Business Environment Chapter 2

7/31/2019 Business Environment Chapter 2

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Economic environment refers to all those economic factorswhich have a bearing on the functioning of every business

organization. Business enterprise is essentially an economic

unit. Every business depends upon the economic environment

for all its requirements or inputs. Similarly it depends upon the

economic environment for the sale of its output. Naturally, thedependence of business on the economic environment is

complete, as it is one unit of the total economy.

Macro economic factors are critical elements of economicenvironment; these elements can be classified under following

mportant heads:

A) Economic system prescribes method ofproduction and distribution of goods, ownership pattern of facto

of production. Based on this, there are three kinds of economic

systems:

I) Capitalism is also described as free enterpriseeconomy or free market economy. In this system ownership o


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business and factors of production is with the people or

capitalists.

1. People are free to startbusiness of their choice.

2. Role of Government in business isminimum; restrictions on business are very few.

Government will have friendly attitude towards

business.

3. Consumer is the king, i.e.goods and services that are liked by the people are

produced and distributed.

4. Owners contribute capital to startbusiness and their main objective is to make profits.

5. Conditions of business are determined bymarket like demand, supply, price etc. Those goods

are distributed that the market accepts.

6. There is open competition between rivafirms and they compete on product, quality, price,

service etc.

I) This system is opposite to capitalism.Ownership of business and other factors of production is wit

the Government. People are workers; Government owns


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land, contributes capital and manages the business for the

social benefit of people.

1) All resources including businessare owned by Government. People are workers, they getwages for their service, and there are no owners or

capitalists.

2) All authority including business arewith the government. Government decides the production

and distribution aspects. Business is under absolutecontrol and ownership of government, people have no

choice.

3) Business is not run to thedemands of market. What to produce, how much to

produce, method of distribution, price fixation etc. are notdetermined by the market, government regulated all thes

aspects.

4) National income of thecountry is equitably distributed to the people or labourers

according to their labour or efforts.

5) Resources are used to producthose goods that are needed by the society and which ar

essential for economic development and growth. There is

no wastage of resources.


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6) There is no competition of private firms athe business is owned by government. This will minimize

the wastage that may take place due to competition.

II) It is compromise between capitalism andcommunism. In this system government and also privatesector participate in business activity.

1) Market conditions like demand, supplyprice etc. are controlled by the government. There is

freedom to the market, but it is not unrestricted.2) Business is owned by

government and also the private. Government normally

concentrates on heavy industries and infrastructure and

the remaining sectors are left to public.

3) Government plays the dual role ofregulator and motivator of business. Government ensure

planned growth of business as per the national priorities.

4) Competition between rival firms is allowed,but competition is restricted through competition act and

other provisions. Competition can be between PSUs and

private sector; between private firms or it may be betwee

large scale and small- scale industries.


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B) Economic policies give directions toconduct business activities. Promotion and regulation of

business activities is monitored through measures like

1) Monetary policy regulates supply ofmoney and credit in the economy. Business requires easavailability of money and credit, which depends on

monetary policy.

2) Fiscal policy states the tax structure andrates. Simplified tax structure and lesser rate of tax is

helpful for business.3) Trade policy can be inward oriented or

outward oriented. An inward looking or oriented policy

gives importance to domestic trade over foreign trade.

Outward looking policy does not discriminate between

domestic and foreign trade. It creates competition betweedomestic firms and foreign firms.

4) Industrial policy regulates the growth andevelopment of industries through measures like licensin

permits, duties, capacity restriction etc.

C) Growth of business depends onprevailing or supportive economic conditions. These conditions

consists of:

1) It is the basic industry. It gives food to the peopand also raw materials to other industries. Growth of a natio


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depends of agriculture as it feeds the people and also

industry. Foundation and growth of business is dependent

on strong agriculture support.

2) Infrastructure facilitates like good roads,transportation system. Communication facilitates powers etare essential for this growth of business. Growth of busines

in India is not taking place to poor infrastructure growth.

3) Survival and growth of business dependenton customer support. People can become customers, if the

have adequate income. If the income level is low it will nothelp for growth of business.

4) Population and its composition give support tobusiness. Growing population with mere young and

educated people will provide large customer base to

business.5) Business requires capital; capital

can be raised either from banks or FIs or directly from habit

of saving and investing that money in banks or in shares an

debentures.

6) There should be equitable distributioof income level i.e. a small portion of population being rich

and large majority being poor will not help for the growth of

business. Because large majority of people cannot afford to

buy.


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7) Development of business requires helpfbusiness environment. Economic reform measure like LPG

helps for competitive growth of business.

8) Standard of living is measured asconsumption of comforts and luxuries. Developed countrieshave high standard of living as people of these countries

spend more on these goods. The spending habit of the

people encourages business activities as more goods are t

be produced to meet the demand.

9) well developed financial system, banksand financial institutions help for the growth of business by

supplying them with money and credit. Business also

depends on various financial services like payments,

cheques etc.

10) Developed economiesprovide better opportunities for business growth by well

developed market, easy availability of finance, better

infrastructure and people who spend on variety of goods an

services.

A) The basic measure of economic growth oa country is the continuous expansion, year after year, of

real national income and real per capita income. Economic


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growth should also include improvement in the quality of lif

of people consisting of increase in life expectancy, reductio

in mortality and increase in literacy etc.

The adoption of the socialist pattern of society as the

national objective, as well as the need for planned and rapidevelopment requires that all industries of basic and

strategic importance, or in the name of public utility service

should be in the public sector. Other industries which are

essential and require investment on a scale which only the

state, in the present circumstances, could provide have alsto be in the public sector.

B) Economic system prescribesmethod of production and distribution of goods, ownership

pattern of factors of production. Based on this, there are

three kinds of economic systems:I) Capitalism is also described as free enterprise

economy or free market economy. In this system ownership

of business and factors of production is with the people or

capitalists.

II) This system is opposite to capitalism.Ownership of business and other factors of production are

with the Government. People are workers; Government

owns land, contributes capital and manages the business fo

the social benefit of people.


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III) It is compromise between capitalismand communism. In this system government and also private

sector participate in business activity.

C) Economic planning, in one form oranother, on a small scale or a large scale, has been adopteby many countries of the world either to achieve rapid

economic development, or to overcome depression, or to

control inflationary conditions, or to maintain economic

stability. In fact, economic planning is considered as a

panacea for all economic ills.During the forty years of economic planning i.e. from 1951

1991, the government has prepared and implemented

comprehensive economic plans, integrating the private

sector with the public sector to achieve the following

important long-term general objectives:i. Increasing production to the maximum possible extent

so as to achieve a higher level of national and per capi

income.

ii. Achieving full employment.iii. Reducing inequalities in the distribution of income and

wealth.

iv. Setting up a socialist pattern of society based onequality and justice and absence of exploitation.


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D) Industry as a business organization is engagein conversion of raw material into finished product. They ca

be classified into large scale and small scale on the basis o

investment of capital; industries play an important role in

economic development of a nation.Industries have following advantages:

1)It provides employment and ensures balanced economicdevelopment.

2)It increases national and per capita income and therebyhelps to increase standard of living.

3)Industrialization will reduce pressure on agriculture. Itstrengthens agriculture by helping in mechanization of

agriculture and using agro raw materials for production.

E) National incomecommittee of India defined National Income as National

income estimates measures the value of commodities and

services turned out during a given period counted without

duplication.

National income of a country can be measured by:

1.Amount of goods and services produced in a year, or2.Total expenditure incurred on production and services, or3.Total income received on factors production i.e. incomes or

rent, wages, interest and profit.


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Per capita income means average income of an individual. It is

calculated by dividing national income with total population.

Study of national income and per capita income throws lighon prevailing condition of business and economy. Increases in

nation income and per capita income show increase economic

activity. Study of national income reveals contribution made by

the different sectors of the business towards national income. It

ndicates standard of living of the made on the basis of nationalncome and per capita income.

Evaluation of these aspects help the policy makers to

prepare right action plans to undertake healthy growth of

business. It helps to device proper policies of business that

usher economic activities and help to increase national income

and per capita income.

The policy was adopted in the background Indiasdiminishing foreign exchange, the LPG wave throughout th

world.

Following are the important features of the policy.


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1.Industrial licensing was made compulsory for only 8 itemThe procedure of obtaining permission for others was

made simple.

2.DFI (Direct Foreign Investment) up 51% of equity wasallowed in high priority areas.

3.Automatic clearance introduced for import of capitalgoods, provided foreign exchange requirement for such

import is to meet through foreign equity.

4.Automatic permission for foreign technology agreementsin high priority industries up to Rs. 1 crore.

5.Foreign equity proposals need not be accompanied byforeign technology agreement.

6.Pre-eminent role for PSUs in eight core areas includingarms and ammunition, minerals, oils, rail, transport and

mining of coal and mineral.7.Dis-investment of governments share in PSUs, especiall

those which are making losses.

The policy made significant changes in:

1.Reducing the conditions and procedures of industriallicensing.

2.Giving more scope for foreign investments andtechnology.

3.The condition of MRTP and FEMA were diluted to makthem more business friendly.


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4.Overall policy was passed to make Indian industriescompetitive and create better environment for industria

growth.

The small scale industries have been classified on the basi

of investment limits.

(1)Ancillary units: investment limit up to Rs. 25 lakhs.(2) Small units: investment limit up to Rs. 1 crore.(3) Tiny units: investment limit up to Rs. 1 crore.

The importance of cottage and small scale industries in the

ndian economy may be explained ad follows:

1. The cottage and small scaleindustries are labour intensive and therefore, they create

more employment per unit of capital employed. It is

estimated that they create employment four times more tha

the large industries. In India, as there is a great shortage of

capital but abundance of labour, small and cottage industrierequire to be developed intensively.

2. SSIs share in the total exports is about 4percent. A larger part of these goods is utilized by other

goods which are exported and thus this part goes to export


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indirectly through other industries. The interesting aspect o

this sector is that it largely adds to the foreign exchange bu

it uses very little by way of purchase of imported goods.

3. Of the total output of themanufacturing sector, about 40 percent comes from thesmall scale sector. And of the total supplies of industrial

consumer goods accounting for 2/3rd of the total output of th

manufacturing sector, a major potion comes from the small

sector.

4. SSIs can be set up quickly; they can staproducing goods quickly, and they can also earn profits

quickly. Therefore the development of small enterprises wil

help in controlling inflationary conditions in the economy.

5. Another very strong argumenin favour of small scale industries is that these industries usand develop resources which are available locally and thes

locally available resources would have remained unutilized

and wasted.

6. large industries create antsocial and immoral tendencies such as exploitation,

selfishness, jealousies etc., whereas small industries

promote the development of moral qualities like love, co-

operation, co-existence, quality etc.


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7. The development of small industries leadsto a rise in the standard of living; it provides equal

opportunities to work and earn; it reduces the disparity

between the rich and the poor and it develops moral

character. Therefore, it paves the way for the establishmenof a socialist pattern of society in the country.

8. The total production of small industries has beenrising at 11.7 percent per annum, which is higher than that

7.8% of large industries.

9. The small industries provide vastopportunities for self-employment. The self-employed peop

are considered as the back-bone of the nation.

10. Small scale industries requi9re relativelysmall amount of capital. As there is a great shortage of

capital in India, small scale industries can be easily started

Small scale industries are facing a number of problems; the

most important of them are such as

1. The raw materials are availableneither in sufficient quantities, nor of requisite quality and n

at reasonable prices. Since the SSIs require small quantitie

of raw materials, they are not able to undertake bulk-buying

as the large industrialists do.


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2. Many small industries arbeing constrained by inadequate physical infrastructure. Th

most severe constraint is power. In addition, they have to

face the problem of transport and communication

infrastructures.3. Adequate and cheap credit facilities are no

available to the small enterprises. Normally they depend

upon the local money lenders who charge very high rates o

interest. In order to repay the loans quickly, they will be

compelled to sell their products at unfavourable price.4. The methods of production used b

the small and tiny industries are old and primitive and

inefficient. The result is low production, poor quality of the

products and high costs.

5. Most of the SSIs get delayed paymentsby large forms and government departments. One study

shows that on an average, the small firms provide 40 days

credit to the buyers of their products but material etc.

everybody knows that the small firms have very little

bargaining power in the markets where they deal.

6. The small industrialists face manydifficulties in marketing their products. Because (a) there ar

no organized sales organizations; (b) their products are not

standardized; (c) there are no adequate transport and


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communication facilities; (d) they cannot get up-todate

market information; (e) they cannot wait for better prices du

to lack of finance; (f) they face severe competition from

technically more efficient units and large firms; (g) they hav

no sufficient holding capacity in case of over-production ordeficient demand etc.

7. Most of the products which had beenreserved for the small sector have now been deserved i.e.

have been removed from the reservation list. This has led t

severe competition from the large industrial undertakingslarge scale industries which are most up-to-date and use

modern machinery.

Stock exchange is a organized market for buying and sellinsecurities of listed joint stock companies.

Securities contract act 1956 defines stock exchange as an

association, organization or body of individuals, whether

ncorporated or not, established for the purpose of assisting,

regulating and controlling business in buying selling and dealing

n securities.

Stock exchange allows for trading of those

securities whose name is listed in the exchange. Companies w


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god credentials and record can list their name with the

exchange.

He is a person who buys shares in expectation

of selling them later at a higher price. Bullish trend in a stock

market means the tendency of rising prices.

He is a person who starts selling securities i

anticipation of a fall in security price in future.

The following are the important functions and services

rendered by the stock exchange.

1. People with cash can conveit into securities and those with securities can immediately

obtain cash for them.2. The investors find it very

convenient to invest their savings in shares which are dealt

in on the stock exchange and such shares possess more

liquidity than any other type of investments.

3.

It includes the investors to invest theirfunds in various industrial and governments securities by

giving wide publicity to these securities and their prices.

4. The stock exchange safeguards thinterest of the investors by enforcing strict rules and


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regulations and preventing the unscrupulous brokers from

charging higher rates of brokerage.

5. The stock exchange directs thflow of capital into the most profitable channels and thereby

secures a proper and effective utilization of the investablefunds for the social benefit.

6. The stock exchangefacilitates the growth of joint stock form of business

enterprises by raising the funds.

7. Stock exchange helps theinvestors to ascertain the market values of their securities

and enables them to decide as to buy or sell them.

8. The stock exchange providesopportunities to shrewd businessmen to speculate and reap

profit from fluctuations in the prices of the securities.

New economic policy of 1991 was passed to satisfy conditions

MF and open the Indian economy to the concept of LPG. The

policy was adopted to achieve following objectives:

1.To attain economic growth rate of 4%2.To reduce inflation rate to 6%3.Reducing the balance of payments position and building

adequate foreign exchange reserves.


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4.Reducing budgetary deficits.Following are some of the important policy reforms undertaken

1. The policy liberalized the economy fromrigorous procedures and restrictions. Investment limit in SS

is increased. Industries are allowed to adopt imported

technology wherever necessary.

2. More encouragement is given to industries inprivate sector. The IPR reserved 8 items only giving more

opportunities to business in private sector.3. Indian economy was made to interact more

freely and openly with global economy. FDI of more than

51% was allowed in Indian firms. Indian firms were allowed

to hire foreign technology and capital.

4.

The new policy of public sectorrestricted their role of PSUs to only to 8 areas.

Disinvestment and privatization of loss making PSUs was

undertaken.

5. Incentives were given to modernize theindustries. Firms were encouraged to spend more on R&Dtax concessions and other facilities were offered to develop

new technology.

6. Reforms undertaken in the areas offinance include:


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Reduction in CRR and SLR Reducing the interest rate More freedom to banks and FIs Provision of NPAs and CAR to banks Banks were allowed to open more branches to suit to

their convenience.

Capital market reforms.7. The policy aimed at bringing down fiscal

deficit from 8% to 4%. Measures were undertaken to bring

financial discipline in government spending. Efforts weremake to reduce the burden of subsidies. Tax system was

rationalized and simplified to encourage collection or more

tax revenue.

LPG process is undertaken throughout the

world. These policies have following advantages.

1. Economic growth rate on India before1980s was in the range of 5%, the policy makers wanted to

achieve growth rate of 10%, which is possible when

initiatives of LPG are seriously undertaken.

2. Indian economy can be made globallycompetitive through LPG measures. PSUs are given more


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autonomy and they are made to compete between MNCs

and domestic firms.

3. LPG will create moreemployments. It gives more job opportunities through

increase in business activities. This will help to reducepoverty and inequality.

4. PSUs have tocompete with private sector to prove their existence and

survival. PSUs, which are weak and inefficient, are closed.

5. LPG policies have given moreincentives and opportunities to SSIs. The new industrial

policy has increased investment limit in SSIs to Rs. 100

lakhs.

6. Fiscal deficit of India was in the rangeof 8% of GDP. It was aimed to bring it down to $%. Fiscalreform measures like reducing subsidies control over public

expenditure, revamping and simplifying the tax structure to

collect more taxes etc are aimed to bring financial discipline

7. Inflation is defined as tendency ofrising prices. It is defined as too much of money chasing to

few goods. Double-digit inflation i.e. inflation rate of more

than 10% is considered as dangerous and harmful for

economic growth and development. LPG measures help fo

increase business activities and increase in income level of


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people. More goods and service are available due to

increase business activities.

Developing countries like India are in

disadvantages position due to their poor technology, lack of

capital and managerial ability. Some of the arguments against

LPG and its identified drawbacks are as follows:

1. LPG policies lead tocompetition between domestic business and MNCs. MNCs

and foreign firms dominate the business due to their superitechnology, better products etc. gradually domestic firms

may lose their business to foreign firms. Control over the

business and economy will pass to the hand of foreign firm

2. Developingnations have to depend on technology and capital ofdeveloped nations to achieve economic development. It is

difficult for them to achieve the efficiency standards achieve

by developed nations.

3. developingcountries like India will not be allowed to design LPGmeasures to suit to their domestic conditions. Developed

countries dictate economic policies of developing countries


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4. Theris strong opposition to LPG policies that they destroy the

domestic culture and encourage the culture of consumerism

5. The gap between richand poor will go on increasing due to LPG. Rich will havemore opportunities to grow. Poor will not have adequate

opportunities due to lack of resources and poor education.

6. More importance is given to theproduction of comforts and luxuries, which are consumed b

rich in the society. The necessities of poor people are nottaken care of.

7. Industry and service sector receivmore importance. Basic sector of the economy like

agriculture and SSIs are neglected.

Documents

Business Environment Chapter 2