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The external environment of a business is made up of various factors. For now, let's take a look at how economic change can impact business decision-making. This is one of the 'E' elements of PESTLE analysis (see Figure 1 below). The economic environment includes factors like economic growth and economic policy and can either be a source of opportunity or a threat to the business.
Figure 1. PESTLE Analysis, StudySmarter
Economic change can be defined as a shift in structure, policy or growth in the economy, and can be considered as one of the external factors that affect business decision-making.
All businesses operate in an economic environment - they do not have a choice or control over this. Economic change is important for businesses to keep in mind because it can be directly related to the demand for goods and services in a market (ie consumer spending). Economic change in business can come from various different factors such as:
Changes in GDP
Exchange rates
Interest rates
Taxation
Government spending
inflation
Policy changes
Economic growth is one of the most important factors of the external environment as it can impact consumer spending, investment and government expenditure. The size and attractiveness of the economy are constantly changing. One of the ways to measure this change is by looking at the gross domestic product (GDP).
Gross domestic product (GDP) measures the total output of the economy over a certain period of time.
You can calculate GDP with the following formula:
GDP = C + I + G + (X - M)
C: Consumer spending
I: investment
G: Government expenditure
X: exports
M: imports
Consumer spending or consumption in general, measures the amount of money consumers have spent on goods and services. Investment measures how much was invested in businesses within a country's economy. Government expenditure measures how much the government has spent on public services and infrastructure.
Net exports (XM) measures how many goods and services we exported abroad (X), and from this value, we subtract the number of goods or services we imported into the country from abroad (M).
With this formula, we can measure the actual growth of an economy. We can look at the yearly percentage increase of a country's GDP to measure economic growth. Economic growth is important because, in general, it means we are better off in our environment.
Some of the advantages of economic growth include:
Higher living standards
The creation of jobs and lower unemployment
Increased investment
Increased tax revenue
Some of the disadvantages of economic growth include:
Risk of inflation
Increase in the income gap
Negative externalities
The business cycle represents the value of economic output and activity.
Changes to the business cycle have a significant impact on business decision-making. When the economy is experiencing an upswing, existing companies are more likely to invest in new product development and operate at maximum capacity. New businesses are also more likely to be founded during an upswing.
During a recession, unprofitable businesses are likely to stop their operations altogether and unemployment may start increasing. Firms are also more likely to try and enter international markets where demand for their goods and services is higher.
Economic policy has a huge impact on how an economy functions. Changes in economic policy will have a significant impact on business decision-making. We will look at protectionism and fiscal policy to explore this further:
Protectionism is a restriction imposed by a country's government on the import and export of goods and services.
Protectionism impacts the open trade of goods and services. Protectionism can be in the form of trade barriers. Some common forms of trade barriers include:
Tariffs: a tax or duty that has to be paid on certain imports of exports (ex. Country X imposing a 5% tax on all imports of oranges)
Quotas: a limit to the number of goods and services allowed to be imported or exported (ex. Country X only allows a maximum amount of 100,000 units of a certain good to be imported into the country)
Subsidies: an amount of money granted by the Government to help local businesses (ex. Country X grants orange farmers money to keep the price of oranges low and competitive)
Fiscal policy is a direct factor influencing economic growth, as it is made up of taxation and government spending.
If fiscal policy is expansionary - where taxation is decreased and Government spending increases - the output of the economy will grow. This is beneficial to businesses, as a prosperous economy increases consumption and investment.
If fiscal policy is contractionary - where taxation is increased and government spending decreases - the output of the economy will decrease. This can be a disadvantage to businesses, as an economic decline will decrease consumer spending and discourage investment.
Economic change can be defined as a shift in structure, policy or growth in the economy. All businesses operate in an economic environment - they do not have a choice or control over this. Economic change is important for businesses to keep in mind because it can be directly related to the demand for goods and services in a market (ie consumer spending). Economic change can come from changes in inflation, exchange rates, policy or economic growth.
Changes in the economic environment affect all business decision making. For example, if an economy is experiencing growth, firms are more likely to start expanding, as customers are spending more and investment is increasing. This could impact marketing decision making, as economic growth implies a good time to diversify, innovate, invest in new product developments and large marketing campaigns, as the firm is more likely to have access to a wide range of capital and resources.
Economic changes can have significant impacts on strategic decision making. For entrepreneurs, new business opportunities are created when the economy is growing. As the economy is experiencing an upswing, entrepreneurs are more likely to have access to a wider range of resources and funds to start their business compared to when the economy is experiencing a slump or a recession.
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