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Business Cycle &
   Economic
    Growth
What is economic growth?

  Economic growth is an
 increase in the value of
    goods and services
produced 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
    household
spending on goods
   and services
Consumption is the biggest part of GDP
Consumer spending is closely linked with
         disposable income
Investment


    This covers
   investment
spending on capital
     projects
Government spending


 This involves the
   spending by
  government on
goods 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                 Boom
GDP growth




                        Recession              Recession
                                    Recovery



                            Slump
Stages of the business cycle
Boom         High levels of consumer spending, business confidence, profits
             and investment. Prices and costs also tend to rise faster.
             Unemployment tends to be low
Recession    Falling levels of consumer spending and confidence mean lower
             profits for businesses – which start to cut back on investment.
             Spare capacity increases + rising unemployment
Slump /      Very weak consumer spending and business investment; many
depression   business failures; rapidly rising unemployment; prices may start
             falling
Recovery     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
The UK Economy – Recent GDP
Businesses that thrived in the
       recent recession (1)




  Dominos UK sales and        Attendance at cinemas in
profits 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 retailers
demand 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 & unemployment




Unemployment has risen
 significantly during the
  recent recession – as
         expected
What happens to business
investment 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 to
inventories during a
    recession?
Business Inventories
The value of inventories held by
 UK firms fell by around £18bn
     during the recession
= lower demand for suppliers &
 knock-on effects through the
         supply chain
The “Credit Crunch” & Recession
What is a credit crunch?

A credit crunch is a liquidity crisis. Banks
  become nervous about lending money
each other and to personal and business
 customers. Where they are prepared to
lend, they charge higher rates of interest
 to cover their risk. The result is a big fall
in the supply of credit and an increase in
          the cost of borrowing.
It started with a bubble bursting
Which triggered a financial crisis
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
Keep up-to-date with business
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The Business Cycle and Economic Growth

  • 1. Business Cycle & Economic Growth
  • 2. What is economic growth? Economic growth is an increase in the value of goods and services produced by an economy over time
  • 3. 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
  • 4. 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
  • 5. GDP – the main measure of economic growth Gross Domestic Product The value of goods and services produced by an economy over a specific period
  • 6. What is included in GDP? GDP = C + I + G + (X − M) where C (Consumption) I (Investment) G (Government spending) and X − M (Net Exports)
  • 7. Consumption This covers household spending on goods and services
  • 8. Consumption is the biggest part of GDP
  • 9. Consumer spending is closely linked with disposable income
  • 10. Investment This covers investment spending on capital projects
  • 11. Government spending This involves the spending by government on goods and services
  • 12. 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
  • 13. Typical shape of the business cycle Boom Boom GDP growth Recession Recession Recovery Slump
  • 14. Stages of the business cycle Boom High levels of consumer spending, business confidence, profits and investment. Prices and costs also tend to rise faster. Unemployment tends to be low Recession Falling levels of consumer spending and confidence mean lower profits for businesses – which start to cut back on investment. Spare capacity increases + rising unemployment Slump / Very weak consumer spending and business investment; many depression business failures; rapidly rising unemployment; prices may start falling Recovery 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
  • 15. 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
  • 16. The UK Economy – Recent GDP
  • 17. Businesses that thrived in the recent recession (1) Dominos UK sales and Attendance at cinemas in profits doubled in the last the UK has risen every 5 years year since 2006
  • 18. 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
  • 19. Businesses that have suffered…(1) Losses of $1bn since 2008 and 5,000 job losses in the UK
  • 20. Businesses that have suffered…(2) Three profits warnings and then a complete collapse in the share price after sharp drop in bookings.
  • 21. Essay analysis opportunity: effect of the business cycle Cyclical Counter-cyclical • Car production • Discount • Electronics retailing retailing • Fast food • Restaurants • Cosmetics
  • 22. Examples of “cyclical businesses” For example: Businesses where Fashion retailers demand is closely Electrical goods House-builders linked to the Restaurants strength of GDP Advertising Overseas holidays
  • 23. 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
  • 24. Economic growth & unemployment Unemployment has risen significantly during the recent recession – as expected
  • 25. What happens to business investment during an economic downturn?
  • 26. 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
  • 27. 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
  • 28. 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?
  • 29. 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
  • 30. What happens to inventories during a recession?
  • 32. The value of inventories held by UK firms fell by around £18bn during the recession = lower demand for suppliers & knock-on effects through the supply chain
  • 33. The “Credit Crunch” & Recession
  • 34. What is a credit crunch? A credit crunch is a liquidity crisis. Banks become nervous about lending money each other and to personal and business customers. Where they are prepared to lend, they charge higher rates of interest to cover their risk. The result is a big fall in the supply of credit and an increase in the cost of borrowing.
  • 35. It started with a bubble bursting
  • 36. Which triggered a financial crisis
  • 37. Which pushed the global economy into recession
  • 38. 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
  • 39. Business responses to the credit crunch • Cut back production capacity • Reduce headcount • Postponed investment • Actions to conserve cash • Intense sales promotional activity • Destocking
  • 40. Keep up-to-date with business stories, resources, quizzes and worksheets for your business course. Click the logo!

Editor's Notes

  1. The clue is in working capital and cash flow management. How to improve cash flow if demand falls? Reduce stocks