Economic Environment

What is Economic Environment of Business

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Economic Environment of Business

The economic environment of business enterprise consists of several external factors such as economic policies, economic systems and economic conditions. For example, the economic condition of a country can be described in the form of the per capita income, economic resources, nature of the economy, income distribution, etc. Demand is the key component of the economic environment. Insecurities or confidence among consumers play an important role in shaping a business’s demand for products and services. Hence, the economic environment plays a vital role in business decision making.

What is Economic Environment?

The economic environment involves external factors of a country which has a considerable impact on the creation and distribution of wealth. The demand and supply of a business organization are directly influenced by these economic factors. From the financial viewpoint, it also verifies the country’s viability for conducting business practices.

The economic system is the basis for deciding the extent of private business. Different countries around the world implement various economic systems. Some countries have capitalist economies or free market economies whereas, others have communist economies or centrally planned economies. There are also a few countries which follow mixed economies, i.e., having features of both capitalist and socialist economies.

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Economic Environment Meaning

The economic environment of business includes all the economic factors that impact the processes of a business unit. These factors play an important role in shaping the business environment. A business’s success depends greatly on the economic environment, as it supplies all the necessary inputs. The connection between a business’s success and the current economic environment is strong because it directly affects the ability to sell finished goods. Businesses are completely dependent on the economic environment, as business is an integral part of the overall economy. Accurately defining the components of a country’s economic environment can be a complex task. But still, there are specific factors that have considerable influence.

Some of the factors are as follows:-

  • Growth strategy
  • Economic system
  • Economic planning
  • Industry
  • Agriculture
  • Infrastructure
  • Financial and fiscal sector
  • Removal of regional imbalances
  • Price and distribution control
  • Economic Reforms

Components of Economic Environment

The major components of economic environment of business are as follows:

Components of Economic Environment

1) Economic Legislation

There are various legislations formulated by the governments of different countries which play an important role in governing business enterprise and in contributing country’s overall progress.

2) Economic Conditions

The economic conditions of a country largely affect the economic policy of a business enterprise. These conditions include the purchasing power of consumers, standard of living, distribution of income, employment level, demand and supply, etc. A rise in the level of these factors may increase the market share of a business enterprise.

3) Economic System

Economic relations among people in society are controlled and maintained by the set of rules, goals and incentives combined to form the economic system. This system plays a vital role by providing solutions to the economic problems of society.

4) International Economic Environment

Nowadays, any business enterprise needs to understand the international economic environment. While doing foreign trade, the business enterprise is not only influenced by its domestic economic environment but also by the economic environment of other countries. For the smooth functioning of export and import activities, many organisations like the World Trade Organisation, IMF, World Bank, etc., have issued various rules and regulations.

5) Economic Policies

Economic policy is a course of actions taken by the government to control the economic environment. There are two major types of economic policies, viz., Monetary policy and Fiscal policy. The decisions related to such policies include formulation of the government budget, setting interest rates, transfer of ownership and other government activities.

Economic Factors Affecting Business

There are various economic factors which affect the functioning of a business organisation. Some of them are as follows:

Economic Factors Affecting Business are as follows:

  1. Money and Banking
  2. Income and Employment
  3. Marginal and Total Utility
  4. Demand and Supply
  5. Trade Cycles
  6. Economic Growth and Development
  7. General Price Level

1) Money and Banking

The business and its customers are affected by the monetary and fiscal policies regulated by the banks. The purchasing power and demand of the customers are influenced by the circulation of money. While the borrowing capacity of individuals and business enterprises is governed by the banking facilities.

2) Income and Employment

The employment level and per capita income of the economy also affect the business. These factors indicate the buying capacity of people and the level of consumer demand.

3) Marginal and Total Utility

Utility is the ability to satisfy the needs and wants of customers through the consumption of goods. If the units of similar goods are consumed on a constant and successive basis, the level of satisfaction starts decreasing. This results in either short-term or long-term decreases in sales. To deal with such a situation, business organisations launch a new product or brand which helps to cover up the fall in sales and revenue losses.

4) Demand and Supply

The main economic factors which influence the operations of business organisations are demand and supply. The demand represents the need and capability of consumers to purchase a product and supply is the ability of the business to fulfil the consumer’s demand. Therefore, the demand and supply of goods and services are interdependent.

5) Trade Cycles

The stages of the trade cycle such as rise, stability, continuity, and fall affect the price of products. The fluctuations in the costs of goods and commodities also affect the business operations.

6) Economic Growth and Development

The total earnings of individuals in the society denotes the economic growth whereas the amount of funds invested in the enhancement of the society is known as economic development. Both these factors directly influence the working of the business organisations.

7) General Price Level

The general price level of the product affects the sales of the business enterprise. The elements involved in setting up of general price of a product comprise the cost of raw materials, production cost, labour cost and transportation cost. If the cost of such elements is high then the price of the product also increases which affects the sale of products.

Factors of Economic Environment

The economic environment of business includes external factors within the business market and the broader economy that possess the potential to influence a business. The economic environment can be divided into two major components: the microeconomic environment and the macroeconomic environment.

The microeconomic environment encompasses factors that directly influence business decision-making, such as the actions of individual businesses and consumers. On the other hand, the macroeconomic environment includes those factors that impact an entire economy and all its participants. Many economic factors place external restrictions on businesses, often leaving them with little or no control over them.

The macroeconomic environment takes a broader perspective, it focuses on the overall health and performance of an entire economy. Macroeconomic factors have a great impact on businesses, as they influence consumer spending power, market demand, and overall business confidence. It considers factors such as:

  • Interest rates
  • Taxes
  • Inflation
  • Currency exchange rates
  • Consumer discretionary income
  • Savings rates
  • Consumer confidence levels
  • Unemployment rate
  • Recession
  • Depression
  • GDP growth
  • government policies.

The microeconomic environment plays an important role in shaping the day-to-day operations of businesses. It involves analyzing the behaviour of individual companies and consumers, understanding their preferences, and assessing market dynamics. By closely examining these factors, businesses can make informed decisions regarding production levels, pricing strategies and resource allocation.

Microeconomic factors influence a business’s operations and the overall decision-making process of a business. Unlike macroeconomic factors, these factors are more specific and don’t necessarily impact the entire economy as a whole. Microeconomic factors influencing a business include:

  • Market size
  • Demand
  • Supply
  • Competitors
  • Suppliers
  • Distribution chain, such as retail stores

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