UNIT 1 INTRODUCTION TO BUSINESS AND ENVIRONMENT

Objectives
After reading this unit you should be able to:
• define what you mean by environment;
• explain the concept of business environment;
• describe the scope of business environment; and
• understand the basic concepts of macroeconomics.

Structure
1.1 Introduction
1.2 Business and Environment
1.3 Basic Propositions
1.4 Nature and Scope of Business Environment
1.5 Types of Business Environment
1.6 Importance of Business Environment
1.7 Environmental Analysis
1.8 Basics of Macroeconomics
1.9 Summary
1.10 Key Words
1.11 Self-Assessment Questions
1.12 References/ Further Readings

1.1 INTRODUCTION

You may have a variety of reasons for studying this course, but the main reason, we presume,
is to become a successful manager. Your success or failure as a manager depends on a
number of factors and these factors may not always be within your control; very often such
factors constitute your work environment. These include your job, your department, your
organisation, your nation and the world around you. After all, as a manager you do not
function in a vacuum. You exist and operate within and not without, an environment.
Therefore as a manager when you think, or take decisions, you cannot neglect the limitations
of your environment. Just think for a while and then answer. Don’t you arrive at decisions

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after examining the possible reactions from the environment in which you are placed ? Say,
as a marketing manager, would you not study your market environment before launching a
new product ? Or, as a finance manager, wouldn’t you study how the capital and money
markets of the country are structured and organised before deciding on the sources and uses
of your funds ? Or, as a personnel managers wouldn’t you care to find the rules and
regulations laid down by the government on subjects like reservation before undertaking
recruitment and selection of your required staff? When you have answered these questions,
you will discover that all your answers are in the affirmative : “Yes, I would”. You can’t do
without thinking about your environment. As a business manager, you have to constantly
evaluate your business environment.

This opening unit aims to set you thinking about three ideas. It aims to help you to: precisely
define “environment”, classify your business environment on the basis of some criteria;
identify some of the critical elements of environment of business;;and establish the nature of
interaction between environment and business.

In pursuing these aims and objectives, our focus will primarily be on the Indian environment
of business. We shall try to identify, describe and analyse the Indian situation to understand
its impact on our business. Our ultimate purpose is to train our business mangers to face the
macro-level environment of business. As managers, wherever you are be it in the public or
the private sector, you have to remain alive and alert to your environment so that you are
successful in your day-to-day business operations.

1.2 BUSINESS AND ENVIRONMENT

The term “environment” refers to the totality of all the factors which are external to and
beyond the control of individual business enterprises and their managements. Environment
furnishes the macro-context, the business firm is the micro-unit. The environmental factors
are essentially the “givens” within which firms and their managements must operate. For
example, the value system of society, the rules and regulations laid down by the Government,
the monetary policies of the central bank, the institutional set up of the country, the
ideological beliefs of the leaders, the attitude towards foreign capital and enterprise, etc., all
constitute the environment system within which a business firm operates. These
environmental factors are many in numbers and various in form. Some of these factors are

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totally static, some are relatively static and some are very dynamic – they are changing every
now and then. Some of these factors can be conceptualized and quantified, while other can be
only referred to in qualitative terms. Thus, the environment of business is an extremely
complex phenomenon.

The environmental factors generally vary from country to country. The environment that is
typical of India may not be found another countries like the USA the (former) USSR, the UK,
and Japan. Similarly, the American/Soviet/British/Japanese environments may not be found
in India. There may be some factors in common, but the order and intensity of the
environmental factors do differ between nations. What to say of countries, the magnitude and
direction of environmental factors differ over regions within a country, and over localities
within a region. Thus, one may talk of local, regional, national (domestic) and
international (foreign) environment of business. For example, the local custom of “coolie”
labour, the climate of the northern region of Assam, the policies of the State and Central
Governments in India and the size of the world market : all these factors together will have
an important bearing on tea industry. The production, consumption and marketing of tea will
be affected by environmental factors.

The environment differs not only over space but also over time within a country. As such,
we can talk of temporal patterns of environment, i.e., past, present and future environment.
Future environment is the product of past and present environments. The Indian economy of
tomorrow will be influenced by what the state of the economy is at present and what it was in
the past.

Sometimes the environment may be classified into market environment and non-market
environment depending upon whether a business firm’s environment is influenced by market
forces like demand, supply, number of other firms and the resulting price competition, or
non-price competition, etc., or by non-market forces like Government laws, social traditions,
etc.

Finally, we may classify the environment into economic and non-economic. Non- economic
environment refers to social, political, legal educational and cultural factors that affect
business operations. Economic environment, on the other hand, is given shape and form by
factors like the fiscal policy, the monetary policy, the industrial policy resolution, physical
limits on output, the price and income trends, the nature of the economic system at
work, the tempo of economic envelopment, the national economic plan, etc. The non-

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economic environment has economic implications just the economic environment may have
non-economic implications. Since the environment is the sum total of the history, geography,
culture, sociology, politics and economic of a national, the interaction between economic and
non-economic forces is bound to take place.

Definition of Business Environment

The word ‘Business Environment’ is defined by many authors in different ways. Few of the
definitions are as follows:

According to Keith Davis, “Business environment is the aggregate of all conditions, events
and influences that surround and affect it”.
According to Reinecke and Schoell, “the environment of a business consists of all those
external things to which it is exposed and by which it may be influenced directly or
indirectly”.
According to Barry M. Richman and Melvgn Copen “Environment consists of factors that
are largely if not totally, external and beyond the control of individual industrial enterprises
and their management. These are essentially the ‘givers’ within which firms and their
management must operate in a specific country and they vary, often greatly, from country to
country”.
According to William F. Glueck “Business environment is the process by which strategists
monitor the economic, governmental, market, supplier, technological, geographic, and
social settings to determine opportunities and threats to their firms”.

All these definitions give a better understanding of the business environment. It can be
concluded that a business environment is a combination of dynamic, complex, and
uncontrollable external factors within which a business is to be operated. It is pertinent to
scan all these forces. Hence, it is crucial to have a thorough understanding of the basic idea
of the business environment and the nature of its different components. This interrelation
assists the business organisation to reinforce its capabilities and efficiently allocate its
resources.

Business organisations interact and transact with the business environment. Therefore
business organisation and business environment are directly related. Business environment
influence the scope and direction of business activity.

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Business can be seen as a specific activity e.g. a retail business in which a company is
making use of the internet and social media for marketing of their products. For example,
Flipkart is a specific form of business and is a private limited company. Business can also be
seen as a broad activity like a business system as a whole where we may refer it as a market
system or capitalism in which a whole range of activities including professional bodies, trade
unions, consumer groups, regulatory agencies and government bodies are included.

The environment may be classified into market environment and non-market environment
depending upon whether a business firm’s environment is influenced by market forces like
demand, supply, number of other firms and the resulting price competition, or non-price
competition, etc., or by non-market forces like Government laws, social traditions, etc.

In early 2015, Nestle’s famous product Maggi Noodles faced a setback in India when food
inspectors claimed to have found it unsafe, as the amount of lead was more than its
permissible limits. But Nestle tried its best to keep consumer trust by continuously interacting
with them on social media platforms and ensuring that Maggi is safe and they are cooperating
with the authorities. Later Maggi was temporarily banned in India and Nestle was asked by
the Food Safety and Standards Authority of India (FSSAI) to recall its Noodles products from
the market and destroy them. It hugely impacted their revenues and profits as Maggi was one
of the most popular products in India.

In the second half of 2015, fresh batch of Maggi was tested and it was allowed to sell again.
But lead controversy adversely affected the trust of consumers and it took lots of promotional
strategies to regain the lost revenue. It launched emotional campaign # Wemissyoutoo on all
social media platforms to revive the bond between consumers and Maggi brand. It took them
sometime to revive from the losses and gain pre ban market share.

Activity 1
If you wish to set up an enterprise you must have a clear understanding of business
environment. Identify an enterprise and study whether the business environment is
conducive.
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1.3 BASIC PROPOSITIONS

As a prelude to the description and analysis of the business environment in any economy, you
may examine the three basic propositions given below:
1. Business is an economic activity.
2. A business firm is an economic unit.
3. Business decision-making is an economic process.
These propositions may be examined separately or jointly to justify the study of the
environment of business in any country.
Business is an economic activity
An economic activity involves the task of adjusting the means (resources) to the ends
(targets), or the ends to the means. An economic activity may assume different forms such as
consumption, production, distribution, and exchange. The nature of business differs
depending upon the form of economic activity being undertaken and organised. For
example, manufacture is primarily concerned with production; the stock exchange. For
example, manufacture is primarily concerned with production; the stock exchange business
of Government is to run the administration. The Government may also own, control and
mange public enterprises. The business of banks is to facilitate transactions with short-term
and long-term ends. These examples can be easily multiplied. The point to be noted is that
each business has a target to achieve, and for this purpose each business has some
resources at its disposal. Sometimes the target has to be matched with the given resources,
and sometimes the resources have to be matched with the given target, Either way, the task of
business is to optimize the outcome of economic activities.

A business firm is an economic unit

A business firm is essentially a transformation unit. It transforms input into outputs of goods
or services, or a combination of both. The nature of input requirements and the type of
output flows are determined by the size, structure, location and efficiency of the business
firm under consideration. Business firms may be of different sizes and forms. They may

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undertake different types of activities such as mining, manufacture, farming, trading,
transport, banking etc. The motivational objective underlying all these activities is the same
viz., profit maximization in the long run. Profit is essentially “a surplus value”- the value of
outputs in excess of the values of inputs or the surplus of revenue over the cost. A business
firm undertakes the transformational process to generate this “surplus value”. The firm can
grow further if the surplus value is productively invested. The firm, therefore, carefully plans
the optimum allocation of resources (i.e., men, money, material, machines, time, energy, etc.)
to get optimum production. The entire process of creating, mobilisation and utilisation of the
surplus constitutes the economic activity of the business firm.

Business decision-making is an economic process

Decision-making involves making a choice from a set of alternative courses of action. Choice
is at the root of all economic activity. The question of choice and evaluation arises because
of the relative scarcity of resources. If the resources had not been scarce, an unlimited
amount of ends could have been met. But the situation of resources constraint is very real. A
business firm thinks seriously about the optimum allocation of resources because resources
are limited in supply and most resources have alternative uses. The firm, therefore, intends to
get the best out of given resources or to minimise the use of resources for achieving a specific
target. In other words, when “input” is the constraining factor, the firm’s decision variable is
the “output”. And when “output” is the constraining factor, the firm’s decision variable is the
“input”. Whatever may be the decision variable, procurement or production, distribution or
sale, input or output, decision-making is invariably the process of selecting the best available
alternative. That is what makes it an economic pursuit.

1.4 NATURE AND SCOPE OF BUSINESS ENVIRONMENT

Every organisation operates in a certain kind of environment. Each organisation has some
opportunities and threats associated with various forces which may be external or internal in
nature.

Nature of Business Environment

1. Dynamic: Business environments such as internal and external business
environments are highly flexible and keep on changing. For example, changing
customer preferences, new competitors entering into the market, novel

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 technology, new marketing channels, new government policies and changing
demography.
2. Uncertain: It is very difficult to pre assume with any degree of certainty about
the factors influencing the business environment because they continue to
fluctuate very quickly.
3. Complex: The business environment is complex as it is continuously exposed to
uncertain challenges such as technological disruptions, global competition,
leadership change, shifting economic, social, and regulatory conditions etc. It
may be easy to scan the environment but its impact on business decisions will be
difficult to estimate. It is very difficult for a firm to survive and prosper in such
an uncertain environment.
4. Relativity: The business environment is associated with societal norms and local
conditions and this is the reason, why the business environment varies from
country to country, region to region which makes it more complex.
5. Interrelation: All the factors and forces of the business environment are related
to each other. For instance, with the proclivity of youth towards western culture,
the demand for fastfood is also rising. Take another example, change in political
parties will result in changing monetary policy, fiscal policies, government rules,
market conditions, technology, etc. Thus, all these factors are required to be
scanned properly as these factors are interrelated to each other.

Scope of Business Environment

a) Internal and external environment: Internal environment means those factors that
are within an organisation and influence the strength or weakness of the business. For
example, superior raw material, inefficient human resources, etc. External
environment means those factors which are beyond the control of the business and are
outside the organisation. They provide opportunities and pose threats to business. For
example, changing political and economic conditions, technological changes, etc.
b) Micro-environment and macro-environment: Sometimes internal and external
environment are interchangeably reffered as micro and macro environment
respectively. Micro-environment affects the working of a particular business. It
directly impacts business activities and incorporates customers, suppliers, market
intermediaries, competitors, etc. These factors are controllable to some extent. Macro-

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 environment is the general environment that impacts the working of all businesses. It
is uncontrollable and influences indirectly. Political conditions, economy, technology,
etc., are part of the macro environment. For example, Technological advancement
such as blockchain, Artificial Intelligence (AI) have changed the face of business
operations.
c) Controllable and uncontrollable environment: All those factors which are
governed by business come under a controllable environment. Internal factors are also
treated as controllable factors, such as money, men, materials, machines, etc.
Uncontrollable factors are external and are beyond the control of business namely
global, technological, legal and natural changes. For example, recent Corona
pandemic is a major example of uncontrollable factor. The pandemic has hugely
impacted the businesses and led to changes in strategies of operations.
d) Specific and general environment: Specific environment refers to external forces
that directly influence business enterprises’ decisions and actions and are directly
pertinent for the achievement of organisational goals. The main forces that include the
specific environment are customers, suppliers, competitors and pressure groups.
General environment refers to the economic, politico-legal, socio-cultural,
technological, demographic, and global conditions that influence organisations. These
external forces or factors impact organisations indirectly and organisations must plan,
organise, lead and control their activities by incorporating these factors.

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 1.5 TYPES OF BUSINESS ENVIRONMENT

There are certain factors or forces internal and external to the organisation influencing the
it in both positive and negative ways. These different components of the business
environment have been explained below as shown in Figure 1. 1.

Business
Environment

External Internal
Environment Environment

Micro Macro ‐ Value System

Environment Environment ‐ Mission and
Objectives
‐ Organisation
‐ Suppliers of ‐ Economic Structure
Inputs ‐ Politico‐ legal ‐ Corporate Culture
‐ Customers ‐ Technological ‐ Human Resources
‐ Marketing ‐ Global or ‐ Physical Resouces
Intermediaries International and Financial
‐ Competitors ‐ Socio‐cultural Capabilities
‐ Public ‐ Demographic
‐ Natural

Figure 1.1: Components of Business Environment

1. Internal Environment
This includes those factors or forces that exist within an organisation influencing the
performance of an organisation. These factors are controllable in nature and
organisations can attempt to change or modify these factors. Organisation’s resources
like men, materials, money, and machines are part of the internal environment. The
different internal factors are given below:

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 i. Values: The values are defined as ethical beliefs that guide the organisation in

attaining its mission and objectives. These are formulated by top-level managers
such as the board of directors. The extent to which these value systems are shared
by all in the organisation is a significant factor leading to its success.
ii. Mission and objectives: Mission reflects the overall purpose or reason for

organisation’s existence. A mission guides and affects the decisions and economic
activities of the organisation. Accordingly, an organisation can change or modify
its mission and objectives.
iii. Organisation structure: The organisational structure is the hierarchical
relationship explaining roles, responsibilities and supervision. The structure of the
board of directors, the professionalism of management, etc., are the part of the
organisation structure and are significant forces affecting business decisions. For
effective management and working of a business organisation and for prompt
decision making, the structure of the organisation should be conducive.
iv. Culture: Shared values and belief in an organisation determine its internal

environment also known as corporate culture. Organisation having strict

supervision and control reflects the lack of flexibility and unsatisfied employees.
These sets of values assist the employees to understand what organisation stands
for, what it considers, how it works. Cultural values of business, thus determine
the direction of activities.
v. Human resources: Human quality of a firm is an important factor of internal

environment. Skills, qualities, capabilities, attitude, competencies and commitment

of its employees, etc., contribute to the strengths and weaknesses of an
organisation. Organisations may find it difficult to carry out modernisation and
redesigning because of resistance by its employees.
vi. Physical resources and financial capabilities: Physical resources, like
machinery, plant and equipment facilities and financial capabilities of a firm
decides its competitive strength which is the significant factor for examining its
efficiency and unit cost of production. Moreover, research and development
capabilities of a company decides its ability to innovate and thus increase the
productivity of workers.

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2. External Environment
This includes those factors or forces that exist outside an organisation influencing the
performance of an organisation. These external factors can be further classified into
micro-environment and macro environment which are defined below.

A. Micro-Environment: Those factors which have a direct impact on business. The

different components under micro-environment are as follows:
i. Suppliers of inputs: The suppliers of inputs are a significant constituent of the
external micro environment of an organisation. Suppliers give raw materials and
resources to the firm. A firm should have more than one supplier for efficient
input inflows.
ii. Customers: Customers are the buyers of the firm's products and services.
Customers are an important part of the external micro-environment as a firm’s
survival and growth are dependent on sales of a product or service. Thus, it is
essential to keep the customers satisfied.
iii. Marketing intermediaries: Intermediaries play an essential role in selling and
distributing products to the final customers. Marketing intermediaries are an
important link between a business firm and its ultimate customers. Retailers and
wholesalers buy in bulk and sell business products and services to the ultimate
consumer.
iv. Competitors: Competitors are the rivalry in business influencing the business
strategies of the organisation. For example, Zomato and Swiggy are major
competitors in food delivery business and their strategies impact each other.
v. Public: Public or groups, such as media groups, women’s associations,
environmentalists, consumer protection groups, are significant factors in the
external micro-environment. The public can be defined as any group affecting a
company's ability to achieve its objectives. Recently People for the Ethical
Treatment of Animals (PETA) India protested against Amul (dairy company)
suggested them to produce vegan milk.

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B. Macro Environment: These are the factors or conditions which are general to all
businesses and are uncontrollable. Because of the uncontrollable nature of macro
forces, a firm needs to adjust or adapt itself to these external forces. These factors are
as follows:
i. Economic environment: Economic environment refers to all those forces and
factors which have an economic impact on businesses. It consists of the role of
the private and public sector, monetary and fiscal policy, role of saving and
investment, economic reforms, agriculture, industrial production, infrastructure,
planning, basic economic philosophy, stages of economic development, trade
cycles, national income, per capita income, money supply, international debt, etc.
For example, an increase in Groos Domestic Product (GDP) will increase
disposable income and thus further rise in demand for products.
ii. Politico-legal environment: Politico-legal environment constitutes all the factors
related to the activities of legislature, executive and judiciary which play a
leading role in shaping, directing, developing and controlling business activities.
For example, rules and regulations, framed by the government, like licensing
policy, Skill India movement, Digital India, Swachha Bharat Abhiyan, polythene
ban, etc., affect the business. Higher business growth can be achieved in a stable
and dynamic politico-legal environment.
iii. Technological environment: Technology is defined as the “Systematic
application of scientific or other organised knowledge to particular tasks”. The
technology incorporates both machines (hard technology) and ways of thinking
(soft technology). These organized knowledge and innovation provide new
methods of producing goods and services and latest ways of operating business.
Recent technological changes such as the online sale of grocery items, online
booking of air tickets, online payments, etc. have changed the business strategies.
As technology is changing fast, organisations should keep a close look at these
technological fluctuations for their adaptation in their business activities.
iv. Global or international environment: The global environment includes all
environmental factors having a global impact which is also important for shaping
business activity. In the era of globalisation, the whole world is a market.
Business analyses the international environment to cope up with the changes.

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 Principles and agreements of the World Trade Organisation (WTO), other
international treaties and protocols such as crude oil prices are examples of the
global environment.
v. Socio-cultural environment: The socio-cultural environment reflects customs
and values which influence business practices. People’s attitude towards work
and wealth, lifestyle, ethical issues, religion, the role of family, marriage,
education and also social responsiveness of business impact the business. For
example, foreign brands like McDonalds were sensitive to Indian culture and
avoided selling beef burgers in India.
vi. Demographic environment: Demographic environment includes the
composition and characteristics of the population. For example, Population size
and growth, the life expectancy of the people, rural-urban distribution of
population, the technological skills and educational levels of the labour force are
part of the demographic environment. These forces also impact the organisations’
functioning. For example, many MNCs are targeting Indian youth because of the
country’s demographic dividend.
vii. Natural environment: Natural environment includes geographical and
ecological resources like minerals and oil reserves, weather and climatic
conditions, water and forest resources, and port facilities. These are very
important for many business activities. For example, in places where climate
conditions such as temperatures are high, demand for coolers and air conditioners
will also be high. Similarly, demand for clothes and building materials is also
conditioned upon weather and climatic conditions. Natural calamities such as
floods, droughts, earthquakes, etc. greatly affect business activities.

1.6 IMPORTANCE OF BUSINESS ENVIRONMENT

Business environment plays an important role in the functioning of organisations in the

following ways:
I. Enable the organisation to identify the business opportunities and achieving
first-mover advantage: Many opportunities are provided by the business
environment to the organisation. Scanning the business environment will help the
organisation to attain the first-mover advantage.

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 II. Help the firms to identify the threats and early warning signals: The business
Enterprises who can scan the business environment and obtain qualitative
information on time will be able to get a warning signal to deal with negative
policies and constraints of the business environment.
III. Help in tapping and assembling resources: Resources such as raw material,
capital, money, labour, etc., are the necessary inputs to the business organisation.
All these inputs are obtained through the environment to the firms for carrying out
their activities and also expect something in return.
IV. Help in adjusting and adapting to rapid changes: Business environment
scanning assists the firms to scan and understand the rapid changes in the
environment and these changes are having important implications on business
strategies.
V. Assist in planning and policymaking: The major strategic plans and policies in
the organisation are formulated based on the business environment because the
policies and strategies have to be implemented in the presence of these
environmental factors.
VI. Help in performance improvement: Continuous scanning of business
environments can improve their performance. By incorporating changes in the
internal environment matching to external environment, business organisations
can enhance and prosper their market share.

1.7 ENVIRONMENTAL ANALYSIS

We know that all organisations perform within a framework of specific factors of business
environment. These can be internal as well external. A proper environmental analysis of the
business environment is very important. There are different steps involved in the
environmental analysis of a business. These are:
1. Scanning the internal / external factors.
2. Grouping of the scanned factors.
3. Observation of internal factors.
4. Monitoring external factors.
5. Defining the variables for the analysis.
6. Identifying specific techniques for analysis.

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 7. Forecasting.
8. Strategy formulation.
9. Evaluation.
In this section we will discuss SWOT analysis to familiarize ourselves with environmental
analysis.

SWOT analysis
SWOT analysis is the business analysis process of examining both the internal and external
environment of an organisation. Here, S, represents Strengths and W, represents Weaknesses.
Both these terms are internal constituents of an organisation. While O, represents available
Opportunities in the market and T, represents the possible Threats in the market. Both of
these are the external constituents of the organisation (Figure 1.2).

Environmental

Internal External Analysis

Analysis
-Opportunities
-Strengths
-Threats
-Weaknesses

Figure 1.2: SWOT analysis Framework

a. Strengths: It reflects the core competencies or capabilities of an organisation for

which it can achieve strategic advantages over its competitors. Even if the
organisation does not gain any advantages over its competitors, it indicates an
organisation’s capacities in which the organisation is having affirmative aspects. For
example, mobile payment platform PhonePe has the strength of easy user interface.
b. Weaknesses: Weaknesses means those factors which prevent successful results
within the organisations. These are exact opposites of Strengths. Strengths indicate

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 competitive advantages while weaknesses indicate the competitive disadvantages of
an organisation.
c. Opportunities: These are favourable circumstances present in the external
environment, which should be grabbed by the organisation, to enhance its strengths to
gain competitive advantage. An organisation strategist must be aware of the upcoming
opportunity in the market so that it could grab them on time and could raise revenues
and profits.
d. Threats: The term ‘threat’ reflects exposing vulnerability to something which leads
to adverse impact. In an external environment, if sudden or even gradual changes
occur which are not in favour of the organisation, then these represent threats to the
organisation.

The SWOT analysis is a tool to evaluate the strengths, weaknesses, opportunities and
threats of an organisation. Every organisation should do SWOT analysis very effectively
to explore both internal and external factors of an organisation and accordingly business
strategy should be formulated.

Activity 2
1. Explain the need for environmental analysis. How can it enchance organisational
effectiveness?
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2. Select any company of your choice and explain the SWOT analysis of that company.
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1.8 BASICS OF MACRO ECONOMICS

Since business is an economic activity, a business firm an economic unit, and business
decision-making an economic process, it is the economic environment of business which is
the primary consideration in evaluating the business policies, business strategies and business
tactics of a corporate entity in any national economy.

Economic transactions are the lifeline of the business and in the preceding sections, you have
learnt how the business environment is influenced by the economic policies and economic
structure prevailing in the country. So, students of the business environment must have some
understanding of the working of an economy, what are different sectors of the economy, how
they interact with one another, how monetary and fiscal policies influence the economy and
so on. In the following sections, we shall study about basics of macroeconomics.

Macroeconomics is primarily the study of the behaviour and performance of the economy as
a whole. The macroeconomic theories make use of macroeconomic models to explain and
establish the relationship among different macroeconomic variables. Income determination,
price level determination, investment, employment, product and money market equilibrium,
exchange rate, the balance of payments, etc. are the main areas of macroeconomic theories.
Macroeconomics also analyses the working and effects of major government policies like
monetary and fiscal policies, on the economy.

According to J.M.Culburtson
‘Macroeconomic theory is the theory of income, employment, price, and money’
According to Paul Samuelson
‘Macroeconomics is the study of the behaviour of the economy as a whole. It examines
the overall level of a nation’s output, employment, prices, and foreign trade’

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 Interaction of Business and Macroeconomics

You must be wondering that we are students of Management then why should we worry
about economics and especially macroeconomics. What is the relationship between the
two? On the contrary, the understanding of macroeconomics, in particular, is of immense
importance for the students of Management. Let us understand this interaction with the
help of an example. Inflation is one of the prominent problems of macroeconomics.
Inflation refers to the situation in which prices of goods and services rises continuously
over a period of time. Inflation can affect both the consumer and producer depending
upon the cause of inflation whether it is demand-pull or cost-push. If it is demand-pull or
due to an increase in demand in relation to supply, then consumers are at a disadvantage.
Cost-push or increase in the cost of production (for example increase in input cost) affects
the supplier or producer. To alleviate the problem, the central bank of the country takes
the help of the Monetary Policy. One of the instruments of the monetary policy is
increasing the repo rates i.e. repo and reverse repo rate. This increase in repo rates leads
to both increases in the cost of borrowing for business and a shortage of money supply in
the system. These both affect the scale of production. So, producers and enterprises keep
a close eye on every move of the government concerning any change in monetary policy
and other policies.

Some Important Concepts of Macroeconomics

Let us understand some of the major concepts used in macroeconomics.

Net National Product (NNP) at Factor Cost (NNPFC) is commonly known as National
Income. The Gross National Product (GNP) or NNP can also be evaluated at factor cost. The
basic cause of difference between the two concepts is that NNP arises because some of the
allocations of market value do not go into the payments to the factors of production.

Gross Domestic Product (GDP)

GDP is defined “as the value of final goods and services produced within the borders of a
country during a fiscal year”. It also includes income earned locally by foreigners and
excludes income received by the nationals from abroad.
GDP is calculated at two prices- market prices (i.e.current prices) and constant prices.

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GDP at Market Price (GDPMP): GDP at market price is the total value of final goods and
services produced within a year at current prices.
GDP at Constant Prices: GDP at constant prices estimates GDP in reference to some base
period.
For example, if we estimate GDP for 2020-21, then it will give us GDPMPfor the fiscal year
2020-21. If we estimate GDP with reference to some base year say 2004-05, then it is GDP at
constant prices or real GDP. The distinction between current and constant prices is important
as GDP at current prices could grow very rapidly if prices are rising. This increase will not
tell anything about the volume of production whether the total output is increasing or not. On
the other hand, growth in GDP at constant prices indicates a rise in the total
production/output of the country.

To obtain GDP at a constant price, GDP at market price is divided by GDP deflator and
multiplied by 100. GDP at constant prices is called real GDP. While calculating GDP at a
constant price, the base period is always mentioned.
• Aggregate Demand and Aggregate Supply
I. Aggregate Demand (AD):Aggregate Demand is one of the most important concepts
in macroeconomics. In simple words, it means total demand for consumer and capital
goods at a given price.

C= Consumption; I = Investment; G = Government Expenditure; X = Exports; and M

= Imports
This equation encapsulates the gist of Aggregate Demand. In the two-sector model,
there is an absence of G and (X-M) so the above equation becomes AD= C+I and
investment is assumed to be constant. Ultimately aggregate demand function is
largely dependent upon consumption expenditure or consumption function.
II. Aggregate Supply (AS): The Aggregate Supply (AS) shows the amount of output
firms plan to supply at different levels of prices or the total supply of goods and
services in an economy. Since firms like to sell more output with increasing product
prices, the AS has an upward sloping supply curve. The intersection of AD and AS
determines the short-run equilibrium in the economy.

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• Multiplier or Investment Multiplier

Investment multiplier is of much importance in macroeconomics. It is a ratio of

change in income/national income to change in investment.

m = investment multiplier; ΔY = change in national income ; ΔI = change in

investment. Multiplier indicates that with one unit change in Investment how much
national income will change. So, it indicates the level of investment required to
achieve the desired level of national income. For example, if the value of m=2 and
investment is increased by Rs 100 crore then with this increase in investment level the
national income will increase by Rs 200 crore.

The Four Macroeconomic Sectors

Macroeconomics has primarily four sectors and the interplay and the interaction of
these sectors give momentum to the economy.
1. Household Sector
This sector covers all the individuals in the economy. The major function of this
sector is to supply the factors of production to the different sectors. There are four
factors of production i.e. land, labour, capital, and entrepreneur. The household sector
is the ultimate consumer who consumes the goods and services that are manufactured
by the firms and in return makes payments to the firms. This sector also provides the
savings and supply finance to the firms.

2. Firms
This sector comprises all the businesses, firms, and corporations. The major function
of this sector is to manufacture goods and supply services for sale in the economy.
They hire the factors of production and pay them factor payments namely rent, wages,
interest, and profits.

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 3. Government Sector
This sector involves the centre, state, and local governments of a country. The major
function of this sector is the management and regulation of the economy. It is mostly
done by its monetary and fiscal policy. Monetary policy is related to the regulation of
the money supply in the economy. Fiscal policy is related to taxes, public
expenditure, and public debt. Tax and non-tax sources are the major sources of
revenue and revenue collected is spent on public health, services, infrastructure, etc.

4. The Foreign Sector

This sector takes into account all the economic transactions with the rest of the world.
The foreign sector primarily consists of export and imports of goods and services.
When we sell domestically produced goods and services to other economies, these are
called exports. Imports are items that the domestic country purchases from the outside
world. Net Exports are exports minus imports.

• The Three Markets

There are three major markets in an economy. These are 1) goods market, 2) factor
market, and 3) financial market or money market.

1) Goods Market
In this market, goods and services are exchanged among the different sectors. The
goods and services produced by the firms/industry are consumed by households, the
government, and the external sector.

2) Factor Market
The factors of production are traded in this market. The factor services are demanded
by the firms for the production of goods and services and these factors are paid in the
form of rent, wages and profits. For example, labour is a factor of production and is
owned by the household sector i.e. the workers. Workers offer their services and they
are hired by firms, the government, and the foreign sector. In return for labour
services, workers receive wages. This equilibrium of demand for labour and supply of
labour is part of the factor market. Similar is the case for other factors of production.

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 3) Money Market
In this market, equilibrium is attained between demand for and supply of money.
Primarily money is provided in the form of savings by the household sector and is
channelized by financial institutions like banks. Firms borrow from these financial
institutions and equilibrium is attained in the money market. The government
regulates the money market by its monetary policy.

• Circular Flow of Income and Expenditure

The economic system can be viewed as the continuous flow of income and
expenditure. It is this flow that determines the size of the national income and the
overall worth of the economy. One of the major objectives of macroeconomics is
income determination, so it is important to understand the circular flow of income and
expenditure. This flow can be understood with the interaction of two sectors, three
sectors, and four sectors.

I. Two Sector Flow

In the two-sector flow, we have two sectors namely households and firms. we have
discussed the main characteristics of both these sectors in the previous paragraphs.
The two sector flow is depicted in Figure 1.3.

factors of production

Saving Investment
Households Firms
Banks

factor payments

Figure 1.3 : Two Sector Flow

Households supply factors of production viz land, labour, capital, and entrepreneurs to the
firms. Firms in return make factor payments rent, wages, interest, and profits to the
households. The flow from households to firms represents the real flow however the flow
from firms to households is money flow as all payments are made in monetary form. The
money flow from firms to households ultimately becomes the total income (Y) of the
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households. Similarly, there is a flow of goods and services from firms to households. In
return for goods and services, households make payments to the firms which is again money
flow. This continuous real and money flow gives momentum to the economy.

Financial intermediaries like banks channelise the savings from the households to the firms.
The firms take the loans from the banks and other financial institutions. The primary
ingredient of loan creation by banks is the savings from households. Households save their
savings in the banks and then banks lend to firms.

In this circular flows of income and expenditure, there are certain leakages /withdrawals and
injections/additions. For example, savings by the households represent leakages from the
system. Saving is that part of income that is not consumed. The amount of saving and the size
of the circular flow are inversely related. More the savings less will be the size of circular
flow and vice versa. On the other hand, additional spending by households from past savings
or borrowings acts as an injection or addition to the circular flow. More the spending, bigger
the size of circular flow.

II. Three-Sector Model

In the three-sector model apart from the above-mentioned model one more sector i.e.
government sector enters into the circular flow. This model is depicted in Figure 1.4.

Government

Firms
Households

Figure 1.4 : Three Sector Model

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Government affects the circular flow of income and expenditure through monetary and fiscal
policy. In our model, we will only consider the fiscal policy effect i.e. taxation and
government expenditure. Taxes both direct and indirect paid by both households and firms
act as a withdrawal from the flow just like savings. Taxes reduce the disposal income of both
households and firms which leads to a reduction in consumption and savings. On the other
hand, government expenditure is like injection to the circular flow. Government expenditure
gives more income into the hand of households that leads to an increase in consumption
expenditure. Similarly, purchases of goods and services by the government from firms
increase the income of the firms.Households also provide factors of production to the
government and in return receive factor payments.

III. Four-Sector Model

Let us now learn about the four-sector model of the economy. This model includes
households, firms, government, and the foreign sector.The four-sector economy has exports
as inflows/injections in the national income whereas the imports are treated as leakages/
outflows from national income.
Let us briefly discuss the export function and import function.

i) Export Function
The economic growth, economic development, and equitable distribution of income depend
upon the export levels of a country. Exports are needed for maintaining foreign exchange
reserves in an economy. Exports also play an important role in increasing the internal trade
and economic stability of a country. The exports of a country depend upon several factors.
Some are listed as follows:
a. The prices of domestic goods in comparison to prices of similar goods in
importing countries.
b. Trade-policy and tariff policies of importing country
c. Export subsidies
d. Income elasticity for import goods in importing countries
e. Level of imports by the domestic country
Thus, while computing national income, exports is taken as an autonomous
variable and represented by X.

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ii) Import Function
Imports represented by M, play an equally important role in the growth of an economy.
Imports help strengthen the global presence of a country. The imports of a country depend
upon the following factors:
a. Import prices in relation to domestic prices
b. Domestic tariffs
c. Domestic trade policy
d. Income elasticity of imports
e. Income levels
f. Export levels
When the value of exports is more than the value of imports (i.e. X > M) we call it trade
surplus. However, when the value of imports is more than the value of exports (i.e. M > X) it
is called a trade deficit and represents an unfavourable situation for any economy. The four
sector circular flow is shown in figure 1.5.

Figure 1.5: Four Sector Flow

Let us assume that Households only supply labour to the foreign sector and in return, they
receive foreign remittances (money sent by a person residing abroad to their families in a

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domestic country). Firms make payments for imports to the foreign sector and firms receive
exports receipts. The foreign sector provides different taxes and tariffs to the government and
the government in return formulates various schemes and policies which facilitates trade. If
the trade balance is positive (i.e,. X > M) then circular flow increases as it increases the
magnitudes of circular flows of income and expenditure.

Activity 3
1. Visit the website of the Ministry of Statistics and Programme Implementation and
find out the value of GDP at both current and constant prices for the last 5 years and
notice the change in both the series. Also, find out the change in the base year for the
calculation of GDP.
_____________________________________________________________________
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_____________________________________________________________________
_____________________________________________________________________
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_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
2. Read the Economic Survey of India for the year 2021-22 and make the list of
important exports and imports of India and also analyse the change which has taken
place in the composition of both exports and imports.
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_____________________________________________________________________
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_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________

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1.9 SUMMARY

The environment is a complex phenomenon. The term environment consists of several

subsets, e.g., economic environment, socio-cultural environment, politico-legal environment,
technological environment, etc. It thus represents the totality of all kinds of environments
which have an impact on business. To a large extent, the environment is external to the firm.
Business firms in general have little influence on external forces. Depending upon the nature
and composition of several subsets of the environments, the business environment varies
from country to country, and may even vary in the same country from one point of time to
another. A number of problems are involved in the identification, description, explanation
and prediction of environmental factors. The environmental factors are dynamic. It is
difficult to conceptualise and/or quantify the proportion of change as well as the direction of
change in environmental factors.

Since the environment and the economic institutional framework affect business
organisations, it is imperative on the part of the management to scan the environment before
taking any decisions. The success of any business enterprise in a large measure, would
depend upon the proper understanding of the business environment.

Macroeconomics studies concepts like national income, nationwide employment, aggregate

demand, aggregate supply etc. It deals with the aggregates of all quantities as opposed to
microeconomics which deals with individual quantities. There are four macroeconomic
sectors, viz the Household Sector, firm sector, government sector and foreign sector. The
concept of aggregate demand and aggregate supply is the total demand and total supply of the
entire economy. Further, the concept of investment multiplier is of much importance to
analyse the effect of investment on the national income.

1.10 KEY WORDS

Environment : The totality of all factors or forces affecting business and external to and
often beyond the control or influence of individual business enterprises. The
environment comprises several subsets, e.g., economic environment, socio-cultural
environment, politico-legal environment, technigological environment, etc.

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Internal Environment : Consists of factors existing within business organisations and which
are controllable.

External Environment: Refers to forces / factors outside an organisation and which are by
and large byond the control.

Economic Activity : Any activity undertaken with economic or financial motive or

consideration. In the business context, it is the task of adjusting the means/resources to the
needs/targets.

Decision-Making : Making a choice from a set of alternative courses of action.

Environmental Analysis: The process through which an organisation monitors and

comprehends various environmental forces in order to identify the opportunities and threats.

1.11 SELF-ASSESSMENT QUESTIONS

1. Explain the concept and nature of business environment.

2. Distinguish between micro environment and macro environment.
3. What are the various elements of internal environment of business?
4. Explain the process of environmental analysis.
5. How environmental analysis can enhance organisational effectiveness? Discuss in detail.

1.12 REFERENCES/ FURTHER READINGS

• N. Gregory Mankiw. Macroeconomics, Worth Publishers, 7th edition, 2010.

• Justine Paul, Business Environment: Text and Cases ; Tata McGraw – Hill
Publishing Company Ltd., New Delhi.
• Gupta C.B., Business Environment: Sultan Chand & Sons, New Delhi.

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