MMPC‐003

School of Management Studies Business Environment

BLOCK 1: INTRODUCTION TO BUSINESS ENVIRONMENT

Unit 1: Introduction to Business and Environment
Unit 2: Economic Growth and Development
Unit 3: Socio-Cultural and Politico Legal Environment
Unit 4: Business Ethics and Corporate Social Responsibility (CSR)

BLOCK 2: OVERVIEW OF INDIAN ECONOMY

Unit 5: Indian Financial System

Unit 6: Industrial Policy Framework
Unit 7: Agri-business Environment

BLOCK 3: STRUCTURAL REFORMS

Unit 8: New Economic Policy
Unit 9: Financial Sector and Fiscal Sector Reforms
BLOCK 4: INTERNATIONAL BUSINESS ENVIRONEMENT
Unit 10: International Financial System
Unit 11: Balance of Payments (BoP)
Unit 12: Foreign Trade
Unit 13: Sources of Global Financing
Unit 14: Technological Environment
COURSE DESIGN AND PREPARATION TEAM

Prof. K. Ravi Sankar Prof. Srilatha

Director, School of Management Studies,
School of Management Studies, IGNOU, New Delhi
IGNOU, New Delhi
Prof. Neeti Agrawal
Prof. Arindam Banik School of Management Studies,
International Management Institute, IGNOU, New Delhi
Qutub Institutional Area, New Delhi
Prof. Nayantara Padhi
Prof. Sunitha Raju School of Management Studies,
Indian Institute of Foreign Trade IGNOU, New Delhi
Qutub Institutional Area, New Delhi
Dr. Anjali Ramteke
Prof. Madan Lal School of Management Studies,
Delhi School of Economics, IGNOU, New Delhi
University of Delhi, Delhi
Mr. T.V. Vijay Kumar
Prof. Bibek Ray Chaudhuri School of Management Studies,
Indian Institute of Foreign Trade IGNOU, New Delhi
Kolkata
Dr. Leena Singh
Dr. Kamal Singh School of Management Studies,
Department of Economics IGNOU, New Delhi
Central University of Himachal Pradesh
Prof. G. Subbayamma (Course Coordinator)
Prof. Shailendra Singh Bhadoria School of Management Studies,
IGN Tribal University, Amarkantak IGNOU, New Delhi

Prof. Ritesh Gupta

Department of Management Studies
Chitkara University, Chandigarh

MATERIAL PRODUCTION
Mr. Y. N. Sharma Mr. Tilak Raj
Assistant Registrar Assistant Registrar
MPDD, IGNOU, New Delhi MPDD, IGNOU, New Delhi

September, 2021
© Indira Gandhi National Open University, 2021
ISBN:
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MMPC 003: BUSINESS ENVIRONMENT
 MMPC – 003: BUSINESS ENVIRONMENT

BLOCK 1: INTRODUCTION TO BUSINESS ENVIRONMENT

Unit 1: Introduction to Business and Environment
Unit 2: Economic Growth and Development
Unit 3: Socio-Cultural and Politico Legal Environment
Unit 4: Business Ethics and Corporate Social Responsibility (CSR)

BLOCK 2: OVERVIEW OF INDIAN ECONOMY

Unit 5: Indian Financial System
Unit 6: Industrial Policy Framework
Unit 7: Agri-business Environment

BLOCK 3: STRUCTURAL REFORMS

Unit 8: New Economic Policy
Unit 9: Financial Sector and Fiscal Sector Reforms

Block 4: INTERNATIONAL BUSINESS ENVIRONEMENT

Unit 10: International Financial System
Unit 11: Balance of Payments (BoP)
Unit 12: Foreign Trade
Unit 13: Sources of Global Financing
Unit 14: Technological Environment
UNIT 1 INTRODUCTION TO BUSINESS AND ENVIRONMENT

Objectives
After reading this unit you should be able to:
• define what you mean by environment;
• explain the concept of business environment;
• describe the scope of business environment; and
• understand the basic concepts of macroeconomics.

Structure
1.1 Introduction
1.2 Business and Environment
1.3 Basic Propositions
1.4 Nature and Scope of Business Environment
1.5 Types of Business Environment
1.6 Importance of Business Environment
1.7 Environmental Analysis
1.8 Basics of Macroeconomics
1.9 Summary
1.10 Key Words
1.11 Self-Assessment Questions
1.12 References/ Further Readings

1.1 INTRODUCTION

You may have a variety of reasons for studying this course, but the main reason, we presume,
is to become a successful manager. Your success or failure as a manager depends on a
number of factors and these factors may not always be within your control; very often such
factors constitute your work environment. These include your job, your department, your
organisation, your nation and the world around you. After all, as a manager you do not
function in a vacuum. You exist and operate within and not without, an environment.
Therefore as a manager when you think, or take decisions, you cannot neglect the limitations
of your environment. Just think for a while and then answer. Don’t you arrive at decisions

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after examining the possible reactions from the environment in which you are placed ? Say,
as a marketing manager, would you not study your market environment before launching a
new product ? Or, as a finance manager, wouldn’t you study how the capital and money
markets of the country are structured and organised before deciding on the sources and uses
of your funds ? Or, as a personnel managers wouldn’t you care to find the rules and
regulations laid down by the government on subjects like reservation before undertaking
recruitment and selection of your required staff? When you have answered these questions,
you will discover that all your answers are in the affirmative : “Yes, I would”. You can’t do
without thinking about your environment. As a business manager, you have to constantly
evaluate your business environment.

This opening unit aims to set you thinking about three ideas. It aims to help you to: precisely
define “environment”, classify your business environment on the basis of some criteria;
identify some of the critical elements of environment of business;;and establish the nature of
interaction between environment and business.

In pursuing these aims and objectives, our focus will primarily be on the Indian environment
of business. We shall try to identify, describe and analyse the Indian situation to understand
its impact on our business. Our ultimate purpose is to train our business mangers to face the
macro-level environment of business. As managers, wherever you are be it in the public or
the private sector, you have to remain alive and alert to your environment so that you are
successful in your day-to-day business operations.

1.2 BUSINESS AND ENVIRONMENT

The term “environment” refers to the totality of all the factors which are external to and
beyond the control of individual business enterprises and their managements. Environment
furnishes the macro-context, the business firm is the micro-unit. The environmental factors
are essentially the “givens” within which firms and their managements must operate. For
example, the value system of society, the rules and regulations laid down by the Government,
the monetary policies of the central bank, the institutional set up of the country, the
ideological beliefs of the leaders, the attitude towards foreign capital and enterprise, etc., all
constitute the environment system within which a business firm operates. These
environmental factors are many in numbers and various in form. Some of these factors are

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totally static, some are relatively static and some are very dynamic – they are changing every
now and then. Some of these factors can be conceptualized and quantified, while other can be
only referred to in qualitative terms. Thus, the environment of business is an extremely
complex phenomenon.

The environmental factors generally vary from country to country. The environment that is
typical of India may not be found another countries like the USA the (former) USSR, the UK,
and Japan. Similarly, the American/Soviet/British/Japanese environments may not be found
in India. There may be some factors in common, but the order and intensity of the
environmental factors do differ between nations. What to say of countries, the magnitude and
direction of environmental factors differ over regions within a country, and over localities
within a region. Thus, one may talk of local, regional, national (domestic) and
international (foreign) environment of business. For example, the local custom of “coolie”
labour, the climate of the northern region of Assam, the policies of the State and Central
Governments in India and the size of the world market : all these factors together will have
an important bearing on tea industry. The production, consumption and marketing of tea will
be affected by environmental factors.

The environment differs not only over space but also over time within a country. As such,
we can talk of temporal patterns of environment, i.e., past, present and future environment.
Future environment is the product of past and present environments. The Indian economy of
tomorrow will be influenced by what the state of the economy is at present and what it was in
the past.

Sometimes the environment may be classified into market environment and non-market
environment depending upon whether a business firm’s environment is influenced by market
forces like demand, supply, number of other firms and the resulting price competition, or
non-price competition, etc., or by non-market forces like Government laws, social traditions,
etc.

Finally, we may classify the environment into economic and non-economic. Non- economic
environment refers to social, political, legal educational and cultural factors that affect
business operations. Economic environment, on the other hand, is given shape and form by
factors like the fiscal policy, the monetary policy, the industrial policy resolution, physical
limits on output, the price and income trends, the nature of the economic system at
work, the tempo of economic envelopment, the national economic plan, etc. The non-

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economic environment has economic implications just the economic environment may have
non-economic implications. Since the environment is the sum total of the history, geography,
culture, sociology, politics and economic of a national, the interaction between economic and
non-economic forces is bound to take place.

Definition of Business Environment

The word ‘Business Environment’ is defined by many authors in different ways. Few of the
definitions are as follows:

According to Keith Davis, “Business environment is the aggregate of all conditions, events
and influences that surround and affect it”.
According to Reinecke and Schoell, “the environment of a business consists of all those
external things to which it is exposed and by which it may be influenced directly or
indirectly”.
According to Barry M. Richman and Melvgn Copen “Environment consists of factors that
are largely if not totally, external and beyond the control of individual industrial enterprises
and their management. These are essentially the ‘givers’ within which firms and their
management must operate in a specific country and they vary, often greatly, from country to
country”.
According to William F. Glueck “Business environment is the process by which strategists
monitor the economic, governmental, market, supplier, technological, geographic, and
social settings to determine opportunities and threats to their firms”.

All these definitions give a better understanding of the business environment. It can be
concluded that a business environment is a combination of dynamic, complex, and
uncontrollable external factors within which a business is to be operated. It is pertinent to
scan all these forces. Hence, it is crucial to have a thorough understanding of the basic idea
of the business environment and the nature of its different components. This interrelation
assists the business organisation to reinforce its capabilities and efficiently allocate its
resources.

Business organisations interact and transact with the business environment. Therefore
business organisation and business environment are directly related. Business environment
influence the scope and direction of business activity.

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Business can be seen as a specific activity e.g. a retail business in which a company is
making use of the internet and social media for marketing of their products. For example,
Flipkart is a specific form of business and is a private limited company. Business can also be
seen as a broad activity like a business system as a whole where we may refer it as a market
system or capitalism in which a whole range of activities including professional bodies, trade
unions, consumer groups, regulatory agencies and government bodies are included.

The environment may be classified into market environment and non-market environment
depending upon whether a business firm’s environment is influenced by market forces like
demand, supply, number of other firms and the resulting price competition, or non-price
competition, etc., or by non-market forces like Government laws, social traditions, etc.

In early 2015, Nestle’s famous product Maggi Noodles faced a setback in India when food
inspectors claimed to have found it unsafe, as the amount of lead was more than its
permissible limits. But Nestle tried its best to keep consumer trust by continuously interacting
with them on social media platforms and ensuring that Maggi is safe and they are cooperating
with the authorities. Later Maggi was temporarily banned in India and Nestle was asked by
the Food Safety and Standards Authority of India (FSSAI) to recall its Noodles products from
the market and destroy them. It hugely impacted their revenues and profits as Maggi was one
of the most popular products in India.

In the second half of 2015, fresh batch of Maggi was tested and it was allowed to sell again.
But lead controversy adversely affected the trust of consumers and it took lots of promotional
strategies to regain the lost revenue. It launched emotional campaign # Wemissyoutoo on all
social media platforms to revive the bond between consumers and Maggi brand. It took them
sometime to revive from the losses and gain pre ban market share.

Activity 1
If you wish to set up an enterprise you must have a clear understanding of business
environment. Identify an enterprise and study whether the business environment is
conducive.
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1.3 BASIC PROPOSITIONS

As a prelude to the description and analysis of the business environment in any economy, you
may examine the three basic propositions given below:
1. Business is an economic activity.
2. A business firm is an economic unit.
3. Business decision-making is an economic process.
These propositions may be examined separately or jointly to justify the study of the
environment of business in any country.
Business is an economic activity
An economic activity involves the task of adjusting the means (resources) to the ends
(targets), or the ends to the means. An economic activity may assume different forms such as
consumption, production, distribution, and exchange. The nature of business differs
depending upon the form of economic activity being undertaken and organised. For
example, manufacture is primarily concerned with production; the stock exchange. For
example, manufacture is primarily concerned with production; the stock exchange business
of Government is to run the administration. The Government may also own, control and
mange public enterprises. The business of banks is to facilitate transactions with short-term
and long-term ends. These examples can be easily multiplied. The point to be noted is that
each business has a target to achieve, and for this purpose each business has some
resources at its disposal. Sometimes the target has to be matched with the given resources,
and sometimes the resources have to be matched with the given target, Either way, the task of
business is to optimize the outcome of economic activities.

A business firm is an economic unit

A business firm is essentially a transformation unit. It transforms input into outputs of goods
or services, or a combination of both. The nature of input requirements and the type of
output flows are determined by the size, structure, location and efficiency of the business
firm under consideration. Business firms may be of different sizes and forms. They may

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undertake different types of activities such as mining, manufacture, farming, trading,
transport, banking etc. The motivational objective underlying all these activities is the same
viz., profit maximization in the long run. Profit is essentially “a surplus value”- the value of
outputs in excess of the values of inputs or the surplus of revenue over the cost. A business
firm undertakes the transformational process to generate this “surplus value”. The firm can
grow further if the surplus value is productively invested. The firm, therefore, carefully plans
the optimum allocation of resources (i.e., men, money, material, machines, time, energy, etc.)
to get optimum production. The entire process of creating, mobilisation and utilisation of the
surplus constitutes the economic activity of the business firm.

Business decision-making is an economic process

Decision-making involves making a choice from a set of alternative courses of action. Choice
is at the root of all economic activity. The question of choice and evaluation arises because
of the relative scarcity of resources. If the resources had not been scarce, an unlimited
amount of ends could have been met. But the situation of resources constraint is very real. A
business firm thinks seriously about the optimum allocation of resources because resources
are limited in supply and most resources have alternative uses. The firm, therefore, intends to
get the best out of given resources or to minimise the use of resources for achieving a specific
target. In other words, when “input” is the constraining factor, the firm’s decision variable is
the “output”. And when “output” is the constraining factor, the firm’s decision variable is the
“input”. Whatever may be the decision variable, procurement or production, distribution or
sale, input or output, decision-making is invariably the process of selecting the best available
alternative. That is what makes it an economic pursuit.

1.4 NATURE AND SCOPE OF BUSINESS ENVIRONMENT

Every organisation operates in a certain kind of environment. Each organisation has some
opportunities and threats associated with various forces which may be external or internal in
nature.

Nature of Business Environment

1. Dynamic: Business environments such as internal and external business
environments are highly flexible and keep on changing. For example, changing
customer preferences, new competitors entering into the market, novel

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 technology, new marketing channels, new government policies and changing
demography.
2. Uncertain: It is very difficult to pre assume with any degree of certainty about
the factors influencing the business environment because they continue to
fluctuate very quickly.
3. Complex: The business environment is complex as it is continuously exposed to
uncertain challenges such as technological disruptions, global competition,
leadership change, shifting economic, social, and regulatory conditions etc. It
may be easy to scan the environment but its impact on business decisions will be
difficult to estimate. It is very difficult for a firm to survive and prosper in such
an uncertain environment.
4. Relativity: The business environment is associated with societal norms and local
conditions and this is the reason, why the business environment varies from
country to country, region to region which makes it more complex.
5. Interrelation: All the factors and forces of the business environment are related
to each other. For instance, with the proclivity of youth towards western culture,
the demand for fastfood is also rising. Take another example, change in political
parties will result in changing monetary policy, fiscal policies, government rules,
market conditions, technology, etc. Thus, all these factors are required to be
scanned properly as these factors are interrelated to each other.

Scope of Business Environment

a) Internal and external environment: Internal environment means those factors that
are within an organisation and influence the strength or weakness of the business. For
example, superior raw material, inefficient human resources, etc. External
environment means those factors which are beyond the control of the business and are
outside the organisation. They provide opportunities and pose threats to business. For
example, changing political and economic conditions, technological changes, etc.
b) Micro-environment and macro-environment: Sometimes internal and external
environment are interchangeably reffered as micro and macro environment
respectively. Micro-environment affects the working of a particular business. It
directly impacts business activities and incorporates customers, suppliers, market
intermediaries, competitors, etc. These factors are controllable to some extent. Macro-

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 environment is the general environment that impacts the working of all businesses. It
is uncontrollable and influences indirectly. Political conditions, economy, technology,
etc., are part of the macro environment. For example, Technological advancement
such as blockchain, Artificial Intelligence (AI) have changed the face of business
operations.
c) Controllable and uncontrollable environment: All those factors which are
governed by business come under a controllable environment. Internal factors are also
treated as controllable factors, such as money, men, materials, machines, etc.
Uncontrollable factors are external and are beyond the control of business namely
global, technological, legal and natural changes. For example, recent Corona
pandemic is a major example of uncontrollable factor. The pandemic has hugely
impacted the businesses and led to changes in strategies of operations.
d) Specific and general environment: Specific environment refers to external forces
that directly influence business enterprises’ decisions and actions and are directly
pertinent for the achievement of organisational goals. The main forces that include the
specific environment are customers, suppliers, competitors and pressure groups.
General environment refers to the economic, politico-legal, socio-cultural,
technological, demographic, and global conditions that influence organisations. These
external forces or factors impact organisations indirectly and organisations must plan,
organise, lead and control their activities by incorporating these factors.

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 1.5 TYPES OF BUSINESS ENVIRONMENT

There are certain factors or forces internal and external to the organisation influencing the
it in both positive and negative ways. These different components of the business
environment have been explained below as shown in Figure 1. 1.

Business
Environment

External Internal
Environment Environment

Micro Macro ‐ Value System

Environment Environment ‐ Mission and
Objectives
‐ Organisation
‐ Suppliers of ‐ Economic Structure
Inputs ‐ Politico‐ legal ‐ Corporate Culture
‐ Customers ‐ Technological ‐ Human Resources
‐ Marketing ‐ Global or ‐ Physical Resouces
Intermediaries International and Financial
‐ Competitors ‐ Socio‐cultural Capabilities
‐ Public ‐ Demographic
‐ Natural

Figure 1.1: Components of Business Environment

1. Internal Environment
This includes those factors or forces that exist within an organisation influencing the
performance of an organisation. These factors are controllable in nature and
organisations can attempt to change or modify these factors. Organisation’s resources
like men, materials, money, and machines are part of the internal environment. The
different internal factors are given below:

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 i. Values: The values are defined as ethical beliefs that guide the organisation in

attaining its mission and objectives. These are formulated by top-level managers
such as the board of directors. The extent to which these value systems are shared
by all in the organisation is a significant factor leading to its success.
ii. Mission and objectives: Mission reflects the overall purpose or reason for

organisation’s existence. A mission guides and affects the decisions and economic
activities of the organisation. Accordingly, an organisation can change or modify
its mission and objectives.
iii. Organisation structure: The organisational structure is the hierarchical
relationship explaining roles, responsibilities and supervision. The structure of the
board of directors, the professionalism of management, etc., are the part of the
organisation structure and are significant forces affecting business decisions. For
effective management and working of a business organisation and for prompt
decision making, the structure of the organisation should be conducive.
iv. Culture: Shared values and belief in an organisation determine its internal

environment also known as corporate culture. Organisation having strict

supervision and control reflects the lack of flexibility and unsatisfied employees.
These sets of values assist the employees to understand what organisation stands
for, what it considers, how it works. Cultural values of business, thus determine
the direction of activities.
v. Human resources: Human quality of a firm is an important factor of internal

environment. Skills, qualities, capabilities, attitude, competencies and commitment

of its employees, etc., contribute to the strengths and weaknesses of an
organisation. Organisations may find it difficult to carry out modernisation and
redesigning because of resistance by its employees.
vi. Physical resources and financial capabilities: Physical resources, like
machinery, plant and equipment facilities and financial capabilities of a firm
decides its competitive strength which is the significant factor for examining its
efficiency and unit cost of production. Moreover, research and development
capabilities of a company decides its ability to innovate and thus increase the
productivity of workers.

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2. External Environment
This includes those factors or forces that exist outside an organisation influencing the
performance of an organisation. These external factors can be further classified into
micro-environment and macro environment which are defined below.

A. Micro-Environment: Those factors which have a direct impact on business. The

different components under micro-environment are as follows:
i. Suppliers of inputs: The suppliers of inputs are a significant constituent of the
external micro environment of an organisation. Suppliers give raw materials and
resources to the firm. A firm should have more than one supplier for efficient
input inflows.
ii. Customers: Customers are the buyers of the firm's products and services.
Customers are an important part of the external micro-environment as a firm’s
survival and growth are dependent on sales of a product or service. Thus, it is
essential to keep the customers satisfied.
iii. Marketing intermediaries: Intermediaries play an essential role in selling and
distributing products to the final customers. Marketing intermediaries are an
important link between a business firm and its ultimate customers. Retailers and
wholesalers buy in bulk and sell business products and services to the ultimate
consumer.
iv. Competitors: Competitors are the rivalry in business influencing the business
strategies of the organisation. For example, Zomato and Swiggy are major
competitors in food delivery business and their strategies impact each other.
v. Public: Public or groups, such as media groups, women’s associations,
environmentalists, consumer protection groups, are significant factors in the
external micro-environment. The public can be defined as any group affecting a
company's ability to achieve its objectives. Recently People for the Ethical
Treatment of Animals (PETA) India protested against Amul (dairy company)
suggested them to produce vegan milk.

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B. Macro Environment: These are the factors or conditions which are general to all
businesses and are uncontrollable. Because of the uncontrollable nature of macro
forces, a firm needs to adjust or adapt itself to these external forces. These factors are
as follows:
i. Economic environment: Economic environment refers to all those forces and
factors which have an economic impact on businesses. It consists of the role of
the private and public sector, monetary and fiscal policy, role of saving and
investment, economic reforms, agriculture, industrial production, infrastructure,
planning, basic economic philosophy, stages of economic development, trade
cycles, national income, per capita income, money supply, international debt, etc.
For example, an increase in Groos Domestic Product (GDP) will increase
disposable income and thus further rise in demand for products.
ii. Politico-legal environment: Politico-legal environment constitutes all the factors
related to the activities of legislature, executive and judiciary which play a
leading role in shaping, directing, developing and controlling business activities.
For example, rules and regulations, framed by the government, like licensing
policy, Skill India movement, Digital India, Swachha Bharat Abhiyan, polythene
ban, etc., affect the business. Higher business growth can be achieved in a stable
and dynamic politico-legal environment.
iii. Technological environment: Technology is defined as the “Systematic
application of scientific or other organised knowledge to particular tasks”. The
technology incorporates both machines (hard technology) and ways of thinking
(soft technology). These organized knowledge and innovation provide new
methods of producing goods and services and latest ways of operating business.
Recent technological changes such as the online sale of grocery items, online
booking of air tickets, online payments, etc. have changed the business strategies.
As technology is changing fast, organisations should keep a close look at these
technological fluctuations for their adaptation in their business activities.
iv. Global or international environment: The global environment includes all
environmental factors having a global impact which is also important for shaping
business activity. In the era of globalisation, the whole world is a market.
Business analyses the international environment to cope up with the changes.

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 Principles and agreements of the World Trade Organisation (WTO), other
international treaties and protocols such as crude oil prices are examples of the
global environment.
v. Socio-cultural environment: The socio-cultural environment reflects customs
and values which influence business practices. People’s attitude towards work
and wealth, lifestyle, ethical issues, religion, the role of family, marriage,
education and also social responsiveness of business impact the business. For
example, foreign brands like McDonalds were sensitive to Indian culture and
avoided selling beef burgers in India.
vi. Demographic environment: Demographic environment includes the
composition and characteristics of the population. For example, Population size
and growth, the life expectancy of the people, rural-urban distribution of
population, the technological skills and educational levels of the labour force are
part of the demographic environment. These forces also impact the organisations’
functioning. For example, many MNCs are targeting Indian youth because of the
country’s demographic dividend.
vii. Natural environment: Natural environment includes geographical and
ecological resources like minerals and oil reserves, weather and climatic
conditions, water and forest resources, and port facilities. These are very
important for many business activities. For example, in places where climate
conditions such as temperatures are high, demand for coolers and air conditioners
will also be high. Similarly, demand for clothes and building materials is also
conditioned upon weather and climatic conditions. Natural calamities such as
floods, droughts, earthquakes, etc. greatly affect business activities.

1.6 IMPORTANCE OF BUSINESS ENVIRONMENT

Business environment plays an important role in the functioning of organisations in the

following ways:
I. Enable the organisation to identify the business opportunities and achieving
first-mover advantage: Many opportunities are provided by the business
environment to the organisation. Scanning the business environment will help the
organisation to attain the first-mover advantage.

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 II. Help the firms to identify the threats and early warning signals: The business
Enterprises who can scan the business environment and obtain qualitative
information on time will be able to get a warning signal to deal with negative
policies and constraints of the business environment.
III. Help in tapping and assembling resources: Resources such as raw material,
capital, money, labour, etc., are the necessary inputs to the business organisation.
All these inputs are obtained through the environment to the firms for carrying out
their activities and also expect something in return.
IV. Help in adjusting and adapting to rapid changes: Business environment
scanning assists the firms to scan and understand the rapid changes in the
environment and these changes are having important implications on business
strategies.
V. Assist in planning and policymaking: The major strategic plans and policies in
the organisation are formulated based on the business environment because the
policies and strategies have to be implemented in the presence of these
environmental factors.
VI. Help in performance improvement: Continuous scanning of business
environments can improve their performance. By incorporating changes in the
internal environment matching to external environment, business organisations
can enhance and prosper their market share.

1.7 ENVIRONMENTAL ANALYSIS

We know that all organisations perform within a framework of specific factors of business
environment. These can be internal as well external. A proper environmental analysis of the
business environment is very important. There are different steps involved in the
environmental analysis of a business. These are:
1. Scanning the internal / external factors.
2. Grouping of the scanned factors.
3. Observation of internal factors.
4. Monitoring external factors.
5. Defining the variables for the analysis.
6. Identifying specific techniques for analysis.

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 7. Forecasting.
8. Strategy formulation.
9. Evaluation.
In this section we will discuss SWOT analysis to familiarize ourselves with environmental
analysis.

SWOT analysis
SWOT analysis is the business analysis process of examining both the internal and external
environment of an organisation. Here, S, represents Strengths and W, represents Weaknesses.
Both these terms are internal constituents of an organisation. While O, represents available
Opportunities in the market and T, represents the possible Threats in the market. Both of
these are the external constituents of the organisation (Figure 1.2).

Environmental

Internal External Analysis

Analysis
-Opportunities
-Strengths
-Threats
-Weaknesses

Figure 1.2: SWOT analysis Framework

a. Strengths: It reflects the core competencies or capabilities of an organisation for

which it can achieve strategic advantages over its competitors. Even if the
organisation does not gain any advantages over its competitors, it indicates an
organisation’s capacities in which the organisation is having affirmative aspects. For
example, mobile payment platform PhonePe has the strength of easy user interface.
b. Weaknesses: Weaknesses means those factors which prevent successful results
within the organisations. These are exact opposites of Strengths. Strengths indicate

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 competitive advantages while weaknesses indicate the competitive disadvantages of
an organisation.
c. Opportunities: These are favourable circumstances present in the external
environment, which should be grabbed by the organisation, to enhance its strengths to
gain competitive advantage. An organisation strategist must be aware of the upcoming
opportunity in the market so that it could grab them on time and could raise revenues
and profits.
d. Threats: The term ‘threat’ reflects exposing vulnerability to something which leads
to adverse impact. In an external environment, if sudden or even gradual changes
occur which are not in favour of the organisation, then these represent threats to the
organisation.

The SWOT analysis is a tool to evaluate the strengths, weaknesses, opportunities and
threats of an organisation. Every organisation should do SWOT analysis very effectively
to explore both internal and external factors of an organisation and accordingly business
strategy should be formulated.

Activity 2
1. Explain the need for environmental analysis. How can it enchance organisational
effectiveness?
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
2. Select any company of your choice and explain the SWOT analysis of that company.
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
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17
 _____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
____________________________________________________________________

1.8 BASICS OF MACRO ECONOMICS

Since business is an economic activity, a business firm an economic unit, and business
decision-making an economic process, it is the economic environment of business which is
the primary consideration in evaluating the business policies, business strategies and business
tactics of a corporate entity in any national economy.

Economic transactions are the lifeline of the business and in the preceding sections, you have
learnt how the business environment is influenced by the economic policies and economic
structure prevailing in the country. So, students of the business environment must have some
understanding of the working of an economy, what are different sectors of the economy, how
they interact with one another, how monetary and fiscal policies influence the economy and
so on. In the following sections, we shall study about basics of macroeconomics.

Macroeconomics is primarily the study of the behaviour and performance of the economy as
a whole. The macroeconomic theories make use of macroeconomic models to explain and
establish the relationship among different macroeconomic variables. Income determination,
price level determination, investment, employment, product and money market equilibrium,
exchange rate, the balance of payments, etc. are the main areas of macroeconomic theories.
Macroeconomics also analyses the working and effects of major government policies like
monetary and fiscal policies, on the economy.

According to J.M.Culburtson
‘Macroeconomic theory is the theory of income, employment, price, and money’
According to Paul Samuelson
‘Macroeconomics is the study of the behaviour of the economy as a whole. It examines
the overall level of a nation’s output, employment, prices, and foreign trade’

18
 Interaction of Business and Macroeconomics

You must be wondering that we are students of Management then why should we worry
about economics and especially macroeconomics. What is the relationship between the
two? On the contrary, the understanding of macroeconomics, in particular, is of immense
importance for the students of Management. Let us understand this interaction with the
help of an example. Inflation is one of the prominent problems of macroeconomics.
Inflation refers to the situation in which prices of goods and services rises continuously
over a period of time. Inflation can affect both the consumer and producer depending
upon the cause of inflation whether it is demand-pull or cost-push. If it is demand-pull or
due to an increase in demand in relation to supply, then consumers are at a disadvantage.
Cost-push or increase in the cost of production (for example increase in input cost) affects
the supplier or producer. To alleviate the problem, the central bank of the country takes
the help of the Monetary Policy. One of the instruments of the monetary policy is
increasing the repo rates i.e. repo and reverse repo rate. This increase in repo rates leads
to both increases in the cost of borrowing for business and a shortage of money supply in
the system. These both affect the scale of production. So, producers and enterprises keep
a close eye on every move of the government concerning any change in monetary policy
and other policies.

Some Important Concepts of Macroeconomics

Let us understand some of the major concepts used in macroeconomics.

Net National Product (NNP) at Factor Cost (NNPFC) is commonly known as National
Income. The Gross National Product (GNP) or NNP can also be evaluated at factor cost. The
basic cause of difference between the two concepts is that NNP arises because some of the
allocations of market value do not go into the payments to the factors of production.

Gross Domestic Product (GDP)

GDP is defined “as the value of final goods and services produced within the borders of a
country during a fiscal year”. It also includes income earned locally by foreigners and
excludes income received by the nationals from abroad.
GDP is calculated at two prices- market prices (i.e.current prices) and constant prices.

19
GDP at Market Price (GDPMP): GDP at market price is the total value of final goods and
services produced within a year at current prices.
GDP at Constant Prices: GDP at constant prices estimates GDP in reference to some base
period.
For example, if we estimate GDP for 2020-21, then it will give us GDPMPfor the fiscal year
2020-21. If we estimate GDP with reference to some base year say 2004-05, then it is GDP at
constant prices or real GDP. The distinction between current and constant prices is important
as GDP at current prices could grow very rapidly if prices are rising. This increase will not
tell anything about the volume of production whether the total output is increasing or not. On
the other hand, growth in GDP at constant prices indicates a rise in the total
production/output of the country.

To obtain GDP at a constant price, GDP at market price is divided by GDP deflator and
multiplied by 100. GDP at constant prices is called real GDP. While calculating GDP at a
constant price, the base period is always mentioned.
• Aggregate Demand and Aggregate Supply
I. Aggregate Demand (AD):Aggregate Demand is one of the most important concepts
in macroeconomics. In simple words, it means total demand for consumer and capital
goods at a given price.

C= Consumption; I = Investment; G = Government Expenditure; X = Exports; and M

= Imports
This equation encapsulates the gist of Aggregate Demand. In the two-sector model,
there is an absence of G and (X-M) so the above equation becomes AD= C+I and
investment is assumed to be constant. Ultimately aggregate demand function is
largely dependent upon consumption expenditure or consumption function.
II. Aggregate Supply (AS): The Aggregate Supply (AS) shows the amount of output
firms plan to supply at different levels of prices or the total supply of goods and
services in an economy. Since firms like to sell more output with increasing product
prices, the AS has an upward sloping supply curve. The intersection of AD and AS
determines the short-run equilibrium in the economy.

20
• Multiplier or Investment Multiplier

Investment multiplier is of much importance in macroeconomics. It is a ratio of

change in income/national income to change in investment.

m = investment multiplier; ΔY = change in national income ; ΔI = change in

investment. Multiplier indicates that with one unit change in Investment how much
national income will change. So, it indicates the level of investment required to
achieve the desired level of national income. For example, if the value of m=2 and
investment is increased by Rs 100 crore then with this increase in investment level the
national income will increase by Rs 200 crore.

The Four Macroeconomic Sectors

Macroeconomics has primarily four sectors and the interplay and the interaction of
these sectors give momentum to the economy.
1. Household Sector
This sector covers all the individuals in the economy. The major function of this
sector is to supply the factors of production to the different sectors. There are four
factors of production i.e. land, labour, capital, and entrepreneur. The household sector
is the ultimate consumer who consumes the goods and services that are manufactured
by the firms and in return makes payments to the firms. This sector also provides the
savings and supply finance to the firms.

2. Firms
This sector comprises all the businesses, firms, and corporations. The major function
of this sector is to manufacture goods and supply services for sale in the economy.
They hire the factors of production and pay them factor payments namely rent, wages,
interest, and profits.

21
 3. Government Sector
This sector involves the centre, state, and local governments of a country. The major
function of this sector is the management and regulation of the economy. It is mostly
done by its monetary and fiscal policy. Monetary policy is related to the regulation of
the money supply in the economy. Fiscal policy is related to taxes, public
expenditure, and public debt. Tax and non-tax sources are the major sources of
revenue and revenue collected is spent on public health, services, infrastructure, etc.

4. The Foreign Sector

This sector takes into account all the economic transactions with the rest of the world.
The foreign sector primarily consists of export and imports of goods and services.
When we sell domestically produced goods and services to other economies, these are
called exports. Imports are items that the domestic country purchases from the outside
world. Net Exports are exports minus imports.

• The Three Markets

There are three major markets in an economy. These are 1) goods market, 2) factor
market, and 3) financial market or money market.

1) Goods Market
In this market, goods and services are exchanged among the different sectors. The
goods and services produced by the firms/industry are consumed by households, the
government, and the external sector.

2) Factor Market
The factors of production are traded in this market. The factor services are demanded
by the firms for the production of goods and services and these factors are paid in the
form of rent, wages and profits. For example, labour is a factor of production and is
owned by the household sector i.e. the workers. Workers offer their services and they
are hired by firms, the government, and the foreign sector. In return for labour
services, workers receive wages. This equilibrium of demand for labour and supply of
labour is part of the factor market. Similar is the case for other factors of production.

22
 3) Money Market
In this market, equilibrium is attained between demand for and supply of money.
Primarily money is provided in the form of savings by the household sector and is
channelized by financial institutions like banks. Firms borrow from these financial
institutions and equilibrium is attained in the money market. The government
regulates the money market by its monetary policy.

• Circular Flow of Income and Expenditure

The economic system can be viewed as the continuous flow of income and
expenditure. It is this flow that determines the size of the national income and the
overall worth of the economy. One of the major objectives of macroeconomics is
income determination, so it is important to understand the circular flow of income and
expenditure. This flow can be understood with the interaction of two sectors, three
sectors, and four sectors.

I. Two Sector Flow

In the two-sector flow, we have two sectors namely households and firms. we have
discussed the main characteristics of both these sectors in the previous paragraphs.
The two sector flow is depicted in Figure 1.3.

factors of production

Saving Investment
Households Firms
Banks

factor payments

Figure 1.3 : Two Sector Flow

Households supply factors of production viz land, labour, capital, and entrepreneurs to the
firms. Firms in return make factor payments rent, wages, interest, and profits to the
households. The flow from households to firms represents the real flow however the flow
from firms to households is money flow as all payments are made in monetary form. The
money flow from firms to households ultimately becomes the total income (Y) of the
23
households. Similarly, there is a flow of goods and services from firms to households. In
return for goods and services, households make payments to the firms which is again money
flow. This continuous real and money flow gives momentum to the economy.

Financial intermediaries like banks channelise the savings from the households to the firms.
The firms take the loans from the banks and other financial institutions. The primary
ingredient of loan creation by banks is the savings from households. Households save their
savings in the banks and then banks lend to firms.

In this circular flows of income and expenditure, there are certain leakages /withdrawals and
injections/additions. For example, savings by the households represent leakages from the
system. Saving is that part of income that is not consumed. The amount of saving and the size
of the circular flow are inversely related. More the savings less will be the size of circular
flow and vice versa. On the other hand, additional spending by households from past savings
or borrowings acts as an injection or addition to the circular flow. More the spending, bigger
the size of circular flow.

II. Three-Sector Model

In the three-sector model apart from the above-mentioned model one more sector i.e.
government sector enters into the circular flow. This model is depicted in Figure 1.4.

Government

Firms
Households

Figure 1.4 : Three Sector Model

24
Government affects the circular flow of income and expenditure through monetary and fiscal
policy. In our model, we will only consider the fiscal policy effect i.e. taxation and
government expenditure. Taxes both direct and indirect paid by both households and firms
act as a withdrawal from the flow just like savings. Taxes reduce the disposal income of both
households and firms which leads to a reduction in consumption and savings. On the other
hand, government expenditure is like injection to the circular flow. Government expenditure
gives more income into the hand of households that leads to an increase in consumption
expenditure. Similarly, purchases of goods and services by the government from firms
increase the income of the firms.Households also provide factors of production to the
government and in return receive factor payments.

III. Four-Sector Model

Let us now learn about the four-sector model of the economy. This model includes
households, firms, government, and the foreign sector.The four-sector economy has exports
as inflows/injections in the national income whereas the imports are treated as leakages/
outflows from national income.
Let us briefly discuss the export function and import function.

i) Export Function
The economic growth, economic development, and equitable distribution of income depend
upon the export levels of a country. Exports are needed for maintaining foreign exchange
reserves in an economy. Exports also play an important role in increasing the internal trade
and economic stability of a country. The exports of a country depend upon several factors.
Some are listed as follows:
a. The prices of domestic goods in comparison to prices of similar goods in
importing countries.
b. Trade-policy and tariff policies of importing country
c. Export subsidies
d. Income elasticity for import goods in importing countries
e. Level of imports by the domestic country
Thus, while computing national income, exports is taken as an autonomous
variable and represented by X.

25
ii) Import Function
Imports represented by M, play an equally important role in the growth of an economy.
Imports help strengthen the global presence of a country. The imports of a country depend
upon the following factors:
a. Import prices in relation to domestic prices
b. Domestic tariffs
c. Domestic trade policy
d. Income elasticity of imports
e. Income levels
f. Export levels
When the value of exports is more than the value of imports (i.e. X > M) we call it trade
surplus. However, when the value of imports is more than the value of exports (i.e. M > X) it
is called a trade deficit and represents an unfavourable situation for any economy. The four
sector circular flow is shown in figure 1.5.

Figure 1.5: Four Sector Flow

Let us assume that Households only supply labour to the foreign sector and in return, they
receive foreign remittances (money sent by a person residing abroad to their families in a

26
domestic country). Firms make payments for imports to the foreign sector and firms receive
exports receipts. The foreign sector provides different taxes and tariffs to the government and
the government in return formulates various schemes and policies which facilitates trade. If
the trade balance is positive (i.e,. X > M) then circular flow increases as it increases the
magnitudes of circular flows of income and expenditure.

Activity 3
1. Visit the website of the Ministry of Statistics and Programme Implementation and
find out the value of GDP at both current and constant prices for the last 5 years and
notice the change in both the series. Also, find out the change in the base year for the
calculation of GDP.
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
2. Read the Economic Survey of India for the year 2021-22 and make the list of
important exports and imports of India and also analyse the change which has taken
place in the composition of both exports and imports.
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_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
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27
1.9 SUMMARY

The environment is a complex phenomenon. The term environment consists of several

subsets, e.g., economic environment, socio-cultural environment, politico-legal environment,
technological environment, etc. It thus represents the totality of all kinds of environments
which have an impact on business. To a large extent, the environment is external to the firm.
Business firms in general have little influence on external forces. Depending upon the nature
and composition of several subsets of the environments, the business environment varies
from country to country, and may even vary in the same country from one point of time to
another. A number of problems are involved in the identification, description, explanation
and prediction of environmental factors. The environmental factors are dynamic. It is
difficult to conceptualise and/or quantify the proportion of change as well as the direction of
change in environmental factors.

Since the environment and the economic institutional framework affect business
organisations, it is imperative on the part of the management to scan the environment before
taking any decisions. The success of any business enterprise in a large measure, would
depend upon the proper understanding of the business environment.

Macroeconomics studies concepts like national income, nationwide employment, aggregate

demand, aggregate supply etc. It deals with the aggregates of all quantities as opposed to
microeconomics which deals with individual quantities. There are four macroeconomic
sectors, viz the Household Sector, firm sector, government sector and foreign sector. The
concept of aggregate demand and aggregate supply is the total demand and total supply of the
entire economy. Further, the concept of investment multiplier is of much importance to
analyse the effect of investment on the national income.

1.10 KEY WORDS

Environment : The totality of all factors or forces affecting business and external to and
often beyond the control or influence of individual business enterprises. The
environment comprises several subsets, e.g., economic environment, socio-cultural
environment, politico-legal environment, technigological environment, etc.

28
Internal Environment : Consists of factors existing within business organisations and which
are controllable.

External Environment: Refers to forces / factors outside an organisation and which are by
and large byond the control.

Economic Activity : Any activity undertaken with economic or financial motive or

consideration. In the business context, it is the task of adjusting the means/resources to the
needs/targets.

Decision-Making : Making a choice from a set of alternative courses of action.

Environmental Analysis: The process through which an organisation monitors and

comprehends various environmental forces in order to identify the opportunities and threats.

1.11 SELF-ASSESSMENT QUESTIONS

1. Explain the concept and nature of business environment.

2. Distinguish between micro environment and macro environment.
3. What are the various elements of internal environment of business?
4. Explain the process of environmental analysis.
5. How environmental analysis can enhance organisational effectiveness? Discuss in detail.

1.12 REFERENCES/ FURTHER READINGS

• N. Gregory Mankiw. Macroeconomics, Worth Publishers, 7th edition, 2010.

• Justine Paul, Business Environment: Text and Cases ; Tata McGraw – Hill
Publishing Company Ltd., New Delhi.
• Gupta C.B., Business Environment: Sultan Chand & Sons, New Delhi.

29
UNIT 2 ECONOMIC GROWTH AND DEVELOPMENT

Objectives

After reading this unit you should be able to:

• explain the concept of economic growth, economic development and some indicators
of economic development;
• discuss the Harrod-Domar model, Solow model, Endogenous growth theory and
major theories of under-development;
• familiraize with national income accounting, Gross Domestic Product (GDP), various
concepts related to national income along with three major methods of estimating
national income; and
• discuss Inflation and its effect on various aspects of the economy.

Structure

2.1 Introduction

2.2 Theories of Economic Growth

2.3 National Income

2.4 Inflation

2.5 Summary

2.6 Key Words

2.7 Self - Assessment Questions

2.8 References/ Further Readings

2.1 INTRODUCTION

Achieving a higher rate of economic growth is the objective of every nation around the
world. It is because of economic growth that production, employment, income, saving and
investment in the country increases. The standard of living improves and the people of the
country prosper. But how can this objective be met? what are the major factors which
contribute to achieving higher rate of economic growth? The various growth models and
theories given by economists provide an answer to this problem. The economic literature is

1
full of many theories like classical, Marxist, neoclassical and many others who have tried to
investigate the reasons behind underdevelopment and the possible solutions.However, in this
unit, you will learn about few models like Harrod-Domar, Solow and endogenous growth
theory along with some theories of underdevelopment.Harrod-Domar theory highlights the
role of saving and investment in achieving higher economic growth, the Solow model talks
about the importance of technology and capital accumulation whereas endogenous growth
theory emphasises the role and importance of investment in human and physical capital.
Having understood these theories in the next section you will read about national income,
various concepts related to national income and various methods of estimating it. Further, in
the last section, you will get yourself familiarise with the concept of inflation and how does it
impact different sections of society.

2.2 THEORIES OF ECONOMIC GROWTH

You all must have heard or read at one time or another that some countries of the world like
USA, Germany, etc. are termed as developed countries. On the other hand, countries like
India, China, etc. are classified as developing. Now you might be guessing how countries are
labelled as developed, developing or underdeveloped and why is it so that some are
developed and other underdeveloped. Well, the answer lies in the per capita income (PCY),
Gross Domestic Product (GDP) and Gross National Income (GNI). Countries are classified
into various categories of development and level of income based on a certain level of
income threshold. These thresholds are defined by different world organisations like United
Nations, World Bank, etc from time to time.

Economic growth indicates an increase in the national income and total output of the country.
The growingGDP, Gross National Income (GNI) and production capacity of the country are
some of the indicators of the economic growth of a nation. Economic growth can be viewed
as the material wellbeing of a country. On the other hand, economic development implies an
upward trend in the real income of the country over a long period. According to Schumpeter
economic development is a change in the stationary state of the economy. This change is
erratic, spontaneous and discontinuous. It is a movement from one equilibrium point to
another. It is a steady and gradual change that happens in long run and is a result of a general
increase in the rate of savings and population. It also implies a per capita increase in the
production of a country. Achieving a higher level of economic growth and economic

2
development are major planning goals of every nation. It is with a higher level of total output
that the standard of living, productive capacity and overall efficiency of the nation increases.
It is because of the increase in GDP that employment increases and more peoplefind jobs.
With an increase in employment level, income level improves and the problems of poverty
and deprivation can be eradicated.

Purchasing Power Parity (PPP)

One of the important curiosity among individuals/politicians/economists is to compare their

country with another and then draw many conclusions as per their convenience. However,
there is a well-developed methodology to do and it is called Purchasing Power Parity or PPP.
PPP is used to make comparisons between economic growth and standard of living among
nations. This task of international comparison is lead by World Bank through its statistical
initiative known as International Comparison Program (ICP). ICP provides comparable price
and volume measures of GDP and its expenditure aggregates among countries and publishes
PPP of the world’s economies.

PPP measures the purchasing power of the currency. It measures the total amount of goods
and services that a single unit of a currency of one country can buy in another country. For
example, if a pair of shoes cost Rs 1000 in India and if the same pair of shoes cost $50 in the
USA then the exchange rate between the US dollar and Indian rupee is $1= Rs 20. It means
$1 is equal to Rs 20. PPP is used to convert the cost of a basket of goods and services into
common currency and in this process, the price difference is eliminated across countries. PPP
equalises the purchasing power of currencies. It was important to discuss the PPP as data on
various developed indicators is published using the PPP approach.

Measurement of Economic Development

Economists are interested in measuring economic development because it can help in ranking
the countries and making meaningful comparisons. From time to time attempt has been made
to measure economic development with some socio-economic indicators ranging from Social
Development Index of United Nations Research Institute on Social Development, Physical
Quality of Life Index (PQLI) of Morris D Morris to Human Development Index (HDI). In
Modern times HDI is one most widely accepted index. Let us understand how does it work
and rank countries. HDI is prepared by United Nations Development Program (UNDP) and
was developed by economist Mahbub Ul Haq. It is a composite index made from 3 indicators
measuring key dimensions of human development. These three indicators are life expectancy

3
 (life expectancy index), expected years of schooling and mean years of schooling (education
index) and a decent standard of living measured by GNI per capita (PPP $) (GNI Index). The
top 5 countries in the HDI ranking of 2020 were Norway (1st), Ireland (2nd), Switzerland(3rd),
Hong Kong and Iceland (both 4th) and in the same ranking, India stood at 131 ranks out of
189 countries.

World Bank has prepared the list of countries based on income level. World Bank has divided countries
into 4 categories namely low- income economies, lower-middle-income economies, upper-middle-income
economies and high-income economies. The following table presents the summary of the World Bank
classification for the 2021 fiscal year.

Classification of Countries on the basis of Income

Classification of Income Level (Gross Countries *

Economies National Income per capita)
Low-income of $1,035 or less in 2019 Afghanistan, Haiti, Somalia, Madagascar,
Ethiopia
Lower middle-income $1,036 and $4,045 India, Sri Lanka, Bangladesh, Bhutan,
Myanmar, Pakistan
Upper middle-income $4,046 and $12,535 China,Thailand, Cuba, Maldives, Tuvalu

High-income $12,536 or more USA, UK, Finland, France, New Zealand,

Germany, Norway, Gibraltar, Oman
Source: World Bank
*The list include only major countries for more details visit World Bank webiste

In the preceding paragraph,we have discussed economic growth and economic development
and its importance, now in the following section, we will discuss in short, some major
theories of economic growth namely the Harrod-Domar model, Solow model, endogenous
growth theory and major theories of underdevelopment.

HARROD-DOMAR MODEL OF ECONOMIC GROWTH

This model of economic growth was given by two economists namely Roy Harrod and
EveseyDomar in the early 1950s. This model highlights the role of saving and investment in
economic growth. According to this model,the growth rate in an economy is dependent upon
two factors. One is the saving-income rate (S/Y) and the second, capital-output ratio (the

4
amount of capital required to produce a unit of output). The model is based on many
assumptions like no government interference in the working of the market (Laissez-faire),
full employment in the economy, closed economy, the law of constant returns to scale,
neutral technical progress, etc.

In this model, three growth rates are explained namely actual growth, warranted growth rate
and natural growth rate. The actual growth rate is determined by the actual rate of saving and
investment. It is expressed aschange in income divided by total income ( ). This growth rate

is determined by the saving-income ratio and capital-output ratio and its relationship can be
expressed in the following functional form.

Or

In above equation ,G = actual growth rate;

C = capital-output ratio; or (I = investment) and

s = saving-income rate (

For example, if the saving rate of an economy is 10 % and the capital-output ratio is 2, then
the economy would grow at 5 % per annum.

Warranted Growth Rate

The warranted growth rate is also known as full capacity growth rate or potential growth rate.
If the economy is making optimum use of its resources and working at full capacity then we
can say that this is the warranted rate of growth or Gw .

Natural Growth Rate

This rate of growth an economy can achieve with the help of natural resources. Factors like
capital equipment, technical knowledge, amount of fertile land, minerals and forest cover,
etc. determine the natural growth rate of an economy. This is the upper limit or the ceiling
beyond which we cannot go. It is denoted by Gn.

Harrod-Domar model highlights that investment has a dual role to play. It increases income
on one hand via multiplier process and on the other hand, it enhances the productive capacity

5
of the country. Further, lack of saving and deficiency of investment are major bottlenecks in
the path of economic growth. So there is a need to mobilise domestic savings or create a
domestic environment conducive for generating investment and achieving higher economic
growth.

SOLOW MODEL OF ECONOMIC GROWTH

Solow model is also known as neoclassical growth theory and was propounded by Robert
Solow of Massachusetts Institute of Technology in 1956, also awarded Nobel Prize for
Economics in 1987. This model propounds that changes in population growth rate, rate of
technological progress and saving rate bring about changes in the level of output. There are
three basic propositions of neoclassical growth theory. First, the growth of output in the long-
run steady state is determined by the rate of growth of the labour force and the rate of growth
of labour productivity. Second, the level of per capita income (PCY) depends upon the rate of
saving and investment to GDP. Third, there will be convergence in the income levels of
different countries with certain assumptions related to labour force growth,
savings,depreciation andproductivity growth.

The major assumptions of the model are:

I. The labour force grows at a constant exogenous rate

II. Constant returns to scale
III. Output is a function of capital and labour and both factors are subjected to
diminishing productivity.
IV. The elasticity of substitution is equal to 1.
V. All of the saving is converted into investment i.e. no independent investment function.
VI. Variable capital-output ratio.

Production Function

In the Solow model, the production function can be presented as

(1)

Where Y = Output; K = capital ; L = Labour and F is the functional relationship between

output and inputs. The important property of the production function is that it exhibits

6
constant returns to scale. It implies that if inputs increase by 10% then the output will also
increase by 10%.

(2)

In the above equation, is some positive number and in our preceding example the value of
is 10 %. Now if you put = 1/L in equation 2, then

or = (3)

In the above equation, is output per worker and is capital per worker. Equation

3 also states that output per worker is a function that depends on the amount of capital per
worker. The graphical representation of the production is given in the Figure 2.1.

Figure 2.1: Production Function

The slope of the production function in Figure 2.1 shows how much extra output per worker
is produced from an extra unit of capital per worker. As we have stated in the assumption that
diminishing return operates. It is because of this reason that the production function assumes
a flat shape as the amount of capital per worker increases or k increases.

Evolution of Capital and Steady-State

In the above section, you have understood about production function and now you will
examine how capital stock impacts economic growth. The change in the capital stock is
affected by two forces investment and depreciation of capital. How much proportion of
output will be allocated between consumption and investment is determined by saving rate S.
At any particular level of k, the output is , investment is and consumption is given
as . The higher the level of capital k, the greater the levels of output and

7
investment. Further, a constant function represents depreciation which takes place in capital
stock every year. Solow model predicts that the saving rate is one of the key determinants of
the steady-state capital stock. refers to labour productivity growth rate and labour force
grows at the rate ‘n’ per year. The total capital stock will tend to grow when savings are
greater than depreciation but capital per worker will grow when savings are greater than what
is needed to equip new workers with the same amount of capital that was available with the
existing workers.

The Solow equation (given in equation 4) shows the growth of capital-labour ratio (k)
depends on savings ( , depreciation( ) and labour force(nk).

(4)

In the Solow model, steady-state refers to a state in which output and capital per worker are
no longer changing. To find a steady-state, let us assume = 0 then equation 4 will become:
*
(5)

Figure 2.2: Equilibrium of capital per worker and output per worker.

From equation 5 and Figure 2.2, we can see that k* is the level of capital per worker when the
economy is in its steady state. The equilibrium which is attained in the above figure is the
stable equilibrium and it highlights that saving per worker (sf(k*)) is just equal to k*, the
amount of capital per worker needed to replace depreciating capital and nk* which needs to
be added to labour force growth. In the steady-state, if k is higher or lower than equilibrium
k*, the economy will return back to its original equilibrium value. As you can see from the
diagram that if for some reason we are on the left of k* , then k < k* and (n+ ) k < sf(k) and
in this scenario, >0, and because of this result k in the economy will grow and move
toward equilibrium point k*.

8
In the above section, you must have understood the neo-classical model, further one of the
major implication of this model is that there will be conditional convergence in the level of
income of various economies.

Endogenous Growth/ New Growth Theory

The central idea of endogenous growth theory is that the economic growth of a nation is
generated by the factors which are within the production process or endogenous like
technological change or increasing returns to scale rather than exogenous factors. GNI
growth is a natural consequence of long-run equilibrium. This conclusion is in contrast to the
famous belief of the neo-classical theory. The major objective of this new growth theory is to
explain differences in the growth rate observed by developed and underdeveloped countries.
Further, the theory assumes increasing returns to scale in production function which implies
that proportionate change in output will be more than proportionate change in inputs.
Moreover, they have highlighted the role of externalities and further propagated that these
externalities do impact the rate of return on capital investment. Externalities are the cost or
benefits that originate from either production or consumption of a good or service. Heavy
investment in human capital like providing training, imparting skill, etc generate external
economies which mitigates the negative effect of diminishing returns, rather it leads to
increasing returns to scale and a higher level of productivity.

The simple equation explaining endogenous growth can be expressed as :

Here Y refers to output or growth and A is the constant marginal productivity of capital i.e.
K. Above type of production function is linear in nature. In the above equation, K, not only
includes physical capital alone but human capital also. Endogenous growth theory propagates
the important role of saving and human capital investment in achieving a higher level of
growth. The higher the level of savings in the economy, the higher will be capital stock and
national income.

Similarly, this theory also explains that a higher level of the international flow of capital
widens the inequality gap between developed and underdeveloped countries. According to
theory, developing countries offer a higher rate of returns on investment which lures the
capital flow towards these countries. But developing countries have much lower levels of
complementary investment in human capital ( investment that supplements and support other

9
productive factors). These countries are marred by a lower level of investment in
infrastructure, education, schooling, research and development. So, these countries are unable
to fully utilise the benefits of international capital flows. Complementary investments create
positive externalities and when these private and social benefits are realised, the government
also contributes to efficient resource allocation. More and more public goods ( like roads,
railways etc) are created by the government agencies. Similarly, the government can
encourage private investment in knowledge-intensive industries like education, training, etc
which leads to the creation of more and more human capital. These changes ultimately help
in mitigating the drawback of diminishing returns. Endogenous growth theories suggest that
government or public policy should work in the direction of expanding the budget and
expenditures on the creation of human capital and promoting/creating a conducive
environment that attracts foreign private investment in the fields like software development,
information and technology, telecommunication, etc.

Major Theories of Under-Development

In the economic literature, there are a vast number of theories related to under-development.
As discussing all of them are beyond the scope of this unit, we present the details about major
theories of underdevelopment namely vicious circle of poverty, low-level equilibrium trap,
critical minimum effort, big push and stages of economic growth.

The Vicious Circle of Poverty Theory: This theory is associated with Prof Nurkse who
propounded that the main reason for the backwardness of underdeveloped countries is the
vicious circle of poverty. According to Prof Nurkse, the vicious circle of poverty is-

“ circular constellation of forces tending to act and react in such a way as to keep a country
in the state of poverty”

Figure 2.3 illustrates how this circle works from both supply and demand side. From the
supply side, low income, low rate of savings and investment, low rate of capital formation
which leads to low productivity and production. From the demand side, low income leads to
low consumption and demand for goods and services which creates less incentive for
investment and production. Underdeveloped countries need to break this circle with the help
of entrepreneurship and the labour force.

10
 Figure 2. 3: Vicious Circle of Poverty

Low Level of Equilibrium Trap Model: Richard Nelson (1956) gave this theory of low
level of equilibrium trap in which he highlights that underdeveloped are trapped in a low
level of income. He propounds that in UDCs there is low per capita income. It is because of
poverty that individual's income levels are low which are the cause of low saving and
investment rate and ultimately low national income. Accordingly, a quantum leap above
minimum per capita income is required to above which people are able to raise the level of
savings and this results in a higher level of national income and economic growth.

Critical Minimum Effort Theory: The critical minimum effort theory is associated with
economist Harvey Leibenstein. Leibenstein was of the opinion that underdeveloped countries
were entrapped in the vicious cycle of poverty and to rise above this poverty trap a minimum
level of investment or critical minimum effort is needed. This minimum level of investment
is of paramount importance for raising per capita income and economic growth. According to
the theory in every economy there are two forces : a) income depressing forces (or shocks)
that lead to a fall in per capita income and b) income-generating forces (or stimulants). The
main feature of underdeveloped economies is that income depressing forces are abundant and
are one of the main reasons for their underdevelopment and to overcome these hurdles or to
break the chain of underdevelopment a critical level of investment is needed.

Theory of Big Push:Prof. Paul N. Rosenstein Rodan gave the theory of big push in 1943.
According to the theory of big push, ‘bit by bit’ investment programme will not yield the

11
desired result in underdeveloped countries and they need huge and comprehensive investment
package (big-push) to move from the stage of underdevelopment towards development.
Citing an example of an aeroplane he says that an aeroplane needs some critical ground speed
to take off and become airborne. Same for an economy a big push is needed to unshackle
itself from chains of underdevelopment. He has identified three kinds of indivisibilities
intending to specify the areas where big push needs to be applied namely indivisibilities in
the production function, indivisibility of demand and indivisibility of savings. Indivisibilities
in the production function may be due to inputs, output or processes and these lead to
increasing returns. An important form of indivisibilities is the social overhead capital like
infrastructure which area major obstacle to economic development and a large sum of
investment is required to overcome this obstacle. Indivisibilities in demand requires that
investment be made in many industries which could mutually support each other instead of
just concentrating on a few for the purpose of complementary demand. Lastly,
underdeveloped countries face a huge dearth of supply of savings due to low-income levels
and this leads to low investment.

Rostow’s Stages of Economic Growth: Rostow (1959) presented the 5 stages of economic
growth which all countries must pass to become developed. The 5 stages are traditional
society, precondition to take off, take off, drive to maturity and age of high mass
consumption. Traditional society is predominant agrarian and production function is
primitive with no scientific temper or perspective. In precondition to take off which is the
transitional phase, ideas begin to germinate for economic progress and better lives for the
present and future. Manufacturing began to develop along with agriculture and the
establishment of institutions for mobilising savings and investment. Take off stage is marked
by dynamic changes in society and a substantial increase in the standard of living. Take off
stage requires the rate of investment which is the range of 5 to 10 % of GNP. Development of
the manufacturing sector and the existence of social, political and institutional framework is
another feature of the take-off stage. According to Rostow after 40 years of takeoff stage,
there is a long interval. In this interval, diversification takes place in all sectors of the
economy. Multiple industries are set up and the process of industrialisation is highly
sophisticated and manufacturing of consumer durables picks up along with capital goods. A
large investment is taken up in infrastructure both physical and social. In the age of high
consumption, the industrial sector dominates the economy, people have a large amount of
disposable income and the urbanisation process gain heavy momentum.

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Activity 1

1. Discuss some of the features and limitations of Harrod-Domar Model of growth.

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2. What are the various stages of economic growth as mentiond in Rostow Theory?
In your opinion, Indian Economy is passing through which stage, support your
answer with data and figures.

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2.3 NATIONAL INCOME

The health and wellbeing of an economy can be judged by the amount of total income that
the citizens of the economy are earning. National Income accounts help us to understand the
growth and trajectory of the economy. The figures of national income accounting (NIA) are
used to make international comparisons. It shows how our country is doing (economically)
in relation to other countries. The planning process of any country is heavily dependent on
these numbers. The interrelationship between different players in the economy can be better
understood in the light of these estimates.

In the NIA, Gross Domestic Product (GDP) is one of the most essential components. The
entire series of national income revolves around this component. Most importantly figures of
national income are derived from the figures of GDP. So to understand national income it is
essential to understand this component. GDP in the simplest sense is the market value of all

13
final goods and services which are produced by the residents of a country within the domestic
territory of a country in a given period of time.

Before we move further few points about GDP needs to be understood. First, it is the market
value of final goods and services. Market value is reflected as market prices and market
prices indeed represent the willingness to pay by the consumers. So, the value of goods and
services are reflected by market prices. Second, it includes only the value of the final goods.
It means that the intermediate goods are excluded when calculating GDP. It is because to
avoid the problem of double counting. Third, goods and services produced by the residents
of the country within the boundaries of the country are included. Fourth, it measures the
value of production which takes place within the specific time period usually fiscal year or a
quarter.GDP indeed measures total income and total expenditure in an economy. However,
they both are the same because for an economy as a whole income must equal expenditure.

Let us take an example. In every economic transaction, there are two parties namely buyer
and seller so one person’s income is the other’s expenditure. For example, Mehta decorator
and painters were given the order to paint the courtyard of Mr Verma and the deal was signed
off with the contract of Rs 10,000 for doing this work. In this example, Mr Verma is a buyer
of the service and Mehta decorator and painters is the seller. The company earns Rs 10,000
and Mr Verma spends Rs 10,000. In this example, the amount of Mr Verma expenditure is
equal to Mehta decorator and painters income. So, whether you measure GDP from the
Income side or expenditure side,it will rise by Rs 1000 in the above example.

Different Concepts related to National Income

Gross National Product or GNP: It is the market value of all final goods and services
produced in the year alongwith net factor income from abroad (NFIA). NFIA is the
difference between factor income received (like rent, interest and profit) from abroad and
factor income paid abroad.

GNP = GDP + NFIA

Net National Product or NNP = It is the market value of all final goods and services
produced by country citizens both domestically and internationally in a given period. NNP is
indeed national income that is available to the economy for consumption and investment.
NNP divided by total population gives per capita income.

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 NNP = GNP - Depreciation

Net Domestic Product (NDP) = It refers to the economic output of the country adjusted for
depreciation (or consumption of fixed capital).

NDP = GDP - Depreciation

Market Price (MP): When any measure of national income like NNP is calculated at a
market price it includes the cost of production and also various taxes/subsidies which are
imposed and provided by the government. Net Indirect tax isthe difference between indirect
tax (like Goods and Services Tax or GST, Value-Added Tax or VAT)and subsidies.

NNPMP = NNP + Net Indirect Taxes (NIT)

Factor Price(FP): In contrast to market price, factor price excludes the effect of NIT.

NNPFC = NNPMP - NIT

Personal Income (PI): PI is the income which an individual or households receive from all
the sources before paying taxes. It includes income from factor services like wages, rent and
interest along with transfer payment, payments like pensions, social security benefits. The
personal income includes transfer payment which is not included in national income.

Disposable Income: It is income that is left with individuals after paying taxes and other
compulsory payments to the government. It is the actual amount of money that is in the hands
of the individual for consumption and other expenditures.

Disposal Income = Personal Income – (taxes + fees+ fines)

Different Approaches of Estimating National Income

There are three approaches of measuring national income namely:

• Product Method or Value Added Method

• Income Method, and
• Expenditure Method

There is one common thing about these three methods, the figures of GDP will be the same
irrespective of any method which you use in estimating National Income.

15
Product Method or Value Added Method

Under the value added method,GDP is calculated by the sum total of gross value added of all the
firms in the economy. Value added by a single firm is obtained by the substracting value of
intermediate goods from the value of output. Let us understand this with the help of an example.
Suppose there are two producers in the economy, one producing cotton and the other producing cloth.
To simplify, we assume that the cotton producer uses only one input i.e. human labour and he sells
some proportion of cotton to the producer producing cloth. On the other hand, cloth producer also
makes use of only one input i.e. cloth. The total value of cotton that the cotton producer has produced
is Rs 500. Out of this Rs 500, cotton worth 450 was sold to the cloth producer. The cloth producer
having used cotton worth Rs 450 produced cloth whose value was estimated to be Rs 1500. Based on
the example cited above, what is the value of total production in the economy? If we were to simply
add up the contribution of each producer then the value of total production would be Rs 500 (share of
cotton producer) + Rs 1500 ( value of output created by cloth producer) will equal Rs 2000.

However, this estimate is not correct. The value of output which the cotton producer has generated is
indeed Rs 500 as he has not paid any amount for the use of intermediate goods (raw material). Though
the same is not true for cloth producer. For calculating the net contribution of his, we need to subtract
the value of intermediate good (i.e. cotton) which amounts to Rs 450 from his contribution. If we do
not do this exercise then we commit the error called ‘double counting’ (counting the value of good
more than once). In our case, Rs 450 worth of cotton will be counted twice. One, as part of total
output produced by cotton producer and second as the value of input while producing cloth. So, the
value added by the cloth producer will be Rs 1500 (value of output) – Rs 450 ( value of intermediate
good) = Rs 1050. The aggregate value of production in the economy consisting of these two producers
will be Rs 500 + Rs 1050 = Rs 1550.

Here at this point, it is necessary to introduce you to the concept of depreciation also known
as consumption of fixed capital. Capital goods like the plant, building etc, when used in the
production process are subject to deterioration which is called depreciation. If we subtract the
value of depreciation from the gross value we arrive at the new concept ‘Net value’. For
instance, in the previous section you learnt about NDP.

NDP= GDP – Depreciation

And similarly, we can estimate the value of Net Value Added as

Net Value Added = Gross Value Product – Depreciation

16
So if we add up the net value added of every good produced we arrive at national output.

Income Method

In the productionprocess, the producer makes use of factors of production namely land,
labour, capital and entrepreneur. In return for their services rendered they receive rent, wages,
interest and profit combinedly called factor payments. Under the income method, national
income is measured by aggregating these factor incomes generated by different producing
units within the domestic territory of the country in one fiscal year.

The different components of the income method are the compensation of employees, rent,
interest, profit and mixed-income. Wages and salaries paid in cash and kind and the
contribution made by the employer to the social security scheme of employees are the major
components of compensation of employees.

Rent is the payment that accrues from ownership of land and building. Interest is the payment
that one receives from lending his funds. Profit is earned by an entrepreneur and it has three
components corporate tax, dividend and retained earnings. Corporate tax is the tax paid to the
government. The dividend is paid to the shareholders of the company and some part of the
profit is retained as the reserves to meet unforeseen contingencies or for business expansion
and growth is termed as retained earnings. Income earned by self-employed persons is termed
as mixed-income.The sum of these five components gives us the value of the net domestic
product at factor cost (NDPFC).

NDPFC = Compensation of employees+ Rent + Interest+ Profit + Mixed Income of self

employed

Further adding net factor income from abroad NFIA(difference between factor income which
is received from abroad and paid abroad ) gives the value of the net national product at factor
cost (national income).

NNPFC = NDPFC + NFIA

Expenditure Method

Under the expenditure method of estimating GDP the demand side of the products is looked
at. GDP is the sum total of all the expenditures made on the final goods and services within
the country. Following equation summaries GDP as:

17
In this equation C, I, G, X and M stands for C = private consumptionexpenditure,I =
Investment made by households and business, G = Government expenditure, X = Exports of
goods and services, M = Imports of goods and services.
Major Components of the Expenditure Method
i. Private consumption expenditure: It includes expenditure by the households on both
durable and non-durable goods along with different services.
ii. Investment or gross fixed capital formation : It included expenditure undertaken by
both households and government for investment purposes.
iii. Government expenditure: Expenditure undertaken by the government on the purchase
of goods and services along with expenditure on building infrastructure, payment for
salaries, etc.
iv. Net export: It is the difference calculated by substracting total imports from total
exports. It represents the contribution of the foreign sector to the GDP.

Some Precautions While Estimating National Income

Following items must be excluded while measuring national income.

• The expenditure of intermediate goods and services otherwise it will encounter the
problem of double counting.

• Transfer payments like scholarships, pension, etc.

• Income earned from second-hand goods.

• Income from sales of shares, bonds, windfall gains like lotteries.

Activity 2

1. Visit the website of the National Statistical Office, Ministry of Statistics &
Programme Implementation, Government of India and analyse the trends in GDP,
GNP, depreciation and other estimates of national income for one fiscal year.

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2.4 INFLATION

In this section, you will study the meaning of Inflation, different methods of its measurement
and how does it affect different sections and dimensions of an economy.

Definition of Inflation

One of the most daunting task before economists is to define Inflation as there are multitudes
of problems in penning down one definition. Therefore there is no universal definition for
this problem. Many economists have given different definition like according to Coulborn,
Inflation can be understood as a situation whereby “too much money chases too few goods”.
A situation in which the value of money falls and price rises is inflation according to
Crowther. These and other definitions have one or another deficiency.

Economists are unanimous that inflation refers to a ‘persistent’ and ‘appreciable’ rise in the
general price level. However, the word persistent and appreciable are not clearly defined so
there is space for ambiguity. For example, whether the rate of price rise by 1 %, 5 % or 30 %
is considerable or there is some other rate which is deemed to be considerable.

The issue of inflation is of utmost importance because it is both boon as well as bane. A rise
in prices is necessary for producers to induce them to supply more in the market. But higher
prices lead to more burden on the consumer pocket and it may also create many political and
social problems. So, what an economy needs is a moderate rate of inflation. This takes us to
another question, what is a moderate rate of inflation? The answer to this question varies
from country to country depending on the level of development. For instance, in the case of
India, a committee set up by the Reserve Bank of India (RBI) to review the monetary system
which is popularly known as Chakravarty Committee (1985) recommended that 4 percent
rate of Inflation is desirable for India’s economic growth.

Different Methods of Measuring Inflation

There are two common methods of measuring inflation.

19
 • Changes in Price Index Number (PIN)
• Gross National Product (GNP) deflator

Changes in Price Index Number (PIN)

The rate of inflation can be estimated by measuring the change in the price index number.
The formula for this change is

are price index number in the current and preceding year

Let us assume that Consumer Price Index (CPI) on March 31, 2020, was 300 and it increased
to 320 on March 31, 2021, then the rate of inflation in 2020-21 will be:

Consumer Price Index (CPI) and Wholesale Price Index (WPI)are two popular price indexes
thatare used to measure inflation. Further in India, CPI has 3 sub-components namely CPI
rural, urban and combined.

GNP Deflator

GNP deflator or known as GNP implicit price deflator. As it is not directly obtained like CPI
and WPI it is called implicit. It can be obtained by the following formula

Nominal GNP is the GNP at the prevailing prices and real GNP is at constant prices of the
base year.

Out of these two indexes, the GNP deflator is considered to be better because of its broadest
coverage.

Different Types of Inflation

The major types of Inflation are:

• Creeping /Moderate Inflation

• Galloping Inflation

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 • Hyper Inflation

Creeping /Moderate Inflation

Generally, when the rate of inflation is single-digit it is termed as the creeping or moderate
rate of inflation. This type of inflation is mostly expected by both consumer and producer and
they plan economic activities accordingly.

Galloping Inflation

When inflation is in the double-triple digit range a year it is termed as galloping. This type of
inflation erodes the savings of the economy and has a disastrous effect on the fixed income
group.

Hyper Inflation

This is one of the most dangerous forms of inflation in which price rise by more than 50 % a
month. During this period paper currency losses it value drastically and current note of
biggest possible denomination are printed. World history is full of many examples when
economies witnessed the episode of hyperinflation. For example in Germany, the wholesale
price index increased by 100 million percent between December 1922 and November 1923.

Causes of Inflation

The main causes of inflation are clubbed under two major headings:

• Demand-Pull Inflation
• Cost-Push Inflation

Demand-Pull Inflation

According to demand-pull inflation, the main cause of inflation is the increase in demand or
aggregate demand (in Keynesian terms). According to Keynes, aggregate demand consists of
four major components i.e. consumption, investment, government expenditure and net
exports i.e. (this equation we saw in the expenditure method of
measuring national income also). If any of the constituent increases then it will lead to an
increase in AD and which will further lead to a rise in prices. Similarly, according to
Monetarists ( a school of thought in economics that gives much importance to monetary
factors) increase in money supply leads to an increase in AD. Due to increases in money

21
supply, more money is given in the hands of the public and they tend to either consume it or
invest it and in both situations, AD will increase.

Cost-Push Inflation

The increase in the cost of production is the major cause of cost-push inflation. Whenever the
cost of production increases, producer tends to shift the burden of this increase in form of
higher prices on to consumers. An increase in money wages due to pressure of trade unions,
decrease in the supply of raw material, increase in the prices of inputs like raw materials etc.
are some of the major constituents of cost-push inflation.

Effects of Inflation

Inflation affects almost all the economic agents of the economy be it consumer, producer or
government. The favourable or unfavourable effect depends upon the rate of inflation. In this
section, you will understand how does it impact the distribution of income and wealth,
producers, wage earners, borrowers and lenders and some other segments of the economy.

Impact on Income Distribution

How will inflation affect income and wealth distribution depends upon the prices of the
output which the producer produces and the prices of the inputs like labour and land. If
output prices rise more than input prices, then income will be distributed in the favour of the
producer or the profit earner or the employer. The plausible explanation is when the price of
output rises, it translates to higher revenue and profit of the producer. So the revenue-wage
gap increases and the larger share of the national income goes to the employer. The overall
impact is that firm/producer who was already rich they get even richer and the poor
(especially labour) get poorer.

Deterioration in the Value of Money

Inflation erodes the purchasing power of money. It implies that the real wages or real income
decline with a rise in prices. For example, let us suppose that the price of good X was Rs 10
per piece and you have Rs 500 as your money income. So if you spend your entire income on
good X, you could buy 50 units/pieces. Now keeping other things constant the price of good
X rise to Rs 20 per piece. Now the same Rs 500 can fetch you only 25 units of X good. So the
currency denomination remains the same but its purchasing power reduces. You can buy
fewer goods with the same income. This type of effect is most harmful to daily wage earners,

22
persons with fixed income and employees working in the unorganised sector, as they do not
have any safeguard against this price rise.

Impact on Borrowers and Lenders

It is the borrowers who tend to gain due to inflation and lenders lose. Now suppose you are a
borrower and you borrow money at the prevailing rate of inflation. Now when you repay the
same amount to your lender no doubt you are paying the same amount with the rate of
interest but the real value of money has reduced. More specifically you pay less in terms of
purchasing power or goods and services. So you(borrower) gain and your lender losses.

Methods of Taming Inflation

Monetary policy is one of the policy option and direct method of controlling inflation.
Reserve Bank of India makes use of monetary policy to regulate the supply of credit in the
market. The various tools and methods used within the monetary policy are discussed in
Unit-5.

Activity 3

1. Read the chapter on Prices and Inflation in the Economic Survey of the current year
and analyse the situation of inflation and the major steps undertaken by the
government to control the problem.

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2.5 SUMMARY

This unit has given a detailed account of economic growth and development. A clear
understanding of the difference between economic growth and development is of paramount
importance. The different theories of growth as discussed in the preceding sections has
equipped us with ideas as to variables like saving, investment, capital accumulation, human
capital are necessary for the economy to achieve higher levels of growth.

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Similarly, the unit discussed in detail about GDP and national income and the various
methods with which the national income estimates can be calculated. The value added
method calculates national income from the production side. Income method combines the
factors of income (like wages, rent, interest and profit) along with income received from
abroad to arrive at national income figures. The expenditure method takes the route of the
expenditure side of the economy to calculate national income.

In the last section of the unit, you have learnt about the meaning of inflation. The different
methods of measuring inflation like CPI, WPI and GNP deflator along with various reasons
for inflation and the effect of inflation on income distribution, wage earners, fixed income
groups, borrowers and lenders.

2.6 KEY WORDS

Gross Domestic Product (GDP): Market value of all final goods and services which are
produced by the residents of a country within the domestic territory of a country in a given
period of time.

Capital-Output Ratio: The units of capital needed to produce one unit of output.

Per capita Income: It is the total income of the country divided by the total population.
Production Function : It is functional relationship between output and various inputs.

2.7 SELF- ASSESSMENT QUESTIONS

1. Highlight the major assumptions of the Harrod-Domar model of economic growth.

2. What are the major conclusions of the Solow model of economic growth?

3. What are the major ideas of Endogenous growth theory?

4. Differentiate between galloping and hyperinflation?
5. Explain some of the methods of estimating inflation.

2.8 REFERENCES/ FURTHER READINGS

1. Dwivedi, D.N (2015). Macroeconomics : Theory and Policy, Tata Mcgraw Hill, New
Delhi.
2. Thirwall. A.P. (2006). Growth and Development with Special Reference to
Developing Economies. 8th Edition, Palgrave, Macmillan, New York.

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3. Todaro, M.P. and Smith, S.C. (2003). Economic Development, Pearson Eduction
Limited, New Delhi.

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UNIT 4 BUSINESS ETHICS AND CORPORATE SOCIAL RESPONSIBILITY (CSR)

Objectives
After reading this unit you should be able to:

• define the concept of Business Ethics;

• explain the need for Business Ethics;
• define Corporate Social Responsibility;
• discuss the benefits and drivers of Corporate Social Responsibility (CSR); and
• identify CSR initiatives by the companies.

Structure

4.1 Introduction

4.2 Business Ethics

4.3 Sources of Ethics

4.4 Importance of Business Ethics

4.5 Ethical Issues in Business

4.6 Corporate Governance and Corporate Sustainability

4.7 Corporate Social Responsibility (CSR)

4.8 Benefits of CSR

4.9 Drivers of CSR

4.10 CSR Initiatives in Indian Companies

4.11 Summary

4.12 Key Words

4.13 Self-Assessment Questions

4.14 References/ Further Readings

4.1 INTRODUCTION

For organisations while ensuring growth is important, ensuring that it takes place in an ethical,
just and inclusive manner is even more important. They have to also ensure that the conduct of
business activities conform to the existing norms of accepted behavior and are run in a socially
responsible manner. Corporate governance plays an important role in the way businesses are
directed and controlled.

This unit focuses on the significance of business ethics and corporate governance in business. It
discusses the concept and benefits of Corporate Social Responsibility (CSR) and some of the
CSR initiatives by the companies.

4.2 BUSINESS ETHICS

Business ethics are a kind of applied ethics. It is the application of moral or ethical norms to
business. The term ethics has its origin from the Greek word ‘ethos’, which means character or
custom- the distinguishing character, sentiment, moral nature, or guiding beliefs of a person, group,
or institution. Ethics are a set of principles or standards of human conduct that govern the
behaviour of individuals or organisations.

Ethics can be defined as the discipline dealing with moral duties and obligations, and explanation
regarding what is good or not good for others and for us. Ethics is the study of moral decisions that
are made by us in the course of performance of our duties. Ethics is the study of characteristics of
morals and it also deals with moral choices that are made in relationship with others. Business
ethics comprises the principles and standards that guide behaviour in the conduct of business.
Businesses must balance their desire to maximize profits against needs of its stakeholders.
Maintaining this balance often requires trade-offs. To address these unique aspects of businesses,
rules, articulated and implicit, are developed to guide the businesses to earn profits without
harming individuals or society as awhole.

Difference between Ethics and Law

While law is obligatory and violation of law attracts penalties from the justice system, ethics are
more voluntary in nature. However, not acting ethically might lead to violation of laws, as most
laws are in one way or the other a codification of ethics.

Business ethics can be said to begin where the law ends. Business ethics is primarily concerned
with those issues not covered by the law, or where there is no definite consensus on whether
something is right or wrong. Business ethics is about the grey areas of business, where values are
in conflict. In such scenarios, there might not be a definitive ‘right answer’.

4.3 SOURCES OF ETHICS

1. Genetically imbibed: Traits like cooperation and selflessness stand centric to the ethical
system and it has been witnessed to be carried from one generation to the other.
 Schooling focuses on ethics to be core of the child development. This is complemented
with the learning from the parents and the society.
2. Religion: The acceptance of religion as ‘law’ has its roots before the onset of the legal
system. Psychologically, this belief or faith in the religion which makes people comply to
the imposed restrictions to accept any unsolicited behaviour in the society.
3. Culture: Culture also drives ethics. Customs, societal norms, traditions and standards get
passed on to next generations. Culture varies from one religion to the other but the ethical
essence doesn’t differ much. Unethical practices are not supported by the culture
irrespective of the wide geographical differences.
4. Philosophical System: It is culturally initiated to affect ethical conduct of a person or
society. There have been many thinking personalities in India who have postulated their
experiences for actions into the society. Mahatma Gandhi, Swami Vivekanand, Subhash
Chandra Bose, Raja Ram Mohan Roy, Bhagat Singh and Swami Dayanand Saraswati had
varied philosophical perspectives which modulated to form and govern the ethical
conduct of people from inspiration and learning.
5. The Legal System: It has been rightly said that “Laws represent a rough approximation
of a society's ethical standards”. The prevailing societal evils like hoarding of essential
commodities, exorbitant charging, concealing facts, deceiving, falsified statements, etc.
amount to unethical behaviour and need to be curbed by necessary formulation,
amendment and implementation of a stringent legal framework.
6. Code of Conduct: The society plays a crucial role in framing the code of conduct for
ethics. The workplace ethics are based on common beliefs and are broader in nature. To
further enhance them, the company formulates a framework of operating policies which
direct the decision making from the ethical perspective. This framework indicates the
ethical decision making in matters pertaining, but not limited to, customer complaint
handling, stakeholders, employee and vendor hiring, etc. Besides the organisational level,
ethics are framed for a particular industry level also irrespective of the number of
companies being served by that industry. For example, the advertising vertical
encompasses extending services to various companies and this vertical has formulated
‘Indian Association of Advertising Agencies’ to develop an ethical code of conduct for
 advertising agencies, firms etc. which is to be followed by the concerned professional and
industry associations.

4.4 IMPORTANCE OF BUSINESS ETHICS

Now, let us understand why Corporate Ethics matter to business. Ethics matter because ethical
conduct is the right conduct. However, in the absence of a time-culture, and context-neutral
definition of ‘right’, it is very difficult to develop a code of conduct on this basis alone. It
basically says that businesses avoid many risks and gain reputation by acting in an ethical
manner.

A good ethics process, operationalised in such a way that all decision making procedures and
structures support it on a day-to-day basis, will give an organisation the best chance possible for
finding out about potential problems early so that they can be dealt with before they become a
disaster. There are also market advantages to be gained from an ethical reputation.

Ways in which Ethics are Important -

Major scandals such as WorldCom, Enron, Lehman Brothers etc., in the US and Satyam in India
tell us why ethical business practices are becoming increasingly important. There are several
reasons why ethics are important to business:

• To understand reasons behind increasing influence of corporates in society.

• To ensure that no harm is done to society.
• To meet ethical expectations more effectively.
• To enable companies to identify employee and customer concerns at an early stage.
• To improve the quality of a firm’s relationships with its key stakeholders.

The government is interested in ensuring ethical business practices to ensure a basic level of integrity
in the market place. This promotes international competitiveness of the economy and improves a
country’s image concerningease of doing business.

Even domestically, predictable levels of ethical behaviour ensures that costs of business such as
transaction costs, hedging and insurance etc., are kept to a minimum.

Unethical behaviour imposes costs on the government and taxpayers. Bad behaviour by a few
impacts on all businesses and might also have an adverse impact on the country’s international
competitiveness.

Ethics can help improve decision making by providing managers with the appropriate knowledge
and tools that allow them to correctly identify, diagnose, analyse, and provide solutions to the
ethical problems and dilemmas they are confronted with.
Ethics help in analysing the reasons behind this, and the ways in which such problems might be
dealt with by managers, and regulators in improving business ethics.

Business ethics can provide us with the ability to assess the benefits and problems associated
with different ways of managing ethics in organisations.

Business ethics also equips us with knowledge that goes beyond the traditional boundaries of
business studies.

Activity 1

Illustrate a business case in which ethical practices have created a strong public image for the
corporate.
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4.5 ETHICAL ISSUES IN BUSINESS

You have understood that business has various motives. Some of the motives are: wealth motive,
profit motive, societal benefit and overall benefit of shareholders and stakeholders. The dilemma
remains between striking the balance between profits and ethics. The organisations practice
ethics as it bolsters their goodwill and reputation of being fair, honest and integral both at the
business and the corporate level thereby, fortifying their image. Organisations expect the
employees at all levels carry this legacy of identity with utmost care. Ethics provide the
framework within which the organisation makes ethical investment. Ethical investment is
followed in management of investment portfolio which consists of company shares. Profit is an
inherent motive of business. But various economic thinkers have propagated various business
motives varying from profitability, wealth, utility maximization, etc. But there are differences of
opinion too. On the one hand there is the ideology of Karl Marx, according to which it is
unethical to do business to accumulate wealth. On the other hand, Mahatma Gandhi believed in
business but preached trusteeship according to which a businessman should look after the
welfare of his employees.
Let us discuss this further with examples from various companies. In the early 1980s the Indian
automobile industry had two leading brands namely the Ambassador from HM and the FIAT.
The Japanese entered with Suzuki and Maruti became a household name. Subsequently we saw a
lot of foreign brands like the Daewoo, Hyundai, General Motors, Toyota, etc. entering the fray.
Each of these multi-national companies had their own management style and ethic orientation.
Few worked on vendor relations, Research and Development aiming at cost reduction, while
others worked on advertising and creating a robust distribution network. Within all this high
level marketing impact the Indica model from the national brand Tata was launched. Though the
model didn’t compete much with the elite MNC brands but it was able to create a significant
presence for the customers who believed in Tata’s ethical philosophy. So a low advertised
product also garnered a market share as the word of mouth from the customers spread fast
thereby creating a brand identity for Tata.

The advantages of being ethical:

1. Preferred by prospective employees and creation of quality talent pool.

2. Less number of employees leaving the organisation i.e lower attrition rate.
3. Less number of employee strike or labour unrest.
4. Corporate goodwill enables bargaining power which results in cost reduction increase
in production achieving economies of scale more revenue and profits longer
business viability.

Activity 2

Study the business ethics of any two leading conglomerates and mention which one, according to
you, is more ethic centric and why? Support your answer with relevant examples.

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4.6 CORPORATE GOVERNANCE AND CORPORATE SUSTAINABILITY

To influence the corporate path to sustainable development, following approaches are advocated
namely:

• The Triple Bottom Line Approach (People, planet and profits), 1995
• United Nations Global Compact (UNGC), 1999
• OECD (1999) – guidelines are addressed to MNCs
• ISO Standards
• Global Reporting Initiative, 1997 – guidelines are for all organisations.
• Sustainable Development Goal, 2015
• World Bank GRI Index, 2020 – World Bank sustainability disclosure index
prepared with core option of the GRI standards.

In addition to the Triple Bottom Line approach which originated from Elkington’s the planet-
people- profit (environmental, social and economic) framework. Elkington argued business can
be sustained by fulfilling stakeholders’ interest, environmental protection policies and public
welfare.

Global Reporting Initiative (GRI) is an international organisation founded in 1997. GRI has its
roots in the US not for profit organisations, the coalition for Environmentally Responsible
Economies. United Nations Environmental Programme (UNEP) was involved in the
establishment of GRI. GRI enjoys strategic partnership with Organisation for Economic
Corporation and Development (OECD), the UN Global Compact, United Nations Environmental
Programme (UNEP) and International Organisation for Standardisation (ISO). GRI has designed
the world’s standard guidelines in sustainability reporting. GRI’s mission is to make
sustainability reporting a standard practice and to enable all companies and organisations to
report their performance on the following criteria: 1) Economic, 2) Environmental, 3) Social and
4) Governance.

The G3 is “Third Generation” of the GRI’s sustainability Reporting guidelines launched in 2006.
G3 reports only on impact study. G4 reports on broader aspect of impact study which includes
general standard disclosure on organisation profile, stakeholder and governance. Global
Reporting Initiative includes governance criteria in addition to the Triple Bottom Line,
economic, social and environmental criteria.

The Organisation for Economic Cooperation and Development (OECD), in 1999, defined
Corporate Governance as “a set of relationships between a company’s management, its board, its
shareholders and other stakeholders. It provides the structure through which the objectives of the
company are set, and the means of attaining those objectives and monitoring performance are
determined. Good corporate governance should provide proper incentives for the board and
management to pursue objectives that are in the interests of the company and shareholders, and
should facilitate effective monitoring thereby encouraging firms to use recourses more
efficiently.”

The purview of Corporate Governance includes:

1. Rights of and equitable treatment of shareholders: Organisations should respect the

rights of shareholders and help shareholders exercise those rights.
2. Interests of other stakeholders: Organisations should recognise that they have legal and
other obligations to all legitimate stakeholders.
3. Role and responsibilities of the board: The board needs a range of skills and
understanding to be able to deal with various business issues and to have the ability to
review and challenge management performance. It needs to be sufficiently sized and have
an appropriate level of commitment to fulfill its responsibilities and duties.
4. Integrity and ethical behaviour: Organisations should develop a code of conduct for
their directors and executives that promote ethical and responsible decision-making.
5. Disclosure and transparency: Organisations should clarify the role of the board and the
management and the same should be conveyed to the public. They should also implement
procedures to independently verify and safeguard the integrity of the company's financial
reporting. Disclosure of financial matters concerning the organisation should be timely
and balanced to ensure that all investors have access to clear, factual information.
Transparency is the best principle of corporate governance.
Role of Corporate Governance

You would have understood that the role of corporate governance is largely significant to the
society and impacts various internal and external stakeholders. Corporate Governance aims at the
following aspects:

a) It fosters an efficient use of resources and curtails wastages.

b) It aims at resource allocation to those verticals for bringing in efficiencies in the
production of goods and services which further generates interest of the shareholders.
c) It chooses best effective managers to manage scarce resources to derive optimal results.
d) It enables the managers to remain attentive and focused for enhanced performance
continuously.
e) It brings in investor’s attractiveness and also increases the shareholders' value.
f) It fosters increased consumer satisfaction which aids in growing market share, besides the
sales.
g) It results in higher employee satisfaction, low turnover rate and lower HR costs. Further,
satisfied employees bring customer satisfaction.
h) It also attracts vendors and brings an efficient inventory management system with
reduced purchase/production costs.
i) It brings down the marketing costs by developing good rapport with the channel partners,
distributors, etc.

4.7 CORPORATE SOCIAL RESPONSIBILITY (CSR)

The CSR has become one of the standard business practices of our time. For companies, the
overall aim of CSR is to have a positive impact on society as a whole while it engages in
maximizing the creation of shared value for the owners of the business, its employees,
shareholders and stakeholders. “Corporate Social Responsibility is a management concept
whereby companies integrate social and environmental concerns in their business operations and
interactions with their stakeholders. CSR is generally understood as being the way through which a
company achieves a balance of economic, environmental and social imperatives (‘Triple-Bottom-
Line-Approach’), while at the same time addressing the expectations of shareholders and
stakeholders” (UNIDO).
The initial definition of CSR was given by Horward R Bowen who defines CSR as “Obligations
of businessmen to pursue those policies, to make those decisions, or to follow those lines of action
which are desirable in terms of the objectives and values of our society”.

In the 1960s, one of the most prominent definitions of CSR was given by Keith Davis who
defines social responsibility as “businessmen’s decisions and actions taken for reasons at least
partially beyond the firm’s direct economic or technical interest”.

The concept of CSR evolved and extended to beyond economic and legal components to
encompass ethical and voluntary aspects as well. Caroll in 1979 gave a definition containing all
four components. “The social responsibility of business encompasses the economic, legal, ethical,
and discretionary expectations that society has of organisations at a given point in time”.

Corporate Social Responsibility (CSR) in its essence fosters the business accountability from the
stakeholder, shareholder and investor perspective which may include factors such as
environmental protection, care for employees, the society and public at large not only in the
present context but in future too. It is a result of continuous interaction between the business and
the society.

Regulatory Mechanism for CSR

With the enactment of Section 135 of the Companies Act 2013, India became the first country to
make CSR spending and disclosure mandatory for large companies with specific turnovers.

The Companies Act 2013 and CSR

The inclusion of the CSR mandate under the Companies Act, 2013 is an attempt to supplement
the government’s efforts of equitably delivering the benefits of growth and to engage the
Corporate World with the country’s development agenda. The Companies in India are governed by
Clause 135 of the Companies Act 2013for performing their CSR activities.

Section 135

Section 135 of the Companies Act 2013 lays down that:

• The companies with an annual turnover of 1,000 crore INR and more, or a net worth of 500
crore INR and more, or a net profit of 5 crore INR and more shall constitute a CSR
Committee of the Board consisting of 3 or more directors of which one will be an
independent director.

• The CSR Committee will be responsible to

i) formulate and recommend to the Board, a Corporate Social Responsibility Policy
which shall indicate the activities to be undertaken by the company as specified in Schedule
VII;
 he amount of expenditurre to be incurrred on the activities
ii) reecommend th a refferred to in (i);
annd

iii) monitor
m the Co
orporate Social Responsibility Policy of the comppany from tim
me to time.

• Thee Board of every

e company shall

i) affter taking into account the reecommendattions made by the Corporate C S

Social
R
Responsibilityy Committeee, approve the Corporaate Social Responsibilit
R ty Policy foor the
coompany and d disclose coontents of such Policy inn its report annd place it on
o the compaany’s
w
website, if an
ny, in such manner
m as maay be prescriibed; and

ii) e nsure that th

he activitie s as are inclluded in Coorporate So cial Responnsibility Poliicy of
thhe company are undertakken by the coompany.

It is also the duty of thee Board to ensure

e that the
t companyy spends tw wo percent of o the
avverage net profits
p made by the comppany in the preceding
p thhree financiaal years and while
w
sppending the CSR
C amountt giving prefference to loccal areas whhere it operattes.

If the
t company y fails to spennd the amouunt, the Boardd in its reporrt shall specify the reasonns for
nott spending th
he same.

Though section 135 makes CSR R spending and reportinng mandatorry, it gives flexibility to t the
companiees to choose the CSR acttivities from
m the list of acctivities that the corporatte can potenntially
undertake.

Source: mca.gov.in
n

Compan
nies Amendm
ment Act, 2019- Section
n 135.

Any amoount unspentt shall be trannsferred withhin 30 days to special acccount in schheduled bankk and
spent witthin 3 financcial years.

For commpany- if coompany conttravenes the company shhall be puniishable with a fine of 500,000
INR - to 25 lakhs INR
R.

For officcer- Who arre defiant aree punishablee with impriisonment forr a term whiich can extend to
three yeaars or fine off 50,000 INR
R - 5 lakhs IN
NR or with both.
b
CSR and Shareholders

Shareholders are one of the important pillars who not only invest in the company’s business but
also remain associated with the financial returns in the form of profits and/or dividends. This
makes companies work for shareholder’s return thus increasing transparency, giving handsome
returns and enabling them in decision making enhances the shareholder’s role in the company
towards wealth maximisation. This is not one time but a continuous effort. Important to
understand here is that shareholders are one of the societal stakeholders too.

CSR and Employees

The employees also are the internal customers of the organisation and the business’s success is
dependent on the employees. With changing times, the employees have become an important
contributory factor towards the attainment of organisational objectives. Organisations have
realized their responsibilities, towards them, thereby ensuring the following:

1. Equal opportunity. Grievance Redressal Mechanism.

2. Fair wages, a transparent performance appraisal system, clear work instructions and work
environments and work policies.
3. Hygienic, safe and congenial working environment.
4. Setting up of labour benefit and welfare amenities.
5. Employee recognition and career growth.
6. Skill enhancement and participation in organisational decision making.
7. Employee Engagement is one of the prominent factors in organisations.

CSR and the Consumer

1. Company offering quality products and meeting regulatory standards.

2. Customer oriented approach leading to more R&D focus and innovative products.
3. Ensure supplies at equitable prices and provide due after-sale services. This includes
the availability of spares and service facility to the customer.
4. All safety norms are followed to ensure safety of the customer.
5. Consumer grievances are addressed on priority basis.
CSR and Community Participation

1. Environmental pollution control and ecological concerns.

2. Enhanced R&D to product regulatory standards.
3. Economic development and improvement of backward areas mainly by the development
of small scale businesses and community services.
4. Social initiatives like basic and primary education, social responsiveness initiatives like
women empowerment and adult education, healthcare and related medical amenities.
5. Conservation of limited and scarce resources thereby proposing environment friendly
solutions like bio-gas, LPG and solar power.
6. Environmental concerns like natural calamities, the role of CSR to the community
increases manifold by putting in measures like adopting curative and preventive
measures for controlling epidemic, cleanliness and other hygiene issues.

Advantages of CSR

Various advantages of CSR initiatives are:

1. Citizens expect that the companies will support them in societal upliftment.
2. CSR activities contribute in local and regional development.
3. A regularly supportive and conducive behaviour enable the company earn a goodwill and
rapport which helps in image building.
4. CSR initiatives like rain water harvesting, enabling educational, legal and health
infrastructure, etc. creates an enabling and supportive environment.
5. A periodic update to the government by the company contributes towards reputation
building.
6. There may be social concerns which might have remained unaddressed by the
government and social institutions, which may be resolved by the corporate intervention
through CSR.
7. CSR initiatives may promote businesses within the vicinity of the companies whose
products and services are required in fulfilling the CSR tasks.
Disadvantages of CSR

1. The cost incurred on economic social and environmental initiatives under CSR curtails
the company of funds for deployment at other business verticals.
2. The share of profit to the shareholders is also impacted by the CSR activities.
3. Such social works need the expertise of management personnel who have to manage time
between priority and non-priority areas.
4. Time spent on CSR could have been utilized on other economic and developmental
activities.
5. Since CSR is an added responsibility to business, the existing manpower needs to be
trained and developed to serve the societal expectations.
6. Businesses pursue CSR activities out of their given allocation of resources and capital for
situations which demand prioritised business attention thereby redirecting the socially
earmarked resources.

Activity 3

Enumerate various CSR activities taken by an Indian business conglomerate of your

choice. Which one according to you is the most mutually beneficial? Why?
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4.8 BENEFITS OF CSR

Businesses these days can no longer limit their focus to profit maximization and be satisfied just
by creating employment and paying their taxes. They are also required to address the needs of
other stakeholders like creditors, employees, shareholders, consumers, government and public.
Companies these days are more vulnerable to consumer boycotts and campaigns. The companies
need to be socially accountable to the communities among whom they operate. Hence, CSR as a
strategy and in fact as a necessary activity, is becoming increasingly important for businesses
due to the following benefits: (CII, 2013)

Communities provide the license to operate: The CSR behaviour of corporate is not just
driven by their values but are also influenced by the stakeholders like government, investors,
customers and community. Todays corporate understands that the license to operate in any
particular area is not just given by the government but also by the communities that get impacted
by the activities of these companies. A strong CSR programme provides the companies with the
license to operate and to maintain the trustof the local community.

Attracting and retaining employees: CSR interventions that help the employees to participate
give them a sense of belongingness to the company. Good CSR initiatives can attract employees to
the company and give them the incentive to remain motivated and committed to the company.

Communities as suppliers: There are instances wherein as a part of CSR activities, the
communities have been incorporated into the supply chain to enhance their livelihood. Such
initiatives have helped in increasing their incomes and ensuring the companies with a steady and
secure supply chain.

Enhancing corporate reputation: When the companies position themselves as responsible

corporate citizens, it creates good will and a positive image, thereby helping them to enhance
their brand image in the market.

4.9 DRIVERS OF CSR

According to the KPMG Survey of Corporate Responsibility Reporting 2011, around the world,
corporate responsibility reporting has become a fundamental imperative for businesses.
According to the KPMG survey, the top ten motivators driving corporations to engage in CSR
for competitive reasons, the following have emerged:

Economic considerations
Ethical considerations
Innovation and learning
Employee motivation
Risk management or risk reduction
Access to capital or increased shareholder value
Reputation or brand
Market position or share
Strengthened supplier relationships
 Cost saving

In simple words, the underlying reasons for business organisations to be involved in CSR are as
follows:

Public Image

CSR creates a positive brand image in the minds of the potential consumers. Effective
communication of CSR activities boosts the purchase intentions of the prospective consumers.
Business can earn goodwill and reputation by performing the activities towards the welfare of the
society. People prefer to purchase products of the company that engage in various social welfare
programs.

For example: Levi Strauss practices CSR in three areas i.e. the masses, climate, and its products.
It’s non-profit Red Tab Foundation provides aid to its employees and retirees in case of financial
emergency. As a part of its contribution to the environment, it has signed the Climate Declaration
and aims to use 100 percent renewable energy in order to reduce carbon emissions and other
greenhouse gases. In addition, in a bid to save water, it has started production of its new denim
cloth-line which has helped them save more than 1 billion litres of water since its inception in
2011.

Government Regulation

Most companies prefer to remain a step ahead of government regulations in identifying the social
needs and formulating policies to address them, out of the fear that if they don’t, the government
may take the responsibility, which might prove costly for the employers. To avoid government
regulations businessmen should discharge their duties voluntarily.

For example, Coca-Cola, USA continues to make strides towards the alleviation of
environmental issues. After realizing that its fleet of delivery trucks accounted for 3.7 million
metric tons of greenhouse gases (GHGs) in 2014, Coca-Cola made significant changes to its
supply chain like investing in trucks that are powered by alternative fuels. Those changes should
support the company’s goal of reducing its carbon footprint by25 percent by 2020.

Survival and Growth

Every business is a part of society. It utilizes the available resources of power, land, water etc. of
the society, therefore it should be the responsibility of every business to spend a part of its profit
for the welfare of the society.

For example, Amul Dairy has launched a novel scheme “Rural Sanitation Campaign” for total rural
sanitation. The dairy with the support of District Rural Development Agency (DRDA) will
provide interest free loans to its milk producers in the districts of Anand and Kheda, to set up
‘pucca’ toilet blocks, which will not only help women milk producers avoid embarrassment but
will ensure hygiene as well.

(For more details visit http://www.amuldairy.com/index.php/component/content/category/13-

csr- initiatives)

Employee Satisfaction

Besides getting good salary and working in healthy atmosphere, employees also expect other
facilities like proper accommodation, transportation, education, and training.

For example, Lemon Tree Hotels Group (‘LTH’) believes that people with disabilities (whether
physical, social or economic disabilities leading to an opportunity deprivation) must be provided
the same opportunities as others to realize their full potential and live with dignity. Lemon Tree
has defined the goal as mainstreaming ‘Opportunity Deprived Indians’ i.e. ODIs into its
workforce. By creating a supportive environment in the organisation that allows them to deliver
their best, LTH helps in bringing social inclusiveness through livelihood creation. (For more
details visit https:// www.lemontreehotels.com/factsheet/LTH_CSR_Policy.pdf)

Consumer Awareness

Nowadays consumers have become very conscious about their rights. They protest the supply of
inferior and harmful products by forming different groups. This has made it obligatory for
businesses to protect the interest of the consumers by providing quality products at competitive
prices.

For example, Burberry announced banning fur in its products along with other ladies’ bag
manufacturing companies like Gucci, Versace, Armani, Stella McCartney and others after a long
campaign from the animal rights group PETA.

4.10 CSR INITIATIVES IN INDIAN COMPANIES

Some of the CSR initiatives of Indian companies are listed below:

Tata Chemicals Ltd.

Tata Chemicals Ltd. has spent 25.68 crores for CSR in 2018-2019 which was much higher than
the prescribed amount of 19.86 crores. Improving the quality of life and fostering sustainable and
integrated development in the communities where it operates is central to Tata Chemicals’
corporate philosophy. In order to do so Tata Chemicals established Tata Chemicals Society for
Rural Development (TCSRD) in 1980 as a society and trust. It lays emphasis on the spirit of
participatory development by involving the beneficiaries at each stage of the development process
which ensures viability and sustainability of the programmes (Fernandes, 2019). Around 30
percent of the TCSRD funds are spent on wildlife conservation. The amount is distributed over
three places the company operates - Mithapur in Gujarat, Haldia in West Bengal and Babrala in
Uttar Pradesh.

Infosys Ltd.

Infosys Limited had established the Infosys foundation in 1996 to implement its social
development projects. During 2019, the company had spent INR 342 crores against the prescribed
340 crores towards various CSR schemes. The major works of the Foundation included the
introduction of Aarohan Social Innovation Awards, restoration of water bodies in Karnataka,
supporting the construction of a metro station in partnership with Bangalore Metro Rail
Corporation Limited, enabling the pursuit of access and excellence in sports through the GoSports
Foundation, and relief efforts in Tamil Nadu, Karnataka, and Kerala (Fernandes, 2019).

Bharat Petroleum Corporation Ltd.

BPCL as a part of its CSR initiatives, focuses on imparting holistic education by facilitating usage
of technology and infrastructural facilities. Additionally, BPCL’s CSR philosophy also includes
participation in projects of national importance like the Swachh Bharat Abhiyan involving
creation and maintenance of toilets, associated sanitation facilities, waste management initiatives
leading to overall health and hygiene for the communities.

Mahindra & Mahindra Ltd.

Among the various development programmes supported by Mahindra and Mahindra Ltd. are
Nanhi Kali programme to provide educational support to underprivileged girls in India. It
sponsors Lifeline Express (hospital on train) to provide medical care, treatment, and surgical
intervention to individuals. Through Mahindra Hariyali 0.95 million trees were planted which
contributed to improving green cover and protecting bio-diversity in the country.

Vedanta Ltd.

The CSR portfolio of Vedanta Ltd. has diverse projects based on 10 broad thematic areas running
across various locations. The Nandghar project is the flagship initiative which aims at rebuilding
Anganwadis to ensure health and learning of children in rural areas and for skilling and
empowering women.

Indian Oil Corporation Ltd.

Indian Oil Co. Ltd. has been involved in various social development activities across the nation.
Most of these projects are for improving the quality of life of the marginalized and
underprivileged sections of the society. The key thrust areas of the company include Safe drinking
water and protection of water resources, Healthcare and sanitation, Education and employment-
enhancing vocational skills, Empowerment of women and socially/economically backward
groups.

Hindustan Unilever Ltd.

Hindustan Unilever Limited (HUL) believes in long term sustainable growth achieved by
reducing environmental footprints and increasing its positive social impact. The various CSR
programmes of the company include Handwashing Behaviour Change Programme, Plastic Waste
Management, Project Prabhat, Water Conservation Project, Swachh Aadat Swachh Bharat,
Project Shakti, Domex Toilet Academy, Asha Daan, Sanjeevani and Supporting Healthcare.

4.11 SUMMARY

Business ethics discusses the extent of exhibited behaviour (correct or incorrect) on moral
standards rather than banking on the financial and operational management perspective only. The
defined ethical framework in decision making is sought in conducting smooth business
operations.

Business has deep ramifications to the natural environment and they must be resolved on moral
grounds. The case of the Korean conglomerate Posco’s investment plans in Orissa is the relevant
example of such concern which not only involves morality but social and legal aspects too.

Corporate governance has been witnessed garnering attraction by the society of its virtue to
address company’s profitability from shareholder’s perspective, as well as societal advantages.
An organisation exhibiting higher standards of the corporate governance becomes benchmark for
others to follow and builds investors’ faith and confidence resulting in financial prosperity of the
organisation.

The concept of Corporate Social Responsibility (CSR) has evolved from being voluntary
practices to regulatory mechanism. CSR helps in building brand image, attaining competitive
advantages and facilitates long term business interest. CSR is growing in terms of its importance
and recognition across the globe where small, medium sized and large companies are adopting
CSR guidelines to make effective social contributions.
4.12 KEY WORDS

Business Ethics: comprises the principles and standards that guide behavior in the conduct of
business.

Corporate Governance: represents the value framework, the ethical framework and moral
framework under which business decisions are taken.

Corporate Social Responsibility (CSR): an obligation of businesses to invest for social good in
the societies in which they operate and earn their profits.

Drivers of CSR: factors that encourage companies to be more socially responsible.

4.13 SELF-ASSESSMENT QUESTIONS

1. What do understand by the term business ethics? Discuss the importance of business
ethics to business citing examples.
2. Define Corporate Social Responsibility (CSR) and discuss the benefits of CSR.
3. Discuss the key motivating factors driving organisations to engage in CSR activities.
4. Write a detailed note on the CSR initiatives undertaken by Indian companies.

4.14 REFERENCES/ FURTHER READINGS

Fernando, A.C., Corporate Governance: Principles, Policies and Practices. Pearson Education
India, 2011.

Bhattacharya D., Encoded Ethics- Social Responsibility of Indian Business. Akansha Publishing
House, 2015.

Bhattacharya Debasis, Corporate Social Development- A Paradigm Shift, Concept Publishing

Company, New Delhi, 2006.

Sharma, J.P., Corporate Governance: Business Ethics and CSR, Ane Books Pvt. Ltd., 2016.

IGNOU Study Material, MEDS-051, Fundamentals of CSR.

IGNOU Study Material, MEDS-052, CSR Process.

UNIT 3 SOCIO-CULTURAL AND POLITICO-LEGAL ENVIRONMENT

Objectives

After reading this unit you should be able to:

• describe the social and cultural environment;

• identify the elements of socio-cultural environment;
• analyse the recent changes in socio-cultural environment;
• describe the political and legal environment;
• identify the elements of politico-legal environment; and
• understand the recent changes in politico-legal environment.

Structure

3.1 Introduction

3.2 Social Environment

3.3 Elements of Social Environment

3.4 Cultural Environment

3.5 Elements of Cultural Environment

3.6 Political Environment

3.7 Elements of Political Environment

3.8 Legal Environment

3.9 Elements of Legal Environment

3.10 Government Framework for Promoting Business

3.11 Understanding the Legal Environment of Business

3.12 Summary

3.13 Key Words

3.14 Self- Assessment Questions

3.15 References/ Further Readings

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3.1 INTRODUCTION

Every economy has certain kind of environmental surroundings within which every organisation
functions. This environment is termed as the business environment. This environment exists for
each and every organisation, whether commercial or non-commercial. There are several factors
which constitute the business environment. These factors are social, economic, technological,
cultural, political, legal and environmental factors. This unit deals with the socio-cultural and
politico-legal environment and the different elements influencing these environments. The
business environment is not stagnant and keeps evolving. Therefore, it is important to monitor
the changing events in the environment on a continuous basis. The unit discusses the impact of
these environments on business and economy along with the present changes affecting the social,
cultural, legal and political environment.

3.2 SOCIAL ENVIRONMENT

Businesses operate in a society thus their continuous interaction with the society is natural.
Businesses require the support from the society in terms of manpower, capital, facilities, etc.
while the businesses owe to fulfill their obligations back to the society as they have a social
purpose. This in-turn enables them fulfill their responsibility and obligations towards the society
as per their accepted levels of social commitment. This becomes an integral part of operating the
business for a businessman and thus the understanding of the social environment of business
becomes imperative.

Social environment is one of the elements of macro environment of the business. Social
environment comprises of social institutions, relationships, beliefs and social structure of the
society. In terms of business, social environment of an organisation includes the social values of
the workforce along with the society within which the organisation functions. It consists of all
the beliefs, customs and practices followed in the society. A business operating within the
parameters of a society has to deal with the distinctive values and customs which formulate the
factors of social environment affecting a business organisation. In case of a country like India,
with diverse cultural backgrounds, the social environment becomes more complex. The social
factors are usually influenced by family, friends, co-workers and even the social media.
Proliferation of social media influence in present day modern life has increased the perimeter of
social environment.

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3.3. ELEMENTS OF SOCIAL ENVIRONMENT

Let us identify the various critical elements of social environment and the reciprocal relationship
between the business and the society.

• Social problems, prospects, social institutions and systems along with their social values
and attitudes.

• Education and culture and their impact on Social groups and activities.

• Socio-economic order and corresponding role and responsibilities of the Government.

Though the above list is suggestive, not exhaustive but it enables you to identify the socio-
cultural environment of business.

Let us now discuss the different elements of the social environment.

Attitudes and Beliefs

Attitudes are the perception which people have towards certain situations or commodities.
Attitudes are primarily formed on the values and beliefs of a person. Consumer attitudes towards
a product or service can influence the demand and supply of that particular product or service.
For example, favourable attitude towards a low sugar diet has led to increased demand for sugar
free products in the market. This shows that the attitudes and beliefs of people have an impact on
the social environment.

Social Class

Each society has a certain extent of social and economic inequality. Social inequality deals with
the discrimination based on caste in a society. The caste system in India resulted in social
differentiation and has created a difference in the number of opportunities available to people. In
other words, social class signified the social status of an individual. Consumer choices differ on
the basis of their social status. Another way of class distribution is based on the wealth and
income of the individuals and are divided into lower class, lower middle class, upper middle
class and upper class. The lower class is considered to have the least earning and upper class is
considered to have the most earnings amongst all. These income groups often coincide with the
social status of an individual. For instance, people belonging to higher income group usually
have a higher social status and vice versa.

Lifestyle

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 Adopted lifestyle is another element which affects the attitude and behavior of the people.
Lifestyle is fundamentally concerned with how the people live and spend their money. The
lifestyle pattern has changed in the recent times. People are opting for more simplified and
natural ways of life. The awareness towards sustainable practices has changed the way of life.
With the pandemic this practice has become all the more prevalent.

Preferences

Preferences are the personal taste of individuals about a product or service. These preferences
are directed by other social elements such as friends, neighbours, family, education and income.
The preferences change with time. This is correlated with the change in the income status
thereby the shift in the lifestyle of people. If we go back few decades back then TV was
considered to be a luxury and now it is considered to be a necessity. The preferences result in a
dynamic shift for a social environment.

Social Communities

Social communities include the circle of friends and co-workers. The need of social
belongingness compels an individual to adhere to practices followed amongst the community
members. In many cases people decide upon purchasing a product based on the reviews of
his/her social circle. The social community in which the individual lives has a great impact on
his/her decisions be it the buying behavior, lifestyle status, education, etc.

Social Institutions

Social institutions refer to social structures in a society under which an individual assumes
certain roles for the fulfillment of social needs. People under these social institutions are required
to follow certain norms and beliefs. There are five kinds of social institutions namely family,
economics, religion, education and government. They are referred to as primary institutions
which are further divided into secondary level institutions. Family gives rise to secondary
institution as marriage and divorce. Hierarchical structure of a family affects an individual’s
choice of goods and services. Further, secondary institutions of economics are property, trading,
credit banking, etc. The secondary institutions also consider temples, churches, mosques, etc. on
the basis of religion.

Education and Culture

Education and culture is another important element of social environment. You also would agree
to the statement that the percolation of education has gained foothold and this may be attributed
to the increasingly positive attitude towards education, especially from the rural areas. Age-old
education, made way to technical or skill based education and then to the structured business

4
education. All were poised to increase the employment opportunities aiming at increased
manpower utilisation arising from a meaningful industry interaction.

Role of Government

Yet another important contributory element is the government and its role as ‘a welfare state’. It
is an ‘apex social institution’ and carries much importance in a democratic set-up where it is
assumed to be maintaining social order and harmony in the society. Business organisations and
Government play a complementary role. In pursuit of performance driven cultures, organisations
strive to bring in social cohesion. So terms like consumerism, trade unionism, the cooperative
movement, professional management, and shareholders’ associations, etc. become the associated
keywords for the social business environment.

Activity 1

a. Having understood business environment in the social context, you visit a business
organisation in your vicinity and identify the various social groups active there.
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b. Enlist various social environment factors detailing how they have impacted your
purchase decision?
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3.4 CULTURAL ENVIRONMENT

Culture is a range of human actions which are socially transmittable. Culture can be explained as
a complex combination of morals, customs, law, art, beliefs, knowledge and habits acquired by
any individual member of a society. Culture is embedded in the way of life. In other words,
5
Culture is a product of social interaction among humans and determines the human behavior.
Cultural environment is concerned with the culture within which the organisation operates and
includes the culture of its target market and the workforce.

3.5 ELEMENTS OF CULTURAL ENVIRONMENT

Cultural environment contains a number of important elements.

Knowledge and Beliefs

Knowledge and beliefs deal with the pre-existing concepts and philosophies possessed by an
individual about his or her surrounding reality. They consist of myths, philosophical thoughts,
abstract concepts as well as scientific facts. It is often witnessed that people belonging to a
specific culture have set beliefs about a particular thing apart from those permissible within that
culture and this may result in not accepting the other view point.

Religion

Religion is an important element of cultural environment. People belonging to different religions

have different religious principles, beliefs, thoughts, customs, rituals and traditions. A business
organisation should take into consideration every aspect of religious sentiments while marketing
their products.

Language

India has a vast number of languages and dialects out of which 22 are officially recognized
languages as per the Government of India. Apart from these officially recognized languages,
there are regional languages which are spoken within communities only. Variances in the
language can be a major concern for business organisation. Different words have different
meanings in different languages. This can be extremely crucial before deciding upon a brand
name in foreign country. Beyond words, non-verbal communications can also create issues for
an organisation. Body language such as gesture and posture has different meanings across
different cultures. A same symbol may have different interpretation in different nations or
different regions of a country. Verbal or non-verbal language, both have an impact on the overall
cultural environment.

Ethnicity

Ethnicity refers to the fact of belonging to a particular cultural tradition. An ethnic group’s
domination in an area can influence the decisions and strategies of the local businesses operating
in that area. Such domination can also influence the choice of trade opportunities. In case of

6
international markets, ethnicity plays a bigger role. For example, Indian citizens belonging to
different cultures within the country belong to a single national ethnicity are referred to as
Indians.

Evaluation of Socio-Cultural Environment

Socio-cultural elements are one of the most important factors of the business environment which
can influence the managerial decision-making process and strategic goals of a business
organisation. Business organisations do not exist in a vacuum. Each and every firm in the
industry is surrounded by an environment. Changes in the factors of social and cultural
environment can have an effect on the commercial activities across the nations. In other words,
shifts in the social and cultural elements of the environment can lead to fluctuations in the
demand and supply of an economy. In order to survive in the market a business organisation
needs to adapt to the shifts of socio-cultural environment.

The earlier concept of business was limited to profit-making. However, in recent times business
is seen as a societal institution working for the betterment of society. Business organisations are
considered to be an integral part of the social systems. These businesses have the capacity to
influence the life styles of their consumers and the way society works.

Likewise, preferences and attitudes of the people can also influence the business strategies. For
example, rising health concerns amongst individuals has resulted in option for a healthy diet.
This has forced the organisations to be more cautious about the quality and choice of the
ingredients they use in their products. Change in income and education level leads to fluctuations
in demand for products and service. A rise in income level led to increased demand for high-end
products. For instance, people earning more generally prefer to buy more expensive range of
FMCG products as compared to low price brands.

Cultural dynamics also affects the functioning of the business organisations, internally as well as
externally. Culture affects many things in an organisation such as pace of business, decision –
making and negotiations, employee management, risk-taking capacity and sales and marketing.
Culture is responsible for developing trust amongst employer and employees as well as between
organisation and its consumers. For example, in India one of the Food and Beverages Company
has to customize its menu as per the customs and traditions of the consumers.

A prime example of effect of socio-cultural environment on business can be seen in the

promotional campaigns during festive seasons. The campaigns show families celebrating
festivals together as a part of their cultural traditions and how the product or service fit into their
traditions.

7
Current Scenario of Socio-Cultural Environment

Change in Fashion Trends

Fashion trends changes every few years. What might be popular ten years ago might not be
popular today. Social media influence has rapidly increased the pace of changes in trends. Such
changes lead to shift in consumer preferences and attitudes. For instance, clothing brands has to
be aware of most recent fashion trends while launching new collection. Another example of this
can be change in advertising patterns. Television and print media were considered to be the most
popular method of promoting products in the past decade. However, with a rise in users of smart
phones and social networking sites, advertising through social media has been a new rage in the
field of marketing (Quain, 2019).

Social Issues

Socio-cultural elements not only impact the business strategies of an organisation but also affect
the internal policies of the organisation. Raising concern around gender issues has forced
organisations to incorporate equal policies and practices for male and female employees. For
instance, flexibility in gender roles among husband and wife has led to creation of policies for
paternity leave alongside maternity leave. Further, awareness about gender sensitivity has led to
change in attitudes towards workplace harassment and gender discrimination. Another instance
of such cultural changes is non-resistance towards racial discrimination at workplace (Quain,
2019).

Population

Rise in population in India has resulted in the constant need of urbanization. About one third of
the population in India lives in urban areas. India has seen a constant rise in the number of urban
population (O’Neill, 2021). Rapid growth in urbanization strengthened the need for urban
infrastructure such as transportation, hospitals, schools, sanitation facilities and power supply. A
major concern behind the rise in urbanization is migration of population due to industrialization.
Moreover, India has major portion of working-age population or young population. This
construct has created a labour class at cheap rates. Besides, this young population has created
demands for digitized economy. Urban working professional are more interested in digital
banking and saving options (UK Essays, 2018).

Multi-Diversity

In present times, a majority of the organisations have a mixed culture workforce, especially in
case of multinational organisation. India is a multi-diversity nation with mixed culture race. In
order to deal with people from different cultures one must be careful about their business
practices, communication style and management style as they might vary among different

8
cultures. For targeting a consumer segment from other culture, an organisation must keep aside
preconceived notions and put in efforts to learn about them (Saylor Academy, 2012).

Activity 2
The socio-cultural environment has been affecting our business. Explain how Mc Donald’s food
chain has modified its product portfolio to match the socio-cultural environment of India.

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3.6 POLITICAL ENVIRONMENT

You understand that Business, though by its very nature is an economic activity, but the business
managers, in order to stay effective, have to consider the non-economic environment of the
business too. In this direction, we have understood the socio-cultural environmental component
in the previous part of this unit. Here, we would understand another important component i.e. the
politico-legal environment of business.
A political system is assumed to be having the qualitative prerequisites such as being stable,
honest, efficient and dynamic. Democracy brings in the political participation of the citizens
thereby providing them personal security which in-turn contributes for growth of any business in
a country. In a political system the role of Government as a political institution is to formulate
social policies aimed to deliver on high social benefits at minimum social costs. The government
thus facilitates business by making decisions and supporting the economic activity in form of
health, infrastructure, education, law and order etc. implemented on different levels like local,
regional, national or international.

The political environment comprises of many political factors which effect the business activities
at various times and impact, like the bureaucracy levels, corruption, freedom of media and press,
tariffs and related measures of trade control, employment regulation, environmental and
pollution control laws, health and social safety laws, Competition regulation and cartelization,
Tax policy (tax rates and incentives), Trade unionism and related laws, consumerism, e-
commerce and related laws about the quality and quantity of the product, Intellectual property
law (Copyright, patents etc.). All this is done based on the ideology of the political party forming
9
the government which attains it by formulating and executing them under a set of policies and
programmes. This is attained through legislations and enactments, rules and regulations, systems
and procedures, policies and plans, statements and announcements, directives and guidelines by
the Government, which is the essence of the politico-legal environment.

Political environment of a country comprises of three elements viz. legislature, executive and
judiciary. Political scenario of a country decides the economic policies and trade regulations.
Hence, political environment of a country can be crucial for the business operations. Most of the
economic reforms are the reason of some political decisions. For instance, prior to 1991
economic reforms, India followed a socialist economic policy approach which was driven by
public sector dominated development strategies. However, 1991 economic reforms introduced
the concept of private players in the market. In the recent times, the government has allowed
100% FDIs in most of the sectors which has resulted in foreign companies investing more in
India markets.

10
3.7 ELEMENTS OF POLITICAL ENVIRONMENT

Let us identify the crucial elements of political environment.

Political Ideologies

Political ideologies are the mix of multifaceted ideas, philosophies and objectives which is the
foundation of the political parties. Most of the political organisations are politically diverse due
to the members of organisation having diverse backgrounds. Political ideologies can differ due to
multi-culture environment in the country. People belonging to different social groups, ethnicities,
communities, economic class or religion can have different ideologies. These variations impact
people to join or support different political parties. Harmony among different political ideologies
is necessary to maintain peace and stability within a country.

Democracy

Democracy has been a fundamental part of India’s progress and growth story and has helped in
binding people from different cultural background and regions. A democratic environment
ensures equal political and legal rights to each and every citizen of a nation. It ensures freedom
of speech, expression and opinion. Since every citizen cannot decide for himself / herself
therefore, countries practice a system of elected representatives. The elected representatives
formulate laws for a nation. These representatives are elected by the people of the nation.
Democracy also ensures a fair and independent judiciary.

Civil Liberties

Civil liberties ensure the provision of freedom and fundamental rights to every citizen. These
include freedom to press, equality before law, personal and social freedom and freedom from
biased government policies. Countries with high civil liberties are considered to be free and are
more preferred by companies for investments. More liberal countries ensure fair judicial trials in
case of disputes and hence are preferred by business organisations.

International Political Relations

Political relations and diplomacy with foreign nations results in more avenues for trade and
business which in turn creates multi-lateral or bilateral trade opportunities. For example, trade
pacts between USA and India have resulted in several development opportunities for both the
nations. Political friendship among different nations creates a favourable environment for
international trade and commerce.

11
Political Stability

Political stability is crucial for growth and development of any economy. Political instability can
hinder the flow of foreign capital and adversely affects foreign investment in the country. For
instance, clashes between two groups in a region can cause adverse effects on the economic
activities in that area.

Government Policy

Stable policies are better for planning corporate strategies and building-up confidence in the
industry. Policies formulated with clear directions can support better economic development.

3.8 LEGAL ENVIRONMENT

Legal environment of any country deals with rules, regulations, policies and the law of the land
as whole. These laws are made for the protection of consumers, investors, environment and
national interest. For example, there are several organisations like SEBI, Consumer
Commissions or National Green Tribunal (NGT) in India for the enforcement of such laws.
Further, the legal environment of a country also includes taxation laws and annual budgets.

The changes in government policies such as trade policies, industrial policies, fiscal and
monetary policies can have a great effect on the business. For example, by increasing the limits
of permissible FDIs in the retail sector has led to the emergence of global e-commerce
companies. While at the same time, it has been seen as the threat to local vendors with increasing
markets for e-commerce.

3.9 ELEMENTS OF LEGAL ENVIRONMENT

Elements of the legal systems include the laws, rules and regulations applicable in the country.
As per Rao (2008) it includes the following:

• Common law – Law is implemented according to the situation and the prevailing
customs, traditions, culture, etc.
• Civil Law – They are the detail set of laws formulated, discussed and passed by the
parliament e.g., contract act, company law and civil codes.
• Theoretical law – These are the laws derived out of the religious laws in the country.
• Property rights
• Intellectual property rights
• Labour laws and codes
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• Fiscal and monetary policy
• Competition Law
• Foreign exchange laws – FEMA and FERA Act

We will discuss the above legal framework in the following section in detail.

Evaluation of Politico-Legal Environment

Political and legal environment plays an integral role in the economy. A favourable politico-legal
environment is crucial for growth and survival of business. These factors govern the entry of
foreign firms in the domestic market of the country. Government and allied agencies act as a
regulator of foreign companies where government policies are considered to be gatekeepers.
Political ideologies of the ruling party are also important for creating a favourable business
environment. A pro-business ideology will lead to more opportunities for foreign investment in
the country. Likewise, legal environment draws the perimeter of the permissible trade and
commerce activities within the geographical boundaries of a country.

Business organisations are required to operate within the legal framework. Due to the rapid
increase in globalization and flexible FDI policies, several laws are created to protect the interest
of domestic traders in India. Business organisations are required to have full knowledge about
the trade laws, rules and related policies. Moreover, the increasing complexity of legal
environment can cause difficulties in the business operations. Increased concern about the
environmental protection and sustainability has led to creation of environmental protection laws.
Failure of implementing these laws will not only lead to governmental actions but will also
effects the image of the business adversely. Hence, favourable politico-legal environment is
necessary for a stable economic growth and development. Political instability can create social
unrest which in turn can hamper local businesses in the area. For example, roadways, being
blocked as protest-sites can hamper the supply chains.

Current Scenario of Politico-Legal Environment

Boost to Manufacturing

Government has given a boost to manufacturing activities in the country through ‘Make in India’
campaign. Under this campaign, government created conducive environment for doing business.
In order to boost manufacturing in India, government has set up panels to fast-track investment
proposals, addressing problems in investment process and creating an investor-friendly
environment in the country. Efforts are being made to make India a manufacturing hub and
crating more employment opportunities for the locals. In the recent times, several multinational
companies have setup production facilities in India.

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Changes in Industrial Policies

Several policy changes have been made in the recent past to ease the entry of foreign investments
in the country. Department of Industrial Policy and Promotions (DIPP) has made efforts to make
policies more flexible and simplified including infusing technology into various processes for
effective and efficient governance. For instance, application for industrial licenses has been made
online which has made it more accessible.

Business Reforms

Several reforms are being undertaken at state as well as centre level to make significant
improvements in way business operates in India. The government has introduced various
initiatives to ease doing business in India. India has been placed at 63rd position on World Bank’s
Doing Business 2020. For instance, Government of India has increased the limits of FDIs in
insurance and defense sectors and thereby attracting more foreign capital in the country. This
will lead to creation of employment and overall economic development (“Doing Business in
India”, 2020).

Bank Mergers

In the past few years, government has decided to merge certain public sector banks to reduce the
number of nationalized banks and improve the quality of governance. The number of national
banks has been reduced from 27 banks to 12 public sector banks (Singh, 2019).

Infrastructure Development

The current government has taken several steps for the modernization and development of
infrastructure in the country. The focus is not only on the urban cities but several tier I and tier II
cities have also been developed as the part of a scheme named as ‘Smart Cities’. The government
has announced to develop 100 cities as smart cities under which many industrial corridors are to
build. Several other projects in different sectors like green energy, transportation and real estate
have been planned. These planed projects will create future business opportunities and foreign
collaborations (Yadav, 2015).

Skill Development Programmes

Indian government launched ‘Skill India’ movement in 2015 with an aim to provide skill based
education to the youth of the country. The programme focussed at imparting vocational training
with a vision to empower workforce suitable for skill-based jobs. For example,
‘SeekhoaurKamao’ was scheme launched for the youth of union territories of Jammu and
Kashmir and Ladakh under which they were trained according to their qualifications and given
employment opportunities in the state (NSDC, 2017). Such initiatives were planned to reduce the
dependency white collar jobs and encourage skill-based employment.
14
Activity 3

How does the politico-legal environment impact the business decision making? Explain.

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3.10 GOVERNMENT FRAMEWORK FOR PROMOTING BUSINESS

In the role of the government to support business and related economic activity, a robust
supportive mechanism is required to be provided in promoting a sustainable institutional
structure. Let us understand the selected government supported organisational set ups.

The Ministry of commerce and Industry

The Ministry of Commerce and Industry has the responsibility to manage and promote the
industrial and commercial activity in the country. It formulates Industrial policy which provides
with the planned framework of promoting industrial development in sync with the economic
goals of the nation. The Niti Aayog, Ministry of Micro, Small and Medium Enterprises, Ministry
of Skill development and Entrepreneurship all contribute in the attainment of their individual
(promotional regulatory, technical and advisory) goals.

The Department for Promotion of Industry and Internal Trade (DPIIT)

The department was earlier called Department of Industrial Policy & Promotion and was
renamed as DPIIT in January, 2019.The Department functions on matters related to Internal
Trade, welfare of traders and their employees and start-ups. The role of DPIIT is to
promote/accelerate industrial development of the country by facilitating investment in new and
upcoming technology, foreign direct investment and support balanced development of industries.

15
The Department for Promotion of Industry and Internal Trade (DPIIT) spearheads ‘the Ease of
doing business’ initiative which provides a ‘carpet welcome’ to the foreign investments to India.
This involved providing time-based and ‘single window clearances’ towards establishing
business in our country. The department also promotes Startup India Initiative and Production
Linked Incentive (PLI) Scheme.

The Department of Commerce regulates the following:

I. International Trade: Policy related matters involving various tariff and non-tariff barriers,
issues related to the WTO, their interpretation and implementation besides the dispute
settlement/redressal mechanism. This further involves strengthening the bilateral and
multilateral trade by International Commodity Agreements.

II. Foreign Trade (Goods & Services): tasks related to external trade and relevant matters
import and export of feature films, as well as unexposed cine-films. This also involves
establishing Agricultural Export Zone (AEZ) and 100% Export Oriented Units (EOUs)
for boosting manufacturing and promoting external trade by suitably amending the
related policy and regulatory framework from time to time.

Aimed at promoting international trade relations it attains the objective through bodies like
Export Promotion Board, Board of Trade and International Trade Advisory Committee and
Export Promotion Councils/Export Promotion Organisations. State Trading Corporation (STC)
also facilitates the said objective of trade promotion.

III. Special Economic Zones (SEZs): Fostering economic development with SEZs is a
relatively new way of attaining industrial as well as foreign trade growth. This includes
providing a favourable policy environment, further comprising a conducive foreign trade
policy, a supportive fiscal regime, and an attractive investment policy, etc. This is
achieved by an organised structure and subordinate offices under this Department-
1. Directorate General of Anti-Dumping and Allied Duties (DGAD).
2. Directorate General of Foreign Trade (DGFT).
3. Directorate General of Supplies and Disposals (DGS&D).

IV. Statutory/Autonomous Bodies/Public Sector Undertakings/Other Organisations:

Agricultural & Processed Food Products Export Development Authority (APEDA),
Coffee Board, Export Inspection Council of India (EIC), Rubber Board, Spices
Board, Tea Board, The Marine Products Export Development Authority (MPEDA),
Tobacco Board. Public Sector Undertakings include: ECGC (Export Credit Guarantee
Corporation of India Limited), ITPO (India Trade Promotion Organisation), MMTC
Limited (formerly Minerals and Metals Trading Corporation of India Limited), PEC
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 Limited (formerly The Projects and Equipment Corporation of India Limited), STC
Limited (State Trading Corporation of India Ltd.), STCL Limited (formerly Spices
Trading Corporation Ltd.).

Of the many acts applicable under the Ministry of Commerce and Industry regime, ‘Special
Economic Zones Act, 2005’, carries a mention here.

The Tariff Commission

Tariff Commission in India got created by the union of the Tariff Board, Tariff Commission
(old) and Bureau of Industrial Costs & Prices (BICP). BICP got combined with it for better
functioning with effect from 1st April, 1999.

Activity 4

You wish to start a manufacturing and distribution of edible oils and similar FMCG products.
How you can get support from the above government bodies? Explain.

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NITI AAYOG (NATIONAL INSTITUTION FOR TRANSFORMING INDIA)

It was in 2014, that the NITI Aayog (National Institution for Transforming India) got constituted
by transforming the earlier existing ‘Planning Commission’ for enhancing the developmental
process; nurture an overall business enabling environment extending from the realms of Public
Sector and Government of India. This involved more coordinated role with the state governments
thereby strategically fostering good governance, best practices, providing strategic expertise and
coordination with all levels of government (central as well as the state) for the collective
attainment of developmental goals.

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Public Private Participation (PPP)

The PPP Vertical is assigned with the various activities involving the policy formulation for
ensuring that the desired objectives for timely creating the infrastructure to promulgate the
economic growth and development. Such projects being capital intensive in nature requires
regular capital infusion and management thus the PPP becomes the choice for Construction,
Operations and Management of the infrastructure projects. For Niti Aayog, the PPP remains
evolutionary, in terms that it remains reform-oriented by suggesting institutional, regulatory and
procedural changes. By process and document standardization, the subsequent appraisal of PPP
projects becomes easy thus resulting in higher FDI in such developmental projects.

The Ministry of Finance

It was re-organized in the year 1949 in two departments namely, the Department of Revenue and
Expenditure; and Department of Economic Affairs. Presently, the Ministry of Finance has the
following five Departments: -

a) Department of Economic Affairs

b) Department of Expenditure
c) Department of Revenue
d) Department of Financial Services
e) Department of Investment and Public Asset Management
f) Department of Public Enterprises

The Department of Economic Affairs, assists the Central Government in maintaining sound
public finances through efficient use of the nation's economic resources, promoting conditions
that accelerate sustainable economic growth through developing sound economic policies and
preparing for future economic challenges and opportunities, and leading India’s bilateral and
multilateral economic and financial engagements. It manages the matters with its institutions
like:

i. Security Printing and Minting Corporation of India Ltd.

ii. National Savings Institute.
iii. Securities and Exchange Board of India.
iv. Securities Appellate Tribunal.
v. Specified Undertaking of the Unit Trust of India/National Financial Holding Company
Ltd.
vi. National Skill Development Corporation.

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vii. National Skill Development Fund/Trust.
viii. National Skill Development Agency.
ix. Delhi Mumbai Industrial Corridor Trust.
x. Forward Markets Commission

FISCAL AND MONETARY POLICY

These two policies formulate the financial framework of the nation. Monetary and Credit
Policy, is formulated by the Reserve Bank of India by which it aims at bringing in price
stability, control inflation and regulate liquidity of the nation’s economy. This is achieved
through various instruments like managing the money supply and other policy matter changes
from time to time. Through the banking system it regulates liquidity and interest rates and
loan off takes for spurring industrial growth. With the Monetary Policy, the RBI strikes the
balance between maintaining liquidity and credit/ loan off take by regulating between lending
and borrowing rates of interest for the commercial banks. This is achieved through careful
assessment of the business environment and then attaining the objectives with deployment of
its instruments like Bank Rate of Interest, Cash Reserve Ratio, Statutory Liquidity Ratio,
Open market Operations, Margin Requirements, Deficit Financing and printing of currency
and credit regulation. It strives for establishing a price stability to overcome the fluctuations
which may deter the market sentiments, especially in the foreign trade. This generates
national economic growth and aids in employment generation too.

The fiscal policy is the nation’s revenue and expenditure policy by which it plans to strike the
balance between the ever growing needs and the limited resources availability in the country.
It indicates the prioritization in the several governmental purchases and taxes. It is done by
virtue of its ‘thrifty nature’ by promoting saving and investments in order to maximize the
demand which stands important in not only providing economic stability but also aids in the
time of recession. This is achieved through careful assessment, budget provisioning and
limiting the Govt. expenditure, Tax management (Direct, indirect and new taxes), Wage
Control, Public Debt and maintaining surplus budget etc.

On one side the Monetary policy acts by altering money supply and the interest rates; the
fiscal policy aims for bringing in much needed price stability by carefully and continuously
managing between the incomes and the expenditures of the country in order to provide a
conducive and stable environment for providing economic growth, overcoming recession and
generating opportunities for employment, infrastructure building, law and order, education,
etc.

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3.11 UNDERSTANDING THE LEGAL ENVIRONMENT

For describing and analyzing the legal environment of business in India, we present here briefly
an overview of some specific socio-economic legislation. We may list these legislations which
define the legal environment of business.

A. Company Laws

For smooth governance of the business, the company laws play a crucial role. These become the
focal laws which impact the commercial environment and subsequent decision making. These
important set of laws are governed by the Ministry of Corporate Affairs through the Companies
Act, 1956, 2013 and other allied acts, bills and rules. The underlying object is to safeguard the
interest of various investors, stakeholders and customers. Two primary bodies ensure its
execution namely the Serious Fraud Investigation Office (SFIO) and the Competition
Commission of India (CCI). Different acts which are constituted in this direction are “Companies
Act 2013, Limited Liability Partnership Act, 2008, Insolvency and Bankruptcy Code, 2016,
Competition Act, 2002, Partnership Act, 1932, Chartered Accountants Act, 1949, Cost and
Works Accountants Act, 1959, Company Secretaries Act, 1980, and Societies Registration Act,
1860” etc. It is regulated through National Company Law Tribunal (Tribunal or NCLT),
National Financial Reporting Authority (NFRA), and the Serious Fraud Investigation Office
(SFIO).

COMPANIES ACT 2013

Meant at improved corporate governance and increased accountability, this act aims at
improving the ‘ease of doing business’ in India. It brings forth conceptions like one–person
company, small company, dormant company and corporate social responsibility (CSR) etc. It
hosts noteworthy modifications in the ways of doing business, including the technologically
advanced ways such as improved governance (e-governance), e-management, timely and orderly
compliance, legal enforcement, self-disclosure and related norms, role of auditors, mergers and
acquisitions, class action suits and registered valuers.
a) The One Person Company: requires having minimum paid up capital of INR 1 Lac
without any legal obligation for holding Annual General meeting (AGM).
b) Small Company (other than a public company) with a paid-up share capital of maximum
fifty lakh rupees or upto five crore rupees (if prescribed) or its last reported profits is not
more than two crore rupees and turnover of maximum twenty crore rupees (if prescribed).
c) Minimum members for private company –maximum member heads can be 200 now from
the earlier 50.

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d) All official communications, should bear the full name of contact person, address of
company’s registered office, Corporate Identity Number (CIN No. which is a 21-digit
number allotted by Government), Telephone number, fax number, Email id, contact
website (if any).
e) All companies (public/private) under the Companies Act 2013 to comply with the
Registrar of Companies (RoC) for beginning their business operations. They require
submitting the Performa with the director’s declaration mentioning the subscribers/
promoters, with the number of paid-up shares or agreed to be taken by them. The
company also requires verifying its registered office with the RoC.
f) The new Companies Act 2013 mandates closing the financial year by the 31stMarch. Also
the eligible age for Managing Director or whole time Director is decreased from 25 to 21
years.
g) The Indian company requires constituting a ‘CSR committee’ and 2% of the average net
profits of the last three financial years be compulsorily be spent on the CSR activities
subjected to fulfilment of certain conditions like the minimum net worth of INR 500 cr.
Or minimum annual turnover of INR 1000 cr. or net profit of Rs. 5 crore or more.
h) Financial Statements are now defined under the act as comprising of all companies
(except one person company, small company and dormant company) are now
mandatorily required to maintain the following, which may not include the cash flow
statement), a balance sheet as at the end of the financial year, a profit and loss account /
an income and expenditure account for the financial year, as the case may be Cash flow
statement for the financial year, a statement of changes in equity (if applicable) etc.

B. Capital Market

Let us understand the legal framework, structure and working of the Indian Capital markets.

The Securities Contracts (Regulation Act, 1956)

SCR Act 1956 is the core law which governs the activities of the Indian stock exchanges.
Besides safeguarding the investors, it aims to curb unsolicited transactions/dealings of
securities and formulate a transparent mechanism. This act recognizes various stock
exchanges’ memberships and the rules governing thereof; lays down processes for trading
activities, including that of security contracts and listing of the securities at the bourses.

By definition, “A stock exchange has been defined as a body of individuals, whether

incorporated or not, constituted for the purpose of assisting, regulating or controlling the
business of buying, selling, or dealing in securities”. Our country had a separate mechanism
to operate the stock exchanges across the nation but now we have nine recognised stock
exchanges namely, the Bombay Stock Exchange (BSE), Calcutta Stock Exchange (CSE),
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India International Exchange (India INX), Indian Commodity Exchange Limited,
Metropolitan Stock Exchange of India Ltd., Multi Commodity Exchange of India (MCX),
National Commodity & Derivatives Exchange Ltd., National Stock Exchange Ltd. (NSE) and
NSE IFSC Ltd.

Securities and Exchange Board of India Act, 1992

Enacted on 4thApril, 1992, the SEBI Act aims developing the securities market in transparent
and disciplined manner for providing investor protection. It attains for providing fairness in
dealings, high governance and institutionalization of standard business practices aimed at
fostering efficiencies by an integrated system offering the services at genuine costs thereby
building trust in investors and issuers, both; flexible to continuously match the emerging
requirements.

SEBI is a statutory regulatory body established under this act. The SEBI board comprises of
the chairman, two members of finance and law background nominated by the Central
Government, one member from the RBI, and two more members appointed by the
Government of India. They ensure the investors security in various ways. Cumulatively, the
SEBI pursues the following functions:

a. Manage the stock exchanges’ and security markets’ business operations.

b. Registering and supervising various capital market entities like stock brokers, sub-
brokers, share transfer agents, bankers to public issues, trustee of trust deeds,
registrars to public issues, merchant bankers, underwriters, portfolio managers,
investment advisers and similar intermediaries or self-regulatory organisations having
roles in the capital markets. This also includes recording and managing the combined
investment schemes like the mutual funds.
c. Curbing prohibitive, fraudulent, unfair and unethical trade practices by promoting
investors’ education, training and awareness initiatives of intermediaries and
customers.
d. Prohibiting ‘insider trading’. It also regulates the acquisition of shares, mergers and
takeovers.
e. Periodic audits of the bourses and related intermediaries, seeking information,
inspections, enquiry matters etc. The board may levy underlying fee or similar charge
for it. Besides, the board carries research for the above purposes to coordinate and
regulate the control over the activities performed.

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Over-the-Counter Exchange of India (OTCEI)

OTCEI was established in 1990 (started functioning in 1992) as an electronic stock exchange
without a proper trading floor. The Exchange was established with an objective of supporting
enterprising promoters for securing cost effective project finance besides offering its investors
with transparent transaction systems. It went further in the capital markets by providing
technologically enabled mechanisms like screen-based nationwide trading, market making
and scrip-less trading. The OTCEI performs the following functions:

i) Extend services to small companies for generating cost effective funds from the capital
market;
ii) Provide easy access for the small investors to the capital market. Also, facilitating
investors’ by boosting their confidence;
iii) Smooth, transparent investor grievance redressal mechanism even to the far geographical
areas; and providing much required liquidity.

Activity 5

Differentiate between a traditional stock exchange like BSE and OTCEI? Cite how OTCEI has
its advantages?

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C. Foreign Exchange Management Act (FEMA)

Under the guidance from the central government which articulates the foreign trade policy, the
central bank i.e. the Reserve bank of India carries the responsibility of implementing it by
deploying the foreign exchange control act, known as “Foreign Exchange Regulation Act 1947”.
This act stood updated in the year 1974 by FERA. Thereafter in 1991, the globalization saw the
requirement of newer policy measures and thus FERA made way for the Foreign Exchange
Management Act (FEMA), 1999. It carries significance in the view point of foreign trade and

23
foreign exchange. It is applicable on any business entity involving an Indian resident. Significant
features of FEMA are enlisted below:

I. Limitations concerning assets owned by the non-residents and transactions pertaining to

bringing in and taking out of the currency and precious metals stood abolished.
Limitation pertaining to the acquisitions of immovable property and its holding etc. in
India also has been done away with.
II. Hospitality to non-residents on Indian visits stood allowed. On similar lines, the Indian
residents visiting outside India for related activities stood allowed too.
III. Lowered restrictions for holding the immovable property outside India.
IV. Cases pertaining to seeking funds, deposits or loans in India from the Indian residents
stand simplified. Also, foreign nationals need not seek approval for taking up
employment in India; appointment of people as agents, advisors on technical/
management profiles relaxed. The new act encourages setting up of branch offices/
liaison offices encouraged and foreign travel permissions have been relaxed.

This act aims at consolidating and amending the legal forex related impediments to promote
international business and external trade besides regulating the Indian forex market.

Activity 6

Study the recent cases of Reliance Infrastructure, Flipkart and Naresh Goyal of Jet airways on
the topic and share your views on each.

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D. The Sick Industrial Companies (Special Provisions) Act 1985, (SICA, 1985)

The rapid industrialization clubbed with the multinational corporations influencing the business
environments in India, there was a growing need for institutionalizing an act to govern the
menace of growing industrial sickness. On one hand the government puts efforts to promote the
industrial setups and on the contrary when these setups are graded ‘sick’ it causes multiple

24
damage in terms of employment, production loss, locking of funds etc. So reviving these
companies to salvage and monetise the assets becomes important. Thus, the Sick Industrial
Companies (Special Provisions) Act, 1985 (SICA) was legislated for appropriate recognition of
sick (and potentially sick) companies. In the same direction the SICA proposed the constitution
of the Board for Industrial and Financial Reconstruction (BIFR) for identifying the industrial
sickness reason, its extent and putting forward remedial measures to limit the sickness. Besides it
aims to contain this sickness and take measures to revive these industrial units. From 1st
December’ 2016, the SICA stood repealed by the Sick Industrial Companies (Special Provisions)
Repeal Act, 2003 (“Repeal Act”), thereby diluting the BIFR and its constituent/ related bodies.

SICA and its Repeal

Broadly, the functioning of BIFR and AAIFR (Appellate Authority for Industrial and Financial
Reconstruction) was not only much time consuming but stood uncertain too. It was therefore
decided to solve the ambiguities and single entity be formed to handle and dispose all such
company related matters.

Thus, the National Company Law Tribunal (NCLT) and the National Company Law Appellate
Tribunal (NCLAT) were formed under the guidelines of the Companies Act, 2013 (Companies
Act). The NCLT works on the company management issues and it got further strengthened by
the Insolvency and Bankruptcy Code, 2016 (Bankruptcy Code) thus obsoleting the BIFR and
AAIFR besides the pending proceedings only.

SICA has the following objectives:

i. identification and timely perusal of sick and potentially sick business entities;
ii. initiation of the ‘Redressal mechanism’ for fast resolvance, either preventive or remedial
process by the expert panel;
iii. accelerate the desired corrective actions;
iv. apprehend, review and coordinate for future scope.

With the increasing complexities in the politico-legal business environments, SICA became
obsolete in combating corporate sickness.

THE INSOLVENCY AND BANKRUPTCY BOARD OF INDIA

The board, established on 1st October, 2016 under the Insolvency and Bankruptcy Code, 2016
(Code), is one of the important pillars in the corporate business system which relates to the
various laws pertaining to re-organisation/ restructuring, insolvency of the company and
25
resolution pertaining to corporate board and stakeholders, partnership firms on scheduled
timelines. It aims at asset maximization (both in quality and quantity), encouraging
entrepreneurship, leveraging assets, etc.

Being a one of its kind entity, it strives to aim at business governance by enhancing its processes.
It oversees the Insolvency Professionals, Insolvency Professional Agencies, Insolvency
Professional Entities and Information Utilities by regularly administers the processes pertaining
to corporate insolvency resolution, corporate liquidation, individual insolvency resolution and
individual bankruptcy. It has recently been tasked to promote and manage corporate
insolvencies.

The function of the Chapter XIX (sections 253 to 269) in Companies Act, 2013, particularly
pertains to the revitalization of the sick units. In the initiatives towards ‘Ease of Doing Business’
27 Sections have been amended in the Companies (Amendment) Act, 2017including redefining
the Associate Company by bringing in the Joint venture perspective. The voting powers of
subsidiary company was also changed. Disclosures by the companies at the time of prospectus to
SEBI were added to. Other modifications involved loans, audits and qualifications and powers of
the directors.

Insolvency and Bankruptcy Code, 2016

The competitive business environments, particularly resulting from the evolving technologies
and increasing competition have served to be an enabler for new businesses but on the other
hand, the weaker ones increasingly demonstrated tendencies towards sickness thus seeking
amendments in repealing the SICA Repeal Act. This was executed by substituting the section 4,
sub-clause (b), the following sub-clause shall be substituted, namely—

“(b) On such date as may be notified by the Central Government in this behalf, any appeal
preferred to the Appellate Authority or any reference made or inquiry pending to or before the
Board or any proceeding of whatever nature pending before the Appellate Authority or the
Board under the Sick Industrial Companies (Special Provisions) Act, 1985 (1 of 1986) shall
stand abated:

Provided that a company in respect of which such appeal or reference or inquiry stands abated
under this clause may make reference to the National Company Law Tribunal under the
Insolvency and Bankruptcy Code, 2016 within one hundred and eighty days from the
commencement of the Insolvency and Bankruptcy Code, 2016 in accordance with the provisions
of the Insolvency and Bankruptcy Code, 2016:

26
Provided further that no fees shall be payable for making such reference under Insolvency and
Bankruptcy Code, 2016 by a company whose appeal or reference or inquiry stands abated under
this clause.

The provisions of the Code dealing with amendment to the SICA Repeal Act came into force
from November 1, 2016; however, the Ministry has appointed December 1, 2016 as a date on
which the provisions of the SICA Repeal Act shall come into force. A question may arise as to
which date shall be considered i.e. November 1, 2016 or December 1, 2016. On careful reading,
one may note that clause (b) of section 4 states as follows:

The Central Government, vide notification dated November 25, 2016 has notified the provisions
of the SICA Repeal Act. Therefore, any reference made to BIFR, any inquiry pending before
BIFR, any appeal preferred to AAIFR, or any proceedings pending before BIFR/AAIFR shall
automatically stand abated w.e.f. December 1, 2016.”

Defining a ‘Sick Company’

The sick company thus is defined as “Where on a demand by the secured creditors of a company
representing fifty per cent or more of its outstanding amount of debt, the company has failed to
pay the debt within a period of thirty days of the service of the notice of demand or to secure or
compound it to the reasonable satisfaction of the creditors, any secured creditor may file an
application to the Tribunal in the prescribed manner enclosing relevant evidence for such default,
non-repayment or failure to offer security or compound it, for a determination that the company
be declared as a sick company”.

E. Monopolies and Restrictive Trade Practices (MRTP) Act 1969 (MRTP ACT)

The MRTP act has its roots arising out of the Directive Principles of State Policy embodied in
the Constitution of India. Article 39(b) and (c) which says to ensure:

i) “that the ownership and control and material resources of the community are so
distributed as best to sub serve the common good, and
ii) that the operation of the economic system does not result in the concentration of wealth
and means of production to the common detriment”.

Monopolies generally benefit a few but harm many as they tend restricting the competition
mainly controlling the prices of commodities in the market thereby resulting manipulation by a
few.

The MRTP (Amendment) Act, 1991, has omitted provisions regarding the Central Government’s
permission for substantial expansion, establishment of a new undertakings, mergers, take-over,
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etc. Establishments, howsoever big or small, are now free to expand, or establish new
undertakings, or effect mergers.

Monopolistic Trade Practices

“Any trade practice which leads or is likely to lead to any of the following effects is regarded as
a monopolistic trade practice:

i) Unreasonably high price;

ii) Unreasonably high cost of the production of goods or the provision of services;
iii) Unreasonably high profits;
iv) Prevention or reduction of competition;
v) Limited technical development;
vi) Limited capital investment; and
vii) Deterioration in the quality of goods”

Restrictive Trade Practices

The term restrictive trade practice is defined t mean a trade practice which has or may have the
effect of preventing, distorting or restricting competition in any manner and in particular if it:

i. tends to obstruct the follow of capital or resources into the stream of production; or
ii. tends to bring about manipulation of prices or conditions of delivery or to affect the flow
of supplies in the market relating to goods or services in such manner as to impose on the
consumers unjustified costs or restrictions.

Every agreement falling within the one or more of the following categories is deemed to be an
agreement relating to restrictive trade practices and is subject to registration under the Act:

• Refusal to deal and/ or Boycott

• Tie-up sales and Exclusive dealing and/or Discriminatory dealings or Territorial
restriction/restrictions or withholding of output or supply
• Concert in prices and terms and conditions of purchase or sale
• Resale price maintenance and controlling manufacturing process
• Agreement having the effect of eliminating competition/competitors etc.

Unfair Trade Practices

They have been defined as per the Act “to mean a trade practice which for the purpose of
promoting sales, use or supply of any goods or for the provision of any services, adopts any

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unfair method or deceptive practice, including: i) bargain sale, ii) bait and switch selling, iii)
offering gift or prizes in promotional contests, and not providing them etc”.

F. Consumer Protection Act, 1986

Our country has been a large market and has attracted traders from the business and commercial
perspective. Owing to the large geographical spread and low level of education amongst the
people, the fraudulent practices were witnessed and in order to curb them many legislations were
enforced like the Sale of Goods Act, 1930; Essential Commodities Act, 1955; the Prevention of
Food Adulteration Act, 1954; Prevention of Black Marketing and Maintenance of Supplies of
Essential Commodities Act, 1980; Standards of Weights and Measures Act, 1956; Agricultural
Products Grading and Marketing Act (AGMARK),1937; Indian Standards Institution
Certification Act, 1952; MRTP Act, 1969, etc.

MRTP Act though was able to put a check on the rapidly increasing consumer fraudulent
practices the need for an inclusive consumer protection legislation was much required, thus
making way for the Consumer Protection Act, 1986 for providing fast and cheap redressal to
consumer grievances.

The Act recognizes the following six rights of consumers namely:

1. “Right to safety, i.e., the right to be protected against the marketing of goods and services
which are hazardous to life and property.
2. Right to be informed, i.e., to be informed about the quality, quantity, potency, purity,
standard and price of goods or services, as the case may be, so as to protect the consumer
against unfair trade practices.
2 Right to choose, i.e., the right of access to a verity of goods and services at competitive
prices. In case of monopolies, say railways, telephones, etc., It means right to be assured
of satisfactory quality and service at a fair price.
3 Right to be heart, i.e., the consumers; interests will receive due consideration at
appropriate forums. It also includes the right to be represented in various forums formed
to consider consumers’ welfare.
4 Right to seek redressal, i.e., the right to seek redressal giant unfair practices or restrictive
trade practices or unscrupulous exploitation of consumers.
5 Right to consume education, i.e., the right to acquire the knowledge and skill to be an
informed consumer.”

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G. Competition Commission of India

The informal activity of regulating the market rivalry by business houses is traditional however it
surfaced in the year 2002 when the government recognised the need to regulate this market
competition and thus the Monopolies and Restrictive Trade Practices Act of 1969 was repealed
thereby making way for the Competition Act of 2002. This act was subsequently amended in
2007 and 2009. The act proposes for a legitimate framework be articulated and practiced in the
competition policies (thereby curbing the anti-competitive practices with punitive action). CCI
was formed under this Act which makes way for providing an environmental culture imbibed
with free, fair and healthy market competition, clubbed with trade freedom and customer and
societal orientation. This forms the three structural pillars to deter the unhealthy competition
namely, anti-competitive agreements, their combination meanings and abuse of dominance. The
commission stands empowered to levy penalty on the offenders amounting “up to 10 per cent of
the average turnover of the company” during the last three financial years upon all offending
enterprises and/or alleged individuals. Further, the entities found involved in cartelization by the
Commission can be penalized for the higher amount of ‘up to three times of the profit’ for the
found period, or ten per cent of the turnover for the period in the agreement.

H. The Environment Protection Act, 1986

The Indian Constitution mentions Indian citizens compassionately protecting and improving the
natural environment including forests, lakes, rivers and wild life. In this direction, the
Environment Protection Act, 1986, envisaged with two complementing acts namely the Water
(Prevention and Control of Pollution) Act,1974, and Air (Prevention and Control of Pollution)
Act, 1981, have an objective to lay down a framework for environmental protection and its
subsequent preservation. The components of the natural environment comprise of water, air and
land besides their interactive relationships with humans and other living elements and the
ecosystem. This act enables the Central Government with certain powers to protect and improve
the environmental quality by curbing and abating the environmental pollution. This involves
constituting and delegate authoritative office to achieve the abovementioned objectives.

I. A Few Other Legislations

We have understood by now that the legally structured environment stands robust enough and we
have gone through certain laws and enactments influencing the said environment. Besides them,
there are certain more legislations which impact the Indian business environment in various other
conditional circumstances:

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 1. The Essential Commodities (Amendment) Act, 2020. Encapsulates tough penal action for
the alleged entities or people. The act proposes stringent legal framework for antisocial
elements like hoarders, profiteers, smugglers and black-marketers.
2. The Trade Marks Act, 1999.
3. The Patents (Amendment) Act, 2005.
4. The Urban Land (Ceiling and Regulation) Act, 1976.

Activity 7

1. Study the case of NCLT- Tata Sons Vs Cyrus Mistry. Share your views.

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2. Posco, a steel business conglomerate, had plans to enter India in 2005 and had a MoU to
establish a steel plant in Odisha. The investments were in tune of USD 5 Billion but it
faced several issues in this regard. Mention the point wise details of what went wrong
with Posco deciding to abandon the business there in 2017.

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3.12 SUMMARY

Socio-cultural environment consists of social and cultural elements affecting the growth and
development of an economy. They include knowledge, beliefs, values, morals, behavior,
attitudes, religion, ethnicity and language. Politico-legal environment is a combination of
political environment and legal environment. It consists of laws, governments, statutory bodies,
judiciary, executive council and legislature. Politico-legal environment changes with each
political development in the country. Sometimes, legal reforms are based on the changes in the
ideologies of the ruling government. These elements can lead to either threat or opportunities for
a business organisation. Any organisation desiring to operate in a country need to undertake
socio-cultural as well as politico-legal elements into consideration before planning a strategy.

The Ministry of Commerce and Industry promulgates the policy support to the businesses
besides playing a pivotal role in ‘ease of doing business’ initiatives. Other legal and policy
support extended by law enactments like the Competition Commission of India, SICA,
Consumer Protection Act, Environment Protection Act bolsters the business functions in other
perspectives arising from time to time.

3.13 KEY WORDS

Expansion: The govt. can both provide business house, the opportunity to expand as well as
restrict their expansion activities. Earlier, through the MRTP Act the government restricted the
expansion of big houses, besides which various restrictions were imposed on increasing
production capacity or launching new variants.

Foreign Direct Investment: It is the government that decides whether MNCs can invest in a
country or not. Because of these government policies there are very few MNCs in India.

Incentives: The government also regulates the industry by providing incentives in the key thrust
areas. For instance, it gives tax breaks if an industrial unit is established in a backward area. It
also grants subsidies under various schemes to the small scale sector.

Legal Role: The Parliament is the law making authority and it is the council of ministers that
presents the proposed law on the table of parliament.

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A Special Economic Zone (SEZ) is a demarcated area which carries out activities to promote
export by granting subsidies and tax relaxations on exports, import licenses and less import duty
for exporters, and easy financing through banks.

3.14 SELF-ASSESSMENT QUESTIONS

1. What are the important elements of socio-cultural environment? Explain.

2. How politico-legal environment does impact various businesses? Discuss.
3. Discuss how the government regulates business.
4. Share your views on the MRTP Act? Enlist the various amendments being made in the
said act.
5. Explain the objective for the formation of SEBI by the government of India.
6. Share your views on the statement “The best protection to consumer is the full and fair
play of market forces”.

3.15 REFERENCES/ FURTHER READINGS

Bedi Suresh, Business Environment, Excel Books, 2006.

Mishra, Puri, Economic Environment of Business, Himalaya Publication House, 2006.

Mittal Vivek, Business Environment, Excel Books, 2007.

8 Critical Elements of Socio Cultural Environment. Commerce Mates. (2020, September 13).

https://commercemates.com/elements-socio-cultural-environment/.

Cherunilam, F. (2016). Business Environment (25th ed.). Himalaya Publishing House.

Doing Business in India: Advantages and Disadvantages, Wolters Kluwer. (2020, March 12).

https://www.wolterskluwer.com/en/expert-insights/doing-business-in-india.

Explain the critical elements of the Politico-Legal environment of business. Owlgen. (2020,
November 24).

https://www.owlgen.in/explain-the-critical-elements-of-the-politico-legal-environment-of-
business/.

Farooq, U. (2018, March 21). How Social Factors Affect Business Environment. Marketing
Tutor.

https://www.marketingtutor.net/how-social-factors-affect-business-environment/.
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Kumar, V. (2019, June 5). Socio-cultural Environment: Factors of Socio-cultural Environment.

Roarwap. https://www.roarwap.com/business-environment/sociocultural-environment/.

NSDC. (2017). Seekhoaur Kamao. National Skill Development Corporation (NSDC).

https://nsdcindia.org/seekhoaurkamao.

O’Neill, A. (2021, July 1). India – Urbanization 2020. Statista.

https://www.statista.com/statistics/271312/urbanization-in-india/.

Quain, S. (2019, February 14). The Effects of Socio-Culture on Business. Small Business –
Chron.com. https://smallbusiness.chron.com/effects-socioculture-business-10602.html.

Rao, P.S. (2008). International Business environment. In International Business Environment

(2nd ed., pp. 34-85). Essay, Himalaya Publishing House.

Saylor Academy, (2012). Understanding How Culture Impacts Local Business Practices.

https://saylordortog.github.io/text_international-business/s07-03-understanding-how-culture-
impa.html.

Sharma, M.K., & Singh, K. (2015). Impact of Changing Socio-Economic Environment on

Business in India. International Journal of Research in Business Studies and Management, 2(4),
21-28.

Singh, S.G. (2019, December 31). Year in Review: 12 policy decisions that affected Indian
economy in 2019. Business Standard. https://www.business-

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