This revision presentation for business students introduces the concept of the economic cycle. GDP, consumer spending, business investment are described as are possible business strategies that are adopted during an economic downturn.
The clue is in working capital and cash flow management. How to improve cash flow if demand falls? Reduce stocks
The Business Cycle and Economic Growth
Business Cycle & Economic Growth
What is economic growth? Economic growth is an increase in the value of goods and servicesproduced by an economy over time
Why economic growth matters• Economic growth is about increase in production within the economy• It is important because our living standards are influenced by our access to goods and services• Without growth, individuals can only enjoy rising living standards at the expense of others in society• With economic growth we can all (potentially) be better off
Benefits of economic growth for business • Increased profits • A rise in average living standards • The creation of new jobs • Lower unemployment • Increased tax revenues for government - used to fund more spending on government services • Improved business confidence • Increased capital investment • Technological innovation
GDP – the main measure of economic growth Gross Domestic Product The value of goods and services produced by an economy over a specific period
What is included in GDP?GDP = C + I + G + (X − M) where C (Consumption) I (Investment) G (Government spending) and X − M (Net Exports)
Consumption This covers householdspending on goods and services
Consumer spending is closely linked with disposable income
Investment This covers investmentspending on capital projects
Government spending This involves the spending by government ongoods and services
What is the “business cycle”?• The sequence of slump, recovery, boom and recession Sometimes• The regular pattern of “ups also called the and downs” in the economy “economic• Measured by changes in cycle” GDP from one quarter to the next
Typical shape of the business cycle Boom BoomGDP growth Recession Recession Recovery Slump
Stages of the business cycleBoom High levels of consumer spending, business confidence, profits and investment. Prices and costs also tend to rise faster. Unemployment tends to be lowRecession Falling levels of consumer spending and confidence mean lower profits for businesses – which start to cut back on investment. Spare capacity increases + rising unemploymentSlump / Very weak consumer spending and business investment; manydepression business failures; rapidly rising unemployment; prices may start fallingRecovery Things start to get better; consumers begin to increase spending; businesses feel a little more confident and start to invest again; but it takes time for unemployment to stop growing
Main causes of the cycle• Changes in the level of business and consumer confidence• Alternating periods of stocking and de- stocking• Changes in the value of consumer spending and business investment• Changes in government policy which can induce a change in the economy
Businesses that thrived in the recent recession (1) Dominos UK sales and Attendance at cinemas inprofits doubled in the last the UK has risen every 5 years year since 2006
Businesses that thrived in the recent recession (2)A dramatic increase in the Poundland has doubled promotion of scrap-gold the number of its stores sales on UK TV since 2007
Businesses that have suffered…(1) Losses of $1bn since 2008 and 5,000 job losses in the UK
Businesses that have suffered…(2) Three profits warnings and then a complete collapse in the share price after sharp drop in bookings.
Essay analysis opportunity: effect of the business cycle Cyclical Counter-cyclical• Car production • Discount• Electronics retailing retailing • Fast food• Restaurants • Cosmetics
Examples of “cyclical businesses” For example:Businesses where Fashion retailersdemand is closely Electrical goods House-builders linked to the Restaurants strength of GDP Advertising Overseas holidays
Examples of “counter-cyclical businesses” Businesses that do For example: well or ok even Value retailers Pawnbrokers when the economy Fast-food outlets is weak Domestic holidays
Economic growth & unemploymentUnemployment has risen significantly during the recent recession – as expected
What happens to businessinvestment during an economic downturn?
Value of UK Capital Investment Spending Quarterly value of capital spending at constant 2003 prices, £ billion 67.5 67.5£ (billions) 65.0 65.0 62.5 £15bn lower 62.5 capital spending 60.0 60.0 per year since 57.5 2007 57.5 billions 55.0 55.0 52.5 52.5 50.0 50.0 47.5 47.5 45.0 45.0 00 01 02 03 04 05 06 07 08 09 10 11 12 Source: UK Statistics Commission
Why firms cut back investment?• Less finance available Good evaluation• Lower returns (e.g. opportunity: future profits) Short-term benefit of cutting back• Increased risk versus• Precaution – conserve Long-term damage to the business? cash
Some possible drawbacks of lower investment spending?• Less new product development and/or innovation• Slower adoption of new technology (adverse effect on competitiveness?)• Competitors may get ahead?
Importance of business confidence• Confidence in the future is an important element in business decision-making; especially about investment• Firms will only invest if they are confident about future demand for their products (link to investment appraisal)• But business confidence can be a self fulfilling prophecy• An optimistic view of the future leads to investment in equipment and in stock. This rise in aggregate demand brings about a boom• Conversely, pessimism about future prospects will lead to low investment with the danger of provoking a downturn in the economy
What happens toinventories during a recession?
What is a credit crunch?A credit crunch is a liquidity crisis. Banks become nervous about lending moneyeach other and to personal and business customers. Where they are prepared tolend, they charge higher rates of interest to cover their risk. The result is a big fallin the supply of credit and an increase in the cost of borrowing.
Which pushed the global economy into recession
Credit crunch effect on UK consumers• The credit crunch has made it harder to get loans – mortgage loan approvals collapsed contributing to a steep decline in property demand and house prices• Many property owners faced increases in fixed-rate mortgages which hit their effective disposable income• A large negative wealth and confidence effect from falling property prices and a large fall in consumer spending on new durable products such as cars, furniture and household appliances• Because consumption is such a high percentage of aggregate demand, the decline in household spending was a key factor driving the UK into recession
Business responses to the credit crunch• Cut back production capacity• Reduce headcount• Postponed investment• Actions to conserve cash• Intense sales promotional activity• Destocking
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