Economic Environment

Introduction

“Economic environment refers to all those econ-omic

factor which have a bearing functioning of the

business unit. Business depends on the economic

environment for all the needed inputs. It also

depends on the economic environment to sell the

finished goods.”

Factors of Economic Environment

• Growth strategy• Economic system• Economic planning• Industry• Agriculture• Infrastructure• Financial and fiscal factor• Removal of regional imbalance• Price and distribution control• Economic reforms• Per capita and national income

Economic System

• An economic environment system refers to the organization arrangements and process through which a society makes its production and consumption decision.

• It is the method used by society to produce and distribute goods and services.

• Types of Economic System– Capitalism– Socialism– Mixed Economy

Capitalism

• Capitalism is a social system based on the principle of individual rights. It is an economic system based on the private ownership of the means of production, distribution and exchange, characterized by the freedom of capitalist to operate or manage their property for profit in competitive condition.

• In capitalist economy the govt. plays a minor role• Enterprise can produced almost everything and has

freedom to produce and distribute goods and services according to public demand.

Features of Capitalism

• Private ownership• Free enterprise• Consumer liberty• Freedom to choose of occupation• Freedom to save and invest• The market system• Competition• Absence of central plan• Limited role of government

Advantages

• Provides optimum allocation of resources, development of enterprise, invention and use of new technology etc. due to individual freedom

• Provides freedom to save and invest, result in higher growth rate because saving made by sacrificing the consumption are invested for growth.

• In capitalism consumers liberty to buy or not to buy goods and freedom of enterprise leads to competition. Therefore, price and other factors are set to equilibrium by market forces, i.e., demand and supply, etc

• Rational talents are better utilizing due to individual freedom and therefore productivity Increases.

Limitations

• Right to property and freedom of enterprise will lead to accumulation of wealth and income disparities

• Theoretically, expressed that there will be free competition but generally larger firms will take advantage, which will lead to monopoly

• Absence of central planning results in no definite guidelines for national development.

• Cut-throat competition among individual may result in imperfection in market & adoption of unfair practices

• Once the upward and downward cycle starts there is no situation to normality. This results in price hike, inflation, deflation, unemployment etc.

Socialism

• Socialism means an economic system in which the means of production are owned by the state.

• In most important aspect of this type of economy is that all major decision related to the production, distribution, commodity and service prices are all made by the govt.

• Govt. is the final authority to take decision regarding production, utilization of the finished industrial products and the allocation of the revenues earned from their distribution

Features of Socialism

• Abolition of private property• Collective ownership of means of production• Central planning • Elimination of unfair gaps in income• Provision of necessaries of life

Advantages

• Elimination of wastage of resources• Elimination of concentrate of wealth• Elimination of unequal distribution of wealth• Provision of necessaries of life• Immunity from Economic crisis• Elimination of unemployment

Disadvantages

• End of liberty• Weakening of the will to work• Error in planning• Failure in practice

Mixed Economy

• Mixed economy is a mix between socialism and capitalism. It is an economic system where some important production is undertaken by the state, directly or through nationalized industry, & some is left for private enterprise.

• In this type of economy both the private ownership as well government takes part in the process of production, distribution and other economic activities.

Features

•Right to private ownership •Free enterprise•Consumer liberty•Freedom of choice of occupation•Central planning•Significant role of government

Privatization

• Privatization means transfer of ownership of an enterprise from the public sector to the private sector.• It also connotes the withdrawal of the state

from an industry or sector, partially or fully.• Highlighting a further facet, it provides entry of

private sector into those fields which were exclusively for the public sector.

Objectives of Privatization

• Improve the performance of PSUs• Reduce govt. interference in the economy• Encourage & facilitate private sector

investments from domestic & foreign sources• Increase size & participation of private sector• Reduce threat of losses

Ways/Routes of Privatization

• Sale to Outsiders• Management Employee Buyout• Equal Access Voucher Privatization• Spontaneous Privatization

Advantages of Privatization

• Improved Efficiency• Lack of Political Interference• Long-term View• Better Management of the Enterprise• Increased Fair Competition• Reduced Fiscal Burden• Encourage Entrepreneurship• Accelerate Growth of Economic Development

Limitations of Privatization

• Lack of proper norms• Ambiguity of objectives• Wrong timing• Monopoly eliminated• Problem of cultural changes• Poor financial strategies• Wrong labor strategies

Conditions for Success of Privatization

• Committed by political leader to affect such changes• Multiplicity of suppliers• Freedom of entry to private sector firms• Public services provided by private firms must be

specific & measurable• Consumer education & awareness about benefits• Private services should be less susceptible to fraud than

govt. services• Benefits of privatization must be passed on to

stakeholders

Monetary Policy

• Monetary policy refers to the process by which the central bank or monetary authority of a country controls the supply of money, often target Government appointed central bank, RBI in India, usually administers monetary policy.

• It is the process by which central bank of a country controls – – Supply of money– Availability of money– Cost of money/rate of interest

Objectives

• To achieve price stability by controlling inflation and deflation.

• To promote and encourage economic growth in the economy.

• To ensure the economic stability at full employment or potential level of output.

Instruments of Monetary Policy

• The instruments of monetary policy (method of credit control) maybe broadly divided into-– General credit control or quantitative methods– Selective credit control or qualitative methods

General Credit Control

• Its main instruments are:– Bank rate– Open market operations– Reserve requirements

Bank Rate Policy

• Discount rate or bank rate is the rate at which central bank rediscounts the bills of exchange presented by the commercial bank. • The central bank can change this rate increase

or decrease depending on whether it wants to expand or reduce the flow of credit from the commercial bank.

Open Market Operations

• The open market operations is sale and purchase of government securities and Treasury Bills by the central bank of the country.

• When the central bank decides to pump money into circulation, it buys back the government securities, bills and bonds.

• When it decides to reduce money in circulation it sells the government bonds and securities.

• The central bank carries out its open market operations through the commercial banks.

Cash Reserve Ratio(5.25%)

• The cash reserve ratio is the percentage of total deposits which commercial banks are required to maintain in the form of cash reserve with the central bank.

• The objective of cash reserve is to prevent shortage of cash for meeting the cash demand by the depositors.Statutory Liquidity Ratio(25%)

• In India ,the RBI has imposed another reserve requirement in addition to CRR. It is called statutory liquidity requirement.

• The SLR is the proportion of the total deposits which commercial banks are statutorily required to maintain in the form of liquid assets in addition to cash reserve ratio.

Selective Credit Control

• Minimum margin of lending against specific securities• Fixing a ceiling on the amounts of credit for certain purposes• Discriminatory rates of interest charged on certain types of

advances• Direct action against commercial banks that violate the rules

& regulations• Moral persuasion may restrict commercial banks to deal in

speculative business or from liberal lending• Legislation adopted for expanding or contracting credit money

in the market• Publicity may be resorted, suggesting commercial banks to

control credit by either expansion or contraction

Increase OR Decrease the lending Rates

• The RBI makes an adjustment in its lending rate in order to influence the cost of credit.

The Central Bank does this by issuing fresh bonds and treasury bills in open market.

CRR

By increasing the CRR, the RBI decreases the lending capacity of the bank to the extent of the increase in the ratio.

Fiscal Policy

• The term fiscal policy refers to the expenditure a government undertakes to provide goods and services and to the way in which the government finances these expenditures.

• Government spending policies that influence macroeconomic conditions are known as fiscal policies.

Objectives of Fiscal Policy

• Economic Growth

• Equitable Distribution of Wealth

• Full Employment

• Exchange Stability

• Balanced Regional Development

Instruments of Fiscal Policy• Budget- Keeping budget in balance, surplus or deficit is in itself a fiscal

instrument. When the govt. keeps its total expenditure equal to its revenue as a matter of policy it means it has adopted a balanced budget policy.

• Taxation- Tax is an important source of raising revenue, taxes maybe direct or indirect.

• Public Expenditure-Public expenditure results in overall rise in the economic activity. Therefore, govt.’s tax revenue will also increase. Hence, there is no increase in the fiscal deficit in such cases.

• Government Borrowings- In developing economies, the govt. resorts to borrowing in order to finance schemes of economic development. Public borrowing becomes necessary because taxation alone cannot provide sufficient funds for economic development.

Role Of Government

Regulatory Role

• By regarding the countries, persons or business firm through the several policies and act.E.g. Industrial licensing policy, MRTP (Monopoly Restricted Trade Practices)

• By regulating the conduct of business firm through laying down general standardE.g. 8 hours of week, prohibition, of child labor etc.

• Regulating and result of business that is profit and dividend through limiting the profit utility, ceiling of dividend, high tax imposition on excess profit, etc.

• By regulating the relationship between various part of business.• Government regulation of the economy broadly divided into direct

control and indirect control

Promotional Role

• The promotional role played by the government is very important in developed countries as well as developing countries. Following are the main objectives behind the promotional role of the government.• To assist and develop industrial, agricultural labor and

consumer interest.• By providing various fiscal monetary and other incentive

government can promote overall economic development.• E.g.. Tax holiday for 5 years, tax free dividend etc.• By establishing financial institution such as IFC,ICICI,IDBI,

SFC, etc.

Entrepreneurial Role

In many countries, states also play the role of an entrepreneur where state establish the business and bear the risk. The government act as on entrepreneur because of the following reason:-• To balance economic ups and down such as inflation and

deflation.• To take over on profitable business to services are required

to general public.• To prevent the wastage of natural resources such as coal

fuel petroleum products steel etc.• To prevent monopoly or oligopoly.

Planning Role

• Especially in developing countries, the states place a very important role as a planner. The need for economic planning is implied in the famous scarcity definition of economics. As Robbins point out in the scarcity of the scares resources. Hence proper planning is required for optimum allocation of scares resources.

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