Changes in Economic Activity

We often refer to 'the economy' or to 'economic activity' without really thinking about what these two terms mean. The economy refers to all the production and exchange activities that go on every day - all the buying and selling. The level of economic activity is how much buying and selling goes on in the economy over a period of time.

This buying and selling goes on all the time and is often complex and too big for us to really comprehend.

Think of it in this way: if you go to a shop and buy a carton of fruit juice, you are contributing to the level of economic activity. You are handing over money to acquire the juice, the shop seller is receiving an income and the makers of the fruit juice have also made a sale, as have the manufacturers of the carton and the growers who grew the fruit in the first place. Every purchase, therefore, involves a chain of different production and exchange activities.

Economic activity can exist on many levels, from a simple street market right through to complex financial transactions between major corporations. Copyright, Christ Coolen and Warren Gibb, both from stock.xchng.

What would have happened if you had walked past the shop and decided you could do without that drink? In this scenario, the shop does not make a sale and the producers of the juice, the carton manufacturers and growers would all have been affected as well.

You might be thinking, does my decision really make that much difference? On its own, no, it does not. The level of economic activity does depend on the number of people making different decisions about what to buy and what not to buy. There might be a very good reason why you decided to not go into the shop and buy the juice. Maybe your income level had changed, maybe your tastes had changed, or perhaps you had decided to save your money because of some uncertainties in the future.

If enough people/businesses in the economy change their behaviour, it can mean that the overall level of economic activity changes. In turn, tjis affects businesses.

Changes in income levels
How people view the future - is their job safe or are they worried about possibly losing their job?
What their current debt levels are - they might have had a spending spree for the last year and now need to think about paying back the debts on those credit cards!
Unexpected changes in income - bonus payments, windfall receipts from shares etc.
The general level of confidence about the future of the economy - do people expect things to be on the up or are they gloomy about the future?
The level of economic activity in the world as a whole - if countries like the US are growing, it has an effect on the UK
Political events around the world - events like 9/11, the war in Iraq, tensions in Iran and so on, can shake confidence around the world and cause changes to the level of economic activity
Major sporting events like the World Cup or the Olympic Games
Natural disasters - things like the Asian tsunami, hurricanes, earthquakes, drought or flood can all affect global trade.

Two large yachts thrown out of the water

Events such as Hurricane Katrina and the Asian tsunami can have major effects on world trade and affect the level of economic activity. Copyright: Palmer Cook and Karsten N, both from stock.xchng.

Changes in prices of raw materials - oil, metals, fuel, energy and so on
Changes in prices of stocks and shares on world stock markets

As you can see from the above, there are many things that might affect economic activity and it is very difficult for any business, whatever its size, to predict what might happen.

Some businesses might spend time looking at official statistics on the economy, reports from analysts, business organisations like the CBI and TUC and the government in an attempt to anticipate possible trends for the future. This can sometimes be helpful, but how many people saw the massive increase in oil prices four years ago?

We measure the level of economic activity by using Gross Domestic Product (GDP). GDP measures the value of all the goods and services produced in the UK over a period of time - usually a year. What this means is that if we took every good or service sold in the UK over a year and multiplied it by the price it was sold at, this would give the value of GDP.

Look around you - there is economic activity going on all the time. On your trip to school or college in the morning, you might see hundreds of commuters going to work, buses carrying people, trains, coffee shops, newspaper sellers, shops selling food, supermarkets, factories and so on. Everyone is likely to be engaged in some form of economic activity. Even the lollipop person is part of that economic activity. The total amount of activity as measured by GDP is therefore huge - far bigger than we can ever comprehend. The ONS estimated that the GDP for 2005 was £731,143,000,000 - that is £731 billion. GDP is often represented in terms of the percentage change from one time period to another. This tells us the rate of growth in economic activity over a period.

UK GDP, 2001-2006. Annual rate of growth and quarterly change.

You can see from the graph above that economic growth does change quite a bit! In 2001, for example, GDP fell from around 2.25% to about 1.6%. By the middle of 2004, GDP had risen to over 3%. It is important to remember that when we talk about growth rising and falling, we are still taking about growth. A rate of growth of 1.5% is still growth, but just not as fast as 3%.

Sometimes, however, GDP can be negative. This means that the value of goods and services produced in one year is actually less than that produced a year before. When we have negative GDP, it can be associated with a period of low levels of economic activity. If GDP is negative for two or more successive quarters it is called 'a recession'. The UK has not experienced a serious recession since the early 1990s and whilst there have been times since then that economic growth has slowed right down, we have experienced far more stable economic conditions in the last ten years.

How are Businesses Affected by Economic Growth?

As with other cases in this resource, it is important to remember that not every business will be affected by changes in economic activity in the same way. Supermarkets, for example, tend to be relatively unaffected by changes in economic activity whereas furniture retailers, car dealerships and electrical goods retailers tend to be affected far more by such changes.

When GDP slows down, businesses will experience a fall in demand for their goods or services. Revenues will fall and profit margins may be squeezed as they cut prices to try and increase sales. Unemployment may start to creep up.

When GDP rises at a faster rate, businesses find they will sell more goods and services. They might need to try and increase stock levels, which puts pressure on prices. Prices may start to creep up. Unemployment will tend to fall because businesses look to employ new staff to help them cope with the increase in demand.

Task 8

Why do you think that a supermarket is less likely to be affected by a change in GDP compared to a company like Dixons, which sells electrical goods?
Look at the graph of GDP above. Describe the changes in GDP over the period.
Can you think of any reasons to explain why the level of GDP changed over the period shown? (Hint - refer back to the list of possible influences on economic activity above).
For a firm that is affected by a slowdown in economic activity, consider the possible strategies they might adopt to cope with the effects they might face.

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Level 2 Business and Economics: External Influences