Impact of Economic Factors on Business Environment - Economic Environment, Business Environment | Business Environment - B Com PDF Download

Several macro economic factors exist in an economy indicating the nature and structure of an economy have significant influence a firm‟s business environment and business decisions. Business has less control over these factors.

1) Stages of Business Cycle – The business cycle is the periodic but irregular up and down movement in economic activities, measured by fluctuations in real gross domestic product and other macro economic variables. A business cycle consists a sequence of four phases.

1. Contraction: It refers to a slowdown in the pace of economic activity. It is the lower turning point of a business cycle.

2. Expansion – It involves increasing pace of economic activity.

3. Peak – the upper turning of a business cycle. It is the peak i.e. highest point of an economic activity.

4. Recession – it occurs if a contraction is severe enough. A deep trough is called a slum or depression

Each stage has different implications for business enterprises by influencing their business decision. For example during boom a business enterprise would like to grow by expanding its production activity by taking loans from the market but in recession they try to cut down production level to reduce their cost.

2) Gross Domestic Products (GDP)

GDP is one of the best indicators to measure the growth rate of an economy. It is a measure of the value of all final goods and services produced in an economy during the year. It is used to calculate national income and as an indicator of economic growth.

After calculating national income, per capita income i.e. the average annual income per person is calculated by dividing the national income with total population of an economy.

The level and growth of gross domestic product and per capita income have considerable implications on the growth and expansion of business activities. The growth of net national product indicates the rate of economic growth while growth in per capita income indicates increase in the standard of living of people. These parameters influence the nature and size of demand and government policies related to business. Low per capita income means low purchasing power of consumers and thus low demand for products or services, so a business man has to reduce the price of his commodity to increase its sale by reducing the cost of production or by selling low cost brands. Rising level of per capita income leads to better prospects for business and increasing demand of well known brands.

3) National Income and Distribution of Income –An increase in national income and equitable distribution of income have a positive effect on business enterprises by creating opportunities for business units to expand their production capacity. A lower national income leading to lower per capita income and an inequitable distribution of income has an opposite effect. The world bank in its world development report 2014 has revealed that the richest 20 percent took 43.3 percent of the total income and the poorest 20 percent received only 8.9 percent of the total income distribution in Indian economy which shows that one fourth of population are below the poverty line which indirectly influences the growth of Indian economic activities negatively. Thus the income level has important implications for product development, pricing, distribution systems and other marketing strategies.

4) Industrial Growth Rate – A higher industrial growth rate makes that industry attractable and encourages business enterprises to enter into the industry.

5) Interest Rate Prevailing in the Economy – The change in interest rate is governed by the monetary policy of an economy as it has strong influence on economic activity like consumption, production and investment decision. An increase in interest rate makes borrowings expensive so it prompt consumers to reduce taking loans and cut down their spending, which ultimately leads to lower demand. Some business operate in the market which are very sensitive to changes in rate of interest like markets offering finance of purchase of goods and services by debt and where the price paid is relatively significant compared with customers income for example house property, motor vehicles, tours and travels and major purchases of consumer goods e.g. new kitchen equipment, audio visual systems etc.

6) Nature and Structure of the Economy: India is a mixed economy wherein both public sector for social welfare and private sector guided by profit motive co exist. Both central planning and market mechanism are used to guide and direct the economy. The structure of an economy can be determined by considering the contribution of different sectors primary, secondary and tertiary in the national income. The primary sector includes agriculture, forestry and fishery. The secondary sector consists of mining, manufacturing, construction, electricity, gas and water supply. The tertiary sector includes services like trade, transport, storage, communication, banking, insurance services etc. In developing economy like India as the economy develops share of primary sector decline and others sector‟s share increases. In India during the period of 1950-2014 the share of primary sector has been declined by more than 50 % while that of the service sector has increased by more than 80%. In India growth rate of the secondary and tertiary sectors has been more than double that of the primary sector as economy grows. These structural changes have significant impact on business environment. As growing service sector is providing strong prospects for growth of business units in the service sector domestically as well as in international markets as export of commercial services particularly in information technology, business and knowledge process outsourcing and consultancy businesses is increasing rapidly. This leads to rise in income level and rise in demand for consumer durables and services to improve living standard of people. There is a growing need of availability and use of better fertilizers, improved variety of seeds and agriculture machinery to improve the productivity of agriculture sector and make its production fit for domestic as well as international markets.

7) Population and Economic Development: In India population has been increasing at very fast pace and it has been estimated that it is going to surpass china by 2045. Thus India is the second largest market in terms of number of consumers. Population is required for utilization of available physical resources in an economy but rapid growth of population retards economic and social development of the country as it leads to excessive pressure on existing resources to meet increasing demand, reduction in per capita income and living standard, retard agricultural development due to increasing pressure on land, low rate of capital formation due to lesser savings, high level of unemployment.

Size and composition of population present both opportunities and threats for business. Opportunities arise because there are more consumers but it does not mean necessarily increasing demand unless it is supported by growth in real per capita income. Population growth also means availability of more workers for production and selling of goods but increase in labor supply is possible only when there is increase in working population and availability of good health and educational facilities. Like in India labor is cheap but its productivity is also low due to poor health, lack of education and dislike for hard work. In highly populated economy market opportunities are high but with intense competition. When population is heterogeneous in respect of language, religion, caste and preferences, different demand patterns leads to requirement for different marketing strategies.

Only increasing number of people are not significant for business, their requirements, income and education levels, occupational structure, sex and age composition also influence the nature and size of industry. Like where women and babies are large in number, business firms selling products meant for babies and ladies will gain. In small families parents spend more on health and education of their fewer babies. Also literacy levels, attitudes and buying habits of population affect advertising and marketing styles of business firms.

8) Urbanization and its Impact: Urbanization means the increasing proportion of a nation‟s population living in urban areas. Industrialization or the migration of people from rural areas has been the major cause of urbanization in Indian economy. Economic development is generally associated with the growth of urbanization in an economy as it is an important process of economic and social development. Large urban areas help to enlarge markets which encourage large scale of production to get economies of scale with specialization, innovation and inventions of advanced technology, efficient transport and communication services. Economies of scale help to reduce the cost of production and thus promote economic growth in an economy. But unplanned urbanization leads to increase in unemployment and population below the poverty line because of exploitation of people working in unorganized sectors, increasing use of capital intensive technology in urban areas and concentration of income in few hands. Planned urbanization helps in rural development because cities and towns plays a significant role in supplying required inputs like essential commodities, seeds fertilizers tractors and other agricultural machinery and consumer items to the rural areas and in marketing the output of the rural economy i.e. the agricultural products and products of village and cottages industries in towns as they are the biggest markets for consumerable goods and expensive products. It leads to increase in income level and living standard of rural people which as a result leads to increase in demand for fast moving consumer goods and consumer durables in rural areas. That is why several MNCs (Unilever, Nestle, Procter and Gamble) and Indian companies like Dabur are now focusing on rural marketing.

9) Deficit Financing: A developing country like India has to spend huge amounts of money on development plans which leads to increase in budget deficit as public expenditures exceeds public revenue collected by the government in the form of taxes. the government funds are inadequate then it restore to deficit financing to make good the budget deficit by issuing of fresh currency by the government. Deficit financing may stimulate demand because of Increase in money supply, lead to expansion of economic activity through the multiplier effect and increase in employment till full employment but beyond that it leads to inflation. It leads to high cost economy because of increasing cost of production as a result of increase in price and the economy become uncompetitive as rupee become weak in capital market. So it is useful only when it is used to a limited extent and for productive purposes only.

10) Planned Investment: The level of economic activity in developing countries like India depends to a large extent on total investment outlay by private and public sector. Planned outlay in India has been increased significantly since 1991 which has boosted economic development in the country by creating opportunities for expansion and diversification of business.

11) Rate of Inflation- Inflation means the process in which the general price level records a sustained and appreciable rise over a period of time. An inflation rate below 5% may be considered as a booster of profits which motivates investment and higher production. But inflation rate higher than 5% leads to decrease in economic growth by increasing cost for business, reducing savings and investment and by increasing uncertainty and risk. It arises because of demand pull factors i.e. the excess of aggregate demand over excess supply and Cost push factors i.e. sudden increase in price of inputs, sharp rise in wage rate, tax rates.

12) Money Supply- Money supply in an economy determines liquidity in the market, interest rate structure, cost of capital to business and the rate of inflation. Thus growth rate of output is related to the growth of money supply. Increase in money supply raises the level of aggregate demand in the economy which may lead to inflation. Thus excess of money supply creates inflation and its shortage causes liquidity crunches. It is controlled by the central bank of a country.

13) Foreign Exchange Reserves-It constitutes foreign currency assets, central bank‟s holdings and special drawing rights. It is an important indicator of macroeconomic environment as it indicates country‟s ability to pay for imports, discharge its external debt liabilities and stabilizes the exchange rate. Absence of adequate foreign exchange reserves decreases a country‟s international credibility and can destabilize the economy by devaluating the country‟s currency as wide fluctuations in exchange rate create uncertainty in foreign trade, encourage speculation and discourage investment by foreign companies.

14) Foreign Trade- Foreign trade (export and import) indicates the degree of a country‟s openness or globalization. The composition of foreign trade reflects the nature of an economy like a high level of foreign trade indicates economic liberalization, degree of international competitiveness and globalization. On the other hand its low level indicates a country‟s inward orientation and poor international economic relations.