Business Environment Unit 2

Unit 2 Economic Environment

Structure:
2.1 Introduction
Objectives
2.2 Economic Environment of Business
Money supply
Aggregate demand
Inflation
Balance of payment
Foreign exchange
2.3 The Global Economic Environment
World Bank classification
Global market condition
2.4 Economic Policies
Fiscal policy
Monetary policy
Instruments of monetary policy
General or quantitative controls
Selective or qualitative controls
2.5 Business and Economic Policies
Stabilization policy
Policy mix
Factors causing change in aggregate demand
Environmental degradation and sustainable development
2.6 Summary
2.7 Glossary
2.8 Terminal Questions
2.9 Answers

2.1 Introduction
In the previous unit, we studied about the social environment of business. In
this unit we will study the economic environment of business. A company
has to work within the economic framework of the country. The economic
framework is the level of income in the country, the external conditions that
affect the economy, and theeconomic policies that affect the economy. The
economic environment affects the way a business operates. When the
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economy is growing and business is booming, there will be more jobs and
people have greater purchasing power. This means companies are able to
sell more, and introduce new products and expand the business. External
factors like slowdown in global economies can affect companies that sell in
international markets. Rise in oil prices can affect the transportation costs.
Hence, when a company has to decide which product to sell, or at what
price, it has to consider the economic environment that it operates in. This
unit explains what is meant by the economic environment of business.
Objectives:
After studying this unit, you should be able to:
 recognize the Nature of the Economic Environment in which business
operates.
 discuss the Global Economic Environment
 explain how Fiscal and Monetary Policy operates
 identify the ways Economic Policies can change Aggregate Demand

2.2 Economic Environment of Business

An economic environment is the total number of economic factors that make
up the economy. Economic environment is of two types: microeconomic and
macroeconomic. The microeconomic environment includes information
relating to the economic situations of individuals in society. The
macroeconomic environment includes economic factors relating to the
aggregate economic information of business industries, sectors or other
particular groups of individuals and businesses. The present day economic
environment is a complex one. The business sector has economic relation
with the government, household sector, capital market and the global sector.
These different sectors influence the trends and structure of the economy.
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 structure of any economic system is conditioned by the ongoing socio
political environment. They influence the macroeconomic decision making.
India, for example, is a democratic country, hence in such a set up, the
public can influence directly or indirectly the decisions taken by the

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government. In contrast, for example in China, the public do not have

democratic rights, hence crucial decisions for the country is taken by the
autocratic party in power without any public influence. Whether decisions
are centralized (decided only by the top level government officials) or
decentralized (decision making starts from the lower levels e.g. from the
panchayat level) are determined by the economic structure and system.
Government is the manager of the nation. Since nature of government
ownership is political in nature, we must understand that political decisions
have got far reaching economic implications. The control and regulation of
economic activities of a country provide form and shape to the nature of
economic organization. We will be learning more about Economic Systems
in the next unit.
Social choice and community preferences direct macroeconomic decisions.
Choices made by business corporations, individuals and society affect
national decisions taken by the economy as a whole. Let us look closely at
some of the factors that constitute the functioning of the economy.
i) Free Market Economy and Centralized Economies: By free market
mechanism we mean the free play of the forces of market demand and
market supply. Commodity prices, factor (input) prices and income
distribution can be determined by the market mechanism or can be
fixed by the government.
ii) Welfare State Principle: The basic objectives of government policies
are growth, efficiency and equity. The welfare state principle induces
the government to enforce minimum wages, commodity control, fair
trade prices etc. Social responsibilities of business are a direct
outcome of the social welfare motive cultivated by national
governments.
iii) Closed and Open Economies: Modern economies are open to
international trade and co-operation. The maintenance of stable growth
in the developed countries is dependent on the acceleration of growth
in the developing countries. Only then would the developed countries
be able to expand and market their goods. This idea has given new
dimension to the role of the multinational corporations (MNCs), the
ecological balance and transfer of technology.

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The above facts define the environment in which modern firms must
operate. Thus the things which a business has to keep in mind are:
 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
Thus we cannot segregate the national and the global environment since in
modern times both are closely interlinked witheach other.
We will now understand certain concepts which are integral to the
understanding to the economic environment.
2.2.1 Money supply
The word money stands for anything that is generally accepted as a medium
of exchange and at the same time can be used as a measure and a store of
value. Money supply is the total stock of money available to a society for
use in connection with the economic activity of the nation at a point of time.
Money supply consists of two elements, namely:
 Currency with the public, and
 Demand deposits with the public.
The term public refers to households, firms and institutions other than banks
and the government. While the public use money, banks and the
government are the money producers. Currency with the public is the sum
total of the currency notes and coins in circulation issued by the Reserve
Bank. The cash reserves with banks must remain with them and hence
have to be deducted from the total currency notes and coins.
The demand deposits with the public are the bank deposits held by the
public. Bank deposits are either demand deposits or time deposits. While
demand deposits can be withdrawn by the public by drawing cheques on
them, time deposits mature only after a fixed period and are money that
people hold as a store of value.
2.2.2 Aggregate demand
Aggregate demand (AD) is the total demand for final goods and services in
the economy at a given time and price level. It is the amount of goods and
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services in the economy that will be purchased at all possible price levels.
This is the demand for the gross domestic product of a country.
AD = C + I + 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 not
included in general government spending because they are not a payment
to a factor of production for any output produced. They are simply a transfer
from one group within the economy (i.e. people in work paying income
taxes) to another group (i.e. pensioners drawing their pension having retired
from the labour force).
The next two components of aggregate demand relate 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.
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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).
2.2.3 Inflation
In economics, inflation is a rise in the general level of prices of goods and
services in an economy over a period of time. When the general price level
rises, each unit of currency buys fewer goods and services. Consequently,
inflation also reflects a reduction in the purchasing power of money, a loss
of real value in the internal medium of exchange in the economy. A chief
measure of price inflation is the inflation rate, the annualized percentage
change in a general price index (normally the Consumer Price Index) over
time. It is calculated by subtracting the last year’s price index from this
year’s index, dividing that difference by the last year’s index and multiplying
by 100. Suppose price index was 200 in 2010 and 210 in 2011.
Then
Inflation rate = (210-200)/200 = 0.05 = 5%
The effects of inflation on an economy can be simultaneously positive and
negative. Negative effects of inflation include a decrease in the real value of
money and other monetary items over time; uncertainty over future inflation
may discourage investment and savings, and high inflation may lead to
shortages of goods if consumers begin hoardingin view of price increase in
the future. Positive effects include adjusting interest rates by central banks
(intended to mitigate recessions), and encouraging investment in capital
projects. Today, most mainstream economists favor a low, steady rate of
inflation. Low (as opposed to zero or negative) inflation may reduce the
severity of economic recessions.
Economists have attempted to distinguish cost and demand inflation. Cost
inflation is started by an increase in some elements of costs, for example
the oil price explosion of 1973-4. Demand inflation is due to too much
aggregate demand.
2.2.4 Balance of payment
A country’s balance of payments is a record of its economic transactions
with the rest of the world. This record shows whether a country has a trade

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surplus (value of exports exceeds value of imports) or a trade deficit

(imports exceed value of exports). Trade figures can be further divided into
merchandise trade and services trade accounts; a country can run a surplus
in both accounts, a deficit in both accounts, or a combination of the two.
Japan enjoys an overall trade surplus and serves as a creditor nation.
2.2.5 Foreign exchange
Foreign exchange provides a means for settling accounts in different
currencies. The dynamics of international finance can have a significant
impact on the nation's economy as well as the fortunes of individual
companies. Currencies can be subject to devaluation as a result of actions
taken by a country’s central bank. Currency trading by international
speculators can also lead to devaluation. When a country's economy is
strong or when demand for its goods is high, its currency tends to
appreciate in value. When exchange rates of currency fluctuate, firms face
various types of economic exposure. These include transaction exposure
and operating exposure. Firms can manage exchange-rate exposure by
hedging, for example, by buying and selling currencies and the forward
market.
Self Assessment Questions
Fill in the blanks:
1. Inflation is a _____ in the general level of _____ of goods and services
in an economy over a period of time.
2. Aggregate demand (AD) is the total _____ for final _____ and _____ in
the economy at a given time and _____.
3. Money supply consists of _____ with the public, and _____ _____with
the public.
4. Select the right option:
A country’s balance of payments is a record of its _________ with the
rest of the world. (economic transactions, non-economic transactions,
both of these)

2.3 The Global Economic Environment

The global economy can be traced back hundreds of years when traders
from the East and West came together to exchange goods. Through the
legacy of mercantilism up to the current GATT Round, marketers have had
to contend with changes and developments in the economic environment,
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including the growth of regional economic blocs, all aimed at increasing

cooperation between the grouped nations.
Markets differ widely in their size and state of development worldwide. It
would be too easy to classify these markets as "rich" or "poor", "developed"
or "less developed", although this is often done for ease of analysis. There
are great differences within a country and marketers have to be aware in
assessing market potential that they do not use general descriptions of
nations as criteria of whether to, or whether not to, open trade negotiations.
2.3.1 World Bank Classification
For operational and analytical purposes, the World Bank’s main criterion for
classifying economies is, Gross National Income (GNI) or Gross National
Product, or GNP per capita.
(Gross National Product: Total market value of the finished goods and
services manufactured within the country in a given financial year, plus
income earned by the local residents from investments made abroad, minus
the income earned by foreigners in the domestic market). Based on its GNI
per capita, every economy is classified as low income, middle income
(subdivided into lower middle and upper middle), or high income. Other
analytical groups based on geographic regions are also used.
Geographic region: Classifications and data reported for geographic
regions are for low-income and middle-income economies only. Low-
income and middle-income economies are sometimes referred to as
developing economies. The use of the term is convenient; it does not mean
that all economies in the group are experiencing similar development or
that other economies have reached a preferred or final stage of
development.
Income group: Economies are divided according to 2009 GNI per capita,
calculated using the World Bank Atlas method. The groups are:
 Low income economies: These are countries whose GNP (Gross
National Product) per capita income is $995 or less;
 Lower middle income: These are countries whose GNP per capita is
between $996 - $3,945;
 Upper middle income: These are countries whose GNP per capita is
$3,946 - $12,195; and

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 High income: These are countries whose GNP per capita is $12,196 or
more.
In Table 4.1 we see 25 countries classified according to the above
classifications.
Table 4.1
SL.NO. Economy Income group
1 Afghanistan Low income
2 Bangladesh Low income
3 Ethiopia Low income
4 Nepal Low income
5 Zimbabwe Low income
6 Bhutan Lower middle income
7 China Lower middle income
8 India Lower middle income
9 Indonesia Lower middle income
10 Pakistan Lower middle income
11 Sri Lanka Lower middle income
12 Thailand Lower middle income
13 Brazil Upper middle income
14 Cuba Upper middle income
15 Iran, Islamic Rep. Upper middle income
16 Libya Upper middle income
17 Malaysia Upper middle income
18 Mexico Upper middle income
19 Australia High income: OECD
20 France High income: OECD
21 Germany High income: OECD
22 Israel High income: OECD
23 Japan High income: OECD
24 United Kingdom High income: OECD
25 United States High income: OECD
Source: World Bank

Countries in the first two categories are sometimes known as less

developed countries (LDCs). Upper middle income countries with high

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growth rates are often called newly industrializing economies (NIEs).

Several of the world's economies are notable for their fast growth; the big
emerging markets (BEMs) include China and India, Poland, Turkey, and
Indonesia (lower middle income), Argentina, Brazil, Mexico, and South
Africa (upper middle income), and South Korea (high income). The group of
seven (G7) and Organization for Economic Cooperation and Development
(OECD) represent two initiatives by high income nations to promote
democratic ideals and free-market policies throughout the rest of the world.
Most of the world's income is located in the Triad, which is comprised of
Japan, the United States, and Western Europe. Companies with global
aspirations generally have operations in all three areas. Market potential for
a product can be evaluated by determining product saturation levels in the
light of income levels.
2.3.2 Global market conditions
In the past fifty years the global economy has changed rapidly. Particularly
marked has been the development of world economic integration and
standardized products. Coca Cola, Nissan and Marlboro cigarettes are
examples of products which serve nearly every market. The economic
environment is a major determinant of global market potential and
opportunity.
 Generally there have been four major changes:
 capital movements and trade have become the driving force of the
global economy
 production has become uncoupled from employment
 primary products have become uncoupled from the industrial economy
and,
 The world economy is in control - individual nations are not, despite the
large world economic share of the USA and Japan.
Let us now see the stages of growth of economies which help us
understand better a nation’s economic development. Rostow (1971)
produced a five stage model of economic takeoff:
 Stage 1: Traditional society, little increase in productivity, no modern
science application systematically, low level of literacy
 Stage 2: The preconditions of takeoff, modern techniques in agriculture
and production, developments in infrastructure and social institutions

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 Stage 3: The takeoff, normal growth patterns, rapid agricultural and

industrial modernization, good social environment.
 Stage 4: The drive to maturity, modern technology applied to all fronts,
international involvement, can produce anything
 Stage 5: The age of high mass consumption, production of durable
goods and services.
These classifications enable marketers to assess where and how to operate
in countries which may display the stage characteristics. For example,
African exporters would look to stage 4 and 5 economies to obtain the
greatest revenue opportunities for their produce.
Another way to assess the market alternatives to a potential global marketer
isto look at the origin of its national product, for e.g. is it farm or factory
generated? Farm workers tend to have low incomes. Input-output tables
provide other insights into a country's potential, that is, what inputs go into a
particular industry's output? What combination of labour, materials and
equipment?
Self Assessment Questions
Fill in the blanks:
5. Rostow produced a ______ stage model of economic ______.
6. World Bank has divided economies into ______, ______, ______ and
______ Economies according to the country’s ______.

2.4 Economic Policies

Economic policies refer to the monetary and fiscal policies that affect the
growth rate of the economy and the attained price stability in the economy.
Economic policies can be expansionary or contractionary. Monetary policy
works through the effect on the money supply, whereas fiscal policy works
through Government expenditure and the taxation policies.
2.4.1 Fiscal policy
Fiscal Policy is a tool, in the hands of the Government, to influence the level
of GDP in the short run, by using taxes and Government Spending. It is
about bringing changes in taxes and spending, so as to affect the demand
for goods and services and hence the output in the short run. The budget
deficit is the difference between its spending and its tax collections. When a

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Government increases its spending or cuts taxes to stimulate the economy,

it will increase the government’s budget deficit.
Fiscal Policy is a very important tool of macroeconomic policy. It is also an
important tool to stabilize the economy, i.e. to overcome recession and to
control inflation. So basically fiscal policies are a set of guidelines for the
government’s earning and spending. The fiscal policy aims at regulating the
aggregate demand by suitable changes in these two variables.
The expansionary fiscal policy is used to cure recession. In this policy the
government expenditure is increased and the taxes are reduced. Both these
measures increase the money supply and thus raise the aggregate demand
in the economy. Contractionary fiscal policy on the other hand prescribes a
decrease in the government expenditure and an increase in the tax rates.
This would decrease the money supply leading to a fall in the aggregate
demand and the general price level so as to control inflation. While an
expansionary fiscal policy enlarges the budget deficit, the contractionary
fiscal policy reduces it.
2.4.2 Monetary policy
Monetary Policy is a tool that incorporates the actions that the Reserve
Bank takes to influence the level of GDP. The Reserve Bank can influence
the level of output in the short run, through open market operations,
changes in reserve requirements or changes in the discount rate. These
tools can be used to form a suitable monetary policy during the times of both
recession and inflation. The aggregate demand can be raised during
recession time by adopting an expansionary or easy monetary policy while it
can be used to control inflation through a contractionary or tight monetary
policy.
Monetary policy regulates the money supply in an economy. It is concerned
with the cost and availability of credit. The broad objectives of monetary
policy are :
 To establish equilibrium at full employment level of output
 Ensure price stability by controlling inflation and deflation
 Promote economic growth of an economy
 Control Credit Availability
 Stability of Exchange Rate
 Control of Money Supply
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2.4.3 Instruments of monetary policy

There are various methods and instruments which the Reserve Bank uses.
Some are general or quantitative methods which control and adjust the total
quantity or size or volume of depositscreated by the commercial banks.
There are others known as selective or qualitative controls as they control
certain types of credits. The former controls the volume (stock) of money
and credit, while the latter controls the availability (flow) of money and credit.
2.4.4 General or quantitative controls
These are the controls that relate to the volume and cost of bank credit in
general without regard to the particular economic activity for which the credit
is used. There are three instruments in this method:
(i) Bank rate or discount rate: This is the rate which the Reserve Bank
charges for giving loans to the commercial banks. When a commercial bank
has low or no cash reserves above the legal requirements, it may obtain
cash reserves from the Reserve Bank at an interest rate which is the bank
rate.
If there is more inflation in the economy, the bank rate is raised. This causes
the commercial banks also to increase their interest rate. This is the interest
rate of loans which increases causing less of business activity. This causes
contraction of income and expenditure, causing reduction in the demand for
goods resulting in a fall in prices.
(ii) Open market operations: The direct buying and selling of government
securities and Bills in the money market by the Reserve Bank with the
objective of expansion or contraction of credit and economic activity is
known as open market operations. If the securities are purchased then there
will be an outflow of money. This will have an expansionary effect on
income, employment, output and prices.
(iii) Reserve requirement: Commercialized banks are legally required to
keep a part of their total deposits with the Reserve Bank of India. This is
known as Statutory Liquidity Ratio (SLR).Changes in reserve requirements
affect the amount of reserves that commercial banks must keep as deposits
with the Reserve Bank and consequently the amount available for lending or
investing. By raising the reserve ratio to be maintained by every bank, the
Reserve Bank can reduce the volume of bank credit and by lowering the

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reserve ratio, it can expand the volume of bank credit. Hence, changes in
reserve requirements are a powerful weapon for influencing the volume of
bank deposits and the money supply.
2.4.5 Selective or qualitative controls
There are several methods by which selective controls can be imposed:
(i) Margin requirements: The Reserve Bank can order the commercial
banks to lend an amount lower than the volume of security. If margin
requirement is 40%, then commercial banks can lend only up to 60% of the
value of a security.
(ii) Control throughDirectives: The Reserve Bank may give directions to
commercial banks in respect of their lending policies about the purpose for
which advances may be made and the margin to be maintained in respect of
secured loans.
(iii) Moral suasion: It implies request and persuasion made by the Reserve
bank to commercial banks to follow the general policy of the Reserve Bank.
(iv) Regulation of consumer credit: The Reserve Bank can regulate the
terms and conditions under which consumer credit is to be given by the
banks.
(v) Rationing of credit: Credit rationing is a method of controlling and
regulating the purpose for which credit is granted by the banks. The
Reserve Bank may fix maximum amount of loans for every commercial
bank. This is known as variable portfolio ceiling.
(vi) Direct Action: It refers to all the controls and directions which the
Reserve Bank may enforce on all banks or any bank in particular concerning
the lending and investment.
Thus monetary policy can be used to cure recession by making the Reserve
Bank undertake open market operations and buy securities in the open
market from banks and the general public. This would increase the
availability of credit with the banks and currency with the public. Lowering of
the bank rate can increase the availability of credit. Reducing the reserve
ratio releases the tied up funds of the banks for providing loans. A tight
monetary policy on the other hand helps suck credit from the market. The
money supply will decrease and the cost of credit will rise. The general price
level would decrease and inflation can be controlled using this policy.
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Self Assessment Questions

Fill in the blanks:
7. Fiscal Policy is a tool, used by the Government, to influence the level of
GDP in the short run by using ______ and _______.
8. The direct buying and selling of government securities and bills in the
money market by the Reserve Bank with the objective of expansion or
contraction of credit and economic activity is known as _______.
9. Select the right option:
This fiscal policy is used to cure recession. (contractionary,
expansionary, Both of these)
10. The ______ rate is charged by the Reserve Bank for giving loans to the
commercial banks.

2.5 Business and Economic Policies

Economic policies not only directly affect business environment, they also
change the aggregate demand which causes a huge impact on the business
activities. Let us see the different factors which can change aggregate
demand.
2.5.1 Stabilization policy
The government can use either fiscal or monetary policy to alter the level of
Gross Domestic Product (GDP). If the current level of GDP is below full
employment, the government can use expansionary policies such as:
 Tax cuts
 Increased spending
 Increases in money supply to raise the level of GDP and
 Reduce unemployment
Both expansionary and contractionary policies are examples of stabilization
policies. Stabilization policies are a set of actions that reduce the level of
GDP, back to full potential output.
It is very difficult to stabilize the level of aggregate output. This is because
there are lags, delays in stabilization of policies. Lags arise because
decision makers are often slow to recognize and respond to changes in the
economy, and policies take time to operate.
In fact poorly timed policies can magnify economic fluctuations. Suppose
GDP was currently below full employment but would return to full
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employment on its own within a year and that stabilization policies took a full
year to become effective; If policymakers tried to expand the economy
today, their actions would not take effect until a year from now. But one year
from now, if stabilization policies were enacted, the economy would be
stimulated unnecessarily and output would exceed full employment.
2.5.2 Policy mix
Policy mix refers to the combination of monetary and fiscal policies in use, at
a given time. A policy mix that consists of a decrease in government
spending and an increase in money supply would favour investment
spending over government spending. This is because both the increased
money supply and the fall in government purchases would cause the
interest rate to fall, which would lead to an increase in planned investment.
The opposite is true for a mix that consists of an expansionary fiscal policy
and a contractionary monetary policy. This mix favours government
spending over investment spending. Such a policy will have an impact of
increasing government spending and reducing the money supply.
2.5.3 Factors causing change in aggregate demand
Changes in expectations: The current spending is affected by anticipated
future income, profit, and inflation. The expectations of consumers and
businesses can have a powerful effect on planned spending in the economy
E.g. expected increases in consumer incomes or wealth or company profits,
encourage households and firms to spend more, boosting Aggregate
Demand. Similarly, higher expected inflation encourages spending now,
before price increases come into effect, a short term boost to Aggregate
Demand.When confidence turns lower, we expect to see an increase in
saving and some companies deciding to postpone capital investment
projects because of worries over a lack of demand and a fall in the expected
rate of profit on investments.
Changes in monetary policy (i.e. a change in interest rates)
An expansionary monetary policy will cause interest rates to fall.This lowers
the cost of borrowing and the incentive to save, thereby encouraging
consumption. Lower interest rates encourage firms to borrow and
invest.There are time lags between changes in interest rates and the
changes on the components of aggregate demand.

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Changes in fiscal policy

Fiscal Policy refers to changes in government spending, welfare benefits
and taxation, and the amount that the government borrows. For example,
the Government may increase its expenditure e.g. financed by a higher
budget deficit, this directly increases Aggregate Demand.Income tax affects
disposable income e.g. lower rates of income tax, raise disposable income
and should boost consumption.An increase in transfer payments raises
Aggregate Demand particularly if welfare recipients spend a high
percentage of the benefits they receive.
Economic events in the international economy
International factors such as the exchange rate and foreign income affect
the business environment. A fall in the value of the pound (£) (a
depreciation) makes imports dearer and exports cheaper thereby
discouraging imports and encouraging exports. The net result should be that
Aggregate Demand rises. The impact depends on the price elasticity of
demand for imports and exports and also the elasticity of supply of exporters
in response to exchange rate depreciation.An increase in overseas income
raises demand for exports and therefore Aggregate Demand rises. In
contrast, a recession in a major export market will lead to a fall in exports
and an inward shift of aggregate demand.
Changes in household wealth
Wealth refers to the value of assets owned by consumers e.g. houses and
shares.A rise in house prices or the value of shares increases consumers’
wealth and allows an increase in borrowing to finance consumption,
increasing Aggregate Demand. In contrast, a fall in the value of share prices
will lead to a decline in household financial wealth and a fall in consumer
demand.
2.5.4 Environmental degradation and Sustainable development
Environmental degradation is the deterioration of the environment
through depletion of resources such as air, water and soil; the destruction
of ecosystems and the extinction of wildlife. Environmental degradation is
one of the Ten Threats officially cautioned by the High Level Threat Panel
of the United Nations. The World Resources Institute (WRI), UNEP (the
United Nations Environment Programme), UNDP (the United Nations

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Development Programme) and the World Bank have made public an

important report on health and the environment worldwide on May 1, 1998.
The United Nations International Strategy for Disaster Reduction defines
environmental degradation as “The reduction of the capacity of the
environment to meet social and ecological objectives, and needs”.[2]
Environmental degradation is of many types. When natural habitats are
destroyed or natural resources are depleted, environment is degraded.
Environmental Change and Human Health, a special section of World
Resources 1998-99 in this report describes how preventable illnesses and
premature deaths are still occurring in very large numbers. If vast
improvements are made in human health, millions of people will be living
longer, healthier lives than ever before. In these poorest regions of the
world an estimated 11 million children, or about one in five, will not live to
see their fifth birthday, primarily because of environment-related diseases.
Child mortality is larger than the combined populations of Norway and
Switzerland, and mostly due to malaria, acute respiratory infections or
diarrhea — illnesses that are largely preventable.
Sustainable development (SD) is a pattern of resource use, that aims to
meet human needs while preserving the environment so that these needs
can be met not only in the present, but also for generations to come
(sometimes taught as ELF-Environment, Local people, Future). The term
was used by the Brundtland Commission which coined what has become
the most often-quoted definition of sustainable development as
development that "meets the needs of the present without compromising
the ability of future generations to meet their own needs."[1][2]
An organisation works within the economic environment and finally affects
the environment that we live in. The importance of protecting the
environment and renewing the resources used is an important concept that
is gaining prominence.
Self Assessment Questions
11. Select the right option:
Expansionary policies involve:
i) Tax cuts
ii) Increased spending

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iii) Increases in money supply to raise the level of GDP and

iv) Reduce unemployment
v) All of the above
Fill in the Blanks:
12. A policy mix that consists of a ______ in government spending and
an______in money supply would favour investment spending over
government spending.
13. International factors such as the _______and _______affect the
business environment.
14. An expansionary monetary policy will cause interest rates to _______.

2.6 Summary
 An economic environment has two separate environments:
microeconomic and macroeconomic. The microeconomic environment
relates to individuals while the macroeconomic environment relates to
the aggregate economic information of business.
 A country’s fiscal, monetary or economic policy can have great
implications on the nation’s entire economic environment.
 An important economic factor is the inflation or deflation that alters the
purchasing power of the nation’s currency. As the purchasing power of
money changes in the economic environment, consumers often change
their spending behaviors and business invests less money in operations.
 Current political systems usually change the monetary and fiscal policy
of the nation in order to correct these changes by consumers and
businesses.Monetary and fiscal policy in an economic environment
attempts to maintain full employment, price stability and economic
growth.
 Under free market principles, governments should be restricted from
significantly altering the market’s monetary or fiscal policy since political
solutions often create more problems when correcting economic
situations.
 Two other significant areas of the nation’s economic environment
include interest rates for borrowing and exchange rates of goods among
countries.Interest rates are the cost of borrowing money usually set by a
nation’s central bank.

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 Government agencies are usually responsible for setting the terms of

importing and exporting goods in the economic marketplace. These
policies help companies determine if they should import or export
economic inputs or resources when producing or selling goods in the
global economic marketplace.
 Thus in this unit, we have studied the impact economic environment has
on the business environment.

2.7 Glossary
 Aggregate demand: The total amount of goods and services
demanded in the economy at a given overall price level and in a given
time period.
 Balance of payments: A record of all transactions made between one
particular country and all other countries during a specified period of
time.
 Bank credit: It includes loans, cash credit and overdrafts, and inland
bills and foreign bills purchased and discounted. Bills exclude those
rediscounted with RBI and IDBI.
 Closed economy: The idea behind the closed economy is to meet all
consumer needs with the purchase and sale of goods and services that
are produced internally.
 Demand deposits: It includes current deposits, demand liabilities,
portion of savings bank deposits, overdue deposits and cash certificates,
outstanding telegraphic and mail transfers and margins against letter of
credit/guarantees.
 Fiscal deficit: This is the gap between the government's total spending
and the sum of its revenue receipts and non-debt capital receipts.
 Fiscal policy: Fiscal policy is a change in government spending or
taxation designed to influence economic activity.
 Free market: A free market is a market in which there is no economic
intervention and regulation by the state, except to enforce taxes, private
contracts, and the ownership of property.
 Inflation: A persistent rise in the price levels of commodities and
services, leading to a fall in the currency’s purchasing power.

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 Monetary policy: Monetary policy is a tool that a national Government

uses to control the supply and availability of money, to influence the
overall level of economic activity in line with its political objectives.
 Money supply: The total supply of money in circulation in a given
country's economy at a given time. This includes the entire quantity of
bills, coins, loans, credit and other liquid instruments in a
country's economy.
 Open economy: An open economy is an economy in which there are
economic activities between domestic community and the international
community.
 Required reserve ratio: The percentage of its deposits that a bank
must keep as its reserves.
 Statutory liquidity ratio: The portion of the total deposits of a bank that
it is required to keep with itself in the form of specific liquid assets.

2.8 Terminal Questions

1. State some factors that are part of the Economic Environment.
2. In what way are Global market conditions important for a business firm?
3. What are Fiscal Policies?
4. Explain the different instruments of Monetary Policies.
5. What are the factors causing change in Aggregate Demand?

2.9 Answers
Self Assessment Questions
1. rise, prices
2. demand, goods, services, price level
3. Currency, Demand deposits
4. economic transactions
5. five, takeoff
6. Low income economies, Lower middle income, Upper middle
income,High income, GNI per capita.
7. Taxes, Government Spending
8. open market operations
9. expansionary
10. Bank/Discount

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11. All of the above

12. Decrease, increase
13. exchange rate, foreign income
14. fall
Terminal Questions
1. Sec. 4.2
2. Sec. 4.3
3. Sec. 4.4
4. Sec. 4.4
5. Sec. 4.5
Acknowledgements, References and Suggested Readings:
 Adhikary, M. (2009). Economic Environment of Business: Theory and
the Indian Case. New Delhi, Sultan Chand and Sons.
 Maheshwari, Y. (2008). Managerial Economics. New Delhi, Prentice Hall
of India Private Limited, New Delhi.
 World Bank. (2010). World Development Report. 2010, Washington, DC:
World Bank.
 wikipedia

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