Meaning and Functions of Economic Environment

Introduction: What is the Economic Environment?

Businesses are impacted by various internal and external factors that affect their financial performance. The combination of all large-scale (macro) and small-scale (micro) economic factors are known as the economic environment. The economic environment is an essential indicator of businesses’ performance and is hence important to study.

In simpler words, the economic environment is the combination of various economic functions that may affect the profitability and performance of a company over a certain period of time. These factors depend on the nature of the business of a company. For example, the weather is a factor that affects agricultural businesses. Similarly, the advancement of the internet is a factor for newspaper agencies because online media companies and newspapers compete for advertising. The economic environment of a company comprises both macroeconomic and microeconomic factors.

Macroeconomic Factors

Macroeconomic factors impact the whole economy and can affect the operations of many different types of companies.

The major macroeconomic factors that build the environment include the following −

Interest Rates

Interest rates indicate the rate of return the money invested in an economy generates. High rates of return indicate that the economy is in a better condition to return the money invested in the economy. High interest rates also indicate that the currency value of an economy is at a higher value.

Exchange rates

Usually, it is normal for an economy to have fluctuations in the value of its currency in comparison to other currencies. However, a too rapid change of exchange rates indicates a weak economy.

Unemployment Rates

Unemployment refers to joblessness in an economy over a certain period of time. Unemployment rates can also impact the economy of a country. A lower rate of unemployment indicates a stronger economy.

Inflation

Inflation refers to an increase in the prices of goods in an economy. A rapid increase in rates of inflation indicates that the economy is unstable while gradual inflation is a sign of stability and improvement in an economy.

GDP Growth

GDP refers to the overall value of goods produced by an economy over a certain period of time. A good GDP growth indicates that the economy is in a stronger position and is growing healthfully. GDP is usually calculated annually to measure the economic strength of nations.

Customer’s discretionary income

Discretionary income refers to the extra money left in people’s hands after paying for the necessary items, such as rent and utilities. A good discretionary income means that the economy is stronger and businesses can thrive in the economy. An economy may become weaker when individuals have less money to spend on their hands.

Taxes

Businesses need to pay government-set taxes and fees and the taxes the businesses pay can have an impact on the economy. In a competitive economy, taxes are often lower than in economies that lag behind in terms of economic growth.

International Trade

International trade is also a good indicator of the strength of an economy. Countries that export more than what they import have the option to raise the price of their products that have a strong demand in the international markets. So, they have a stronger economy.

Retail sales

This shows how much the population of a country is spending on retail items as a whole. It is an important measure of a country’s economic strength. Businesses watch the retail spending norms to understand if retail sales have dropped which indicates that the economy is in trouble.

Natural Environment Factors

Natural factors, such as calamities can also have a big impact on economies. For example, floods can have an impact on sales and they may reduce the demand for some products while increasing the demand for others.

Microeconomic Factors

Microeconomic environment refers to the factors that impact businesses at individual levels. The major microeconomic factors include the following −

Demand

The demand of a market is an important measure of microeconomic strength. Various external and internal factors impact demand. Changes in demand result in a change of strategy of businesses. For example, change in technology often leads to change in the nature of individual demand.

Supply

Supply is also a very important measure of change in market dynamics. Usually, when the supply of a product changes, the profitability of firms is affected which is why firms want to produce only as much demand is there in the market.

Competitors

Individual firms also have to look at competitors to remain competitive in the market. If competitors produce more of demanded products, businesses should also adapt to those changes. Similarly, when competitors change the price of a similar item, the companies need to follow suit.

Market Size

Market size shows the total possible sales a company can make in a given market. When the value of market size changes, companies need to look for alternatives, such as reducing prices or looking for newer markets.

Suppliers

With a change in the services and materials provided by the suppliers, companies may need to look for alternatives, such as finding a new supplier. Suppliers play a key role in determining the microeconomic environment of a business.

Distribution Channels

There are differences in the form of distribution chains of businesses, some of them may sell on the internet while others may sell in stores. If some of these distributors go out of business, companies will have to look for alternative sources to avail the products.

Availability of investors

The availability of investors is an important factor for businesses to carry on doing business. For example, if an investor or group of investors move out of the business, the company in which they had invested will be struck financially. So, a lack of investors may hurt businesses.

Availability of employees

No company can sustain itself without employees that have the right skills. For example, tech firms often need employees with a very special set of skills. When there is a shortage of employees with the right skills, businesses may suffer from losses.

Media and community

Bad media coverage can prove to be a costly affair for businesses. Similarly, companies need to be efficient and care about the stakeholders to be respected in the community they operate.

Conclusion

Learning about the micro and macroeconomic factors that impact businesses is important because these are the factors that help businesses grow and thrive. Without proper knowledge of the environment, no business can sustain itself. That is why everyone should have knowledge of the business environment in general.

FAQs

Qns 1. What is meant by economic environment?

Ans. Businesses are impacted by various internal and external factors that affect their financial performance. The combination of all large-scale (macro) and small-scale (micro) economic factors are known as the economic environment.

Qns 2. Name four macroeconomic factors that impact the economic environment?

Ans. Interest rates, currency exchange rates, rates of unemployment, and Inflation are macroeconomic factors.

Qns 3. Name four microeconomic factors that impact the economic environment

Ans. Demand, Supply, Market Size, and Suppliers are microeconomic factors that impact the economic environment.