ECONOMIC ENVIRONMENT OF BUSINESS

WHAT IS ECONOMICS?

CHAPTER

2003 Pearson Education Canada Inc.

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Definition of Economics
Scarcity All economic questions arise because we are unable to satisfy all our wants. Our inability to satisfy all our wants is called scarcity. Economics is the social science that studies the choices that we make as we cope with scarcity and the institutions that have evolved to influence and reconcile our choices.

 Economics is the study of how individuals and societies choose to use the scarce resources that nature and previous generations have provided. The key word in this definition is choose. Economics is a behavioral, or social, science. In large measure, it is the study of how people make choices. The choices that people make, when added up, translate into societal choices.

1. To Learn a Way of Thinking...

Three Fundamental Concepts of Economic Thinking
Opportunity Cost Marginalism Information, Incentives, and Market Coordinations

Why Study Economics?

An important reason for studying economics is to learn a way of thinking. Three fundamental concepts:
Opportunity cost Marginalism, and Efficient markets
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Opportunity Costs
The opportunity cost of something is that which we give up when we make that choice or decision. The implication is that all decisions involve trade-offs.

Theres no such thing as a free lunch!!

Question to Consider
What is the opportunity cost of your attending university?
Include all forgone options in your consideration.

Margins and Incentives

People make choices at the margin, which means that they evaluate the consequences of making incremental changes in the use of their resources. The benefit from pursuing an incremental increase in an activity is its marginal benefit. The opportunity cost of pursuing an incremental increase in an activity is its marginal cost.

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What is Business
Activities connected with production trade transport, banking, insurance, etc. It covers a complex field of industry and commerce which involves activities related to both production and distribution. These activities on the one hand satisfy societys needs and desires and on the other hand bring profits to business firms.

Nature of Modern Business

Characteristics of modern business are as follows: Large size Diversification Global reach Technology orientation Change Government Control

Environment Environment is something external to an individual or an organization.

Business Environment
Business Environment refers to all external factors which have a direct or indirect bearing on the activities of business. Environment of business is divided in to two: Internal environment External environment

Internal environment includes Value system Goals and objectives Management structure Physical resources and technology Human resources

External Environment includes: It consists of Institutions Organizations Forces operating outside the company

Structure of Eco.Environment of business

Business Environment Internal Environment
Micro Environment

External Environment
Macro Environment NonEconomic Environment Global economic Environment

Economic Environment
National Eco.Environment

The Scope of Economics

Microeconomics
Microeconomics is the study of choices made by individuals and businesses, the way these choices interact, and the influence that governments exert on them.

Macroeconomics
Macroeconomics is the study of the effects on the national and global economy of the choices that individuals, businesses, and governments make.

Economic System

Types of Economic System

Capitalism Communism/Socialism Mixed Economy

What is Capitalism?
"Capitalism is a system of economic organization featured by private ownership and its use for private profit of man-made and nature-made capital."

Features of Capitalism
Right to Private Property Freedom of Enterprise Freedom of Choice by Consumer Profit Motive Competition Importance of Price System

Socialism
"the important essentials of socialism are that all the great industries and the land should be public or collectively owned, and that they should be conducted (in conformity with a national economic plan) for the common good instead of private profit."

Features of Socialism
Social Ownership of Means of Production No Private Enterprise Economic Planning Classless Society Consumer is not sovereign

Mixed Economy
Co- Existence of Public and Private Property Price System and Government Directives Government Regulates and Controls the Private Sector Consumers' sovereignty is protected Government Protects Labor Interest

Economic Growth & Economic Development

The term economic growth refers to increases over time in a countrys real output of goods and services product per capita. Economic development implies progressive changes in the socio-economic structure of a country. Economic growth refers to a rise in output, economic development implies changes in technological and institutional organization of production as well as in distributive pattern of income.

Indicators of Economic Development

Growth versus Development

Economic growth may be one aspect of economic development but is not the same Economic growth: A measure of the value of output of goods and services within a time period Economic Development: A measure of the welfare of humans in a society

Growth

Development

Factors in Economic Development/Economic Growth Economic development is influenced by both economic and non-economic factors. Economic Factors: Capital Formation Marketable surplus of agriculture Conditions in foreign trade Economic system

Non-Economic Factors in Economic development Human resources Technical know how and general education Political freedom Social organization Corruption Desire to develop

Consider the importance of the structure of a firm in providing a solid base for its profit seeking activities

Make a balanced assessment of the role played by the PSUs in rapid economic development of India.

INTRODUCTION
The Economy Of India is the ninth largest in the world by nominal GDP and the fourth largest by Purchasing Power Parity. The independence-era, Indian economy was inspired by the economy of Soviet Union with socialist practices, large public sectors, high import duties and lesser private participation characterizing it, leading to massive inefficiencies and widespread corruption. However, in 1991, India adopted free market principles and liberalized its economy to international trade. Following these strong economic reforms, the country's economic growth progressed at a rapid pace with very high rates of growth and large increases in the incomes of people.

Features
1. The Indian economy is a developing economy. Its a mixed economy in the sense that both private sector and public sector coexist and participate in the production process. 2. It is characterized by high population density and population growth. 3. About one-third of the population live below poverty line. 'Vicious cycle of poverty' operates in many sectors of the economy.

4.There is high level of unemployment and underemployment In addition, there is 'disguised unemployment' in the agricultural sector. 5.The level of technology used in production process is low in many sectors. Modern technology has not been adopted in all sectors of the economy. 6.There is a shortage of physical and economic infrastructure.

India's SWOT analysis

STRENGTHS High savings/investment , forex reserves, quality talent and IT, broad based and growing entrepreneurial class, market size, macro economic and financial stability, language, democracy and political system stability WEAKNESSES Physical infrastructure, human development indicators, agriculture, shortage of skilled manpower OPPORTUNITIES Demographic , knowledge based growth , increased integration with world economy, urbanization THREATS Global Uncertainty, fiscal deficit, climate change energy and food security, regional and social inequalities

The India Story

TODAY One of the fastest growing economies ; 9%+ growth rate for 5 years prior to current crisis 5-6% growth at the peak of the global crisis

Resilient Economy
YESTERDAY

Socialist policies minimal

private sector role

Opening up sectors for investment Promising consumer markets Significant investment in infrastructure
development

Bureaucratic Protected market Small consumer markets Underdeveloped

infrastructure

An Enabling Environment

Largest democracy; Stable government. Dominant private sector; Increasing withdrawal of

government from business

Robust banking sector; Capital markets World class IT & telecom infrastructure A connected economy; Economic efficiency &

INDIAN ECONOMY
MAIN FEATURES OF INDIAN ECONOMY AND MAJOR ISSUES OF DEVELOPMENT
Low per Capita Income

Income inequalities. High incidence of poverty. Predominance of agriculture and instability of output. Rapid population growth. High dependency Ratio. Low level of human development. Unemployment. Imbalance between population size, resources and capital. Inadequacy of entrepreneurs.

CHANGING SCENARIO OF INDIAN ECONOMY

Growth of National Income.

Rise in per Capita income. Structural transformation. Slowly changing occupational distribution of population. Growth of basic capital goods industries. Expansion of social capital.

Beneficial Effects of the Reform Process

Fourth Largest Growing Economy in terms of PPP with a GDP of US $3.36 trillion In Exchange terms , Tenth Largest in the world with a GDP of US$ 691.87 billion (2004) Second Fastest Growing Major Economy of the World with a growth rate of 8.1% for the 1stQ of 2005-06

Reason for the highest growth rates in the mid-2000s

The growth was led primarily due to a : huge increase in the size of the middle class consumer population(AVERAGE working age being 25) a large workforce comprising skilled and nonskilled workers(NAREGA scheme) improvement in education standards(mid-day meal for rural) and considerable foreign investments(FDIs and FIIs).

Major issues of Development

Low per-capita income Income inequalities High incidence if poverty Predominance of agriculture and instability of output Rapid population growth High dependency ratio Low level of human development Unemployment Imbalance between population size, resources and capital Inadequacy of entrepreneurs

Changing scenario of Indian economy

Growth of national income Rise in per-capita income Structural transformation Expansion of social capital Slowly changing occupational distribution of population Growth of basic capital goods industries

Gross Domestic Product

The GDP of a country is defined as the market value of all final goods and services produced within a country in a given period of time usually a year Includes only goods and services purchased by their final users, so GDP measures final production. Counts only the goods and services produced within the country's borders during the year, whether by citizens or foreigners. Excludes transfer payments since they do not represent current production. It provides the measure of aggregate output and its comparison over time enables us to calculate the rate of growth (usually calculated both at current and constant prices)

Gross Domestic Product

Gross domestic product (GDP) is a measure of the income and expenditures of an economy. It is the total market value of all final goods and services produced within a country in a given period of time. How much is the current GDP?

Gross Domestic Product

Gross domestic product (GDP) is a measure of the income and expenditures of an economy. It is the total market value of all final goods and services produced within a country in a given period of time. How much is the current GDP?

The Circular-Flow Diagram

Revenue

Goods & Services sold

Market for Goods and Services

Spending Goods & Services bought

Firms

Households

Inputs for production

Wages, rent, and profit

Market for Factors of Production

Labor, land, and capital

Income

The Measurement of GDP

GDP is: the market value of all final goods and services produced within a country in a given period of time.

What Is Counted and Not Counted in GDP?

GDP includes all items produced in the economy and sold legally in markets. GDP excludes services that are produced and consumed at home and that never enter the marketplace. Caring labor, the work that is normally produced by women. Because GDP does not count it, it diminishes its importance. GDP also excludes black market items, such as illegal drugs.

Other Measures of Income

Gross National Product (GNP) Net National Product (NNP) National Income Personal Income Disposable Personal Income

The Components of GDP

GDP (Y ) is the sum of the following:

Consumption (C) Investment (I) Government Purchases (G) Net Exports (NX)

Y = C + I + G + NX

GDP and Its Components (1998)

Total (Billions of Dollars)
GDP (Y) $8,511

Per Person (In Dollars)

$31,522 21,511 5,507 5,507 -559

% of Total
100% 68% 16 18 -2

Consumption C 5,808 Investment I Government G 1,367 1,487

Net Exports NX -151

GDP and Its Components (1998)

Government Purchases Investment Net Exports 18% 16% -2 %

Consumption 68 %

Major Limitations of GDP

The GDP fails to measure or express changes in a nation's: Quality of life Unpaid labor Wealth distribution Underground economy Externalities

Net National Product - NNP

This refers to the net production of goods and services in a country during a year NNP is also called National Income at Market Prices We get NNP, by deducting the depreciation from GNP Therefore NNP = GNP - Depreciation
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 The monetary value of finished goods and services produced by a country's citizens, whether overseas or resident, in the time period being measured (i.e., the gross national product, or GNP) minus the amount of GNP required to purchase new goods to maintain existing stock (i.e., depreciation). In other words, NNP is the amount of goods that can be consumed within a nation each year without reducing the amount that can be consumed in following years

Measuring Economic Growth

We use real GDP to calculate the economic growth rate. The economic growth rate is the percentage change in the quantity of goods and services produced from one year to the next. We measure economic growth so we can make: Economic welfare comparisons International welfare comparisons Business cycle forecasts

Measuring Economic Growth

Business Cycle Forecasts
Real GDP is used to measure business cycle fluctuations. These fluctuations are probably accurately timed but the changes in real GDP probably overstate the changes in total production and peoples welfare caused by business cycles.

Meaning of Business Cycle

The business cycle or economic cycle refers to the fluctuations of economic activity about its long term growth trend. The cycle involves shifts over time between periods of relatively rapid growth of output (recovery and prosperity), and periods of relative stagnation or decline (contraction or recession). Phases of Business Cycle Prosperity Recession Depression Recovery

 A business cycle refers to periods of expansion and contraction. A peak is the high point following a period of economic expansion. A trough is the low point following a period of economic decline.

Prosperity Phase
Unemployment rate declines Income tends to rise Investment increases Investors become more optimistic Consumption tends to rise Share price index tends to rise Money Supply increases

Recessionary Phase
Recession is turning point ie when prosperity ends recession begins Liquidation in stock market, fall in prices are symptoms Banks & People try to gain greater liquidity so credit sharply contracts Business expansion stops

Depression Phase
Shrinkage in volume output Rise in level of unemployment Fall in aggregate demand Contraction of Bank credit Fall in prices

Recovery Phase
Rise in demand for consumption goods which in turn lead to demand for capital goods and new investment is induced This will give rise to increase in income and employment

Phases of Business Cycle

Peak

Peak Peak Prosperity

Trough

Trough

2005

2010 Year

2015

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

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Recession in U.S.
The United States housing market correction a possible consequence of United States housing bubble and subprime mortgage crisis has significantly contributed to a recession. U.S. employers shed 63,000 jobs in February 2008. The unemployment rate of US grew to 8.5 percent in March 2009, and there have been 5.1 million job losses till March 2009 since the recession began in December 2007.

Recession: Impact on India

Exports had declined by around 12 per cent in November 2008. There was a double-digit decline owing to lack of demand from most of the buying markets including the US, the UK, Japan and other countries in the Euro zone. These are Indias major export destinations. Indian industry has also shrunk for the first time in 15 years with a 0.4 per cent year-on-year decline in October 2008. The growth was about 12.2 per cent in October last. It had been partly due to a dip of over 12 per cent in Indias exports.

How to tackle the Recession

Government Measures.
The government attempt to control fluctuations in economic growth Aims to achieve growth at around trend level. The Government use Fiscal and Monetary policy to achieve this objective. ?

Fiscal Policy....
It is represented by the executive and legislative branches of government and captures changes in taxes (T) and government spending (G). If the economy is in a recession, a combination of tax cuts and increases in government spending can stimulate economic activity. ?

Monetary Policy.....
It is conducted by the central bank of a country. Monetary policy embraces banking and credit policy relating to loans and interest rates as well as the monetary standards and public debt and its management. In a depression a policy of chief money may be adopted o stimulate business investment and thus assist recovery. ?

RBIS Monetary Policy

The repo had been brought down to 6.5 per cent effective November 3, 2008 and The CRR reduced to 5.5 per cent effective November 8, 2008. There is no doubt these measures have helped the economy and thereby the demand for goods and services. ?

Parts of Business Cycle: Revival

Consumer confidence grows leading to increased borrowing and spending Firms increase output build up stock levels Spare capacity used, then Investment occurs Unemployment falls it make take more than a year of recovery for large changes in unemployment. ?

Indian Money Market

WHAT IS MONEY MARKET-:

As per RBI definitions A market for short terms financial assets that are close substitute for money, facilitates the exchange of money in primary and secondary market. The money market is a mechanism that deals with the lending and borrowing of short term funds (less than one year). A segment of the financial market in which financial instruments with high liquidity and very short maturities are traded.

FEATURES OF MONEY MARKET

Transaction have to be conducted without the help of brokers. It is not a single homogeneous market, it comprises of several sub market like call money market, acceptance & bill market. The component of Money Market are the commercial banks ,acceptance houses & NBFC (Non-banking financial companies) In Money Market transaction can not take place formal like stock exchange ,only through oral communication, relevant document and written communication transaction can be done

OBJECTIVE OF MONEY MARKET

To provide a reasonable access to users of shortterm funds to meet their requirement quickly, adequately at reasonable cost
To provide a parking place to employ short term surplus funds

IMPORTANCE OF MONEY MARKET

Development of trade & industry Development of capital market Smooth functioning of commercial banks Effective central bank control Formulation of suitable monetary policy. Non inflationary source of finance to government

CHARACTERISTICS OF THE INDIAN MONEY MARKET

Lack of integration Lack of rational interest rates structure Absence of an organized bill market Shortage of funds in the money market Seasonal stringency of funds Inadequate banking facilities.

COMPOSITION OF MONEY MARKET

Money Market consists of a number of sub-markets which collectively constitute the money market. They are, Call Money Market Commercial bills market or discount market Acceptance market Treasury bill market

INSTRUMENT OF MONEY MARKET

A variety of instrument are available in a developed money market .In India till 1986, only a few instrument were available. They were Treasury bills Money at call and short notice in the call loan market Commercial bills, promissory notes in the bill market

NEW INSTRUMENT
Now, in addition to the above the following new instrument are available: Commercial papers. Certificate of deposit. Inter-bank participation certificates. Repo instrument Banker's Acceptance Repurchase agreement Money Market mutual fund

COMMERCIAL PAPER
CP)Cp is a short term unsecured loan issued by a corporation typically financing day to day operation. CP is very safe investment because the financial situation of a company can easily be predicted over a few months. Only company with high credit rating issues CPs. Commercial paper is a money-market security issued (sold) by large corporations to get money to meet short term debt obligations.
(

TREASURY BILLS (T-BILLS)

T-bills) are the most marketable money market security. They are issued with three-month, six-month and one-year maturities. T-bills are purchased for a price that is less than their par (face) value; when they mature, the government pays the holder the full par value.
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Treasury Bills are money market instruments to finance the short term requirements of the Government of India. T-Bill is issued at a rate lower than the Face value, and redeemed at Face value on maturity, this difference is the rate of interest on T-Bill. This rate of interest is called Risk free Rate of the country.

CERTIFICATE OF DEPOSIT
(CD) A CD is a time deposit with a bank. Like most time deposit, funds cannot withdrawn before maturity without paying a penalty. CDs have specific maturity date, interest rate and it can be issued in any denomination. The main advantage of CD is their safety. Any one can earn more than a saving account interest.CD has a specific, fixed term (often monthly, three months, six months, or one to five years), and, usually, a fixed interest rate. It is intended that the CD be held until maturity, at which time the money may be withdrawn together with the accrued interest. A savings certificate entitling the bearer to receive interest.

REPURCHASE AGREEMENT (REPOS)

Repo is a form of overnight borrowing and issued by those who deal in government securities. They are usually very short term repurchases agreement, from over night to 30days or more. The short term maturity and government backing usually mean that Repos provide lenders with extremely low risk. Repos are safe collateral for loans. It is the sale of securities together with an agreement for the seller to buy back the securities at a later date

A bankers acceptance (BA) is a short-term credit investment created by a non-financial firm. BAs are guaranteed by a bank to make payment. Acceptances are traded at discounts from face value in the secondary market. BA acts a s a negotiable time draft for financing imports, exports or other transactions in goods. This is especially useful when the credit worthiness of a foreign trade partner is unknown. The banker's acceptance specifies the amount of money, the date, and the person to which the payment is due. After acceptance, the draft becomes an unconditional liability of the bank.

BANKER'S ACCEPTANCE

STRUCTURE OF INDIAN MONEY MARKET

ORGANISED STRUCTURE 1. Reserve bank of India. 2.DFHI (discount and finance house of India). 3.Commercial banks i. Public sector banks SBI with 7 subsidiaries Cooperative banks 20 nationalized banks ii. Private banks, Indian Banks, Foreign banks 4. Development bank IDBI, IFCI, ICICI, NABARD, LIC, GIC, UTI etc

CONTINUED..
II. UNORGANISED SECTOR 1. Indigenous banks -an indigenous banker or bank is defined as an individual or private firm which receives deposits, deals in hundies or engages itself in lending money. 2. Money lenders A moneylender is a person or group who offers small personal loans at high rates of interest. The high interest rates charged by them 3. Chits

 III CO-OPERATIVE SECTOR 1. State cooperative i. central cooperative banks ,Primary Agric edit societies ,Primary urban banks 2. State Land development banks central land development banks Primary land development bank

DISADVANTAGE OF MONEY MARKET

Purchasing power of your money goes down, in case of up in inflation. Dichotomized and loosely integrated Irrational structure of interest rates Highly volatile(unpredictable) market Seasonal stringency of loanable funds Lack of funds in the money market Inadequate banking facilities

CHARACTERISTIC FEATURES OF A DEVELOPED MONEY MARKET

Highly organized banking system Presence of central bank Availability of proper credit instrument Existence of sub-market Ample resources Existence of secondary market Demand and supply of funds

Integration of unorganized sector with the organized sector Introduction of innovative instrument Offering of Market rates of interest Promotion of bill culture Entry of Money market mutual funds Setting up of credit rating agencies Adoption of suitable monetary policy Establishment of DFHI Setting up of security trading corporation of India ltd. (STCI)

RECENT DEVELOPMENT IN MONEY MARKET