The economic environment can be defined as the combination of all the economic factors such as, inflation, income, employment rate, etc. which affect the buying behavior of consumers and thus put an impact on businesses.
What is Economic environment?
The economic environment consists of economic factors which affect the buying habits of consumers and the commercial behavior of companies.
There are several internal as well as internal factors which affect the economy. The buying habits of consumers and the commercial behavior of organizations id interdependent.
For example, if an organization increases the price of a particular product, then people will start buying less from the organization and similarly when the demand of a particular product decreases the company reduces the production of the product.
Factors Affecting the Economic Environment
There are various factors which affect an economic environment. These factors can be divided into two categories.
Microeconomic environment factors are those factors which affect and individual organization and do not affect the whole industry. The examples of microeconomic factors are demand, competitors, market size, distribution chain, suppliers, supply, etc.
Macroeconomic environment factors are those which impacts at a larger level and does not only impacts one company but impact the whole economy. The examples of microeconomic factors are inflation, unemployment, interest rates, taxes, tariff, the trust of customers, etc.
In this section, you will learn about all the factors which affect the economic environment and will also learn how these factors affect an economic environment.
Increased demand for product results in more profits whereas a decrease in demand for your product cause loss. Therefore, companies use various strategy to increase the demand for their product in the market.
2) Market size
The profit margin of the organization will be low if it has a small market size. Meaning of market size is the total number of potential buyers in a market. For example, a company which produces asthma inhalers has a small market size as it can sell inhaler to people who suffer from asthma.
The production of a company will halt if its suppliers suddenly stop to provide supplies of raw material to produce a product. Similarly, the production cost will also increase with the increase in the price of supplies by the supplier.
Similarly, the production process highly dependent on the supplies supplied by the supplier. The production process will suffer if there is a scarcity of supplies.
Income is the total earning of an individual or an entire family. Income affects the buying habits of the consumers and thus impacts the commercial businesses.
There is a direct relationship between the buying habits of an individual and his income. For example, people with low income tend to buy only goods and services which are necessary for living and don’t spend much money on entertainment and luxurious items.
For example, a person with low income will prefer to spend money to pay the tuition fee for his children’s education rather than buying an expensive car. On the other hand, people with high income have a tendency to spend more money on entertainment and luxurious services and goods.
They tend to spend low money on necessary goods for a living, such as basic food items like wheat grain, rice, etc. They seek for expensive good quality and branded goods. They go out in restaurants to dine in.
Therefore, it is right to say that the high income of people is good for commercial businesses and low income of the population is cause loss to commercial businesses.
6) Inflation rate
The inflation rate can be defined as the rate at which the process of goods and services increases. With increased prices, the buying ability of people gets affected.
People start buying less, and they spend their money on the necessary goods and services only. Inflation rate put bad impact on services businesses.
For example, people decrease going out for eating and travel less. Inflation rate impacts the commercial business, which deals in leisure services and sells branded goods. Therefore, inflation is undesirable by both consumers as well as businesses.
7) Increasing Interest Rates
Increasing interest rates also impact the businesses, especially those businesses where people require to take a loan to buy goods. For example, people mostly buy houses and cars on loans. Therefore, the sales of such goods decrease with the increased rate of the interest rate.
Because of this reason, many banks advertise their loans services at lower rates than other banks in order to attract customers, because people always prefer to get a loan at a lower rate of interest.
8) Unemployment level
Another factor which impacts the economic environment is the unemployment level. The countries with high unemployment level have a weaker economic environment.
If most of the population will not earn, then they will not have sufficient money to spend on buying goods and services. This creates a bad economic cycle in the country.
For example, if people will not buy, then, companies will not hire people in order to cut costs, and if companies do not provide employment, the unemployment level will increase.
Therefore, it is one of the most important concerns of government to create jobs in the country in order to lower the unemployment level in the country so that the economic growth of the country can be saved.
High taxes in the country impacts the economic environment badly. People will have low disposable income. Taxes not only affect the consumers, but it also affects businesses as high taxes results in the high cost of production.
Therefore, businesses become bound to increase the cost of products that they sell. As a result of which, people start buying less, and thus, the economic environment gets impacted.
Tariffs are a type of taxes which is imposed on imported goods. Tariffs put an opposite impact on the sales of goods than taxes. People will import more goods from foreign countries if there are low tariff rates, and the local markets will be flooded with cheap foreign products and will impact the sells of local products.
Therefore, high tariff rates are preferable, as a result of which there will be less import of foreign products and people will buy more local products.
This will not only help the commercial businesses but also the economy of the country as the money will remain in the country. High tariff rates also motivate entrepreneurs to set up new businesses and to sell products which are only available in the foreign market and not available in the country.
Therefore, we can say that high tariff rates are good for the economic environment.
11) Cost of Labor
Cost of labor also impacts the economic environment of the business. High labor cost means the high cost of production and high cost of production forces businesses to increase the price of the products.
People will buy a smaller number of goods if the price of the goods is high and they will look for cheap alternatives for expensive products. Reduce sales will impact the business negatively.
The population has both positive and negative impact on the economic environment. For example, high population means there are chances of finding skilled employees.
High population results in tough competition and people get ready to even at low wages which is good for the business as they can hire more people to increase their production.
However, high population causes many other issues in the country. for example, unemployment, poverty, immorality, lower per capita income. The income and lifestyle of people reduce and thus, there buying capacity, which impacts the economic environment.
On the other hand, underpopulation is also not good, as there will be a smaller number of consumers in the market and lower chances of getting skilled and unskilled employees. Therefore, it is important to keep a balanced population in the country.
Innovation has both positive and negative impact of the economic environment. Innovation pose risk for already established businesses. As entrepreneurs come with innovative ideas of business and they give competition to the already established businesses, which impacts the sales of their products.
However, if companies look ahead and invest in research and development and can develop innovative ideas to improve their products to fulfill the current requirement of customers, innovation also helps in to reduce the production cost.
For example, with the introduction of automation, most of the work of production, which is performed by labor can now be performed by machines. This helps in lowering the labor wage expenses.
14) International Condition
The international market condition also impacts the economic environment. For example, there are many businesses which import and export goods from international companies.
The tension between two countries or the increased tariff rates increases the import cost as a result of which the cost of production also increases. Increased production cost means increases in the prices of products.
When prices of products increase, people tend to buy less, and the sales of the product get impacted. For example, the price of vegetables in Pakistan increased when the export of vegetables was closed by India Amidst of tension between both countries.
15) Capital Market
Money and capital market impact the economic environment. When the capital market is not good, natural, and, human resources can be used efficiently.
However, a healthy capital market results in lower dependence on foreign currency. The nation becomes self-sufficient, and areas like agriculture, banking, trade, etc. develop.
16) Economic Laws
There are various economic laws such as labor laws, competition laws, factory act, commercial act; industrial laws impact the economic environment. Companies are required to set up their business by being bound by the law, and violation of any law can result in a penalty or the cancellation of business license.
In addition to this, the government can introduce a new law which forces companies to change their method of doing business which puts a bad impact on the business.
17) Social Cultural environment
Social and cultural environment put a great impact on the economic environment of business. The buying habits and choices of people are highly influenced by the culture they are born in or the society that they are part of.
For example, in the southern states of India, women prefer to wear traditional sarees, whereas western women prefer to buy western clothes. Even the social-cultural environment impacts the way products are produced.
For example, A well-known American subsidiary company of PepsiCo, Frito Lays sells products like lays, Fritos, Doritos, etc., and you find the difference in the flavor of their products from one country to another.
In India, they sell spice products, whereas, in America, the flavor of products are less spice and is according to the taste of people living in that particular region.
18) Government Policies
Government policies also put an impact on the economic environment. Companies might be required to change the production process of a product according to the change in government policies.
For example, companies required to stop the production of certain drugs after they were banned by the government.
19) Technological environment
Technological environment put a huge impact on the economic environment. Technology changes rapidly, and organizations are required to change their technology or update their technology to keep up with the changing technological environment.
This requires them to update their machinery and hire new employees with new skills or to train existing employees to use new technology. This impacts the production process of the organization and increases the expenses as a result of which the cost of production increases and sales of a product decreases.
20) Natural Resources
Natural resources play an important role in the business environment.
Many business activities are reliable on natural resources. For example, fuel, water, mineral resources, soil, vegetation, rainfall, topography, etc. are the basic natural resources which are used frequently in the production process.
For example, the vegetation of vegetables and fruits is the main elements which are used in restaurants. The increase in the price of vegetables and fruits will reduce the profit margin of restaurants. Similarly, with the increase in the price of fuel, the cost of transportation will also increase.