The Economic Environments

Facing Businesses
Chapter Four
Chapter Objectives
To understand the importance of economic analysis
To identify the major dimensions of international economic
analysis
To compare and contrast macroeconomic indicators
To profile the characteristics of the types of economic systems
To discuss the idea of economic freedom
To profile the drivers of economic transition
Importance of Economic Environments
Managers study economic environments to estimate how
market trends and government policy influence the
performance of their companies.
A country’s economic policies are a leading indicator of
government’s goals and its planned use of economic tools and
market reforms.
Economic development directly impacts citizens, managers,
companies, policymakers, and institutions.The relationships
among institutions, and the political norms and rules that
govern their functions
International Economic Analysis
Threeconditions hamper the development of a universal
scheme:

Difficulty
in stipulating a definitive set of indicators to estimate the
performance and potential of a country’s economy.
Today’s set of perfect measures may prove imperfect tomorrow.
Interdependencies complicate interpreting the relationship among
elements of the economic environment.
International Economic Analysis
Key economic forces include:

The general economic framework of a country

Economic stability
The existence and influence of capital markets
Factors endowments
Market size
Availability of an economic infrastructure
Economic Factors Affecting International
Business Operations
Elements of the Economic Environment
Gross National Income (GNI): the income generated both by
total domestic production as well as the international production
activities of national companies

Gross National Product (GNP): the value of all final goods and
services produced within a nation in a given year, plus the
income earned by its citizens abroad, minus the income earned
by foreigners from domestic production.
Elements of the Economic Environment

Gross domestic product (GDP): the total value of all final goods
and services produced in a country in a given year equal to
total consumer, investment, and government spending, plus the
value of exports, minus the value of imports.
Improving the Power of GNI

Managers improve the usefulness of GNI by adjusting it for

the number of people in a country, growth rate, and the local cost
of living.

Per Capita Conversion

GNI per capita is the value of all goods and services produced in the
economy divided by the population.
World Bank uses a classification scheme. They refer countries with low
and middle-income as developing countries. High-income countries are
often called developed countries or industrial countries.
Improving the Power of GNI
Rate of Change - Gross figures are a snapshot of one year of
activity. Consequently, they do not measure the rate of change
in an indicator. Understanding present and prediciting future
economic performance requires pinpointing the rate of change.

Purchasing Power Parity - This is an adjustment in gross

domestic product per capita to reflect differences in the cost of
living. Technically, the PPP is the number of units of a country’s
currency required to buy the same amount of goods and
services in the domestic market that one unit of income would
buy in the other country.
Improving the Power of GNI
Degree of Human Development - The Human Development
Index combines indicators of real purchasing power, education,
and health to give a more comprehensive measure of economic
development. HDI measures the average achievement in a
country on three dimensions:
Longevity, as measured by life expectancy at birth
Knowledge, as measured by the adult literacy rate and the combined
primary, secondary and tertiary enrollment ratio
Standard of living, as measured by GNI per capita expressed in PPP for
US dollar
Features of an Economy
Inflation
Unemployment
Debt
Income distribution
Poverty
Labor costs
Productivity
Balance of payments
Inflation
Inflation is a measure of the increase in the cost of living.
Inflation result when aggregate demand grows faster than
aggregate supply - essentially, too many people are trying to
buy too few goods, thereby creating demand that pushes prices
up faster than incomes grow.
The consumer price index measures the average change in
consumer prices over time in a fixed market basket of goods
and services.
Often, governments try to reduce inflation by raising interest
rates, installing wage and price controls and imposing
protectionist trade policies and currency controls.
Unemployment
Unemployment is a measure of the number of workers that
want to work but do not have jobs.
The unemployment rate is the number of unemployed workers
divided by the total civilian labor force, which includes both the
unemployed and those with jobs.
Countries that are unable to create jobs for their citizens create
a risky business environment.
Debt
This is the sum total of a government’s financial obligations,
measures the state’s borrowing from its population, from foreign
organizations, from foreign governments, and from international
institutions.
The larger the total debt becomes, the more unstable a
country’s economy becomes, both in the present as interest
expenses direct money from more productive uses, and the
future, as people worry about the ability of future generations to
pay back the debt.
Debt
A country has two types of debt:
InternalDebt: Portion of the government debt that is denominated in the
country’s own currency and held by domestic residents
External Debt: Debt owed to foreign creditors and denominated in foreign
currency.

Heavily Indebted Poor Countries (HIPC) - those poor countries

with large debts that are the target of initiatives to forgive the
debt as a means of assisting their development.
Income Distribution
Income distribution is a description of the fractions of a
population that are at various levels of income.
A global concern is the growing gap between the poor and rich,
especially in many developing countries.
There is a strong relationship between skewed income
distributions and the split between those who live in urban
settings versus those who live in rural areas.
Poverty
POVERTY - the state of having little or no money, few or no
material possessions, and little or no resources to enjoy a
reasonable standard of life.
In many parts of the world, workers and consumers struggle for
food, shelter, clothing, clean water, health service, to say
nothing of safety, security and education.
International companies facing such situations must deal with
their implications to virtually every every feature of the
economic development.
Labor Costs
Labor and Total Costs
For many goods and services, the cost of labor is a key
element of total costs. Consequently, companies scan the world,
looking for markets that offer lower-cost labor.
Productivity

Productivity measures the efficiency with which products are

produced.
Balance of Payments
 Balance of payments (BOP), officially known as the Statement
of International Transactions, records a country’s international
transactions that take place between companies, governments,
or individuals.
The BOP reports the total of all money that comes into a
country from abroad less all the money going out of the country
to any other country during the same period.
 Companies monitor the BOP to watch for factors that could
lead to currency instability or government actions to correct
imbalance.
Balance of Payments
 Balance of payments (BOP) has two main accounts:
Current Account: tracks all trade activity in merchandise
Capital Account: tracks both loans given to foreigners and
loans received by citizens
 Merchandise trade balance - the net balance of expos minus
imports of merchandise.
 Deficit - imports exceed exports
 Surplus - exports exceed imports
Components of a Country’s Balance of Payments
Definition of Economic System
A mechanism that deals with the production, distribution, and
consumption of goods and services

Types:
Market economy
Command economy
Mixed economy
Market Economy
 A market economy, the leading example of a capital economy,
describes the system where individuals, rather than government,
make the majority of economic decisions.
It permits an open exchange of goods and services between
producers and consumers.
The theoretical principles that define free-market economies are
based on the principle of laissez-faire.
A market economy depends on as few as possible government
restrictions- the less invisible the “hand” becomes due to
government intervention, the less efficiently will the market works.
Example: Hong Kong, Canada and United States
Command Economy
A command economy, also known as centrally planned
economy, descried the economic system whereby the
government owns and controls all resources.
Hence the government commands all authority to decide what
goods and services a country will produce, the quantity in which
they are produced, and the price at which theyr are sold to
consumers.
Command economies can appear to perform well, especially in
terms of growth rates for short periods of times, perhaps even
up to a generation.
Example: North Korea
Mixed Economy
Most economies broadly labeled mixed economies, fall in the
wide middle of the capitalism-communism spectrum.
A mixed economy is a system where economic decisions are
largely market driven and ownership is largely private, but the
government intervenes in many private economic decisions.
Economic Freedom: Idea, Performance and Trends

Economic Freedom - absence of government coercion or

constraint on the production, distribution, or consumption of
goods and services beyond the extent necessary for citizens to
protect and maintain liberty itself.
The Economic Freedom Index is the most comprehensive
approximation of the extent to which the government of a
country intervenes with the principles of free choice, free
enterprise, and free prices for reasons that go beyond the basic
need to protect property, liberty, citizen safety and market
efficiency.
Dimensions of The Economic Freedom Index
Business freedom
Trade freedom
Monetary freedom
Freedom from government
Fiscal freedom
Property rights
Investment freedom
Financial freedom
Freedom from corruption
Labor freedom
Means of Economic Transition
The process of transition to a market economy differs from
country to country.
Transition includes liberalizing economic activity, reforming
business activity, and establishing legal and institutional
frameworks.
Success is linked to how well the government deals with:
Privatization
Regulation
Property right protection
Fiscal and monetary reform
Antitrust legislation
Means of Economic Transition
Privatization - the sale of state-owned enterprises to the
domestic or foreign private sector, this process helps
governments reduce internal debt.
Deregulation - the removal of rules that control or restrict the
operations of an industry or company.
Property rights - permit an individual to own property and keep
income earned from it
Fiscal and monetary reform - adopting free market principles to
manage money supply
Antitrust laws - aim to maintain and promote market
competition
THANKS