Introduction
A company must operate within the country's economic framework. The economic framework includes the country's level of income, external conditions that affect the economy, and economic policies that affect the economy. The economic environment has an impact on how a business operates. When the economy and business are thriving, there will be more jobs and people will have more purchasing power. This means that businesses can sell more, introduce new products, and expand their operations. External factors such as global economic slowdowns can have an impact on companies that sell in international markets. The rise in oil prices may have an impact on transportation costs. As a result, when deciding which product to sell or at what price, a company must consider the economic environment in which it operates.
Economic Environment of Business
The total number of economic factors that comprise the economy is referred to as the economic environment. There are two types of economic environments: microeconomic and macroeconomic. The microeconomic environment includes information about individuals' economic situations in society. The macroeconomic environment includes economic factors pertaining to aggregate economic data of business industries, sectors, or other specific groups of individuals and businesses. The current economic environment is complicated. The business sector has economic ties to the government, the private sector, the capital market, and the global sector. These various sectors have an impact on the economy's trends and structure.
The economic environment may be classified on different criteria such as:
- Space- Local, regional, national and international
- Time- Past, present and future
- Forces-Market and Non market
The ongoing sociopolitical environment influences the structure of any economic system. They have an impact on macroeconomic decision making. Because India, for example, is a democratic country, the public has the ability to influence government decisions directly or indirectly. In contrast, the public does not have democratic rights in China, so crucial decisions for the country are made by the autocratic party in power with no public input. The economic structure and system determine whether decisions are centralized (made only by top-level government officials) or decentralized (made at lower levels). The government is the nation's manager. Because the nature of government ownership is political, we must recognize that political decisions have far-reaching economic consequences. The control and regulation of a country's economic activities give form and shape to the nature of economic organization.
Macroeconomic decisions are influenced by social preferences and community preferences. Choices made by businesses, individuals, and society have an impact on national decisions made by the economy as a whole. Examine some of the factors that contribute to the functioning of the economy.)
i) Free Market Economy and Centralized Economies: The free play of market demand and supply forces is referred to as the free market mechanism. The market mechanism can determine commodity prices, factor (input) prices, and income distribution, or the government can fix them.
ii) Welfare State Principle: The primary goals of government policies are to promote growth, efficiency, and equity. The welfare state principle motivates the government to impose minimum wages, commodity control, and fair trade prices, among other things. Business social responsibilities are a direct result of the social welfare motive fostered by national governments.
iii) Closed and Open Economies: Modern economies are open to international trade and cooperation. The ability of developed countries to maintain stable growth is dependent on the acceleration of growth in developing countries. Only then will developed countries be able to grow and market their products. This concept has given a new dimension to the role of multinational corporations (MNCs), ecological balance, and technology transfer.
The facts stated above define the environment in which modern businesses must operate. Thus, the following are the considerations for a business:
- Market or the Non-Market Environment
- Objectives of National Planning
- Policies of the Government Social Responsibilities
- Structure and pace of Economic Changes
- International Business Environment
As a result, we cannot separate the national and global environments because they are inextricably linked in modern times. We will now comprehend certain concepts that are critical to comprehending the economic environment.
Money supply
Money refers to anything that is widely accepted as a medium of exchange and can also be used as a unit of measurement and a store of value. The total stock of money available to a society for use in connection with the nation's economic activity at a given point in time is referred to as the money supply.
The money supply is made up of two components:
- Currency with the public, and
- Demand deposits with the public.
Other than banks and the government, the term "public" refers to individuals, businesses, and institutions. While the general public uses money, banks and the government create it. Currency in circulation is the total of the Reserve Bank's currency notes and coins in circulation. Banks must keep their cash reserves, which must be deducted from the total currency notes and coins.
The public's demand deposits are bank deposits held by the public. Bank deposits can be either demand deposits or time deposits. While demand deposits can be withdrawn by drawing checks on them, time deposits mature after a set period of time and are money that people keep as a store of value.
Aggregate demand
Aggregate demand (AD) is the total demand in the economy for final goods and services at a given time and price level. It is the total amount of goods and services purchased in the economy at all possible price levels. This is a country's demand for its gross domestic product.
AD C+1+G+ (X-M)
Where:
C = Consumers' expenditure on goods and services: This includes demand for consumer durables (e.g. washing machines, audio-visual equipment and motor vehicles)& non-durable goods such as food and drinks which are consumed.
I = Capital Investment: This is investment spending by companies on capital goods such as new plant and equipment and buildings. Investment also includes spending on working capital such as stocks of finished goods and work in progress.
G = Government spending: This is government spending on state provided goods and services including public and merit goods. Decisions on how much the government will spend each year are affected by developments in the economy and also the changing political priorities of the government. In a normal year, government purchases of goods and services accounts for around twenty per cent of aggregate demand.
Transfer payments in the form of welfare benefits (e.g., pensions) are excluded from general government spending because they do not compensate a factor of production for any output produced. They are simply a transfer from one sector of the economy to another (i.e., people who work and pay income taxes) (i.e. pensioners drawing their pension having retired from the labour force).
The following two aggregate demand components are related to international trade in goods and services between an economy and the rest of the world.
X = Exports of goods and services: Exports sold overseas are an inflow (an injection) into our circular flow of income and therefore add to the demand for the country's output.
M = Imports of goods and services: Imports are a withdrawal of demand (a leakage) from the circular flow of income and spending. Goods and services come into the economy for us to consume and enjoy, but there is a flow of money out of the economy to pay for them.
Net exports (X-M) reflect the net effect of international trade on the level of aggregate demand. When net exports are positive, there is a trade surplus (adding to Aggregate Demand); when net exports are negative, there is a trade deficit (reducing Aggregate Demand).
Inflation
In economics, inflation is defined as a rise in the overall level of prices for goods and services in an economy over time. Each unit of currency buys fewer goods and services as the general price level rises. As a result, inflation reflects a decrease in the purchasing power of money, as well as a loss of real value in the economy's internal medium of exchange. The inflation rate, which is the annualised percentage change in a general price index (typically the Consumer Price Index) over time, is a key measure of price inflation. It is calculated by subtracting the previous year's price index from the current year's index, dividing the difference by the previous year's index, and multiplying by 100.
Suppose price index was 200 in 2020 and 210 in 2021.
Then,
Inflation rate = (210-200)/200 = 0.055%
Inflationary pressures on an economy can be both positive and negative. Inflation has a negative impact on the real value of money and other monetary items over time; uncertainty about future inflation may discourage investment and savings; and high inflation may lead to shortages of goods if consumers begin hoarding in anticipation of future price increases. Positive effects include central banks adjusting interest rates (to avoid recessions) and encouraging capital investment. Most mainstream economists now advocate for low, consistent inflation. Inflation that is low (rather than zero or negative) may mitigate the severity of economic downturns.
Economists have attempted to differentiate between cost and demand inflation. Cost inflation is initiated by an increase in some cost components, such as the 1973-4 oil price explosion. Demand inflation is caused by an excess of aggregate demand.
Balance of payment
The balance of payments of a country is a record of its economic transactions with the rest of the world. This record indicates whether a country has a trade surplus (exports exceed imports) or a trade deficit (imports exceed value of exports). Trade figures are further subdivided into merchandise trade and services trade accounts; a country can run a surplus, a deficit, or a combination of the two. Japan has a large trade surplus and is a creditor country.
Foreign exchange
Foreign exchange allows you to settle accounts in different currencies. International finance dynamics can have a significant impact on both the national economy and the fortunes of individual companies. Currency depreciation can occur as a result of actions taken by a country's central bank. Currency trading by international speculators can also result in currency depreciation. When a country's economy is strong or when demand for its goods is high, the value of its currency tends to rise. Firms face various types of economic exposure when currency exchange rates fluctuate. These include transaction and operational risk. Firms can manage exchange-rate risk by hedging, such as buying and selling currencies and using the forward market.
