U1.07 — Impact of Economic Factors on Business Function
Overview
Dotpoint 7: Impact of economic factors on business function
Economic factors are conditions in the broader economy that influence how businesses operate and make decisions. Changes in economic conditions can affect a business’s costs, sales, profits, staffing and overall performance.
This dotpoint focuses on four economic factors that can significantly affect business performance:
- Inflation
- Interest rates
- Availability of skilled and unskilled labour
- Unemployment rates
The key idea is that businesses do not operate in isolation. Changes in the wider economy can flow through to consumer spending, borrowing costs, wages, labour availability and operating costs, which can then affect decisions across marketing, finance, human resources and operations.
Inflation
Inflation is the general rise in prices over time. When inflation rises, the same amount of money buys less.
Inflation affects businesses from both the cost side and the demand side. Businesses may pay more for inputs such as ingredients, electricity, fuel, rent, packaging and wages. At the same time, households face a higher cost of living and may have less money available for non-essential purchases.
Businesses therefore need to decide whether to absorb higher costs, raise prices, find cheaper inputs, reduce waste or change what they sell. These decisions can directly affect sales, profit margins and competitiveness.
Over the long run, Australia’s inflation has generally averaged around 2–3%, but it was much higher during the inflation spike of 2021–2023.
How inflation impacts business functions
- Operations: higher input prices can increase the cost of producing goods and services. Businesses may renegotiate with suppliers, reduce waste, switch inputs or change production methods.
- Marketing: businesses may raise prices, promote value bundles or emphasise value for money as customers become more price-sensitive.
- Finance: rising costs can squeeze profit margins and increase working-capital needs. If prices cannot be increased enough, cash flow and profitability may weaken.
- Human resources: employees may seek higher wages to maintain purchasing power, increasing labour costs for the business.
Overall: inflation can place businesses under pressure because costs rise while customers may simultaneously reduce discretionary spending.
WA examples
✔ A café in Fremantle faces higher coffee bean and milk prices. It may raise menu prices or reduce waste to protect profit.
✔ A Perth tradie pays more for fuel and building materials. Quotes may rise, while some customers delay renovations because household budgets are tighter.
✔ A boutique in Claremont sells fewer “nice-to-have” items as customers prioritise essentials.
Example of how to write this in an exam
Higher inflation can increase a business’s operating costs because inputs such as fuel, electricity, ingredients and packaging become more expensive. For example, a Fremantle café may pay more for coffee beans and milk, increasing the cost of producing each meal or drink. The café may respond by raising prices to protect its profit margin. However, because inflation also reduces household purchasing power, customers may cut back on café visits or choose cheaper menu items. As a result, inflation can affect operations through higher input costs, marketing through pricing and value promotions, and finance through pressure on revenue, cash flow and profit.
Interest rates
Interest rates are the cost of borrowing money and the return earned on savings.
Interest rates affect businesses directly because many businesses borrow to finance equipment, vehicles, stock, renovations or expansion. When rates rise, repayments on variable-rate loans and other forms of credit can increase, leaving less cash available for day-to-day operations or investment.
Interest rates can also affect businesses indirectly through consumer spending. If households face higher mortgage or loan repayments, they may have less disposable income and cut spending on discretionary goods and services.
When interest rates fall, the opposite effects can occur: borrowing becomes cheaper and households may have more capacity to spend.
How interest rates impact business functions
- Finance: higher rates increase interest expenses and loan repayments, reducing cash flow and borrowing capacity.
- Operations: businesses may delay machinery purchases, renovations, vehicles or expansion because finance is more expensive.
- Marketing: if household spending falls, businesses may use discounts, promotions or cheaper product options to support demand.
- Human resources: weaker demand and tighter cash flow may cause businesses to slow hiring, reduce overtime or postpone new positions.
Overall: higher interest rates can affect a business twice — through higher borrowing costs and through weaker customer spending.
WA examples
✔ A café in East Victoria Park has a loan for fit-out equipment. Higher interest rates increase repayments and reduce cash flow.
✔ A small retailer in Armadale delays opening a second store because borrowing costs are too high.
✔ A furniture store in Osborne Park sees lower sales because some customers postpone major purchases when mortgage repayments rise.
Who sets the rate?
In Australia, the Reserve Bank of Australia (RBA) sets a target for the cash rate. Changes in the cash rate influence the interest rates banks charge on mortgages, business loans and other forms of credit, as well as the interest paid on savings.
The RBA changes the cash rate in response to conditions in the economy, particularly inflation and economic activity.
Example of how to write this in an exam
Higher interest rates increase the cost of borrowing for businesses. For example, an East Victoria Park café with a variable-rate loan for fit-out equipment may face larger monthly repayments. This reduces the cash available for stock, wages or future expansion. Higher interest rates can also reduce consumer demand because households with larger mortgage repayments have less disposable income. The café may therefore experience both higher finance costs and weaker sales. As a result, interest rates can affect finance through higher debt servicing, operations through delayed investment, and marketing through greater use of promotions or value offers to maintain demand.
Availability of skilled and unskilled labour
Labour availability is how easy it is for businesses to find workers with the skills and experience they need.
Businesses rely on both skilled labour and unskilled or entry-level labour. Skilled labour includes workers such as electricians, chefs, nurses, engineers and accountants, while unskilled or entry-level labour includes roles such as retail assistants, warehouse workers and kitchen hands.
When suitable workers are difficult to find, businesses may experience vacancies, staff shortages and higher recruitment costs. They may need to offer better pay, more flexible conditions or training to attract and retain employees.
If shortages continue, the business may be unable to operate at full capacity, leading to longer waiting times, reduced opening hours, delayed projects or lower output.
How labour availability impacts business functions
- Human resources: businesses may increase wages, offer better rosters, recruit more widely or invest in training and apprenticeships.
- Operations: staff shortages can reduce operating capacity, slow production, increase waiting times or force shorter opening hours.
- Finance: higher wages, overtime, recruitment and training costs can reduce profit, particularly in the short term.
- Marketing: businesses may need to manage customer expectations if labour shortages reduce service speed or product availability.
Simple way to remember it: when suitable staff are hard to find, businesses often have to pay more, train more or do less.
WA examples
✔ A construction company in Perth’s south struggles to find qualified tradies. Projects take longer and overtime costs rise.
✔ A restaurant in Northbridge cannot find enough experienced chefs, so it reduces its menu or opening hours.
✔ A retail store in Midland receives many casual applicants for weekend shifts, making entry-level positions easier to fill than specialist roles.
Example of how to write this in an exam
Low labour availability can make it difficult for a business to recruit enough workers with the required skills. For example, a Perth construction company that cannot find enough qualified tradies may offer higher wages, overtime or apprenticeship opportunities to attract workers. These strategies increase labour and training costs, reducing profit. If positions remain unfilled, the business may also complete fewer projects or extend completion times because it lacks sufficient workers. Therefore, labour shortages can affect human resources through recruitment and remuneration decisions, operations through reduced capacity, and finance through higher labour costs and pressure on profit.
Unemployment rates
Unemployment is the percentage of people in the labour force who are without a job, are actively looking for work and are available to work.
Unemployment affects businesses mainly through consumer spending and labour market conditions. When unemployment is high, more households have lower incomes or feel less secure about future employment, so they may reduce spending on non-essential goods and services.
However, high unemployment can make recruitment easier because more people are looking for work. This can increase the number of applicants and reduce some of the pressure on wages.
When unemployment is low, more people are earning wages and consumer demand may be stronger, but businesses may find it harder to recruit workers and may need to offer higher pay or better conditions.
How unemployment impacts business functions
- Marketing: during high unemployment, businesses may use discounts, value bundles or lower-priced options to encourage cautious consumers to keep spending.
- Operations: if demand falls, businesses may reduce output, stock levels or operating hours to avoid excess capacity.
- Human resources: high unemployment can make recruitment easier because more applicants are available; low unemployment can make recruitment harder and increase wage pressure.
- Finance: weaker sales can reduce revenue and cash flow, causing businesses to focus more closely on cost control and profitability.
Overall: high unemployment can weaken demand but improve labour availability, while low unemployment can strengthen demand but make workers harder and more expensive to recruit.
WA examples
✔ If unemployment is high, a gym in Cannington may lose memberships as households cut discretionary spending.
✔ If unemployment is high, a café in Mount Hawthorn may notice fewer add-ons such as desserts and extra sides because customers are more cautious.
✔ If unemployment is low, a café in Subiaco may struggle to staff weekends and may need higher pay rates or incentives to attract workers.
Example of how to write this in an exam
High unemployment can reduce consumer spending because more households have lower incomes or are uncertain about future employment. For example, a gym in Cannington may lose memberships as customers cut non-essential spending. Lower membership revenue may cause the gym to introduce cheaper promotions, reduce staffing during quiet periods or delay purchasing new equipment. However, high unemployment can also make recruitment easier because more people are seeking work. Therefore, unemployment can affect marketing through pricing and promotions, operations through changes to output or opening hours, human resources through labour availability, and finance through changes in revenue, cash flow and profit.
Real WA Business Scenarios
Inflation example
A café in Leederville sees higher ingredient costs because of inflation and slower weekday sales because customers are cutting spending.
Impact → raises prices slightly, introduces a value lunch bundle and reduces quiet-hour staffing.
Functions hit → marketing (pricing/promotion) + human resources (rostering) + finance (cash flow).
Interest rates example
A retailer in Innaloo relies on a small business loan for stock. Interest rates rise and repayments increase.
Impact → reduces stock orders, runs clearance sales and delays a planned store refurbishment.
Functions hit → finance (debt/cash) + operations (inventory) + marketing (promotions).
Availability of skilled labour example
A building business in Rockingham cannot find enough skilled tradies because of a labour shortage.
Impact → offers higher wages, invests in apprentices and extends project timelines.
Functions hit → human resources (recruitment/training) + operations (capacity) + finance (costs).
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🃏 Flashcards
Card 1 of 16
🎮 Revision Games
💰 BME Millionaire
Master inflation, interest rates, labour availability and unemployment using three lifelines.
🧩 Economic Dominoes
Follow seven economic changes through to their most likely business impacts.
⚡ 60 Second Showdown
Race the clock with rapid questions on all four economic factors.
Biz Fact: Café test: Inflation hits venues twice: food inputs (beans, milk, oil) go up and customers cut back on “extras” when budgets tighten.