How GDP, Inflation and Exchange Rates Affect Business
Learn how GDP, inflation and exchange rates affect business demand, costs and profit, with a worked example and the key A Level Business exam mistake to avoid.
GDP, inflation and exchange rates affect business by changing customer demand, costs and competitiveness. The effect on a particular business depends on what it sells, where it buys its supplies and which markets it serves.
GDP and demand
Gross domestic product (GDP) measures the value of goods and services produced in an economy. When GDP grows, incomes and spending may rise, so businesses may sell more and consider expanding. When GDP falls, demand may weaken, especially for non-essential products. GDP is an indicator of the wider economy, though: growth does not guarantee higher sales for every business.
Inflation and costs
Inflation is a sustained rise in the general price level. It can increase a business’s wage, energy and materials costs. A business may raise its prices to protect profit, but customers facing higher living costs may buy less. If it keeps prices unchanged, its profit per unit may fall.
For example, suppose a product sells for £120\pounds 120£120 and costs £100\pounds 100£100 to make. If its cost rises to £110\pounds 110£110 but its selling price stays the same, profit per unit falls from £20\pounds 20£20 to £10\pounds 10£10, assuming there are no other costs.
Exchange rates and trade
An exchange rate is the price of one currency in another. If the pound strengthens, imported materials priced in foreign currencies can become cheaper for a UK business, while its exports may become more expensive for overseas buyers. If the pound weakens, the reverse may happen: imports can cost more, but exports may become more competitive.
In an exam answer, avoid saying an economic change is simply “good” or “bad” for business. Identify the business’s customers, suppliers and markets, then explain how the change affects its demand, costs or profit.
