Have you ever wondered why some countries are good for businesses to invest in and others not so much? For example, why did Apple open its stores in the UK but not in Ethiopia? One of the reasons is probably that the GDP of Ethiopia is not as high as that of the UK. Moreover, in the UK, the unemployment rate is lower in the UK, and people are more likely to afford Apple products. All of these aspects are related to the economic climate and how it affects businesses.
Economic climate definition
In order to understand the term economic climate, it is essential to first look at the definition of the economy. For example, in the UK, there are millions of British customers, millions of both British and foreign businesses, the UK Government, and local governments. All of these entities buy, sell, produce, import, and export goods and services. The sum of all these activities creates the economy. The state of the economy is referred to as the economic climate.
The economic climate describes the overall economic conditions in a given country or region. This includes various factors such as inflation, unemployment rate, consumer spending, or GDP growth rate.
The economic factors mentioned in the definition above affect businesses because they impact the quantity of goods and services produced, the affordability of those goods and services, as well as the availability of jobs.
Economic climate change in business
The economic climate tends to change. It may either improve or weaken in accordance with several key factors (see Figure 1 below).
Figure 1. Economic climate change
As you can see, the economic climate is highly influenced by changes in key factors such as levels of production, consumer income, spending, and employment. When one of these factors increases, the economic climate improves. Conversely, when one of them decreases, the economic climate weakens.
Because of COVID-19, workers in many countries were fired, leaving them unemployed. The levels of employment decreased and changed the economic climate for the worse.
Impact and example of economic climate change on businesses
The economic climate is a factor that a business should consider when entering a new market. The success and profitability of the business are highly related to the economic situation of the country it operates in.
There are three main aspects of the economic climate that can affect a business:
Interest rates
Level of employment
Consumer spending.
Interest rates
Interest rates are the cost of borrowing money (expressed as a percentage).
When taking out a loan, a business or a customer not only has to repay the amount borrowed, but also an additional fee is known as the interest rate. A high interest rate means that the borrower has to pay more, whereas a low interest rate means that the borrower has to pay less. For a lender, it's the reverse: when an interest rate is high they earn more, but when the interest rate is low, they earn less.
Imagine you borrowed £1,000 from a bank and the interest rate is 5%. When repaying the loan, you will have to pay £1,050 (105%). This way, you lose £50 and the bank earns £50.
Influence of interest rates on customers and businesses
Consumers - When it comes to consumers, interest rates can have an impact on the amount of money they spend. If interest rates are low, they will feel encouraged to take out a loan and spend more money, as low interest rates mean less money to repay. However, when interest rates are high, customers will be discouraged from taking out a loan and therefore spend less money. After all, with high interest rates, they will have more to repay.
Businesses - Interest rates can also affect business costs. If interest rates are low, firms have to repay less on their existing loans and their costs will thus be reduced. Moreover, they will be encouraged to invest by taking out further loans. However, if interest rates are high, they will have to repay more on their existing loans and their costs will increase. They will also most likely refrain from investing by taking out further loans.
Influence of low and high interest rates
Low interest rates typically result in an improvement in the economic climate. When interest rates are low, customers are willing to spend more and businesses are willing to produce more. In general, low interest rates are associated with increased sales. This benefits both customers and businesses.
High interest rates typically worsen the economic climate. When interest rates are high, customers tend to spend less and businesses produce less. In general, low interest rates are associated with decreased sales. This is unfavourable for both customers and businesses.
Level of employment
The level of employment reflects the number of people that are employed. These can either be employees of a business or self-employed persons.
The level of employment is defined as the number of people engaged in productive activities in an economy.
Influence of high level of employment
When the level of employment is high, this means that the great majority of people in the economy have a job. For businesses, this means that they are employing more people, who in turn produce more goods and services. As a result, sales increase, which can result in higher earnings. When it comes to customers, a high level of employment typically means that they earn more money and can afford to buy more products and services.
Influence of low level of employment
A low level of employment means that a small number of people have jobs. Low levels of employment typically mean that businesses are employing a relatively small number of people, who in turn produce fewer goods and services. This downturn is associated with decreased sales and lower earnings. For customers, low levels of employment are related to low earnings and the inability to buy many products.
Consumer spending
Customers spend money on a variety of goods and services. These items may include necessities such as food and housing or products that are not essential, such as designer clothes and expensive electronics.
Consumer spending is the monetary value of goods and services bought by consumers over a time period, usually a month or a year.
Demand and income
Consumer spending is highly related to both consumer demand and income.
If consumers earn a high income, demand will typically increase. This applies particularly to non-essential luxury products. High demand and income are typically associated with high consumer spending. When customers spend more, business sales and earnings increase.
However, when the income of consumers is low, demand for products and services will typically decrease. Customers will most likely refrain from buying non-essential luxury products, as they will be more willing to save. Low demand and income contribute to low customer spending. If customers spend less, business sales and earnings then decrease.
As you can see, the economic climate is a factor that has a significant influence on businesses and their sales and earnings. For this reason, companies should keep close track of the economic situation of the countries where they operate.
Economic climate - Key takeaways
- The economic climate describes the state of the economy.
- The economic climate considers key factors within a country including the number of goods and services produced, affordability of goods and services, and the availability of jobs.
- Rising levels of production, consumer income and spending, and employment improve the economic climate. Falling levels of production, consumer income and spending, and employment weaken the economic climate.
- There are three main aspects of the economic climate that can affect a business: interest rates, level of employment, and consumer spending.
- Interest rates are the cost of borrowing money expressed as a percentage.
- The level of employment is defined as the number of people engaged in productive activities in an economy.
- Consumer spending is the value of goods and services bought by consumers over a period of time, usually a month or a year.
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