates in the US have stagnated at an average of 3.23% with the first quarter of 1950 witnessing the highest growth rate of 16.90% while the first quarter of 1958 recorded the lowest at -10%.

In terms of expenditure, 68% of total GDP is attributable to personal consumption expenditure 23% of which is purchase of goods and 45% is purchase of services. Still, 18% is attributed to government consumption and investment leaving about 16% of the GDP to private investment. Net exports reduce the GDP value by 3% due to higher imports compared to exports at 16.5% and 13.5% respectively.

Overall, the UK recovery from 2009 has been faster than other G7 economies despite it being quite low compared with other historical times. In contrast, the country has recorded a strong domestic demand growth resulting from lower domestic oil prices and rising employment. In addition, a pick-up in growth of real earnings in 2015 has ensured stronger growth rates.

Although the UK economy witnessed a slow growth in 2015, the relatively lowers oil prices ensured a stronger internal demand growth. Elsewhere, there are mixed outlooks with the Eurozone and US witnessing gradual pick-up and China facing a slowdown. In both Russia and Brazil there is continued recession while emerging economies face increased volatility.

It is largely expected that the UK will increase its GDP by between 2.2 and 2.3% in both 2016 and 2017. The main drivers are vouched to be business investment and consumer spending. Still, the short term risks to growth will be considerably low owing to the influence of international risks coupled with the EU referendum and its uncertainties. However, accelerated growth rates within the UK as well as favourable global environments would result in higher growth rates.

What is the current rate of growth of the UK economy? How does this compare to Germany, USA and China? Which phase of the business cycle do you think the UK economy is in? Why is the most important event in recent UK economic history the financial crisis of 2008?

Countries all over the world analyse a vast number of statistics in order to keep track of their economic growth, this can be in form of the national income. The national income is a collated amount of how much sources earn over a specific period of time e.g one year. Another way of assessing economic growth is with the (GDP) gross domestic product, which is the broadest quantitative measure of both monetary growth within an economy and general economic activity. Further, it depicts the overall value of services and goods production within a country over a specified period of time.

The Office of National Statistics (ONS) projects teh UK economy to have grown by 0.6% during the final quarter 2015, comparatively higher than the predicted estimate of 0.5%. As of March 29th 2016 from, the predicted first quarter of 2016 currently stands at 0.46%, with the Office for Budget Responsibility (OBR) predicting a forecast of 2% growth for the first quarter (Emily Cadman, 2016).

The closing quarter of 2015 the rate of economic growth in China stood at 6.9% (Trading Economics, 2016) in comparison to the UK’s 2.3%. China’s economy has been slowing down since 2011 with a slight rise and slump in 2013. In 2011 the Chinese economic growth rate was at 9.8% (Trading Economics, 2016).

At the end of 2015 the closing quarter registered Germany’s growth rate at 0.3% compared to the UK’s 0.6%. Germany consisted an annual growth rate going up to 2.1% (Trading Economics, 2016). Within the European Union Germany has the largest economy out of the 28 nation bloc. In comparison of GDP the UK had a higher percentage growth rate for the closing quarter of 2015 and an overall annual growth rate of 2.3% in comparison to Germany’s 2.1%.

During the closing three months of 2015, the USA’s increased by 1.4% compared to the UK’s 0.6%. Annually for 2015 the USA’s growth rate was 2% compared to the UK’s 2.3% (Trading Economics, 2016).

It may be argued that the current phase of the UK trade cycle is still in expansion. The UK economy has witnessed its production expand annually by 2.5% for the last sixty years (Anderton, 2015). With statistics released by the ONS the final quarter of 2015 was the twelve consecutive quarter of positive growth since the first quarter of 2013 (Office of National Statistics, 2015). For an economy to be peaking or in boom it may be argued the growth rate has to exceed the average growth rate of 2.5% in the UK.

Many economists have cited the global financial crisis of 2008 as the worst financial crisis since 1930’s emergence of the Great Depression. It may be argued that the crisis originated from the USA through mortgage brokers authorising mortgages with terms unfavourable to the borrowers. Many of these families are those that wouldn’t normally qualify for ordinary home loans (Havemann, 2010). The shock waves that followed were felt across the global economy resulting in the crash of the housing market and a total loss of faith in the banking industry.

For UK the financial crisis saw unemployment at its highest along with house prices falling dramatically. In addition, imports and exports had slowed down due to relatively low demand, caused by the lack of employment and also, job security due to wide spread redundancy. Furthermore, the crisis saw the UK government spending well over £800 billion bailing out many major independent banks within the UK, these independent including RBS & Lloyds Banking Group (Andrew Grice, 2009).


Criteria 3.2 analyse the reasons for inflation and evaluate its effect

  1. What is meant by the term inflation

Inflation is a measure of the general increase in the price of goods and services and helps in ascertaining the fall in a currency’s purchasing power. In keeping the economy running, central banks put measures to limit inflation while avoiding deflation.

Discuss what is meant by the term ‘inflation’?

Inflation can be described as a continued rise in general or aggregate price levels across a nation’s economy (Anderton, 2015). If general price levels are increasing by three percent per annum this is inflation (Anderton, 2015). The effect of inflation to the consumer is a reduction in the purchasing power of the money in their possession. Whereas, deflation is the opposite to inflation. Deflation is derived as a sustained fall in prices across a nation’s economy. If general price levels were to fall by one per cent per annum this is classed as deflation (Anderton, 2015). A decrease in the inflation rate is known as disinflation (Anderton, 2015), if there is disinflation, it means that there is inflation in the economy, with the rate of inflation falling (Anderton, 2015).

Inflation is measured in the change of average prices over a set period of time within an economy. The change in price level is presented as an index. In the UK the Retail Prices Index (RPI) and the Consumer Prices Index (CPI) are commonly used (Anderton, 2015). If the CPI was 100 today and 120 in a year’s time, the rate of inflation would be twenty per cent.

Hyperinflation is known when inflation levels are extremely high. Theirs is no exact figure to when inflation can be classed as hyperinflation. Most economists classify hyperinflation when an economy has annual inflation rates over fifty per cent (Anderton, 2015). Stagflation can describe a period when inflation is high or rising when an economy is in a recession (Anderton, 2015).


  1. b) Why do the government and bank of England think its important to control inflation?

The control of inflation is necessary due to its potential to increase in the price of exports, which results in decreased exports and, occasionally, a recession. Normally, recessions are bound to follow excessive inflation thus causing damaging effects to a country. The negative effects of recession result in a restructuring of a country’s economy.

Essentially, governments have maintained the objective of keeping a strong control over inflation in all countries over the world. In this regard, most governments have formulated policies targeted at identifying the fundamental drivers of inflation within their economies. In addition, these legislations aim to improvise methods that can tame the inflationary conditions.


  1. c) Interest rates are the main economic policy tool used to control inflation. Explain how changing interest rate can have an impact on inflation (Explain the effect on disposal income, demand and prices in your answer?)

In reducing inflation, policies with potential to reduce the growth of aggregate demand while boosting that of growth of aggregate supply (AS) are most effective.

Fiscal policy:

This is one of the most effective methods that function by controlling aggregate demand. In instances where the aggregate demand is thought to be too high, governments may opt to ‘tighten fiscal policy’ through the reduction of public spending. In addition, the government may opt to increase direct taxes thus resulting in a reduction in the amount of real disposable income. Ultimately, output and demand and output are lower which has a negative effect on jobs and real economic growth in the short-term

Monetary policy:

In addition to the fiscal policy, the government can also tighten the monetary policy through the central bank. Ideally, the government reduces investment spending by increasing interest rates. The result of higher interest is the appreciation in exchange rates thus reducing the cost of imported goods and an equal fall in demands for exports.

Supply side economic policies:

The government may also seek to maintain lower prices through increased competition, innovation and productivity. In the medium term, the following measures are effective in controlling inflation:

  1. Policies to open a market to more competition to increase supply and lower prices
  2. A reduction in company taxes to encourage greater investment

iii. A reduction in taxes which increases risk-taking and incentives to work – a cut in income taxes can be considered both a fiscal and a supply-side policy

The impact of increased productivity is a resultant outward shift of aggregate supply.

Direct controls – a government may also choose to effect direct measures on specific wages and prices.

    1. Since the prices of water bills and other utilities controlled by the government, changes in price capping leads to short-term effects on the rate of inflation.
    2. Public sector pay awards – the government can control or freeze the annual government sector pay through decreased real wage.

Evaluation points – how best can inflation be controlled?

  • The most appropriate way to control inflation in the short term is for the government and the central bank to keep control of aggregate demand to a level consistent with our productive capacity
  • Controlling demand to limit inflation is likely to be ineffective in the short run if the main causes are due to external shocks such as high world food and energy prices
  • The UK is an open economy in which inflation is strongly affected by events in the rest of the world
  • AD is probably better controlled through the use of monetary policy rather than an over-reliance on using fiscal policy as an instrument of demand-management
  • In the long run, it is the growth of a country’s supply-side productive potential that gives an economy the flexibility to grow without suffering from acceleration in cost and price inflation.
  1. d) Taxes can also be used by the government to control inflation and demand in the economy. VAT was cut in January 2009 from 17.5% to 15% ( it has now risen again). The government did this to try stimulating growth in the economy to help the UK out of recession. Explain how this cut in VAT would achieve this?

The government has temporarily cut the VAT 15%, which returned to 17.5% by the end of 2009. In making the decision, the government predicted that the action will increase consumer spending by about 0.5%. The result is that the discretionary income of workers increases. The lowering of income tax rates results in more money at the disposal of workers due to higher gross incomes. Moreover, a rise in consumer spending is probable because workers are better off with a higher aggregate demand. Also, the government can increase its borrowing thus financing the tax cut effectively.

During a recession, higher AD is most probable since people that want to save money would finance government borrowing. Essentially, the government pumps idle resources into the country’s flow of money. In such times, the people’s spending power is affected by the tax cut to a great degree.

In cases where the government increases its borrowing in a bid to finance tax cut measures, crowding out is necessary. This, the government achieves through the sale of bonds to the private sector thus increasing its borrowing. In effect, the private sector is left with less money to invest in other areas. Further, more borrowing can result to increased bond yields and thus resulting in financial crowding out during high growth.

Higher consumer spending is occasioned by tax cuts that are financed through growing economy, higher productivity and rising tax revenues. The use of cuts in income tax results in impacts on the supply side of the economy.

In addition, people may be encouraged to work longer when income tax rates are lowered. This is because overtime becomes more worthwhile as it attracts less tax rates thus making work more attractive.

Nonetheless, lower tax rates which translate to higher wages may lead to higher income for fewer hours worked. In such cases, the result of tax cuts may not directly result in increased labour supply since people do not have to work long hours to attain their target incomes.

In instances when indirect taxes such as VAT are cut by the government, similar effects are observed. Consumers attain more purchasing power due to lower prices from tax cuts. Eventually, the consumers are left with more money to spend in other activities thus raising the general consumer spending.


Criteria 3.3 differentiate the different types of unemployment, identity their causes and interrelationship and evaluate the government actions used to combat them.


  1. a) Differentiate the four categories of unemployment, identifying their causes and explain how employment levels can affect the stability of a nations economy.

Unemployment is when a person is able and willing and actively seeking to work at the going wage rate but cannot find a job. According to the Office of National Statistics, the current unemployment level (April 2016) is 5% in the United Kingdom. The 4 main types of unemployment include Cyclical unemployment, structural unemployment, frictional unemployment and seasonal unemployment.

Structural Unemployment occurs when there is a long-term decline in demand in an industry leading to less demand for labour in this industries therefore causing job losses. This type of unemployment is often long term and exists where there is a mismatch between their skills and the requirements of the new job opportunities. Structural Unemployment was particularly high when many people in the manufacturing of cars, coal and steel lost their jobs. The UK lost its cost advantage in manufacturing because of many cheaper alternative manufacturers in different countries so many jobs were lost in these industries.

Frictional unemployment is when workers lose their current job and are in the process of searching and moving to another job. This is near enough impossible to eliminate because their will always be a time delay when most workers are in the process of changing from one job to another. Seasonal Unemployment is when there is a limited need for a certain type of work to be undertaken in a specific period of time within the year. Industries where seasonal unemployment is common include farming, tourism, and construction.

Cyclical unemployment is a type of unemployment that occurs when there is not enough aggregate demand in the economy to provide jobs for everyone who wants to and is willing to work. This is often seen in periods of time when the economy is in a recession or slump on the business cycle. An example of when cyclical unemployment was particularly prevalent was in the 2008 recession that the United Kingdom experienced. As seen in the graph below due to less GDP and productive output in the economy, the employment rate in 2008 was significantly low.
Employment levels can affect the stability of the economy in many different ways. Without a high level of employment many problems can arise for the economy that creates instability in business, the economy and with people, for example;

An increase in unemployment decreases the level of GDP in the economy. This is because the economy is not operating to its full capacity and not being as efficient as it can be leading to lower output and incomes. In addition, unemployment increases government spending in the economy. As governments receive less tax revenue due to less people paying income tax, the government have to give out more money to finance people that rely on the welfare system and give housing benefits and income support so that they can still be able to buy any necessities to survive without any income.

For the unemployed, they face lower living standards because of not having a stable income. Many unemployed people have no other choice but to live off savings or rely on the welfare system. Often they face cut backs on buying certain items and have less money to spend on goods and services. Not only does this create instability in the economy but to add, the unemployed can face the problem of loss of skills. When someone becomes unemployed they will stop working and will start losing their skills and ability to work. The longer someone stays unemployed, the less employable they will be to firms because firms will need to spend money on retraining them.

  1. b) Analyse possible ways that business and society could help to solve or eliminate economic problems in the future

The United Kingdom faces many problems in regards to solving its economic problems. The main problems that most countries face is having a stable unemployment rate, maintaining low inflation, having low government debt and reducing the level of poverty (absolute or relative).

One way businesses can solve the problem of low unemployment is to hire more people to work for them. This will increase employment rate which in has a positive effect on a number of things for example, increases government tax revenue and increased spending on goods and services. However, many businesses face issues when hiring new people due to the high trainings costs and paying out wages. Therefore, the government can offer employment subsidies and/or employment tax cuts for businesses that take on the long-term unemployed – for example, as part of the UK Youth Contract, payments of up to £2,275 are available to employers who take on young people (aged 18-24) who have been claiming JSA for more than six months.

Another way in which businesses and society can reduce relative poverty is to be a living rate employer. This means that each employee that a company hires has to receive the current living wage which is £7.70 per an hour. (REFERENCE) This can easily eliminate or reduce the amount of people that experience relative poverty because they now earn more money and have more disposable income to use on saving or consumption of goods and services.

Not only does implementing the living wage decrease relative poverty but also it can boost tax revenue that the government receives which decreases the national deficit of the country. As more people see employees offering the living wage they are more incentivised to get a job. Once people get a job it is obligatory that they pay income tax and VAT on goods and services that they spend from there disposable income. This all contributes to more money flowing into the economy and reducing the deficit.

A second way in which society and the government can reduce absolute and relative poverty is to invest in education and training. Many people lack the skills and knowledge to have a high paying wage rate therefore, investing in education will cause the labour workforce to be much better trained and become more productive and efficient.

The economic problem of maintaining a stable inflation rate is more difficult to solve however society and the government can take a number of steps in order to keep prices stable in the economy.

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