Economic Factors that Drive Market Demand


By linking the business planning process to the economic environment, business managers are better equipped to understand whether Strategic Alternatives are creating value. Assessment of the economy involves both examining current conditions and analyzing the future economic outlook based on selected current economic factors. To make more meaningful and complete assumptions, businesses sometimes build forecasting models. Such models can provide a more realistic understanding of possible outcomes and the risks inherent in your business. In order to build a forecasting model, it is important to create and validate a framework for economic (and financial) forecasting. This can involve one or more of the following:

  • Identifying data patterns and applying time series modeling techniques

  • Modeling and forecasting your key business drivers

  • Selecting and using appropriate measures in your forecasting model

  • Simulating a complete forecast

  • Dealing with uncertainty

  • Weighing approaches to interest rate risk modeling

The importance of these specific economic factors in your business is validated through statistical techniques such as regression analysis (discussed in Chapter 9). Here are some prevalent indicators used in analyzing the economy:

  • Gross national product (GNP)

  • Gross domestic product (GDP)

  • Inflation (deflation) CPI

  • Interest rates

Gross National Product

"GNP measures the output of the citizens of the U.S. and the income from assets owned by U.S. entities, regardless of where they are located".[1]

Since GNP includes output from multinational corporations, it may not be a true indication of how the U.S. economy is performing. This has led to the development of GDP, gross domestic product, a refined picture of the economy that is limited to domestic production.

GNP in mature economies such as the United States grows at a much slower rate than in emerging nations. The growth of output is measured in real terms, meaning that increases in output due to inflation have been removed.

Gross Domestic Product

GDP is defined as "the total value of goods and services produced within the borders of the United States, regardless of who owns the assets or the nationality of the labor used in producing that output".[2] The growth of output is measured in real terms, meaning increases in output due to inflation have been removed.

GDP growth is used to forecast demand for goods and services. Since GDP is an indicator of the economy as a whole, it may not reflect production within various segments of the economy. The U.S. economy continues to mature and growth rates will moderate. The present Federal Reserve policy attempts to hold economic growth to an annual rate of 3 percent.

Inflation (Deflation) CPI

Inflation and deflation are two of the key drivers of product-pricing decisions. Inflation, or increased costs of goods and services, tends to erode profits and exert upward pressure on prices to customers. Price increases to your customers without increases in your costs improve profits. Inflation needs to be analyzed in the context of your firm's buyers, suppliers, and timing of price increases. Inflation can be economically destructive because it creates an upward spiral in prices.

Deflation is a downward force in prices. Deflationary pressures also require careful consideration to determine their effect on your business. Downward pricing pressures may also have negative effects on businesses and the economy as a whole as they decrease GDP. Global pricing pressures force U.S. firms to reduce prices, thus lowering profits. Lower prices require increased unit sales to attain the same revenue.

Interest Rates

Interest rates are a closely watched economic indicator. They are driven by inflation and have a significant impact on economic sectors that require use of debt for asset acquisition such as real estate, heavy equipment, and financial services. Relatively low interest rates portend increased economic activity as the cost of acquisition declines. Low interest rates fuel home buying because the costs of owning a home (monthly mortgage payments) decrease. Cost advantages from lower rates are temporary as product prices increase to reflect elevated demand. Low rates will bring more potential buyers to the residential real estate market bidding up prices of homes and eventually erasing the cost advantage of low interest rates. Conversely, demand for products may decline as interest rates increase.

Interest rates are an important component of planning because they are an indicator of economic growth and can change the viability of long-term investments.

[1]U.S. Department of Commerce, Bureau of Economic Analysis.

[2]Ibid.




Translating Strategy into Shareholder Value. A Company-Wide Approach to Value Creation
Translating Strategy into Shareholder Value: A Company-Wide Approach to Value Creation
ISBN: 0814405649
EAN: 2147483647
Year: 2003
Pages: 117

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