Economic Environment

After Midterm Session

 Learning Objectives
After studying this chapter, you will be able to:
• Explain the different kinds of economic systems
• Discuss the various economic policies
• Describe the current inflationary position of India and its impact on
businesses
• Discuss the various economic legislations
 Economic Environment
• External factor
• Have a significant effect on the creation and dissemination of wealth
• Directly influence the demand and supply
• Plays a crucial role in the decision making of a business
 The economic environment of a firm
comprises
• Economic conditions :
• income distribution, per capita income, economic nature, economic resources,
interest rate, taxation, and so on
• Economic system and
• Economic policies
 Economics System
• An economic system can be referred to as a system that encompasses the
methods of production, distribution and exchange of goods and services
(excluding their consumption).
 Types of economic system
• Free market economies or capitalist economies
• Centrally planned economy or socialist economy
• Mixed economy
 Capitalism
• “Capitalism is a particular mode of organisation of production
which is characterised by wage slavery, production of profit,
and creation of surplus value”. (Karl Marx)
• “Capitalism is a system of the economic organisation featured
by the private ownership and the use for private profit of man-
made and nature made capital.” (Louks and Hoots)
 Capitalist economy
• Capitalism is an economic system in which the industries, trade and
production means are completely owned by private bodies.
• This type of economy is also known as a capitalist economy or a free-
market economy
• This type of economy involves no governmental interference.
• Samples of nation: Germany, U.S
 Capitalist Economy
• The production task of a capitalist economy is completely controlled
by firms and industries.
• The market mechanism, decision-making process, the means of
production carried out for the supply of products in the market are owned
by private organisations.
• The productive activities are not controlled or planned by anyone instead
they are decided by the demand and supply of products and the price
mechanism
 Demand and Supply
• What will the producers do with the prices and level of production if the
demand for products exceeds the supply?, and
• What will the producers do with the prices and level of production if the
supply of products exceeds the demand?
 The Features of Capitalism
• Private property (In capitalism, it is a fundamental right of all the individuals
to be the owner of private property)
• Large scale production (The installation of large plants and the division of
labour resulted in increased levels of production)
• Profit institution (the process of production is oriented towards profit)
• Competition (A capitalist economy has to face strong competition in the
market. This results from the artificial rise in the demand and reduction in the
supply)
 The Features of Capitalism
• Price mechanism (In capitalism, the prices of goods and services are decided by their demand
and supply)
• Wage institution (capitalist tries to extract maximum possible output from the workers and pays
very less wages in return)
• Money and credit (Capitalists establish their business and generate profit on the basis of credit.)
• Business organization (combining a huge amount of funds from them and similarly from other
shareholders)
• Market economy (In capitalism, it is a fundamental right of all the individuals to be the owner of
private property)
 SOCIALIST ECONOMY
• Socialism is an economic system where ownership and
regulation are under the government. All the activities of
production and other functions like allocation of resources,
consumption, distribution of income, investment pattern, etc.,
are under the direction and control of the government.
• In socialism, enterprises which are owned by the government
have limited access to incentives for cost control since they
cannot go past their policies of the business
• Under socialism, private firms are restricted and no incentives are offered
for their efforts to cater to the needs of the consumers
• In the words of Leftwitch, “In socialism the role of the state is central. It
owns the means of production and directs economic activity.”
• As per H.D. Dickinson, “Socialism is an economic organisation of
society in which the material means of production are owned by the whole
community and operated by the organs representative of and responsible
to the community according to a general economic plan, all members of
the community being entitled to benefit from the results of such socialised
production on the basis of equal right.”
 The Features of Socialism
• Social ownership: In socialism, there is no private ownership since all the
production means such as banks, railways, mines, factories, farms,
etc., belong to the society.
• Social welfare: Social welfare is one of the crucial objectives of
socialism. This is achieved through proper resource utilisation and
catering to the society’s needs and wants. It takes care of the economy’s
benefits as a whole instead of the needs of some individuals
• Central planning: Under socialism, all the activities of production and their associated
goals and plans are designed by the Central Planning Authority.
• Equality of income and opportunity: Socialism strives to remove or reduce disparities
in income and wealth and offers equal opportunity to every individual. It also offers equal
opportunity to every person by way of professional training, free education, and so on.
• Classless society: Contrary to capitalism, socialism is a classless society, where there is
no division of society into classes like labour class or elite class, etc. Here, all the
activities of production are carried out by the community as a whole and, therefore class-
conflict is very less likely to happen
 MIXED ECONOMY
• Mixed economy combines the characteristics of both capitalism and
socialism. It is the aggregate of both public and private ownership. A
mixed economy offers private enterprises the freedom to function and
develop but also permits government interference in matters for
maintaining economic objectives. The combination of government
interference and private sector varies from one nation to another
• In a mixed economy, some areas are operated by private firms, whereas
some areas are reserved for the public firms. Also, there are few areas,
where both private and public sectors work in a collaborative way.
• As per Samuelson, “Mixed economy is that economy in which both public
and private institutions exercise economic control.”
• In the words of Pickersgill, “The primary difference between the mixed
economy and market socialism is the relatively greater importance of
individual decision making, private property and the reliance on market-
determined prices to guide the allocation of resources. The mixed
economy differs from competitive capitalism with respect to the share of
collective decision making in the economy.”
 Features of Mixed Economy
• Co-existence of the public and private sector: In a mixed economy, both public and private
sectors operate independently but strive to achieve a single objective. Public sectors operate for the
society’s welfare while the private sector is oriented towards earning profits. Therefore, the
government has devised several economic policies in order to regulate and govern the economic
activities of the private sector. Such policies include monetary policy, fiscal policy, taxation policy,
etc.
• Individual freedom: Government imposes restrictions for ensuring the welfareof the society.
Hence, manufacturers have to abide by these rules and regulations. For example, the government
might put restrictions on the production of harmful and hazardous goods. However, individuals are
free to buy any product. Therefore, despite all sorts of government control, people have the
freedom to purchase and choose the occupation or profession of their own choice.
• Economic welfare: The primary purpose of a mixed economy is to
ensure economic welfare. This can be brought about by reducing regional
imbalances and by offering opportunities for employment. The
government has taken several steps towards society’s upliftment. The
monetary and fiscal policies are designed to govern and control the
economic activities of the private secto
• Economic planning: The Central Government devises economic plans and direct the
functions of both the public and private firms in view of that. The public sector activities
are directly regulated by the government whereas different incentives and subsidies are
offered to the private sector for functioning as per the economic objectives.
• Price mechanism: Price system of the economy is regulated by the price policy framed
by the government. For offering commodities at economical rates to the weaker sections
of the society, the government provides financial and economic aid to the producers. It
offers subsidies to the target groups and also provides material inputs below the market
price or free of cost to various firms. Therefore, under a mixed economy, people avail an
enormous amount of benefits and support from the government.
• Free and controlled economic development: Mixed economy is regarded as the best
alternative to the socialist and capitalist economies. It attempts to eliminate all the issues
and drawbacks associated with the sustainable growth and development of the economy.
It gives freedom of occupation and choice as well as controls and governs the economic
activities.
• Government intervention: Under the mixed economy, the government can interfere in
order to stabilise the economy, particularly during a crisis. For example, during the
global crisis of 2008, the governments of the United States and other nations intervened
into the affairs of the economy for controlling and managing the effect of the crisis.