Economic Environment Defined

The economic environment consists of external factors in a business market and the broader
economy that can influence a business. You can divide the economic environment into the
microeconomic environment, which affects business decision making - such as individual
actions of firms and consumers - and the macroeconomic environment, which affects an entire
economy and all of its participants. Many economic factors act as external constraints on your
business, which means that you have little, if any, control over them. Let's take a look at both
of these broad factors in more detail.

Macroeconomic influences are broad economic factors that either directly or indirectly affect
the entire economy and all of its participants, including your business. These factors include
such things as:

• Interest rates
• Taxes
• Inflation
• Currency exchange rates
• Consumer discretionary income
• Savings rates
• Consumer confidence levels
• Unemployment rate
• Recession
• Depression

Microeconomic factors influence how your business will make decisions. Unlike
macroeconomic factors, these factors are far less broad in scope and do not necessarily affect
the entire economy as a whole. Microeconomic factors influencing a business include:

• Market size
• Demand
• Supply
• Competitors
• Suppliers
• Distribution chain, such as retail stores

Why Is the Economic Environment Important?

The economic environment of a business will play a pivotal role in determining the success or
failure of a business.

Let's first consider some macroeconomic factors. If interest rates are too high, the cost of
borrowing may not permit a business to expand. On the other hand, if the unemployment rate
is high, businesses can obtain labor at cheaper costs. However, if unemployment is too high,
this may result in a recession and less discretionary consumer spending resulting in
insufficient sales to keep the business going. Tax rates will take a chunk of your income and
currency exchange rates can either help or hurt the exporting of your products to specific
foreign markets.
Now let's turn our attention to microeconomic factors for a bit. Market size may determine the
viability of entering into a new market. If a market is too small, there may not be sufficient
demand and profit potential. This leads us to the concept of demand and supply. If your
product is in high demand but there is a low supply of it, you are going to make a tidy profit,
but if your product is in low demand and the market is flooded with similar products, you may
be facing bankruptcy. The quality and quantity of your competition will affect how well you
do in winning customers in the marketplace. Suppliers are the arteries pumping vital supplies
and resources to you for production. If you have problems with suppliers, it can clog up those
arteries and cause serious problems. Likewise, the type of relationship you have with your
distributors, such as retail stores, may influence how quickly your products leave their
shelves.

Lesson Summary
The environment in which a business operates is very complex and has a great deal of
influence on how a business performs and whether it will succeed. Macroeconomic factors
influence not only a business but also all participants in an economy and include such things
as interest rates, inflation, unemployment rates, taxes, discretionary spending, periods of
growth, and recession. Microeconomic factors also influence the success or failure of a
business and include such things as market size, demand, supply, competitors, suppliers, and
distributors.