Business Economics

Economic Environment
Economic Conditions: The economic conditions of a nation refer to a set of
economic factors that have a great influence on business organizations and their
Operations.
These include gross domestic product, per capita income, markets
For goods and services, availability of capital, foreign exchange reserve, growth of
Foreign trade, the strength of capital market etc. All of these help in improving the pace
of economic growth.
Economic Policies :

• All business activities and operations are directly influenced

• by the economic policies framed by the government from time to time. Some of
• the important economic policies are:
• (i) Industrial policy
• (ii) Fiscal policy
• (iii) Monetary policy
Economic System: The world economy is primarily governed by three types of
economic systems
Capitalist economy
(ii) Socialist economy
(iii) Mixed economy.
India has adopted the mixed economy system which implies co- existence of
the public sector and private sector.
• (iv) Foreign investment policy
• (v) Export-Import policy (Exim policy)
• The government keeps on changing these policies from time to time in view of the
• developments taking place in the economic scenario, political expediency and the
• changing requirements. Every business firm has to function strictly within the policy
• framework and respond to the changes therein.
Business Environment
• The environment includes factors outside the firm which can lead to
opportunities or threat to firm.
• There are many factors, the most important of the factors are socio-
economic, technological, competitors and government.
• Like the changes in tariff rates effect the industries.
• The changes in RBI’s policy effect the industry.
• The business environment is not all about the economic environment but
also about the social and political environment.
Non- Economic Environment
• Political environment
• Legal environment
• Socio-culture
• Technological
• Legal Environment: This refers to a set of laws, and regulations, which influence
the business organizations and their operations. Every business organization has
to obey and work within the framework of the law. The important legislation
that concern the business enterprises include:
• (i) Companies Act, 1956
• (ii) Foreign Exchange Management Act, 1999
• (iii) The Factories Act, 1948
• (iv) Industrial Disputes Act, 1972
• Industries (Development and Regulation) Act, 1951
• (vii) Prevention of Food Adulteration Act, 1954
• (viii) Essential Commodities Act, 2002
• (ix) The Standards of Weights and Measures Act, 1956
• (x) Monopolies and Restrictive Trade Practices Act, 1969
• (xi) Trade Marks Act, 1999
• (xii) Bureau of Indian Standards Act, 1986
• (xiii) Consumer Protection Act, 1986
• (xiv) Environment Protection Act
• (xv) Competition Act, 2002
• Demographic Environment: This refers to the size, density, distribution, and
• growth rate of the population. All these factors have a direct bearing on the
demand for various goods and services. For example, a country where the
population rate is high then there is more demand.
• The availability of skilled labor in certain areas motivates the firms to set up their
units in those areas.
• For example, business units from America, Canada, Australia, Germany, UK, are
coming to India due to the easy availability of skilled manpower. Thus, a firm
that keeps a watch on the changes on the demographic front and reads them
accurately will find opportunities knocking at its doorsteps.
Natural Environment: The natural environment includes geographical and
ecological factors that influence business operations. These factors include the
availability of natural resources, weather, and climatic condition, location aspect,
• Political Environment :

• This includes the political system, the government policies and attitude towards
the business community and unionism.
• All these aspects have a bearing on the strategies adopted by the business firms.
• The stability of the government also influences business and related activities to
a great extent. It sends a signal of strength, and confidence to various interest
groups and investors. Further, the ideology of the political party also influences
the business organization and its operations.
World Economic Situation and Prospects 2023
Economic environment

• Macro level factors related to the means of production and distribution

of wealth, have an impact on the business of an organization.
• The economic structure of a country, whether it is socialist, mixed, or
capitalist, has a drastic impact on the economy.
• Economic policies such as foreign trade policy, industrial policy, fiscal
policy, GDP growth rate, a policy of licensing, monetary policy,
development of financial institutions, development of money and the
stock market, and the extent of globalization are some of the aspects
of an economy that reflect on business in an economy.
Types of environment
• Internal environment
• External environment
Internal environment
• Internal environmental factors are events that occur within an
organization:

• Human resource

• Management

• Organizational culture
Human Resources
• The characteristic of Human Resource is the skill, ability, quality and
commitment of the Employee.

• Human Resource contribute to the strength and weakness to the

organization.
Management
• Managing the whole market set up is an important task.

• All hands should come together to form a perfect management.

Organizational culture
• Organization has style of culture it can be the dress code and others.

• Markets emphasize of wearing uniforms so that the organization is

properly maintained.
External Environment
• The external environment of an organization are those factors outside the
company that affect the company's ability to function
• Climate
• Technology
• Political scenario
Climate
• Climate is a natural factor that can affect the environment at any time.

• Due to Earthquake the whole market would have become unarranged.

• So it would affect the sale of the market for few days.

Technology
• Technology is known as the systematic application change.

• Technology is not constant it keeps on changing.

 National Income

• National income is the total money value of all goods and services produced
by a nation during one year after deducting the depreciation value of the
machine used in production.

• National income is the total payments received by the factors of production

through the production of goods and services in a country in a year.

• National income as a total net output of the nation.

Concepts of national income
• Gross domestic product
• Gross national product
• Net national product
• National income at factor cost
• Personal income
• Disposable income
 Gross domestic product

• Total market value of all final goods and services produced by factors of
production in a country over a given period of time.

• GDP exclude goods and services produced by Indian citizens working

overseas as well as intermediate goods.
• Output produced by citizens of Nepal in India will be
a. Included in GDP of the country
b. Excluded from the GDP of the country
Gross national product

• Total market value of all final goods and services produced by the
residents of a country during a given period of time.
• GNP is the total amount of income earned by national of the country
regardless of where they are.
• GNP= GDP+ net factor income from abroad
• GNP= GDP+ (factor income from abroad- factor income paid
abroad)
• Income earned by the Indians working in Canada, America, Singapore and
other countries will be
a. Included in GNP of the country
b. Excluded from the GNP of the country
Market price and factor cost
• Market price refers to the current price in the market through the forces of
demand and supply.
• Market prices are actual prices paid by consumers
• Market prices includes indirect taxes and excludes subsidies given to
producers
 Important point of adjustment

• GDP at factor cost= GDPMP-indirect taxes+ subsidies

• GDP at market price= GDPFC+ indirect taxes-subsidies

Net national product
• The market value of the net output of goods and services produced by a
nation in a year.

• NNPMP= GNPMP- depreciation

National income at factor cost
• Total of all income payments made to factors of production.

• National income= NNP at market cost+ subsidies-indirect taxes

 Personal income

• Personal income is the income that is actually received by individuals and households in an economy in a year.

a. Corporate income taxes- a certain portion of corporate profits that are paid out as corporate income tax before
being distributed among shareholders.

b. Retained earnings- that part of corporate profits retained by corporations and distributed among shareholders.

c. Social security contributions- contributions of a certain percentage of the worker’s income to provident funds
or pension funds.

d. Insurance premium- a certain percentage of income that is used to pay for insurance.

e. Transfer payment- government give some social security benefits such as unemployment allowances, old age
pensions and other benefits to the public.
• Personal income= National income+ transfer payments- corporate income
taxes- retained earnings- social security contributions- insurance premium
Disposable income
• Part of personal income that is left after the payment of personal direct
taxes.

• Disposable personal income= Personal income – personal income tax

Measurement of national income
• Expenditure method
• Income method
• Product method
NFIA
• It is the difference between the factor income earned by a country from abroad/rest of the world
and factor income paid by a country abroad/rest of the world.
• Factor income from abroad is the income earned by a country’s normal residents from the rest
of the world for the factor services provided by them.
• The income is earned in the form of rent, wages, interest, salaries, dividends and retained
earnings.
• However, Factor income to abroad is the income paid by a country’s normal residents to the
normal residents of other countries (i.e., non-residents of the former country) for the factor
services given by them within the economic territory.  
• Net Factor Income from Abroad = Factor income earned from abroad – Factor income
paid abroad
 Important points about NFIA

• The Net Factor Income from Abroad of an economy can be zero, positive, or negative. 
• It will be zero when the factor income earned from abroad and paid to abroad is equal.
• NFIA will be positive when the factor income earned from abroad is more than the factor
income paid to abroad. 
• However, it will be negative when the factor income earned from abroad is less than the
factor income paid to abroad. 
• Components of NFIA 
• 1. Net Compensation of Employees: It is the difference between income received from
work by the resident workers living or employed abroad for less than one year and similar
payments made by an economy to the non-resident workers staying or employed  within the
economic/domestic territory of a country for less than one year. 
• 2. Net Income from Property and Entrepreneurship: It is the difference between income
received in the form of rent, dividend, interest, etc., from property and entrepreneurship by
the residents of a country and similar payments made to the non-residents of that country. 
Various Concepts of National Product
Q) Calculate (1) GDP at market prices and (2) national
income from the following information for the year
2021, Cr. Rupees?
Solution....
Q2) Calculate the national income and personal disposable income from the following
information :
Solution
Solution..
Q3) Calculate Gross Domestic Product at Market Prices and Net National Product at
Factor Cost and Gross Domestic Product at Factor Cost from the following data:
Note that (viii) wages and salaries and (ix) Employer’s contribution to social
security schemes together constitute compensation to employees .

Net national product at factor cost (NNPFC) = Wages and salaries +

Employers’ contribution to social security schemes + Rent + Profit + Interest +
Mixed Income of Self employed + Net factor income from abroad
Q) Calculate gross domestic product at market prices (GDPMP), gross domestic
product at factor cost (GDPFC) and net national product at factor cost (NNPFC)
from the following data:
From National Income to Personal Disposable Income
 MEASUREMENT OF NATIONAL INCOME

• Value Added Method

Gross Value Added at Market Prices (GVAMP)
• Gross value added at market prices (GVAMP) = Value of Output – Intermediate Consumption

Net Value Added at Market Prices (NVAMP)

• NVAMP = GVAMP – Consumption of Fixed Capital i.e. Depreciation

Net Value Added at Factor Cost (NVAFC)

• NI or NNPFC = NDPFC + Net factor income from abroad
Precautions
• The following precautions should be taken while measuring national income
of a country through value added method:

1. Imputed rent values of self-occupied houses should be included in the value of

output. Though these payments are not made to others, their values can be
easily estimated from prevailing values in the market.

2. Sale and purchase of second-hand goods should not be included in measuring

value of output of a year because their values were counted in the year of
output of the year of their production. Of course, commission or brokerage
earned in their sale and purchase has to be included because this is a new
service rendered in the current year.
 Conti.....

3. Value of production for self-consumption are to be counted while measuring national

income.
In this method, the production for self-consumption should be valued at the prevailing
market
prices.

4. Value of services of housewives are not included because it is not easy to find out correctly
the value of their services.
Income Method

• Thus, under this method, national income is obtained

by summing up of the incomes of all individuals of a
country.
• Individuals earn incomes by contributing their own
services and the services of their property such as
land and capital to the national production.
Classification the factor payments
•
1. Compensation to employees which includes wages and salaries, employers’
contribution to
social security schemes.
2. Rent and also royalty, if any.
3. Interest.
4. Profits: Profits are divided into three sub-groups:
(i) Dividends
(ii) Undistributed profits
(iii) Corporate income tax
• 5. Mixed income of the self-employed: In India, as in other developing countries, there
is fifth category of factor income which is termed as mixed income of self-employed.
• In India a good number of people are engaged in household industries, in family
farms and other unorganised enterprises.
• Because of self-employment nature of the business it is difficult to separate wages
for the work done by the self-employed from the surplus or profits made by them.
Therefore, the incomes earned by them are mix of wages, rent, interest and profit
and are, therefore, called mixed income of the self-employed.
Conti..

• 3. Now the step is to measure factor payments. Income paid out by each enterprise can be estimated by
gathering information about the number of units of each factor employed and the income paid out to
each unit of every factor. Price paid out to each factor multiplied by the number of units of each factor
employed would give us the factor’s income.

4. By summing up the incomes paid out by all industrial sectors we will obtain domestic factor income
which is also called net domestic product at factor cost (NDPFC).

5. Finally, by adding net factor income earned from abroad to domestic factor income or NDPFC we get
net national product at factor cost (NNPFC) which is also called national income.
Income Approach to National Income
Conti.....

• Precautions. While estimating national income through income method the following
precautions
should be taken:
1. Transfer payments are not included in estimating national income through this method.
2. Imputed rent of self-occupied houses are included in national income as these houses provide
services to those who occupy them and its value can be easily estimated from the market value
data.
3. Illegal money such as hawala money, money earned through smuggling etc. are not included
as they cannot be easily estimated.
4. Windfall gains such as prizes won, lotteries are also not included.
Conti....

5. Corporate profit tax (that is, tax on income of the companies) should not be separately
included as it has already been included as a part of profits.

6. Death duties, gift tax, wealth tax, tax on lotteries, etc., are paid from past savings or wealth and
not from current income. Therefore, they should not be treated as a part of national income of
a year.

7. The receipts from the sale of second-hand goods should not be treated as a part of national
income. This is because the sale of second-hand goods does not create new flows of goods and
services in the current year.

8. Income equal to the value of production used for self consumption should be estimated and
included in the measure of national income.
Expenditure Method

• We add up the following types of expenditure by households,

government and by productive
enterprises to obtain national income:
• Expenditure on consumer goods and services by individuals and
households. This is called final private consumption expenditure, and is
denoted by C
• Government’s expenditure on goods and services to satisfy collective
wants. This is called government’s final consumption expenditure, and is
denoted by G.
Conti....
• The expenditure by productive enterprises on capital goods and inventories or
stocks. This is called gross domestic capital formation, or gross domestic investment and
is denoted by I or GDCF. Gross domestic capital formation is divided into two parts:
(i) Gross fixed capital formation
(ii) Addition to the stocks or inventories of goods

• The expenditure made by foreigners on goods and services of a country exported to

other countries which are called exports and are denoted by X.
• We deduct from exports (X) the expenditure by people, enterprises and government
of a country on imports (M) of goods and services from other countries. That is, we
have to estimate net exports (that is, exports– imports) or (X—M).
Conti....

• GDPMP = Private final consumption expenditure + Government’s final

consumption expenditure
+ Gross domestic capital formation + Exports – Imports or
GDP MP = C + G + I + (X — M)
= C + G + I + Xn
• On deducting consumption of fixed capital (i.e., depreciation) from gross domestic product at
market prices (GDPMP) we get net domestic product at market prices (NDPMP).
**In this method, we then subtract net indirect taxes (that is,
indirect taxes – subsidies) to arrive at net domestic product at
factor cost (NDPFC)**
Precautions
• While estimating Gross Domestic Product through expenditure method or measuring final
expenditure on Gross National Product, the following precautions should be taken:

1. Second-hand goods: The expenditure made on second-hand goods should not be included
because this does not contribute to the current year production of goods and services.
2. Purchase of shares and bonds. Expenditure on purchase of old shares and bonds from other
people and from business enterprises should not be included while estimating Gross
Domestic Product
through expenditure method.
 Conti.....

• 3. Expenditure on transfer payments by government such as unemployment

benefits, old-age pension should also not be included because no goods or
productive services are produced in exchange by the recipients of these
payments.

4. Expenditure on intermediate goods such as fertilisers and seeds by the farmers

and wool, cotton and yarn by manufacturers of garments should also be
excluded to avoid double counting.
 Product Approach

• National income is measured by net value of final goods

and services produced by a nation during a year.

• This approach is also known as output approach and value

added approach.

• Money value of final goods and services are included in

calculation of GDP of the country.
Sectors contributing to GDP
• Primary sector
• Secondary sector
• Tertiary sector
• Tertiary sector comprising
a. Electricity
b. Gas and water
c. Wholesale and retail trade
d. Finance
e. Insurance, real estate and business services
f. Transport, storage and communication
g. Government services and other services
• GDP at market price= All final products in the economy

• GNP at MP= GDP +NFIA

• GNP at FC= GNP at MP- Indirect taxes+ subsidies

• National income= GNP at FC – depreciation

• Personal income= national income+ transfer payments- corporate

income taxes- retained earnings – social security contributions-
insurance premium

• Disposable income= personal income- personal income tax

Uses of National Income
• Standard of living comparison
• Economic performance over time
• National planning
• Sectoral contributions
• Economic policy
• Inflationary and deflationary gaps
• Public sector
• Distribution of income
Difficulties in calculation of national income

• Problem of non-monetized sector

• Problem of illiteracy

• Problem of expertise

• Problem of less sophisticated machinery

• Problem of double counting

• Problem of false information

• Problem of multi-occupation
Circular flow of money

• In the modern economy, money is used in the process of

exchange.

• Money has facilitated the process of exchange and has

removed the difficulties of the barter system.

• Thus money acts as a medium of exchange.

• The households supply the economic resources or factors to

the productive firms and receive in return the payments in
terms of money.
 Circular Income Flow in a Two-Sector Economy

• It is assumed that all incomes which households receive are spent on consumer goods and
services and thus there is no savings by them.

• The resources such as land, capital and entrepreneurial ability flow from households to
business firms. In opposite direction to this, money flows from business firms to the
households as factor payments such as wages, rent, interest and profits.

• Money flows from households to firms as consumption expenditure made by the

households on the goods and services produced by the firms, while the flow of goods and
services is in opposite direction from business firms to households.
 Important facts

• Flow of money income will not always remain the same in volume.

• The flow of money income will not always continue at a constant level.

• In years of depression, the circular flow of money income will contract, i.e., will become lesser
in volume, and in years of prosperity it will expand, i.e., will become greater in volume.

• This is so because the flow of money is a measure of national income and will, therefore,
change with changes in the national income.

• In years of depression, when national income is low, the volume of the flow of money will be
small and in years of prosperity when the level of national income is quite high, the flow of
money will be large.