Five Economic Factors

by Barbara Bean-Mellinger; Updated June 11, 2018
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No one ever said running a business was easy. Just when you think you've got your products well-priced and the right employees in place, the economy throws you a curve. Many factors affect the economy and keep it fluctuating so that it's difficult, even for economists, to know what will happen next. Still, some major occurrences happen often through the years and can impact your business.

What are Five Economic Factors of Business?

Although numerous economic factors can affect business, five of the most common are:

  • Supply and demand
  • Interest rates  
  • Inflation 
  • Unemployment
  • Foreign Exchange rates 

What Are Supply and Demand?

The laws of supply and demand are among the most important factors in business. Supply refers to the amount of a product that's available for purchase. Demand refers to how much consumers want to buy the product. Together, supply and demand have a huge effect on prices.

Fruits and vegetables in the grocery store are a good example. When frost or disease kills a good portion of the orange crop, there aren't as many oranges available for sale. Consumers still want to buy oranges, so the demand for oranges hasn't changed, but the supply has decreased. To make up some of the profit they'll lose, growers increase prices. Stores are paying more per orange, so they raise their prices, too.

New suppliers entering the market also affect supply and demand. In May 2017, the U.S. government announced it would end the 16-year ban on importing lemons from Argentina. California growers, who produce over 90 percent of the U.S. lemon crop, were outraged, according to an Associated Press report in the Los Angeles Times.

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The ban was initiated over fears that Argentina's lower sanitary standards could introduce disease and pests to the U.S. that could wipe out California's crop. Of course, importing Argentine lemons will likely cause an increased supply, which could cause prices to fall, hurting California growers. Such an outcome doesn't hurt all businesses, though. Restaurants that use lemons for drinks, dishes and garnishes will save money on the cases of lemons they buy.

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What Is Inflation?

Prices of goods are expected to rise slightly through the years. But, when prices rise rather quickly, over months or one year, and continue to rise steadily, economists say the higher prices are due to inflation. During such times, the dollar doesn't buy as much as it did several months or a year ago, which is called decreasing purchasing power.

Inflation is measured by indexes such as the Consumer Price Index, which tracks prices continuously. The Federal Reserve, which controls interest rates, tries to keep inflation to between 2-and-3 percent each year. That's the accepted sign of a healthy economy.

Different economists pose theories as to the types of inflation. But, the generally accepted types of inflation are demand-pull, cost-push and monetary.

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Demand-pull inflation is when the demand for products or services rises sharply and surpasses the available supplies of those goods. It's often caused, at least partially, by easier credit availability. The high demand and lack of supply cause prices to rise. In times of high demand, you may find your suppliers increasing their prices to you, and that increase is reflected in the price increase of your product.

Cost-push inflation occurs when wages rise. If the minimum wage rises, soon employers will have no choice but to raise their employees' wages across the board so that higher-skilled workers continue to earn more than minimum-wage workers and so on up the line. To cover that cost, companies raise the prices of their goods and services.

This is one of the main concerns over the initiatives to raise the U.S. minimum wage to $15-per-hour. Since that's a substantial increase for states whose current minimums are close to the federal minimum wage of $7.25-per-hour, many states plan to increase their wages gradually over several years. States in the South and Midwest, which tend to have lower wages, would be hard hit by the $15 minimum wage.

In 2018, many states raised their minimum wages. For example, hourly minimums were increased to $7.85 in Missouri, $8.25 in Florida, $10.50 in Vermont and between $13-and-$15.50 in California, depending on the city. Economists are divided as to whether inflation will increase as states approach $15-per-hour. It seems likely that businesses will need to raise prices on their products to cover the increases they're paying in wages.

Monetary inflation is when the government prints more money to make up for their deficit. Having more money in circulation, all vying for the same goods can cause prices to rise.

What are Interest Rates?

When individuals or businesses borrow money, they repay the amount they borrowed plus interest. The interest rate of the loan determines how much they pay in addition to the loan amount. To calculate the interest and total repayment:

Loan amount + (loan amount x interest rate) = total repayment

For example, if you borrow $100,000 at 10-percent interest:

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$100,000 + ($100,000 x .10) = $100,000 + $10,000 = $110,000 repayment

If the interest rate is only 6 percent, the repayment would be significantly lower:

$100,000 + ($100,000 x .06) = $100,000 + $6,000 = $106,000

Rising interest rates can affect businesses in several ways. First, their borrowing cost is higher, which affects profitability. This makes the business look less capable of paying its bills, which can make it difficult to get a loan the next time. As with other factors that affect a business's profits, management may decide to raise its prices to keep its profitability from decreasing.

Second, the higher interest rates mean consumers have to pay more on their car and home loans and have less left over for other purchases. So, the demand for products can decrease, which could lead to excess supply and cause prices to fall.

What Is Unemployment?

The nation's unemployment rate is a sign of how well the economy as a whole is doing. A low unemployment rate is always desirable because it means more people have jobs, which means they have money to spend which keeps the economy moving.

But, since the unemployment rate only counts people age 16 and older who are looking for jobs, it can be misleading. People who were job hunting but gave up are not counted. It has the effect of appearing that they found jobs since they're not part of the unemployment statistics.

Unemployment rates started to rise with the recession that began in 2008. According to the Bureau of Labor Statistics, after rising to a high of 9.8 percent in 2010, the rate has been declining steadily since. As of May 2018, the unemployment rate was 3.8 percent. This means far fewer people are unemployed than in 2010, a sign of a healthy and growing economy.

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For businesses, though, a low unemployment rate means they'll have a tougher time keeping employees and a harder time finding competent candidates to hire, according to Bridget Miller, writing in HR Daily Advisor in January 2017, "Downsides to Low Unemployment."

It's much like real estate agents talking about "buyers' markets" and "sellers' markets." Lower unemployment means it's a job hunter's market.

When unemployment is high, employees want to hold tight to their jobs. They're not as likely to quit, go on strike or otherwise cause problems, said Bruce Bartlett, author of "Do Businesses Benefit from High Unemployment?" for The Fiscal Times. On the other hand, he pointed out, those who are unemployed don't have money to spend, and even the employed may become cautious because of the high unemployment rate. If sales then drop, and your products aren't selling as they were, profits begin to decline. You may even need to lay off workers, which adds to the unemployment rate.

But, when unemployment is low, employees may quit at the slightest provocation for what looks like a greener pasture. And that "green" includes money. Employers often have to offer incentives like higher salaries or better benefits, bonuses and time to get the employees they want. It may take longer to fill job openings and in the meantime, production can slow down. In the end, businesses might have to higher less-skilled workers for the job and spend more time and money training them in the job.

What Is Foreign Exchange Rate?

If you've ever traveled to another country, you've most likely had to determine what the U.S. dollar was "worth" in that country at that time. That's the foreign exchange rate, also known as the exchange rate. Or, as Investing Answers defines it: "An international currency exchange rate is the rate at which one currency converts to another."

For example, on May 29, 2018, the exchange rate was 1.1728 dollars/Euros. This means that 1 Euro = 1.1728 U.S. dollars. So, to obtain one Euro, you'd need to pay $1.17 U.S. dollars.

Exchange rates are often related to interest rates. If a country's interest rates increase, foreign investors put their money in that country's banks to take advantage of higher yields. This increases the value of that country's currency comparative to another country with lower interest rates.

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If the business's goods in the foreign country are priced significantly lower than U.S. suppliers' goods, a business may still decide it's a good deal to work with the foreign business.

Exchange rates can vary from one day to the next, although changing from one that's appreciating (increasing in value) to one that's depreciating (decreasing in value) takes some time. Exchange rates are affected by many factors, including interest rates, inflation and the general robustness of a nation's economy or lack of it.

What does it mean for businesses? It's becoming more and more common for businesses of any size to do business globally, and when they do, the exchange rate with each country matters. If the U.S. dollar is stronger than the other country's currency, the U.S. business will pay less to buy from that country. On the other hand, the business may have difficulty exporting goods to that country because its businesses will have to pay higher prices for the U.S. goods.

A business that's considering doing business globally or at least with one or more foreign countries would be advised to consider the exchange rate between the U.S. and each of those countries. If it's unfavorable to the U.S., it might be wise to do business with a U.S. company instead.

How to Prepare for Changing Economic Factors

Since economists make a career of studying the economy and still can't entirely predict what will happen and when it will happen, it's difficult for anyone to prepare for what's coming. Keeping an eye out for signs of change will help, though.

If you notice a trend towards less demand for your products, for example, look into why that is and make adjustments such as changing the product to increase its demand, or if the market is saturated with the product, begin working on a new one. If interest rates are creeping up, get the loan you were considering before rates go any higher. If the minimum wage in your state or area is raised, consider whether you'll need to raise salaries across the board and if so, look into cutting costs elsewhere.

Think now about ways to improve employee morale so you can keep valued employees no matter what happens in the economy. Many ideas don't even cost money, like keeping open lines of communication, complimenting people on their efforts and involving them in some decision-making. Regardless of the unemployment rate, employees that find their jobs fulfilling can only make your company stronger.

About the Author

Barbara Bean-Mellinger is an award-winning writer in the Washington, DC area. She writes nationally for newspapers, magazines and websites on topics including careers, education, women, marketing, advertising and more. She holds a Bachelor of Science from the University of Pittsburgh.

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