What is Economic environment?

The economic environment consists of economic factors which affect the buying habits of
consumers and the commercial behavior of companies.
There are several internal as well as internal factors which affect the economy. The buying
habits of consumers and the commercial behavior of organizations id interdependent.
For example, if an organization increases the price of a particular product, then people will
start buying less from the organization and similarly when the demand of a particular product
decreases the company reduces the production of the product.

Factors Affecting the Economic Environment

There are various factors which affect an economic environment. These factors can be
divided into two categories.

Microeconomic environment
Microeconomic environment factors are those factors which affect
and individual organization and do not affect the whole industry. The examples of
microeconomic factors are demand, competitors, market size, distribution chain,
suppliers, supply, etc.

Macroeconomic environment

Macroeconomic environment factors are those which impacts at a larger level and does not
only impacts one company but impact the whole economy. The examples of microeconomic
factors are inflation, unemployment, interest rates, taxes, tariff, the trust of customers, etc.
In this section, you will learn about all the factors which affect the economic environment
and will also learn how these factors affect an economic environment.
1) Demand
Increased demand for product results in more profits whereas a decrease in demand for your
product causes loss. Therefore, companies use various strategy to increase the demand for
their product in the market.

2) Market size
The profit margin of the organization will be low if it has a small market size. Meaning of
market size is the total number of potential buyers in a market. For example, a company
which produces asthma inhalers has a small market size as it can sell inhaler to people who
suffer from asthma.
3) Suppliers
The production of a company will halt if its suppliers suddenly stop to provide supplies of
raw material to produce a product. Similarly, the production cost will also increase with the
increase in the price of supplies by the supplier.
.
4) Income
Income is the total earning of an individual or an entire family. Income affects the buying
habits of the consumers and thus impacts the commercial businesses.
There is a direct relationship between the buying habits of an individual and his income. For
example, people with low income tend to buy only goods and services which are necessary
for living and don’t spend much money on entertainment and luxurious items.
For example, a person with low income will prefer to spend money to pay the tuition fee for
his children’s education rather than buying an expensive car. On the other hand, people with
high income have a tendency to spend more money on entertainment and luxurious services
and goods.
5) Inflation rate
The inflation rate can be defined as the rate at which the process of goods and services
increases. With increased prices, the buying ability of people gets affected.
People start buying less, and they spend their money on the necessary goods and services
only. Inflation rate put bad impact on services businesses.
For example, people decrease going out for eating and travel less. Inflation rate impacts the
commercial business, which deals in leisure services and sells branded goods. Therefore,
inflation is undesirable by both consumers as well as businesses.

6) Increasing Interest Rates

Increasing interest rates also impact the businesses, especially those businesses where people
require to take a loan to buy goods. For example, people mostly buy houses and cars on
loans. Therefore, the sales of such goods decrease with the increased rate of the interest rate.
Because of this reason, many banks advertise their loans services at lower rates than other
banks in order to attract customers, because people always prefer to get a loan at a lower rate
of interest.

7) Unemployment level
Another factor which impacts the economic environment is the unemployment level. The
countries with high unemployment level have a weaker economic environment.
If most of the population will not earn, then they will not have sufficient money to spend on
buying goods and services. This creates a bad economic cycle in the country.
For example, if people will not buy, then, companies will not hire people in order to cut costs,
and if companies do not provide employment, the unemployment level will increase.
8) Taxes
High taxes in the country impacts the economic environment badly. People will have
low disposable income. Taxes not only affect the consumers, but it also affects businesses as
high taxes results in the high cost of production.

9) Tariffs
Tariffs are a type of taxes which is imposed on imported goods. Tariffs put an opposite
impact on the sales of goods than taxes. People will import more goods from foreign
countries if there are low tariff rates, and the local markets will be flooded with cheap foreign
products and will impact the sells of local products.
10) Cost of Labor
Cost of labor also impacts the economic environment of the business. High labor cost means
the high cost of production and high cost of production forces businesses to increase the price
of the products.

11) Population
The population has both positive and negative impact on the economic environment. For
example, high population means there are chances of finding skilled employees.
12) Innovation
Innovation has both positive and negative impact of the economic environment. Innovation
pose risk for already established businesses. As entrepreneurs come with innovative ideas of
business and they give competition to the already established businesses, which impacts the
sales of their products.

For example, with the introduction of automation, most of the work of production, which is
performed by labor can now be performed by machines. This helps in lowering the labor
wage expenses.

13) International Condition

The international market condition also impacts the economic environment. For example,
there are many businesses which import and export goods from international companies.
The tension between two countries or the increased tariff rates increases the import cost as a
result of which the cost of production also increases. Increased production cost means
increases in the prices of products.
When prices of products increase, people tend to buy less, and the sales of the product get
impacted. For example, the price of vegetables in Pakistan increased when the export of
vegetables was closed by India Amidst of tension between both countries.

14) Government Policies

Government policies also put an impact on the economic environment. Companies might be
required to change the production process of a product according to the change in
government policies.
For example, companies required to stop the production of certain drugs after they were
banned by the government.

15) Technological environment

Technological environment put a huge impact on the economic
environment. Technology changes rapidly, and organizations are required to change their
technology or update their technology to keep up with the changing technological
environment.
This requires them to update their machinery and hire new employees with new skills or to
train existing employees to use new technology. This impacts the production process of the
organization and increases the expenses as a result of which the cost of production increases
and sales of a product decreases.
Elements of Economic Environment
Several external factors have a significant influence on a country’s economy. These factors
play a huge role in deciding consumer behaviour and financial flow of a country, thereby
affecting its economic activities. All these elements together constitute the economic
environment definition.

These elements of economic environment are as follows –

 Gross Domestic Product (GDP)
Gross Domestic Product is the total value of all products and services produced in a country.
Therefore, the growth of GDP signifies that the economy of a country is stable and
improving. It also means that people have more disposable income that, in turn, leads to
increased demand for products and services.

It evaluates the financial worth of final goods and services—those that are purchased by the
end user—produced in a country over a specific time period (say a year). It includes all of the
output generated within the country. GDP also includes non-market production, for example,
education services which are provided by the government itself.The GDP growth rate
measures the economic reports and amount of a country ’s economic growth (or contraction).
Faster growth in the gross domestic product (GDP) expands the overall size of the economy
and strengthens fiscal conditions.
 Unemployment
A high level of unemployment in a country means that such an economy is not using its
resources to its full potential. At the same time, it would negatively impact individual
disposable income that will result in lower demand. It affects the commercial aspect of an
economy significantly. This phenomenon is markedly noticed in the existing economic
environment in India.

The individuals not only lose income but also face other hurdles financially as well as
mentally. Government expenses extend further than the provision of benefits to the loss of
worker output, which eventually reduces the gross domestic product (GDP) which in turn
leads to economic issues and then poverty. It will lead to lower GDP growth and fall in tax
revenue for the government.
 Inflation
When the overall prices of goods and services increase in a given period, it is known as
inflation. It happens when even though the prices of goods and services are rising the general
income level of consumers stays the same. Therefore, individuals have less money at their
disposal. Small businesses and cottage industries are also affected as prices of raw goods and
labour increase, resulting in smaller profit margins.

The propensity for the price level to rise over time is referred to as inflation. Inflation boosts
prices and has the potential to reduce the purchasing power of consumers. People buy more
than they need to avoid paying higher costs tomorrow, which drives up demand for products
and services. Suppliers are unable to keep up. Worse still, neither can salaries. As a result,
most individuals are unable to afford common products and services. Inflation reduces the
value of pensions and savings.
  Government Policy
Government policies also play a huge role in influencing the economy of a country.
Government policy can have a major influence on the economic environment. This can
include fiscal or monetary policy. An example of monetary policy is a reduction in interest
rates on bank loans which encourages consumers’ demand for loans. An example of fiscal
policy would be when the government decides to reduce income tax. Both of these policies
attempt to gradually increase individual disposable income and encourage consumers to
spend more, thus boosting commercial activities.
It can influence interest rate, taxation and a rise, which tends to increase the borrowing cost.
Consumers will spend less if the interest is higher but if the interest rate is lower it might
attract investments. In general, a government’s active role in responding to the economic
circumstances of a country is for the purpose of preserving important stakeholders' economic
interests.
 Reforms in the Banking Sector
The banks are considered to be one of the most crucial aspects of the Indian economy. As a
consequence, any reforms in this sector will have a huge impact on the economy.

The banking sector plays a vital role in the betterment of the economy. By boosting the
quality of financial services and increasing money accessible, banking sector openness may
directly improve growth.
 Role of the Public and Private Sector
India has a mixed economy where both the private and public sector plays a significant role.
While the public sector plays a valuable role in carrying out plans and reforms, developing
infrastructure and building a strong industrial base, the private sector is responsible for
generating employment opportunities. About 80% of the population is working in either
organised or unorganised private sectors.

The public sector promotes economic development at a rapid pace by filling gaps in the
industrial structure. It reduces the disparities in the distribution of income and wealth by
bridging the gap between the rich and the poor. Agriculture and other activities like dairying,
poultry come under the private sector. It plays an important role in managing the entire
agricultural sector.
 Balance of Trade and Balance of Payment
Briefly, Balance of Trade (BOT) is the difference between the money value of a country's
imports and exports of material goods only whereas Balance of Payment (BOP) is the
difference between a country’s receipts and payments in foreign exchange. When the exports
are greater than the imports, it leads to a favourable trade balance. It means there is a high
demand for its goods offshores, and that increases the demand for its currency. On another
hand, when the outflow is greater than the inflow, there is a current account deficit.

BOT records only merchandise and doesn’t record transactions of a capital nature. BOP
records transactions relating to both goods and services. BOP is a true indicator of the
economic performance of an economy.
 Consumer Confidence
The consumer is confident about his purchasing habits or decisions when they know they
have income stability, and income is stable when the overall economy of a country is. It also
affects the markets. For instance, if manufacturers and retail stores detect weak consumer
confidence, they have to manage their inventory and cut back on production. Therefore, the
economy will experience a slow down and ultimately, recession. A stable and growing
economy usually boosts a consumer’s confidence.

The confidence of consumers impacts their economic decision and hence is a key indicator
for the overall shape of an economy.

Role of Economic Policies

The basic purpose of economic policy is to help their country thrive economically through
determining tax rates, money supply, government budgets, and interest rates, among other
things.

Apart from the components of the economic environment, economic policies introduced by
the government can also have an impact on markets. The components of economic policies
are mentioned below.

Liberalisation
Liberalization is a broad phrase that refers to any process in which a government removes
limitations on some individual person activities. It occurs when something which used to be
banned is no longer banned. In simple language, you can say that Govt. eliminates regulation
on private firms and trade.

Earlier it was restricted by the government for the production of goods and there is various
permission that has to be taken from Govt. Due to this, there was a strong influence of the
government in business.

This refers to when a state lifts the restrictions imposed on private business ventures so as to
enable them to continue their operations without any hindrance and to facilitate economic
growth. For instance, in 1991, the government of India removed some previously enforced
restrictions on Indian companies. This includes –

 Removing almost all licenses except for a few

 Freedom in setting the price of products and services
 Reducing tax rates
 Relaxation on import and export of goods
 Allowing foreign investment in India

Some features of liberalisation in India are:

 Abolition of the existing License Raj in the country.
 Reduction of interest rates and tariffs.
 Removing the state sector's monopoly from several aspects of our economy.

Privatisation
In general, privatisation involves transfer of all national economies from the public to the
private sector. Privatization can take multiple forms, one of which is the 'partial or total
denationalisation of assets.' Disinvestment of government’s equity in PSU’s and the opening
up of hitherto closed areas to private participation is the meaning that economics generally
specifies.

The privatization of government assets and functions are seen to generate savings for
taxpayers by increasing efficiency, improving incentives, and reducing waste.
This refers to when industries in the private sector are given more roles and the participation
of the public sector decreases. Toward this, the Indian government took several steps like –

 Migrating public sector organisations to the private sector

 Setting up a board to manage those public sector enterprises that are not performing
well
 Selling off government-owned stakes to private organisations
Recently, The Centre had proposed to privatise the Indian Overseas Bank (IOB) and the
Central Bank of India.

A recent example of privatisation would be when the Indian government opted to privatise
Bharat Petroleum Corporation Limited in November 2019.

Globalisation
Globalisation refers to something that encompasses or connects the entire world rather than
being limited to a single country.

We exist in a world that is now constantly linked. Our everyday lives are strewn with the
imprints of other cultures, communities, and economies. The smartphone we use may be
made in China, the clothing we wear could be made in Bangladesh, and the fast-food places
we frequent could be from a little state in the United States.. It determines how quickly
globalisation rates can move by allowing countries to expand their links for mutual benefit
with other countries.

This refers to when the economy of a particular nation integrates with the world or global
economy. This is done via increased trade with other countries, the use of technology, foreign
direct investments, etc. The Indian economy was globalised in 1991 when it faced a severe
economic crisis.

Impact of LPG Policies in India

The above economic policies were adopted by our government when India went through a
major financial crisis in the year 1991. These policies impacted the business environment of
our country in several ways. These include –
 Indian companies faced increasing competition from foreign businesses.
 They had to adopt new technology into their business to keep up.
 Indian industries became more market-oriented, which means that they started
manufacturing products based on customer demands.
Economic systems are the methods societies and governments use to organize, allocate and
distribute goods, services and resources across locations. Understanding how economic
systems work can benefit anyone in the workforce. In this article, we'll explore what an
economic system is, the five primary types of economic systems and the advantages and
disadvantages of each type.
What is an economic system?
An economic system serves as a regulatory system for controlling different aspects of
production and distribution, including capital, labor, land and other physical resources. In an
economic system, there are many essential entities, agencies and decision-making authorities.
Additionally, economic systems typically follow patterns of use and consumption that make
up the structure of society and communities.
The five types of economic systems
There are five distinct types of economic systems, including the following:
1. Traditional economic system
In a traditional economic system, each member of a community or society has a specific role
that contributes to the whole progress of the community. Traditional economic systems
represent the oldest model, where societies are more physically connected and socially
satisfied through labor, farming and other simple processes. While traditional economic
systems can have several benefits, their antiquated model can also present several potential
drawbacks.
Some advantages include:
 Rarely any surplus in goods or resources
 Community members are generally more satisfied in social roles
 Absence of total economic hierarchy results in a lack of economic competition
Some potential drawbacks include:
 Antiquated methods of distribution
 Lack of growth and technology development
 Reliance on localized resources and services inhibits globalization
 Less focus on industrialized production and more focus on agricultural processes

2. Command economic system

In command economic systems, governments and centralized powers control much of the
economic processes, including allocating and distributing resources, goods and services. In a
command economy, the government plays a key role in directing and intervening in business
processes that provide essential goods and services to the community. Many command
economies consist of governments that have total control over the distribution and use of
valuable resources, like oil and gas.
Additionally, these types of systems may operate under governing entities that have
ownership of essential industries like transportation, utilities and energy, and technology.
Command economies can be beneficial for creating sustainability, however, there are a few
potential drawbacks to this type of system.
Some advantages include:
 Creates potential for mass mobilization of necessary resources due to government
control
 Creates additional jobs for community members and citizens due to increased
mobility of resources
 Focuses on benefits to society over individual interests
 Encourages more efficient use of valuable resources
Some disadvantages could include:
  Creates scarcity due to an inability to plan for individual needs
 Forces government rationing due to inability to calculate demand on set prices
 Eliminates market competition, resulting in a lack of innovation and advancement
 Inhibits employees' freedom to pursue creative jobs and careers
3. Centrally planned economic system
In a centrally planned economy, the society creates and dictates economic plans to drive the
production, investments and allocation of goods, services and resources.
The government only intervenes in production processes to regulate fair trade agreements and
ensure compliance with international policy. Additionally, governments in a centrally
planned economy take part in coordination efforts to provide public services. This type of
economic system is an offshoot of the command economy, where governments still maintain
a level of control over the allocation and distribution of resources.
Advantages of this system include:
 Better able to meet national and social objectives by addressing issues like
environmentalism and anti-corruption
 Gives governing powers the ability to make decisions regarding the production and
distribution of goods and resources when private industries cannot raise enough
investment capital
 Allows input from community members on government plans for setting product
prices, determining production quantity and opening up job sectors
Some disadvantages could include:
 Can create a lack of government resources to respond efficiently to shortages and
surpluses
 Potential for corrupt actions within governing bodies and established powers
 Creates a potential loss of freedom for citizens wanting to start their own enterprises
 Institutes governing powers that sometimes develop into repressive political systems
4. Market economic system
In a market economic system, or a “free-market system,” communities, firms and proprietors
act in self-interest to decide how to allocate and distribute resources, what to produce and
who to sell to. Governments in market systems typically have little intervention on how
businesses operate and generate income, however, can regulate factors like fair trade, policy
development and honest business operations.
While market economic systems can benefit emerging businesses and sole proprietorships,
there are some potential disadvantages to using a free-market economic system.
Advantages may include the following:
 Provides incentive for innovative entrepreneurship
 Gives consumers a choice in goods, services and purchase prices
 Creates market competition for resources, resulting in quality offerings and efficient
use of resources to produce goods
 Inspires research, development and advances in goods and production of goods
Some disadvantages could be:
 Highly competitive markets can cause a scarcity in resources for disadvantaged
individuals
  Potential for monopolizing of industries and niches, such as technology, health care
and pharmaceuticals
 Can increase income disparity by placing focus on economic needs over societal,
community and human needs
5. Mixed economic system
Mixed economic systems combine two or more economic practices to form one central
system. Traditionally, a mixed economy consists of a market and command economy
combined to form an economic system where the market is generally free from government
or national ownership. However, the government can still have control over essential
industries and sectors like transportation and defense.
Additionally, the governing entities in mixed economic systems usually have a predominant
oversight over the regulation of private corporations and businesses. While mixed economies
are fairly common around the world and offer many benefits, they also can have some
weaknesses:
A mixed economic system often has these advantages:
 Allows for private companies to operate more efficiently and reduce operational costs
because of less government oversight
 Creates an outlet for market failures through allowing certain government intervention
 Enables governments to create net programs like social security, health care and food
and nutrition programs
 Gives governments power to redistribute income through tax policies, reducing
income disparities
Some potential disadvantages include:
 Government intervention can be too frequent or not frequent enough, creating an
imbalance
 Creates potential for government subsidiaries within state-run industries
 Can cause subsidized government industries to go into debt with a lack of competition
in state-run industries