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What is Economic Environment?

Economic Environment

Economic Environment consists of economic factors that influence the business in a country. These factors include gross national product, corporate profits, inflation rate, employment, balance of payment, interest rates, consumer’s income, etc.

Macro-economic scenario determines the prospects of business in a country – In an environment of rapid growth, stable prices, high rates of savings and investment, fiscal stability and favourable balance of payments, prospects of business growth are bright.

The successful businessman visualizes the external factors affecting the business, anticipates the prospective markets situations and makes suitable plans to get the maximum with minimum cost.

Explained below are the key components of economic environment –

A. Economic system:

An economic system in an organization is that which provides living to the people. In different countries, different economic systems prevail. Prevailing economic system and changes in it affect the business enterprises to a large extent. The economic system of a country may be:

  1. Capitalistic-

    Capitalism believes in private ownership of production and distribution activities. UK, USA, and Japan are examples of capitalist countries.

  2. Socialist and Communist –

    Communism is where the State owns all the factors of production and distribution. Cuba is an example of the last remaining predominantly communist country.

  3. Mixed Economy System –

    It is one where the major factors of production and distribution are owned, managed and controlled by the State. India, France, Holland, are example of mixed economies.

In three alternative economic systems: capitalistic, mixed, and socialistic, organizations have to face different types of control ranging from total freedom to total control. We have mixed economic system where a partial control system is applied, both on production and its distribution depending in the situation. The system is marked by the existence of both a private and public sector, combination of planning with system and co-ordination among the objectives of private profits and social welfare.

Thus, the economic system existing in the country affects the business enterprise to a very great extent. In fact, economic system of the country determines the parameters of the business activity.

B. Financial System:

Since finance is a basic requirement of business, the level of development of the financial system is of crucial importance for business. In India, for example, the financial system is broadly divided into two segments, viz., (i) The money market and (ii) The capital market.

The basic fluctuation of financial markets both money market and capital market occurs due to the collection of savings and their transfer to business enterprises for investment purpose and thereby stimulating capital formation, with in turn accelerates the process of business growth.

In short, developed financial system is now a pre-condition for the efficient mobilization of financial resources for the business.

C. Economic Policies:

The government adopts economic policies to effectively influence the economic environment of business, the major economic policies are-

  1. Monetary Policy:

    Monetary policy regulates the economic growth through the expansion or contraction of money supply. There are three basic objectives of Indian monetary policy: (a) To provide necessary finance to the industries, particularly in private sector; (b) To control the inflationary pressure in the economy and (c) to generate and maintain high level of employment.

  2. Fiscal Policy:

    Fiscal policy deals with the tax structure and governmental expenditure. Generally the fiscal policy is adopted for: (a) Mobilizing maximum possible resources; (b) Optimal allocation of resources so as to attain rapid growth; (c) Attainment of greater equality in the distribution of income and (d) Maintenance of reasonably possible stability of prices, there are two aspects of fiscal policy relevant to management. First, how tax structure is affecting the growth of individual organizations and he Industry as a whole. Second, how government’s spending affects economic activities.

  3. Industrial Policy:

    The term industrial policy refers to governments’ policy towards industries – their establishment, functioning, growth and management. The policy will indicate the respective areas of Public, Private, Joint and Co-operative Sectors. It wills also spiel out government’s policy towards foreign capital, labour, tariff and other related aspects. Naturally, controlled by its industrial policy. Similarly, the Trade Policy, Foreign Exchange policy, and Foreign Investment and Technology Policy directly affect the functioning of business enterprises.

The Government can use economic policies to either promote, regulate or restrict the working of business enterprises, e.g., many developing countries suffer from severe balance of payment problems. Therefore, their import policies in general are very restrictive.

In short, economic policies of the government shape the opportunities for business. However, at times, these policies are used by the governments to regulate the operations of business firms.

D. Other Economic Conditions:

General economic conditions affect business. Economies pass through periods of boom and recession. A boom is characterized by high level of output, employment and rising demand and prices. A recession has the opposite of these characteristics.

Over the past two hand a half decades Americans have experienced two serve recessions. The so-called Miracle Economies of Asia viz., South Korea, Thailand, Indonesia and Malaysia were in the grip of recession during the latter half of the 1990s. There is deep economic crisis in Japan.

Economic conditions also include –

  1. Economic Indices like national income, distribution of income, rate and growth of GNP. per capita income, disposable personal income, rate of savings and investments, value of exports and imports, the balance of payments etc.
  2. Infrastructural factors such as financial institutions, banks, modes of transportation, communication facilities, energy source, etc.
  3. The availability of natural resources, raw materials, plant and equipment.

Strategists are actually aware of the importance and impact of the economic environment on the organizations. Almost all annual company by reports presented by the chairman devote attention to the general economic environment prevailing in the country and about the specific aspects that have an impact on their organizations and the business they are in.

The effect of changes in economic policy on business prospects has been demonstrated over a period of time in different ways. For example:

  • Partial decontrol of cement in 1982 led to a rapid increase in production capacity and resultant abundant supply, changing the market situation form that of scarcity to comfortable surplus.
  • Recent changes in economic and fiscal policies led to man developments, such as the entry of financial institutions and banks in stock trading.
  • Banking sector reforms led to attractive deposit avenues, easier credit terms, better service and above all, a sound, effective and reliable banking system.

In analyzing the economic factors the organization intending to enter a particular business sector may ask the following question:

  • What is the stage of economic growth and what is the rate of growth? Is it maturing, declining, or at take-off stage?
  • What is the level of on come-national and per capita? Does it offer market of large size?
  • What are the infrastructural facilities available and what are bottlenecks therein? (iv) What are the sources of financial resources and what are the costs?
  • Is adequate manpower – managerial, technical and worker available and what is their salary and wage structure?
  • Are critical raw materials and components available and at what costs?
  • What are the rates of taxes, both direct and indirect in general and levied on specific products?
  • Does the economic system allow entering in the business sector sought? In communist countries economic systems have lot of such barriers.
  • How far economic policies of Government are congenial to the proposed business?

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