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Economic and Social Environment

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All Blocks

Note : Attempt all questions and submit this assignment on or before 30th April, 2015 to the
coordinator of your study centre.
1. Explain environment of business in detail and examine the interaction between economic
environment and business management giving suitable examples.
2. Evaluate the working and performance of public sector in India.
3. a) Describe the salient features of the protective policy adopted by the government for
Small Scale Industry (SSI).
b) State the objective and achievements of administered price mechanism.
4. a) Analyse the need for foreign capital for a developing country. Give illustrations.
b) Define Balance of Payments (BoP). Briefly discuss the significance and composition of
5. Briefly review the impact of economic reforms in India in terms of achievements and
1. Explain environment of business in detail and examine the interaction between economic
environment and business management giving suitable examples.
Ans.: Decisions made by managers are crucial to the success or failure of a business. Roles played by
business managers are becoming increasingly more challenging as complexity in the business world
grows. Business decisions are increasingly dependent on constraints imposed from outside the
economy in which a particular business is basedboth in terms of production of goods as well as the
markets for the goods produced. The impact of rapid technological change on innovation in products
and processes, as well as in marketing and sales techniques, figures prominently among the factors
contributing to the increasing complexity of the business environment. Moreover, because of
increased globalization of the marketplace, there is more volatility in both input and product prices.
The continuous changes in the economic and business environment make it ever more difficult to
accurately evaluate the outcome of a business decision. In such a changing environment, sound
economic analysis becomes all the more important as a basis of decision making. Managerial
economics is a discipline that is designed to provide a solid foundation of economic understanding in
order for business managers to make well-informed and well-analyzed managerial decisions.
While environmental sustainability is an integral part of the Lisbon strategy, protection of the
environment and economic growth are often seen as competing aims. Proponents of tighter
environmental regulation challenge this view. They highlight the financial benefits of increased eco1
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efficiency and the emergence of a European eco industry with million of jobs together with the need
to improve how we protect public health and manage natural resources. European industry and
business, meanwhile, often claim that tightened European environmental regulation is hampering their
growth, undermining their international competitiveness, and destroying jobs, and will force them to
eventually relocate their activities to emerging market economies outside the EU. This chapter tries to
shed some light on this controversy by identifying and analysing mechanisms and driving forces that
could work in one direction or the other, by looking for empirical evidence for or against the above
claims, and by coming up with some recommendations for better policy making.
The controversy surrounding environmental policy has, perhaps surprisingly, arisen not so much from
the issue of conserving non-renewable commodities such as fossil fuels or industrial metals, but from
the increasing scarcity or overuse of renewable natural resources, causing problems such as water and
air pollution, or damage to global commons such as the atmosphere or the ozone layer. This apparent
paradox reflects the fact that, while functioning markets exist for the non-renewable commodities,
there are typically no markets for environmental commons. This has not posed a problem in the past,
since there was an abundance of natural resources. However, due to rising demand linked to growing
populations, industrialisation based on the burning of fossil fuels and the associated pollution, and
new insights into the cause-effect relationship between pollution and public health, it has become
necessary to find ways of managing these goods efficiently. Normally, rising scarcity tends to move
goods up a property-rights hierarchy, that is, free goods are first made subject to a commonproperty regime, and then, eventually, turned into private goods. Environmental policy aims at putting
environmental resources such as land, water, air, the atmosphere and specific habitats under a
common property regime, with clear and enforceable rules. The tools at the environmental
policymakers disposal are various forms of restriction on activity: access to these resources may be
limited (for example, by placing limit values on emissions), or their use may be limited (by restricting
the kind of activities allowed in natural habitats or drinking-water reservoirs) or made subject to
specific conditions (such as paying a tax or an environmental levy or the obligation to clean or recycle
them after use).
The theory of the property-rights hierarchy has been borne out in practice. Rising incomes and rising
pollution have brought with them a rising demand for environmental protection (policies). Market
forces themselves have led to a reduction in the pollution intensity of economic activity in Europe,
both because of the dynamic growth of the cleaner services sector, and because the private rates of
return for local and regional pollution are closer to social rates than for global commons. However,
strong policy action has nevertheless been needed to decouple economic activity and emission levels.
These policies have been most successful in the context of ambient air pollution and acidification,
while progress still needs to be made on cutting back greenhouse gas emissions. There is no evidence
to support the assertion that this decoupling has been achieved by exporting pollution through large
scale delocalisation, as this process tends to be determined by factors other than environmental
legislation. Moreover, the environmental ambitions of emerging market economies such as China are
also rising, and standards seem to be converging globally, suggesting that pollution havens are at
most a temporary phenomenon.
While demand for environmental protection is growing, it comes at a cost. The costs and benefits of
taking action or not must therefore be estimated when environmental legislation is being drafted.
However, it is rare for the costs and benefits particularly the benefits that actually materialise to be
assessed after the policy has been implemented. Where they are, it appears that costs tend to be
overestimated, possibly owing to both asymmetric information and a tendency to underestimate
innovation and progress in abatement technologies. That said, spending on environmental protection
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estimated by Eurostat at about 1.5 per cent of GDP in the late 1990s does divert the resources of
regulated industries from their core business. Typically, it makes their production more capital
intensive and more expensive, with a negative knock-on effect on the productivity of other production
factors, and on demand. If competitors do not have to comply with similar policy constraints, this
spending also worsens the (international) competitiveness of the industries affected. On the plus side,
gradual but credible long-term tightening of environmental standards and ambitions helps to establish
new markets for environmental technologies - both abatement and clean technologies. It is estimated
that spending on environmental protection accounts for 2 million jobs in the EU15, or about 1.2 per
cent of total employment.

2. Evaluate the working and performance of public sector in India.

Ans.: Amartya Sen raised some important issues relating to the performance evaluation of public
enterprises in India. While his diagnosis of the problem was correct, his prescriptions were too
abstract to provide guidance for policy formulation.
There are two prerequisites for eliciting superior performance from public enterprises. First, we must
have an appropriate criterion for evaluating their performance, i e, we must be able to distinguish
'good1 performance from 'bad' performance using an appropriate criterion. Second, we must devise
appropriate incentive schemes so that the public enterprise managers will be willing to do their best in
terms of this criterion. The focus of this paper will be on the meaning and the search for the
appropriate criterion with only a brief discussion of the appropriate incentive schemes and other
institutional requirements necessary for ensuring good performance.
The following passage from Sen (1983) is very instructive as a backdrop for the discussion in this
section: In the absence of any well-formulated alternative criterion, the public tends to judge success
or failure of public enterprises by profits, and this has led in India to much cynicism about the abilities
of public enterprises. This might be at least partly unjustified, but it is fairly inescapable in the
absence of a different system of performance evaluation. Even in political discussions in Parliament
or in Assemblies, or in newspapers, it becomes difficult to avoid using the profit criterion, since there
is no other precise measure of success that is offered for discussion. Having a well-formulated system
of social profits based on shadow prices, despite the possible crudity of these shadow prices may,
therefore, serve the purpose of both giving the management a clear perception of interest of the
respective public enterprises (and related to it, of their own selfinterest), and also provide the public
with a basis of evaluation other than profits. Sen makes several good points. There exists a strong and
urgent need for an alternative to private profit (we shall henceforth use the prefix 'private' to avoid
confusion with other concepts such as the social profit). In the absence of such an alternative, private
profit will continue to be in wide currency.
There are several problems with Sen's prescription, however. Ironically, his solution is itself part of
the problem. It is a big leap from private profits to social profits at shadow prices. To exhort policy
makers to undertake this task without providing help on the specifics is similar to asking a person to
cross the ocean without giving him the means to do so. This is perhaps the reason why fifteen years
after Sen first urged the use of social profits at shadow prices it still remains unimplemented. It is
especially surprising because Sen is fully aware of these pitfalls. In his own words: .One would like to
avoid the danger of hollow purism that has made so much of modem economics unfit for actual use.
Another problem relates to the criterion of social profits suggested by Sen. While it is superior to
private profits and moves us in the right direction, it does not go far enough. In the balance of this

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section, we will attempt to develop an alternative to the notion of private profits that is conceptually
sound and accessible for actual use.
Consider a situation in which a public enterprise manager succeeds in getting a subsidised loan at five
per cent and deposits it at ten per cent in another bank. This arbitrage yields him a five per cent return.
Should this be considered a benefit in the social calculus? Should a public enterprise manager be
rewarded for this activity? Of course not. If that was not what the public enterprise was set up for,
then that activity was an unintended deviation from desirable behaviour. Also, this constitutes a
transfer of surplus from one party to another and not a net increase in social welfare.

3. a) Describe the salient features of the protective policy adopted by the government for Small
Scale Industry (SSI).
Ans.: The Small Scale Industrial sector is one of the most vital sectors of the Indian Economy in terms
of employment generation, the strong entrepreneurial base it helps to create and its share in
production. With the advent of planned economy from 1951 and the subsequent industrial policy
followed by Government of India, both planners and Government earmarked a special role for smallscale industries and medium scale industries in the Indian economy. Due protection was accorded to
both sectors, and particularly for small-scale industries from 1951 to 1991, till the nation adopted a
policy of liberalization and globalization. Certain products were reserved for small-scale units for a
long time, though this list of products is decreasing due to change in industrial policies and climate.
SMEs always represented the model of socio-economic policies of Government of India which
emphasized judicious use of foreign exchange for import of capital goods and inputs; labour intensive
mode of production; employment generation; no concentration of diffusion of economic power in the
hands of few; discouraging monopolistic practices of production and marketing; and finally effective
contribution to foreign exchange earning of the nation with low import-intensive operations. It was
also coupled with the policy of de-concentration of industrial activities in few geographical centers.
Some of the Government Policies for development and promotion of Small-Scale Industries in India
are: 1. Industrial Policy Resolution (IPR) 1948, 2. Industrial Policy Resolution (IPR) 1956, 3.
Industrial Policy Resolution (IPR) 1977, 4. Industrial Policy Resolution (IPR) 1980 and 5. Industrial
Policy Resolution (IPR) 1990.
Since Independence, India has several Industrial Policies to her credit. So much so that Lawrence A.
Veit tempted to say that if India has as much industry as it has industrial policy, it would be a far
well-to-do nation. With this background in view, in what follows is a review of Indias Industrial
Policies for the development and promotion of small-scale enterprises in the country.
Micro, Small and Medium Enterprises, including khadi and village/rural enterprises credited with
generating the highest rates of employment growth, account for a major share of industrial production
and exports. They also play a key role in the development of economies with their effective, efficient,
flexible and innovative entrepreneurial spirit. The socio-economic policies adopted by India since the
Industries Development and Regulation Act, 1951 have laid stress on micro, small and medium scale
industries as a means to improve the countrys economic conditions.
The small-scale industries sector plays a vital role in the growth of the country. It contributes almost
40 percent of the gross industrial value added in the Indian economy. It has been estimated that a
million Rs. of investment in fixed assets in the small scale sector produces 4.62 million worth of
goods or services with an approximate value addition of ten percentage points. The small-scale sector
has grown rapidly over the years. The growth rates during the various plan periods have been very
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impressive. The number of small-scale units has increased from an estimated 0.87 million units in the
year 1980-81 to over 3 million in the year 2000. When the performance of this sector is viewed
against the growth in the manufacturing and the industry sector as a whole, it instills confidence in the
resilience of the small-scale sector. 3 manufacturing and the industry sector as a whole, it instills
confidence in the resilience of the small-scale sector.

3. b) State the objective and achievements of administered price mechanism.

Ans.: The Indian government has, since independence, subsidised many industries and products, from
fuel to food. Loss-making state-owned enterprises are assisted by the government and farmers are
given access to free electricity. Overall, a 2005 article by International Herald Tribune stated that
subsidies amounted to 14% of GDP. As much as 39% of subsidised kerosene is stolen
In 1997, the Indian government took a strategic decision to deregulate the oil sector and dismantle the
administered price mechanism (APM) existing in the Indian oil industry in three phases by the end of
March 2002. For the last three years, the oil industry had been undergoing a transformation stage from
administered price mechanism to market-determined price mechanism. During this period of
transition, the government also aimed at clearing the oil pool deficit and reducing the subsidies on
petro-products. The oil pool account is now completely abolished and the deficit has been transferred
to the general budget. The government has repaid most of the oil companies' outstandings through the
payment of oil bonds. With the dismantling of APM from April 2002, oil companies stand exposed to
the vagaries in the international prices of crude oil and products. Hence, their profitability would now
be governed by a different set of factors.
In Budget 2002-03, the government increased the excise duty on LPG, kerosene and auto CNG from
8% to 16%. Excise duty on petrol was reduced from 90% to 32% and that on diesel from 20% to 16%.
Import duty on non-PDS kerosene has been reduced from 35% to 20% while that on PDS kerosene
has been increased from 5% to 10%. Import duty on petrol and diesel has been retained at 20%. In a
major step, the government reduced the subsidies on LPG and kerosene from 40% and 45% to 15%
and 33% respectively. This led to an increase of LPG cylinder for domestic purpose by Rs 40 per
cylinder and that of kerosene by Rs 1.5 per liter. However, the increase in LPG cylinder was later
rolled back to increase of Rs 20. Meanwhile, disinvestment in oil companies is in full swing. The IBP
disinvestment was a fine example. BPCL and HPCL are also lined up for divestment in fiscal 2002.
Following the dismantling of APM, the government has allowed hedging in crude and petroleum
products by corporates in order to mitigate risk from volatility of international oil prices.
Post-APM dismantling, import of oil, mainly from the Gulf countries, could become a serious threat
to domestic players what with lower cost of crude and lower transportation costs. The gross imports of
crude oil and products for the year 2001-02 was estimated to be 93.70 mmt. Even as the refining
companies are fully insulated from any adverse impact of a rise in global oil prices, it is the marketing
companies that are currently being hit. Stand-alone refining companies sell products to marketing
companies at import parity prices which are significantly higher than the retail prices at which PSU
companies sell petrol and diesel. The real impact of APM will be felt only when the government sells
its stake in BPCL and HPCL to the private sector and the private sector with a retail network come to
the forefront for marketing of oil and gas. The government is yet to frame guidelines private sector

4. a) Analyse the need for foreign capital for a developing country. Give illustrations.
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Ans.: Attracting capital and foreign exchange flows is crucial for developing countries. Yet, these
flows could lead to real exchange rate appreciation and may thus have detrimental effects on
competitiveness, jeopardizing exports and growth. This paper investigates this dilemma by comparing
the impact of six types of capital and foreign exchange flows on real exchange rate behavior in a
sample of 57 developing countries covering Africa, Europe, Asia, Latin America, and the Middle
East. The results reveal that portfolio investments, foreign borrowing, aid, and income lead to real
exchange rate appreciation, while remittances have disparate effects across regions. Foreign direct
investments have no effect on the real exchange rate, contributing to resolve the above dilemma.
Maintaining a high level of competitiveness is an important objective for developing and emerging
economies, as it enhances their exports and growth and contributes to their economic diversification3.
Therefore, investigating the determinants of competitiveness and identifying the factors that might
undermine them is essential. Competitiveness can have different measures, including labor
productivity, the real effective exchange rate (REER), unit labor cost, terms of trade, Balassa's index
of revealed comparative advantage, and the World Economic Forum competitiveness index. The
paper uses the real effective exchange rate (REER)4 as it has been the most widely used measure for
competitiveness in the literature in recent years5 . Capital flows are an important determinant of the
possible loss of competitiveness. Most of the related literature indicates that an increase in capital
flows leads to the appreciation6 of the real effective exchange rate (REER), which may have
detrimental effects on the external competitiveness (Corden, 1994).
On another hand, capital flows are essential for developing and emerging markets. They contribute to
enhancing investments and financing current account deficits. This dual effect creates a dilemma for
policy makers on how to manage capital inflows to maximize the benefit for the economy. Resolving
this dilemma requires identifying which capital flows lead to the least significant appreciation of the
REER, or have no impact on the REER at all, and thus do not necessarily undermine competitiveness.
Capital flows can be divided into several types. Three distinctive flows appear in the financial account
of the balance of payments, namely foreign direct investments (FDI), portfolio investments and other
investments. Three others appear in the current account remittances, aid, and income. While these
flows are not typically labeled as capital flows, their implications for competitiveness could be
significant. These flows are referred to in the paper as foreign exchange flows.

4. b) Define Balance of Payments (BoP). Briefly discuss the significance and composition of BoP.
Ans.: The balance of payments (BOP) is the place where countries record their monetary transactions
with the rest of the world. Transactions are either marked as a credit or a debit. Within the BOP there
are three separate categories under which different transactions are categorized: the current account,
the capital account and the financial account. In the current account, goods, services, income and
current transfers are recorded. In the capital account, physical assets such as a building or a factory are
recorded. And in the financial account, assets pertaining to international monetary flows of, for
example, business or portfolio investments, are noted. In this article, we will focus on analyzing the
current account and how it reflects an economy's overall position.
The balance of payments reports all financial flows of a country vis--vis the rest of the world. It is a
farly complicated balance sheet but, in this short text, we shall present it in quite simplified way for
the absolute beginner. In very aggregate terms, let's consider all "money" entering into a country (for
whatever reason and transaction) and all "money" exiting from it. The difference between the two is
the change in the official currency reserves of the central bank. In other terms, people from abroad
bring their currency to the central bank, obtaining the local currency in exchange. The local people
buy foreign currency in the central bank. All these transactions can have intermediaries (as banks) but
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at the end, there is a place (the "reserves" of the central bank) that accommodate for the differences
between inflows and outflows. Since reserves are usually small in comparison with the flows - and
their systematic decrease or increase create problems, as we shall see in a moment - to a large extent,
inflows and outflows tend to be equal. In fact, if outflows are larger than inflows, the reserves are
going down, until the central bank reacts (e.g. by devaluating the currency). If outflows are smaller
than inflows, reserves pile up. Since they could be profitably used, there is a pressure to reduce them
(e.g. by stimulating an outflow in terms of outgoing FDI). In absence of tight currency control and
central bank activities, the exchange rate tends to react with a spontaneous devaluation in the first
case, and with a revaluation in the second one, helping reducing the unbalance.

5. Briefly review the impact of economic reforms in India in terms of achievements and failures.
Ans.: If one traces the changes in India's economic policies over the last five decades, they bear the
imprint of changing geopolitical dynamics. While India's policy makers often couch their agendas in
ideological terms, in reality the economy has been steered by the ruling elite to their economic
advantage. Therefore, liberalization and the permissible boundaries within which a reform process
will operate can be best understood if contextually examined and interpreted. This paper attempts to
explain the dynamics of the economic policy process and outlines the contours of India's liberalization
program. There is a feeling that the Nehruvian development model was wrong. Socialism has failed
because it could not generate wealth on a sustained basis. Yet, basic socialist concerns about poverty
and inequalities have still not disappeared. Indias basic objectives have not changed but the need to
change the strategy of growth has been increasingly accepted. There is a passive consensus in favour
of the strategic shift in the development strategy. So the real question in the process of environment
reforms is not the sterile debate between the state and a pure market but the question of how-to
manage the transition (I) from excessive to educed state intervention; (ii) from intervention in the
wrong areas to those in previously neglected important ones; and (iii) from one form of reliance on
quantity controls to another form (reliance on prices) of policy. period of two years. Macroeconomic stabilization reforms (along with structural economic reforms) were launched in June
1991.Through prudent macro-economic stabilization policies including devolution of the rupee and
other structural economic reforms the balance of payments crisis was clearly over by the end of
March 1994. Foreign exchange reserves had risen to the more than adequate level of US$15.07 billion
and the current account deficit as a percentage of GDP was nearly eliminated. Export growth rate at
20.0 percent in 1993-94 over the previous year was quite encouraging. Macro-economic stability has
endured in the ten years of economic reforms to 2003. Foreign-exchange reserves peaked at US$70
billion at the end of March 2003 (and touched US$80 billion in June 2003).
The current account recorded a surplusequivalent to 0.3 percent of GDPin 2001-02. Food
stocks with the Food Corporation of India, held to ensure national food security, peaked at sixty
million tons (compared to the required twenty million tons). It took longer to control inflation but this
led to relatively more enduring results (excluding the impact of externally determined fuel prices).
Since 2002, the country has enjoyed a low interest-rate regime. These performance indicators have
helped to provide an enabling environment for the macroeconomic policy stance. India has also
increasingly integrated its economy with the global economy. After half a century of inward
orientation, the share of Indias trade as a proportion of GDP rose from 13.1 percent in 1990 to 20.3
percent in 2000. By Indian standards this is an impressive performance. Indias economy has also
successfully moved into a higher trajectory of growth and displayed strong dynamism in selected
sectors. This encouraging performance brightens the prospects for stepping up Indias growth rate and
improving the competitive edge in the years to come through further appropriate economic reforms.
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The average annual growth rate of 5.8 percent achieved by the Indian economy during the years of
economic reforms since 1992 is encouraging. Currently, after China, India is among the fastestgrowing countries in Asia. Since the annual rate of population growth has slowed significantly to
nearly1.8 percent during the 1990s, per capita income has been growing at a healthier real rate of four
percent per annum. Indias growing middle class of more than 350 million people, with a reasonably
affluent standard of living, provides a huge market for foreign corporations, especially since April
2003, when all quantitative restrictions on imports were lifted.
Along with its fairly good growth rate (which, however, is far below the potential growth rate of eight
percent targeted by Indias Tenth Five-Year Plan), India has been successful in reducing poverty. The
poverty ratio (that is, people below the poverty line as a percentage of the population) as estimated by
the Planning Commission at the national level came down from 36 percent in 1993-94 to 26.1 percent
in 1999-2000. The poverty ratio during this period declined both in rural areas and in urban areas.
There is little doubt that poverty in India has been reduced during the last decade. The Planning
Commission has set a poverty ratio target of 19.3 percent by the end of the Tenth Plan period (to
March 2007). An important indicator of gains from economic reforms, reflecting the attractiveness of
India as an investment destination, is shown by the increasing inflows of both FDI and Foreign
Institutional Investment (FII) into India. Inflows of both FDI and FII into India have increased in the
decade to 2002.

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