‘The economy’ is a broad term which refers to:
- how people make, buy, and sell goods and services;
- how money flows between people, businesses and governments;
- and how those things affect the overall value of resources, assets and goods in a country.
The relative demand for these goods and services, and the relative supply of the resources required to produce them, determines their price (or market value).
Adding up the market values of all the things produced gives a total measure of the size of the economy. This is also known as total output or Gross Domestic Product (GDP). If GDP is bigger this year than last year, then the economy has grown.
The economy’s output is constrained by consumer demand and inputs such as land, capital, energy and labour. Levels of output also depend on how well these inputs are used to produce goods and services – this is known as productivity. A key measure of labour productivity is GDP per hour worked.
To improve productivity, organisations should constantly review their operations to take advantage of new ideas, machinery and software, new sources of labour and new ways of organising the business. Employee engagement is also key to improving productivity. As our report Productivity: getting the best out of people (archived: member-only) shows, companies that invest in skills and intelligently adapt modern management practices to the needs of the business tend to have superior productivity.
Economic growth and inflation
There's a limit to the level of GDP a country can achieve, also known as capacity or potential GDP. If the demand for goods and services exceeds potential GDP, there will be upward pressure on costs and prices. This means the rate of inflation will increase. Inflation can go up or go down irrespective of the balance of demand and supply in the UK. For example, if there are big changes in prices of the commodities that the UK imports (such as oil). There was a period of high inflation between the end of 2021 and mid-2024, which had a number of contributing factors.
Periods of high inflation are bad for workers as it erodes their purchasing power, meaning their wages buy less goods and services. It also makes it more challenging for businesses as inflation feeds through into the price of goods and services they acquire and employees demand higher pay rises.
The Monetary Policy Committee (MPC) of the Bank of England takes action through monetary policy, usually interest rates, to ensure that the rate of inflation stays low. Their objective, set by Government is that the Consumer Price Index (CPI) stays close to 2%. The Consumer Prices Index, including owner occupiers' housing costs (CPIH), is the inflation measure preferred by the ONS.
