What is an economic environment? Definition and examples

By Indeed Editorial Team

Published 8 April 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

There are varying internal and external factors that have an impact on businesses of all types and affect their financial performance. The combination of small-scale and large-scale factors that can affect a company's profits is known as the economic environment. If you're interested in a career in economics, finance or business, it can be useful to understand exactly what these factors entail and how they can affect different types of businesses. In this article, explore what an economic environment is, list some of the factors that contribute to it and provide some examples to help you understand.

What is an economic environment?

The answer to 'What is an economic environment?' is essentially the various economic factors that can affect a company's profit and performance. These are different depending on the nature of the business in question. For example, factors such as the weather might affect an agricultural business, as significant changes could affect the growth of the crops. For a newspaper business, factors such as the rise of the Internet would be more likely to have an effect because online media competes with newspapers when advertising business. The economic environment a company operates in includes both macroeconomic (large-scale) and microeconomic (small-scale) factors.

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Microeconomic factors

The microeconomic environment refers to factors that have an effect at the individual company or consumer level. They don't affect the whole economy but can have an effect on particular companies. Examples of microeconomic factors include:

  • Competitors: Companies may see an impact on their profits when the number of competitors in the market changes. For example, if a new company opens that sells a similar product at a lower rate, the more expensive company might lose business.

  • Demand: Various external factors can affect how much demand there is for a company's products or services, which can significantly affect its bottom line. For example, a company that makes accessories for a piece of technology would be likely to rethink its strategy if that technology became obsolete.

  • Market size: Market size refers to the total possible number of sales a company can make, often over the course of a year or other economic period. If the market changes, it can affect the company's profits.

  • Suppliers: Companies that sell products may experience changes to their microeconomic environment if there is a change in the materials or services that their suppliers can provide. This might mean that they decide to find a new supplier.

  • Supply: Changes to the availability of a particular material that a company uses to make its products might influence its profit margins.

  • Distribution chain: Companies use various methods to distribute their products, for example, by selling them over the Internet or in shops. If there are any changes to these distribution methods, such as a chain of shops going out of business, this can affect the company's financial performance.

  • Availability of employees: All businesses need employees to make, promote and sell their products or services, and a change in the availability of people with the right skills can have a big effect on a company. For example, tech companies might need employees with very specific skills, which could cause a problem if these become less readily available.

  • Availability of investors: Many companies rely on shareholders and investors to provide funding. If an investor drops out or there are fewer people investing in companies in a certain area or business, this could badly affect a company's ability to do business.

  • Media and community: The way in which local media and the community more widely perceive a company can also have an effect on the company's success. Bad press can negatively affect a company's bottom-line, while companies that provide employment, pay taxes and operate with social and environmental awareness are likely to be respected within their community.

Related: 17 types of economists (with job options and tips)

Macroeconomic factors

The macroeconomic environment concerns the economy and includes large-scale factors that can affect many different companies. Examples of macroeconomic factors include:

  • Unemployment rates: A country's employment rate can have an effect on the economy. A low rate of unemployment generally indicates that the economy is healthier.

  • Inflation: Inflation describes an increase in the cost of goods in an economy that occurs over time. Rapid inflation is generally seen as a sign of economic instability, while gradual inflation is a normal economic factor.

  • Interest rates: Interest rates refer to the amount of return that money invested in a country's financial system generates. High-interest rates indicate that the country's currency has a higher value.

  • GDP growth: GDP, or gross domestic product, is the overall value of the goods and services that a country produces. Economists usually calculate this annually as a way of measuring the health of the general economy in a country.

  • Taxes: Companies are liable for various taxes and charges that the government sets. Changes to the rates companies pay can have an effect on the economy.

  • Exchange rates: It's a normal factor of the economy that exchange rates between different currencies fluctuate over time. A rapid change in the exchange rate can indicate a weak economy.

  • Customers' discretionary income: Societal changes can affect the amount of extra income that customers have available after paying expenses such as rent and utilities. This can have an effect on the economy, which can become weaker if consumers have less money to spend.

  • Retail sales: Retail sales indicate how much the population of a country is spending as a whole and is an indicator of an economy's health. Business traders can watch spending reports to determine whether retail sales have dropped, which could show that the economy is in trouble.

  • International trade: The level of international trade that a country is doing can also be a clue as to the state of the economy. Countries that export more products than they import can raise the price of their goods as there is a strong demand for them, indicating a healthy economy.

  • Environmental factors: Environmental factors, such as natural disasters, can also have an impact on the economy. For example, spending in certain industries might decrease after a natural disaster, such as an earthquake, while other industries might experience an increase in sales.

Related: How to calculate inflation rate and why it's useful

Economic environment examples

The economic environment can be a complex concept to understand. Here are some examples to help further your understanding:

Example one

A small shop, Bert's Greengrocer, is a high street shop that sells fruits and vegetables to consumers. There are various microeconomic and macroeconomic factors that can affect their turnover and profit. For example, if another greengrocer opened on the next street and was able to sell their products cheaper because of lower rent or other factors, this would create competition for Bert's Greengrocer and affect the company's profit. This is an example of a microeconomic factor.

There are also larger-scale factors that might affect the company. For example, a macroeconomic factor that could affect the business would be if there was an increase in unemployment in the area, which meant that Bert's Greengrocer's customers had less disposable income to spend in more expensive local stores and started shopping in a nearby discount supermarket instead.

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Example two

Another company, CLT Security, manufactures tapes for CCTV cameras and has several large contracts with national high street chains. A change in the taxes the company was liable for would be an example of a macroeconomic factor that could affect their profit and would also affect lots of other companies.

There are also microeconomic factors that may affect them. For example, because of technological advancements, many stores now capture and store CCTV footage digitally, which means they no longer have a need for physical tapes. This might mean that CLT Security loses contracts and has to reassess its business model.

Economic environment vs environmental economics

Although these terms sound similar, they are actually very different concepts. Environmental economics is a sub-field of economics that is concerned with the environment. This discipline studies the economic impact of environmental policies and decisions. Environmental economics is based on the principle that environmental goods or amenities, such as clean water, clean air and the climate, have economic value. Environmental economists might work with government bodies or charitable organisations to help them to define policies with the aim of protecting the environment.

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