ECONOMIC FACTORS

AFFECTING BUSINESS
• The economic Factors Affecting Business

• Both international and domestic businesses are often

affected by the dynamic economic conditions prevalent
in the market.

• Factors like demand and supply, interest rates,

recession, inflation, etc. often have an impact on the
businesses.

• Every business has one goal, to maximize its profit. This

can be done by analyzing the demand of consumers,
providing appropriate supply, along with maintaining
quality of goods and services.
Ecnomic Factors That Influencing Businesses

1. Demand and Supply

• The demand and supply are two principal factors that affect the working of
any business model.

• The demand is the will and ability of consumers to purchase a

particular commodity,

• while supply is the ability of the business to provide for the demand of
consumers.

• Suppose, a mobile phone infused with latest technology is introduced in the

market, it will have a higher price because of its demand in the market. Its
prices will continue to increase if the supply does not meet the demand.

• For instance, in the year 2000, weather played havoc with the sugar crops
of Brazil, which is the largest sugar producer in the world. This led to a
decrease in the supply of sugar, which in turn resulted in a steep rise in the
sugar prices. However, after the initial price rise, the market forces came
into play and the demand for sugar became equal to the supplied sugar.
• Marginal and Total Utility

• Utility is the amount of satisfaction, that is derived by

consumers from the consumption of goods. It so
happens that after continuous and successive
consumption of units of the same goods, the satisfaction
that is experienced by a consumer starts decreasing.

• This often results in short-term or long-term fall in sales.

Some organizations prepare for the launch of another
brand, before the fall in utility and sales is experienced.

• The launch of new brand ensures that the revenue trend

of the business does not fall. Diminishing utility is among
the external factors affecting business.
• For example, when we buy a pizza, the first few
slices give us immense satisfaction.

• However, there is a fall in the satisfaction levels,

when we are eating the rest. Let's assume, the
marginal utility derived on the consumption of
the first slice was 90.

• However, due to diminishing utility, the second

slice had the score of 80 and the third slice was
just 70. The satisfaction derived on consumption
will be in a decreasing order.
2. Money and Banking

• Banking facilitates monetary and fiscal policies that

affect business and also the customers of the business.
Money in circulation dictates the purchasing power or
rather the demand of the consumers.

• On the other hand, the banking facility dictates the

borrowing capacity of individuals as well as the business.

• The banking policies play a decisive role in affecting the

prices of goods and interest rates along with investment
and asset prices.

• The monetary polices of countries also influence the

economic activities and inflation. This whole dynamic
process is also known as monetary policy transmission
mechanism
3. Economic Growth and Development

• Economic growth dictates the amount of finances that

the society at large is earning and development indicates
the volume of money that is being invested into channels
of long-term up gradation.

• Among all the economic factors, development is the

most important one, as a business has to cater to the
demands of an economically dynamic society.

• For example, the luxury brands perform well during an

economic upturn, much more than the companies which
produce essential offerings.
4. Income and Employment

• Other important aspects of the economy that affects a

business operation, are the employment density and rate
of income.

• The per capita income and density of employment

determines the rate of demand, density of demand, and
also the purchasing power of the people.

• For example, during an economic upturn, there are

employment opportunities which generate income that
enables people to possess a stronger purchasing power.

• On the contrary, as the employment density and income

rate go down during recession period, the purchasing
power of the people also diminishes.
5. General Price Level

• Another very important aspect of the economy that plays a part in

the growth of business is the general price levels of commodities.

• Costs of raw materials, paying power of people, cost of production,

and cost of transportation are some of the most important
components that determine the general price levels and in turn,
lower the profit margin of a business.

• For example, an increase in the price will reduce the total revenue
generated as there might be a dip in the demand. Let us assume
that we have bought 16 pizzas for the price of $4.

• However, after an increase in the price of pizzas, we may get to buy

only 8 pizzas even after shelling out $6.
6. Trade Cycles

• A trade cycle plays a part in fluctuating the costs

of goods and commodities in an economy.

• Prosperity, recession, depression, and recovery

are the phases of a business cycle that affect
the demand and supply of all goods.

• Also, trade cycles often affect the general price

levels of essential and non-essential
commodities.
7. Inflation

• Inflation is a phenomenon that occurs when there is too much

supply of money in the economy that is not supported by the output
of goods and services.

• As there is a lot of money floating around, the prices of goods also

increase in order to sustain the businesses, resulting in the increase
of costs of raw materials which are needed for production. A hike in
the prices of raw materials, thus, also increases the cost of a
product.

• In simple words, the buying capacity of people decreases, when

their incomes remain constant but the prices of products and
services increase.

• This affects the demand for the goods. For example, in 2008,
Zimbabwe faced the worst case of inflation, which proved disastrous
for its economy and led to the abandonment of its currency.
8. Recession (kemelesetan)

• During recession, companies face a decrease in sales

revenues and profits. To curtail cost, they resort to
cutting back on hiring new employees, making capital
expenditure, marketing and advertising expenditures,
research and development activities, etc.

• This not only affects large organizations, but also the

small ones which act as vendors to these big companies.

• Smaller organizations may find it difficult to survive in

recession due to lack of financial funds or availability of
loans. Also, people may shift their preferences to slightly
affordable products during recession or may not spend
on luxury items at all.
• This will also have a negative impact on the demand for
these products.

• Factors like falling stocks, lack of dividends, below par

quality, employee lay-offs, bankruptcy, etc. during
recession may also affect the business adversely.

• For example, in 2007, when the banking industry was

unable to face the meltdown of the mortgage market, it
inadvertently led to a free fall of the stock market and a
decrease in consumer spending.

• It also set into motion a chain of events that resulted into

a global recession within a year.
9. Exchange Rate

• When a company buys certain goods from a US-based organization, it will

have to convert its currency into US dollars for making the payment. If the
currency of the buyer is stronger than the US dollar, it will be beneficial for
the company.

• However, if it is weak, the company will have to shell out more money. This
was an example of an export business. A similar logic will also be applicable
to the import business.

• Moreover, price competition in the international market often leads to

fluctuating prices. This is because a foreign company in the US market may
increase or decrease its prices depending on the changes in the exchange
rate.

• Suppose some time ago, 1 pound was 1.5 US$. However, today, it may
decrease to 1.3 US$ if the value of dollar appreciates. This will cause the
imported goods from UK to become cheaper for the consumers in the US.
However, this will not be a good news for US exporters as UK consumers
will find that they are getting lesser returns for a pound's worth.
10.Rate of Interest

• The rate of interest has a direct impact on the loans that

business take to sustain or propel their growth.

• The higher the interest rates, businesses find it difficult to

commit to projects that require investment.

• On the contrary, lower rates make it easier for people to

borrow money in order to buy cars and houses.

• Low loan rates also provide an opportunity to people to

spend more on other things, thus creating a demand for
various goods and services, and thereby spurring the
growth of economy.
11. Government Regulations

• There are several government agencies that regulate

businesses for the safety of humans, animals, and
environment. Some industries are heavily regulated and
introduction of new laws discourage uncontrolled growth
of factories and plants.

• For example, a coal-powered power plant may be asked

to be shut down because of an environmental threat it
poses. This may affect a business drastically.

• Every changing factors in an economy affect the working

of businesses. Hence, companies need to have a
foolproof strategy and contingency revenue reserves to
cope with such dynamic changes.

• It is best to take calculated risks and expand a business

when the rates of interest are low and the demand is
high.
Questions For Review

1) What is demand?
2) What is supply?
3) What is utility?
4) What is inflation?
5) Explain five economic factors that
influencing business.