Unit 2 Economic environment Concept and nature of economic environment: Economic environment refers to all those economic factors

which have a bearing on the functioning of every business organization. Business enterprise is essentially an economic unit. Every business depends upon the economic environment for all its requirements or inputs. Similarly it depends upon the economic environment for the sale of its output. Naturally, the dependence of business on the economic environment is complete, as it is one unit of the total economy. Critical elements of economic environment: Macro economic factors are critical elements of economic environment; these elements can be classified under following important heads: A) Economic system: Economic system prescribes method of production and distribution of goods, ownership pattern of factors of production. Based on this, there are three kinds of economic systems: I) Capitalism: Capitalism is also described as free enterprise economy or free market economy. In this system ownership of

business and factors of production is with the people or capitalists. Features of capitalism: 1. Freedom of enterprise: People are free to start business of their choice. 2. Government: Role of Government in business is minimum; restrictions on business are very few. Government will have friendly attitude towards business. 3. Consumer sovereignty: Consumer is the king, i.e. goods and services that are liked by the people are produced and distributed. 4. Profit motive: Owners contribute capital to start business and their main objective is to make profits. 5. Market: Conditions of business are determined by market like demand, supply, price etc. Those goods are distributed that the market accepts. 6. Competition: There is open competition between rival firms and they compete on product, quality, price, service etc. I) Communism: This system is opposite to capitalism. Ownership of business and other factors of production is with the Government. People are workers; Government owns

land, contributes capital and manages the business for the social benefit of people. Features of communism: 1)Government ownership: All resources including business are owned by Government. People are workers, they get wages for their service, and there are no owners or capitalists. 2)Centralized authority: All authority including business are with the government. Government decides the production and distribution aspects. Business is under absolute control and ownership of government, people have no choice. 3)Absence of market forces: Business is not run to the demands of market. What to produce, how much to produce, method of distribution, price fixation etc. are not determined by the market, government regulated all these aspects. 4)Equitable distribution of income: National income of the country is equitably distributed to the people or labourers according to their labour or efforts. 5)Efficient use of resources: Resources are used to produce those goods that are needed by the society and which are essential for economic development and growth. There is no wastage of resources.

6)No competition: There is no competition of private firms as the business is owned by government. This will minimize the wastage that may take place due to competition. II)Mixed economy: It is compromise between capitalism and communism. In this system government and also private sector participate in business activity. Features of mixed economy: 1)Controlled market: Market conditions like demand, supply, price etc. are controlled by the government. There is freedom to the market, but it is not unrestricted. 2)Public and private enterprise: Business is owned by government and also the private. Government normally concentrates on heavy industries and infrastructure and the remaining sectors are left to public. 3)Role of government: Government plays the dual role of regulator and motivator of business. Government ensures planned growth of business as per the national priorities. 4)Competition: Competition between rival firms is allowed, but competition is restricted through competition act and other provisions. Competition can be between PSUs and private sector; between private firms or it may be between large scale and small- scale industries.

B) Economic policies: Economic policies give directions to conduct business activities. Promotion and regulation of business activities is monitored through measures like 1)Monetary policy: Monetary policy regulates supply of money and credit in the economy. Business requires easy availability of money and credit, which depends on monetary policy. 2)Fiscal policy: Fiscal policy states the tax structure and rates. Simplified tax structure and lesser rate of tax is helpful for business. 3)Trade policy: Trade policy can be inward oriented or outward oriented. An inward looking or oriented policy gives importance to domestic trade over foreign trade. Outward looking policy does not discriminate between domestic and foreign trade. It creates competition between domestic firms and foreign firms. 4)Industrial policy: Industrial policy regulates the growth and development of industries through measures like licensing, permits, duties, capacity restriction etc. C) Economic conditions: Growth of business depends on prevailing or supportive economic conditions. These conditions consists of: 1)Agriculture: It is the basic industry. It gives food to the people and also raw materials to other industries. Growth of a nation

depends of agriculture as it feeds the people and also industry. Foundation and growth of business is dependent on strong agriculture support. 2)Infrastructure: Infrastructure facilitates like good roads, transportation system. Communication facilitates powers etc. are essential for this growth of business. Growth of business in India is not taking place to poor infrastructure growth. 3)Income levels: Survival and growth of business dependent on customer support. People can become customers, if they have adequate income. If the income level is low it will not help for growth of business. 4)Population: Population and its composition give support to business. Growing population with mere young and educated people will provide large customer base to business. 5)Saving and investment: Business requires capital; capital can be raised either from banks or FIs or directly from habit of saving and investing that money in banks or in shares and debentures. 6)Distribution of income: There should be equitable distribution of income level i.e. a small portion of population being rich and large majority being poor will not help for the growth of business. Because large majority of people cannot afford to buy.

7)Economic reforms: Development of business requires helpful business environment. Economic reform measure like LPG helps for competitive growth of business. 8)Standard of living: Standard of living is measured as consumption of comforts and luxuries. Developed countries have high standard of living as people of these countries spend more on these goods. The spending habit of the people encourages business activities as more goods are to be produced to meet the demand. 9)Financial system: well developed financial system, banks and financial institutions help for the growth of business by supplying them with money and credit. Business also depends on various financial services like payments, cheques etc. 10) Level of economic development: Developed economies provide better opportunities for business growth by well developed market, easy availability of finance, better infrastructure and people who spend on variety of goods and services. Economic factors A)Growth strategy: The basic measure of economic growth of a country is the continuous expansion, year after year, of real national income and real per capita income. Economic

growth should also include improvement in the quality of life of people consisting of increase in life expectancy, reduction in mortality and increase in literacy etc. The adoption of the socialist pattern of society as the national objective, as well as the need for planned and rapid development requires that all industries of basic and strategic importance, or in the name of public utility services, should be in the public sector. Other industries which are essential and require investment on a scale which only the state, in the present circumstances, could provide have also to be in the public sector. B)Basic economic system: Economic system prescribes method of production and distribution of goods, ownership pattern of factors of production. Based on this, there are three kinds of economic systems: I) Capitalism: Capitalism is also described as free enterprise economy or free market economy. In this system ownership of business and factors of production is with the people or capitalists. II)Communism: This system is opposite to capitalism. Ownership of business and other factors of production are with the Government. People are workers; Government owns land, contributes capital and manages the business for the social benefit of people.

III)

Mixed economy: It is compromise between capitalism

and communism. In this system government and also private sector participate in business activity. C) Economic planning: Economic planning, in one form or another, on a small scale or a large scale, has been adopted by many countries of the world either to achieve rapid economic development, or to overcome depression, or to control inflationary conditions, or to maintain economic stability. In fact, economic planning is considered as a panacea for all economic ills. During the forty years of economic planning i.e. from 1951 to 1991, the government has prepared and implemented comprehensive economic plans, integrating the private sector with the public sector to achieve the following important long-term general objectives: i. Increasing production to the maximum possible extent so as to achieve a higher level of national and per capita income. ii. iii. Achieving full employment. Reducing inequalities in the distribution of income and wealth. iv. Setting up a socialist pattern of society based on equality and justice and absence of exploitation.

D)

Industry: Industry as a business organization is engaged

in conversion of raw material into finished product. They can be classified into large scale and small scale on the basis of investment of capital; industries play an important role in economic development of a nation. Industries have following advantages: 1)It provides employment and ensures balanced economic development. 2)It increases national and per capita income and thereby helps to increase standard of living. 3)Industrialization will reduce pressure on agriculture. It strengthens agriculture by helping in mechanization of agriculture and using agro raw materials for production. E)National income and per capita income: National income committee of India defined National Income as National income estimates measures the value of commodities and services turned out during a given period counted without duplication. National income of a country can be measured by: 1. Amount of goods and services produced in a year, or 2. Total expenditure incurred on production and services, or 3. Total income received on factors production i.e. incomes or rent, wages, interest and profit.

Per capita income means average income of an individual. It is calculated by dividing national income with total population. Per capita income= Study of national income and per capita income throws light on prevailing condition of business and economy. Increases in nation income and per capita income show increase economic activity. Study of national income reveals contribution made by the different sectors of the business towards national income. It indicates standard of living of the made on the basis of national income and per capita income. Evaluation of these aspects help the policy makers to prepare right action plans to undertake healthy growth of business. It helps to device proper policies of business that usher economic activities and help to increase national income and per capita income. F) Industrial policy: New industrial policy 1991 The policy was adopted in the background Indias diminishing foreign exchange, the LPG wave throughout the world. Following are the important features of the policy.

1. Industrial licensing was made compulsory for only 8 items. The procedure of obtaining permission for others was made simple. 2. DFI (Direct Foreign Investment) up 51% of equity was allowed in high priority areas. 3. Automatic clearance introduced for import of capital goods, provided foreign exchange requirement for such import is to meet through foreign equity. 4. Automatic permission for foreign technology agreements in high priority industries up to Rs. 1 crore. 5. Foreign equity proposals need not be accompanied by foreign technology agreement. 6. Pre-eminent role for PSUs in eight core areas including arms and ammunition, minerals, oils, rail, transport and mining of coal and mineral. 7. Dis-investment of governments share in PSUs, especially those which are making losses. The policy made significant changes in: 1. Reducing the conditions and procedures of industrial licensing. 2. Giving more scope for foreign investments and technology. 3. The condition of MRTP and FEMA were diluted to make them more business friendly.

4. Overall policy was passed to make Indian industries competitive and create better environment for industrial growth. Small scale industries The small scale industries have been classified on the basis of investment limits. (1) Ancillary units: investment limit up to Rs. 25 lakhs. (2) Small units: investment limit up to Rs. 1 crore. (3) Tiny units: investment limit up to Rs. 1 crore. Arguments for promotion of small scale industries: The importance of cottage and small scale industries in the Indian economy may be explained ad follows: 1. Employment generation: The cottage and small scale industries are labour intensive and therefore, they create more employment per unit of capital employed. It is estimated that they create employment four times more than the large industries. In India, as there is a great shortage of capital but abundance of labour, small and cottage industries require to be developed intensively. 2. Export promotion: SSIs share in the total exports is about 40 percent. A larger part of these goods is utilized by other goods which are exported and thus this part goes to exports

indirectly through other industries. The interesting aspect of this sector is that it largely adds to the foreign exchange but it uses very little by way of purchase of imported goods. 3. Enhancement of production: Of the total output of the manufacturing sector, about 40 percent comes from the small scale sector. And of the total supplies of industrial consumer goods accounting for 2/3rd of the total output of the manufacturing sector, a major potion comes from the small sector. 4. Quick investment: SSIs can be set up quickly; they can start producing goods quickly, and they can also earn profits quickly. Therefore the development of small enterprises will help in controlling inflationary conditions in the economy. 5. Utilization of local resources: Another very strong argument in favour of small scale industries is that these industries use and develop resources which are available locally and these locally available resources would have remained unutilized and wasted. 6. Development of moral standard: large industries create antisocial and immoral tendencies such as exploitation, selfishness, jealousies etc., whereas small industries promote the development of moral qualities like love, cooperation, co-existence, quality etc.

7. Socialist society: The development of small industries leads to a rise in the standard of living; it provides equal opportunities to work and earn; it reduces the disparity between the rich and the poor and it develops moral character. Therefore, it paves the way for the establishment of a socialist pattern of society in the country. 8. Output: The total production of small industries has been rising at 11.7 percent per annum, which is higher than that 7.8% of large industries. 9. Self-employment: The small industries provide vast opportunities for self-employment. The self-employed people are considered as the back-bone of the nation. 10. Less capital: Small scale industries requi9re relatively small amount of capital. As there is a great shortage of capital in India, small scale industries can be easily started. Problems of small scale industries: Small scale industries are facing a number of problems; the most important of them are such as 1. Problem of raw materials: The raw materials are available neither in sufficient quantities, nor of requisite quality and nor at reasonable prices. Since the SSIs require small quantities of raw materials, they are not able to undertake bulk-buying as the large industrialists do.

2. Problem of infrastructure facilities: Many small industries are being constrained by inadequate physical infrastructure. The most severe constraint is power. In addition, they have to face the problem of transport and communication infrastructures. 3. Lack of finance: Adequate and cheap credit facilities are not available to the small enterprises. Normally they depend upon the local money lenders who charge very high rates of interest. In order to repay the loans quickly, they will be compelled to sell their products at unfavourable price. 4. Low level of technology: The methods of production used by the small and tiny industries are old and primitive and inefficient. The result is low production, poor quality of the products and high costs. 5. Delayed payments: Most of the SSIs get delayed payments by large forms and government departments. One study shows that on an average, the small firms provide 40 days credit to the buyers of their products but material etc. everybody knows that the small firms have very little bargaining power in the markets where they deal. 6. Marketing problem: The small industrialists face many difficulties in marketing their products. Because (a) there are no organized sales organizations; (b) their products are not standardized; (c) there are no adequate transport and

communication facilities; (d) they cannot get up-to date market information; (e) they cannot wait for better prices due to lack of finance; (f) they face severe competition from technically more efficient units and large firms; (g) they have no sufficient holding capacity in case of over-production or deficient demand etc. 7. De-reservation: Most of the products which had been reserved for the small sector have now been deserved i.e. have been removed from the reservation list. This has led to severe competition from the large industrial undertakings large scale industries which are most up-to-date and use modern machinery. Stock exchange Stock exchange is a organized market for buying and selling securities of listed joint stock companies. Securities contract act 1956 defines stock exchange as an association, organization or body of individuals, whether incorporated or not, established for the purpose of assisting, regulating and controlling business in buying selling and dealing in securities. Listing of securities: Stock exchange allows for trading of those securities whose name is listed in the exchange. Companies with

god credentials and record can list their name with the exchange. Bulls / Tejiwala: He is a person who buys shares in expectation of selling them later at a higher price. Bullish trend in a stock market means the tendency of rising prices. Bear / Mandiwala: He is a person who starts selling securities in anticipation of a fall in security price in future. Functions of stock exchange: The following are the important functions and services rendered by the stock exchange. 1. Ready and continuous market: People with cash can convert it into securities and those with securities can immediately obtain cash for them. 2. Liquidity and mobility of capital: The investors find it very convenient to invest their savings in shares which are dealt in on the stock exchange and such shares possess more liquidity than any other type of investments. 3. Capital formation: It includes the investors to invest their funds in various industrial and governments securities by giving wide publicity to these securities and their prices. 4. Safeguard for investors: The stock exchange safeguards the interest of the investors by enforcing strict rules and

regulations and preventing the unscrupulous brokers from charging higher rates of brokerage. 5. Proper distribution of capital: The stock exchange directs the flow of capital into the most profitable channels and thereby secures a proper and effective utilization of the investable funds for the social benefit. 6. Growth of corporate form of business: The stock exchange facilitates the growth of joint stock form of business enterprises by raising the funds. 7. Proper evaluation of securities: Stock exchange helps the investors to ascertain the market values of their securities and enables them to decide as to buy or sell them. 8. Facilities for speculation: The stock exchange provides opportunities to shrewd businessmen to speculate and reap profit from fluctuations in the prices of the securities. New economic policy: New economic policy of 1991 was passed to satisfy conditions to IMF and open the Indian economy to the concept of LPG. The policy was adopted to achieve following objectives: 1. To attain economic growth rate of 4% 2. To reduce inflation rate to 6% 3. Reducing the balance of payments position and building adequate foreign exchange reserves.

4. Reducing budgetary deficits. Following are some of the important policy reforms undertaken: 1. Liberalization: The policy liberalized the economy from rigorous procedures and restrictions. Investment limit in SSIs is increased. Industries are allowed to adopt imported technology wherever necessary. 2. Privatization: More encouragement is given to industries in private sector. The IPR reserved 8 items only giving more opportunities to business in private sector. 3. Globalization: Indian economy was made to interact more freely and openly with global economy. FDI of more than 51% was allowed in Indian firms. Indian firms were allowed to hire foreign technology and capital. 4. New public sector policy: The new policy of public sector restricted their role of PSUs to only to 8 areas. Disinvestment and privatization of loss making PSUs was undertaken. 5. Modernization: Incentives were given to modernize the industries. Firms were encouraged to spend more on R&D. tax concessions and other facilities were offered to develop new technology. 6. Financial reforms: Reforms undertaken in the areas of finance include:

 Reduction in CRR and SLR Reducing the interest rate More freedom to banks and FIs Provision of NPAs and CAR to banks Banks were allowed to open more branches to suit to their convenience. Capital market reforms. 7. Fiscal reforms: The policy aimed at bringing down fiscal deficit from 8% to 4%. Measures were undertaken to bring financial discipline in government spending. Efforts were make to reduce the burden of subsidies. Tax system was rationalized and simplified to encourage collection or more tax revenue. Arguments for and against LPG Arguments for LPG: LPG process is undertaken throughout the world. These policies have following advantages. 1. Economic growth: Economic growth rate on India before 1980s was in the range of 5%, the policy makers wanted to achieve growth rate of 10%, which is possible when initiatives of LPG are seriously undertaken. 2. Competitiveness: Indian economy can be made globally competitive through LPG measures. PSUs are given more

autonomy and they are made to compete between MNCs and domestic firms. 3. Reduces poverty and inequality: LPG will create more employments. It gives more job opportunities through increase in business activities. This will help to reduce poverty and inequality. 4. Efficiency and profitability of public sector: PSUs have to compete with private sector to prove their existence and survival. PSUs, which are weak and inefficient, are closed. 5. Development of SSIs: LPG policies have given more incentives and opportunities to SSIs. The new industrial policy has increased investment limit in SSIs to Rs. 100 lakhs. 6. Contain fiscal deficit: Fiscal deficit of India was in the range of 8% of GDP. It was aimed to bring it down to $%. Fiscal reform measures like reducing subsidies control over public expenditure, revamping and simplifying the tax structure to collect more taxes etc are aimed to bring financial discipline. 7. Control over inflation: Inflation is defined as tendency of rising prices. It is defined as too much of money chasing too few goods. Double-digit inflation i.e. inflation rate of more than 10% is considered as dangerous and harmful for economic growth and development. LPG measures help for increase business activities and increase in income level of

people. More goods and service are available due to increase business activities. Arguments against LPG: Developing countries like India are in a disadvantages position due to their poor technology, lack of capital and managerial ability. Some of the arguments against LPG and its identified drawbacks are as follows: 1. Loss of economic sovereignty: LPG policies lead to competition between domestic business and MNCs. MNCs and foreign firms dominate the business due to their superior technology, better products etc. gradually domestic firms may lose their business to foreign firms. Control over the business and economy will pass to the hand of foreign firms. 2. Dependence on foreign capital and technology: Developing nations have to depend on technology and capital of developed nations to achieve economic development. It is difficult for them to achieve the efficiency standards achieved by developed nations. 3. Policies under pressure of IMF and World Bank: developing countries like India will not be allowed to design LPG measures to suit to their domestic conditions. Developed countries dictate economic policies of developing countries.

4. Encouragement to western culture and consumerism: There is strong opposition to LPG policies that they destroy the domestic culture and encourage the culture of consumerism. 5. More divide between rich and poor: The gap between rich and poor will go on increasing due to LPG. Rich will have more opportunities to grow. Poor will not have adequate opportunities due to lack of resources and poor education. 6. Lack of social commitment: More importance is given to the production of comforts and luxuries, which are consumed by rich in the society. The necessities of poor people are not taken care of. 7. Disregard rural economy: Industry and service sector receive more importance. Basic sector of the economy like agriculture and SSIs are neglected.

THE END