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
Statutory Liquidity
cash for meeting the cashRatio(25%)
demand by the depositors.

• 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 standard
E.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.
 U !
A N K
TH