Module 5

Meaning of Business Environment

The term “Business environment” represents the sum of all the individuals,
institutions, competing organisations, government, courts, media, investors, and other
factors outside the power of the business organisations but affects the business
performance. Hence, changes in government economic policies, rapid changes in
technology, changes in consumer tastes and preferences, increasing market
competition, etc. are outside the business organisations' power but affect the business
performance immensely.
For example, an increase in taxes by the government makes everything expensive in
the market; technology changes may make the existing product obsolete, political
uncertainty creates fear in the mind of investors, increase in competition in the market
due to competitors may affect business profit, and changing in demand and
preferences may increase the need for a new product and decrease the demand for old
product.
External - An external Environment includes those outside factors that exercise an
influence on a business’s operations. It is further classified into two segments.
Macro - Socio-cultural, political, legal, and global factors fall into this
category.
Micro - This environment has a direct and immediate impact on a business. It
consists of customers, investors, suppliers, etc.

Nature and Scope of Business Environment: The business environment is a

mixture of various factors that affect the operation of a business. It comprises
internal and external factors that influence the functioning of a business.
Understanding the business environment is crucial for business leaders to
make informed decisions and stay ahead of the competition.
Nature of Business Environment:
1. Dynamic: The business environment is continuously changing due to
various internal and external factors. The change could be due to technological
advancements, changes in consumer behavior, government policies, or
economic conditions.
2. Complex: The business environment is complex and interdependent. The
factors that affect the business are not limited to one aspect, but various factors
such as political, legal, social, and economic factors.
 3. Uncertain: The business environment is uncertain, and businesses need to
be prepared for unexpected changes. The uncertainty could be due to changes
in government policies, market trends, or natural disasters.

4. Diverse: The business environment is diverse as it comprises various

internal and external factors that affect the business. Internal factors such as
employees, management, and organizational culture influence the business,
while external factors such as competitors, customers, and suppliers also have
a significant impact.

Dimensions of Business Environment (scope)

The dimension of the business environment refers to the sum of all factors, enterprises,
and forces that constitute direct or indirect influence over business activities. Such
five key elements are listed below.

Social Environment
It implies the tradition, culture, customs, and values of a society in which the
business exists.

Tradition: In India, festivals like Diwali, Christmas, and Holi provide a

financial opportunity for several market segments like sweet manufacturers,
gifting products suppliers, etc.
Value: A company that follows long-held values like social justice, freedom,
equal opportunities, gender equality, etc. excels in that given society.
Recurrent Trends: It refers to development or general changes in a society
like consumption habits, fitness awareness, literacy rate, etc. which influence a
business. For example, the demand for organic vegetables and gluten-free food
is increasing; therefore, companies that manufacture food items keep this in
mind to attract more crowds.

Legal Environment
It includes the laws, rules, regulations, and acts passed by the government. A
company has to operate by abiding by the rules and regulations of laws like
the Consumer Protection Act 1986, Companies Act 1956, etc. A proper
understanding of these laws assists in the smooth operations of a company.
Example: A cigarette-selling company compulsorily has to put the slogan
“smoking is injurious to health” on every packaging.

Economic Environment
It involves market conditions, consumer needs, interest rate, inflation rate,
economic policies, etc.

Interest Rate - For example, interest rates of fixed-income instruments

prevalent in an economic environment impact the interest rate it will offer on
its debentures.
Inflation Rate - A rise in the inflation rate leads to a price hike; hence, it
limits businesses.
 Customer’s Income - If the income of customers increases, the demand for
goods and services will rise too.
Economic Policies - Policies like corporate tax rate, export duty, and import
duty influence a business.
Political Environment
It consists of forces like the government's attitudes towards businesses, ease-
of-doing-business policies, the stability of the governing body, and peace
within the country. All of these factors are extremely crucial for a company to
sustain itself. If the central and local government sanctions, policies, or acts
are in favour of businesses, the nation's overall economy strengthens due to
increasing employment, productivity, and import and export of various
products.
Example - A pro-business government will make foreign investments more
attractive in that country.

Technological Environment
It comprises the knowledge of the latest technological advancements and
scientific innovations to improve the quality and relevance of goods and
services.
A company that regularly keeps track of these news can mould its business
strategies accordingly.
Example: A Watch Company that sells smartwatches and traditional watches
will prosper as smartwatches are trendy recently.

Circular Flow Of Economic Activity

The individuals own or control resources which are necessary inputs for the firms in
the production process. These resources (factors of production) are classified into
four types. Land: It includes all natural resources on the earth and below the earth.
Non renewable resources such as oil, coal etc once used will never be replaced. It
will not be available for our children. Renewable resources can be used and replaced
and is not depleted with use. Labour: is the work force of an economy. The value of
the worker is called as human capital. 8 Capital: It is classified as working capital
and fixed capital (not transformed into final products) Entrepreneurship: It refers to
the individuals who organize production and take risks. All these resources are
allocated in an effective manner to achieve the objectives of consumers (to maximize
satisfaction), workers (to maximize wages), firms (to maximize the output and profit)
and government (to maximize the welfare of the society). The fundamental
economic activities between households and firms are shown in the diagram. The
circular flows of economic activities are explained in a clockwise and
counterclockwise flow of goods and services. The four sectors namely households,
business, government and the rest of the world can also be considered to see the flow
of economic activities. The circular flow of activity is a chain in which production
creates income, income generates spending and spending in turn induces production.
The major four sectors of the economy are engaged in three economic activities of
production, consumption and exchange of goods and services. These sectors are as
follows: Households: Households fulfill their needs and wants through purchase of
goods and services from the firms. They are owners and suppliers of factors of
production and in turn they receive income in the form of rent, wages and interest.
Firms: Firms employ the input factors to produce various goods and services and
make payments to the households. Government: The government purchases goods
and services from firms and also factors of production from households by making
payments. Foreign sector: Households, firms and government of India purchase
goods and services (import) from abroad and make payments. On the other hand all
these sectors sell goods and services to various countries (export) and in turn receive
payments from abroad

National Income

National Income Is the final outcome of all economic activities of a nation valued in
terms of money. National income is the most important macroeconomic variable and
determinant of the business level and economic status of a country. National income
is the money value of all final goods and services produced in a country during a
period of one year. National income is the money value of all the final goods and
services produced by a country during a period of one year. National income consists
of a collection of different types of goods and services of different types. In common
terms, National Income means the total value of goods and services produced
annually in a country. In other words, National Income is the total amount of income
accruing to a country from economic activities in a year‘s time. National Income
helps us to know the economic progress achieved and to make comparative study.
Simon Kuznets defines it as ―The net output of commodities and services flowing
during the year from the country‘s productive system in the hands of the ultimate
consumers. JM.Keynes, a famous economist defined National Income as - ”National
Income is the money value of all goods and services produced in the country during
a year.”

Methods of Measuring National Income

PRODUCT METHOD >> The total value of the final goods and services produced
in a country during a year is calculated at market price. >> All productive activities
such as agricultural products, commodities produced at industries, etc are collected
and assessed at market price. >> Only final goods and services are included and the
intermediary goods and services are left. >> Money sent by Indian citizens working
aboard are also added. GROSS NATIONAL INCOME = Money Value of total
goods and services + Income from abroad

INCOME METHOD >> The net income payments received by all citizens of a
country in a particular year are added up. >> Income details are obtained from
Income Tax Dept. (High Income) and Wages Bills. (Workers) >> Income by way of
net wages, net rents, net interest, net profits are added together but 100 incomes
received in form of transfer payments are exempted. GROSS NATIONAL INCOME
= Rent + Wages + Interest + Profit + Income from abroad

EXPENDITURE METHOD The total expenditure incurred by the society in a

particular year is added together. This includes personal consumption expenditure,
 net domestic investment, government expenditure on goods and services, net foreign
investment. GROSS NATIONAL INCOME = Individual Expenditure + Government
Expenditure

VALUE ADDED METHOD >> The difference between the value of material
outputs and inputs at each stage of production is the value added. >> All such
difference are added up for all industries in the economy, to arrive at the GDP

CONCEPTS OF NATIONAL INCOME

Gross Domestic Product (Gdp)
Gross National Prodcut (Gnp)
National Domestic Product (Ndp)
Net National Product (Nnp)
Personal Income
Per Capita Income
Personal Disposable Income

LIMITATIONS IN MEASURING NATIONAL INCOME

o Non availability of reliable statistics
o Service of Housewives
o Owner-occupied Houses
o Self Employed persons
o Goods meant for self-consumption
o Illegal Activites
o Wages and Salaries paid in Kind
o Second-hand Goods and Assets
o Price Changes
o Transfer Payments etc..

Aggregate Demand-Aggregate Supply (AD-AS) Approach

Aggregate demand (AD) is the total amount of final products and services that all
sectors of the economy intend to purchase over a single accounting year at a specific
level of income. Whereas, Aggregate Supply (AS) refers to the monetary value of
finished goods and services that all producers are prepared to supply to an economy
over a specific time frame. The Aggregate Demand-Aggregate Supply Approach
(AD-AS Approach) is used to determine the equilibrium level of income, output,
and employment in an economy.
Determination of Equilibrium Level
The Keynesian Theory states that the equilibrium situation is usually expressed in
terms of Aggregate Demand (AD) and Aggregate Supply (AS). When aggregate
demand for products and services over a given period of time equals aggregate
supply, an economy is in equilibrium.
So, equilibrium is attained when:
AD = AS

Macroeconomic equilibrium
Macroeconomic equilibrium is a condition in the economy in which the quantity of
aggregate demand equals the quantity of aggregate supply. If there are changes in
either aggregate demand or aggregate supply, you could also see a change in price,
unemployment, and inflation.

Aggregate demand is the sum of four components: consumption, investment,

government spending, and net exports. Consumption can change for a number of
reasons, including movements in income, taxes, expectations about future income,
and changes in wealth levels.
The term aggregate supply refers to the supply of products that companies produce
and plan to sell at a certain price in a given period. Put simply, it refers to the
finished goods that consumers purchase during a specified time. Aggregate supply is
represented by the aggregate supply curve. There is typically a positive relationship
between aggregate supply and the price level.
The value of total output is distributed among the factors of production in the form
of rent, wages, profit, and interest, and the sum of these factor incomes at domestic
and national level is known as National Income. Hence, it can be said that
Aggregate Supply is equal to the National Income (AS = Y).
Main components of aggregate supply are two, namely, consumption and saving. A
major portion of income is spent on consumption of goods and services and the
balance is saved. Thus, national income (Y) or aggregate supply (AS) is sum of
consumption expenditure (C) and savings (S).
The multiplier effect refers to the effect on national income and product of an
exogenous increase in demand. For example, suppose that investment demand
increases by one. Firms then produce to meet this demand. That the national
product has increased means that the national income has increased.