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Economic Factors

Updated on April 4, 2024
Article byWallstreetmojo Team
Edited byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What are Economic Factors?

Economic factors are internal and external factors in the market that affect the economy, including interest rates, tax rates, laws, policies, wages, and governmental activities. These factors are not directly related to the business but influence the investment value in the future. Macro and micro economic factors affect the profit-making process of the company and its efficiency.

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Businesses study these factors in detail to make an attempt at influencing consumer spending and even curate their marketing strategies accordingly. Moreover, it also helps companies make decisions regarding investments and employment. Even though most of these factors are beyond the control of the company, it is crucial to prepare the process keeping them in mind.

Key Takeaways

  • Economic factors are variables that impact the economy as a whole, as well as individual businesses. 
  • Economic factors include tax rates, exchange rates, inflation, labor supply and demand, wages, laws and policies, government activities, and recessions.
  • In terms of development, some of the top economic factors include education and training, natural resources, power, transportation, and communication.
  • When it comes to business specifically, some of the most important economic factors include interest rates, exchange rates, tax rates, inflation, labor supply and demand, wages, laws and policies, government activities, and recessions.

Economic Factors Explained

Economic factors are variables internal and external to the company that can have an effect on the profitability and efficiency of the company’s process. These factors could be tax rates, inflation, labor supply, exchange rates, recession, government policies, changes in law, etc.

It also helps companies and investors with when to invest, where to invest, and when to take money out from a particular company or sector, as changes in economic factors will affect the return on investment. There are various examples of economic factors that affect business and economic development.

Like life, change is the only constant in business and markets as well. Despite the fact that most external economic factors are beyond the control of even the policymakers of the country, they have to be kept in the foreground while decision-making. They can have an adverse effect on the profitability of the project, deal, or overall business.

The investor needs to be prepared for changes in economic factors and their consequences. By knowing the impact of economic factors, investors can make the right decision in terms of investment. These factors also help management make decisions and prepare for any positive or negative changes in the economy.

Economic factors that affect business as it is connected to business and influence the drive of business-like labor and cost are always controversial economic factors that affect the economy. Many countries have started outsourcing work from other countries.

Interest rate is a major factor that affects the liquidityLiquidityLiquidity is the ease of converting assets or securities into cash.read more of cash in the economy. A higher return on investment will attract investors. Management plays a vital role in the growth of the company. Though it is not an economic factor, it is affected by economic factors and drives the business to generate maximum revenue.

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Video Explanation of Economic Factors

 

Examples

Let us understand the concept of macro and micro economic factors that affect investments and business with the help of a couple of examples. These examples shall give us a practical outlook of the concept and its related factors.

Example #1

ABC Corporation is a manufacturer of calculators and other electronic products. They mass produce products and stock them their warehouse. During one of these years, the economy showed signs of an upcoming recession. Therefore, they decided to stock up to save costs relating to small production cycles.

In a couple of months, a recession was announced and the inflation rose significantly. The management did not account for the rising cost of rent, labor, and logistics. Therefore, they had to adapt and up-sell other products along with the calculators to survive the lean patch in the economy.

Example #2

In July 2023, the Russian economy worsened from the previous years of slump due to the war it instigated against Ukraine. Due to ties being cut off from large world economies and destruction within the country, Russia was facing a hard time as such. To add to their woes, a few economic factors led to a further decline in the country’s economy.

The three major factors that led to the decline of the Russian economy were the decline in supply, deterioration in consumer sentiment, and exorbitant prices. In fact, the citizens of the country had virtually stopped spending on anything other than essentials.

The central bank of Moscow reported an astonishing 93% drop in the current account surplus which went from $76.7 billion to a mere $5.4 billion in comparison to the previous year.

Factors Affecting Business

Let us understand the internal and external economic factors that affect businesses through the explanation below.

#1- Interest Rate

Interest rate is a major factor that affects the liquidity of cash in the economy. With an increase in investment, cash flowCash FlowCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more in the country decreases and results in a reduction in the country’s liquidity. Conversely, a decrease in investment cash flow in the country increases and increases the country’s liquidity.

A higher return on investment will attract investors. But, if the interest rate on loans increases, cash flow in the country decreases, resulting in a decrease in the nation’s liquidity. In contrast, with the decline in interest rate over a loan, cash flow in the country increases and increases the country’s liquidity. So, the interest rate affects the economy.

#2 – Exchange Rate

The exchange rate comes into the picture in the case of export and import. Due to this, it affects international payment and the price of goods, affecting the economy.

#3 -Tax Rate

The tax rate is a crucial part of the economy. The tax rate affects the price of goods and their sales, affecting the economy.

#4 – Inflation

The increase in the demand price of goods or services increases inflation and money supply.

#5 – Labor

Labour and cost or wage are always the important economic factors affecting the economy. As a result, many countries have started outsourcingOutsourcingOutsourcing refers to contracting out specific business processes to a third-party or specialized service provider, i.e., an individual or company.read more labor from other countries. The company begins its plant or production where labor is cheap.

#6 – Demand / Supply

Demand or supply of goods or services affects the economy as with the increase in demand price of goods or service increase, which results in inflation. With inflation, the money reserve in the economy increases with the rise in the supply of goods or services. The price of the same decreases. Demand and supply depend on each other.

#7 – Wages

Wages paid to labor or employee are a direct cost to the companyDirect Cost To The CompanyDirect cost refers to the cost of operating core business activity—production costs, raw material cost, and wages paid to factory staff. Such costs can be determined by identifying the expenditure on cost objects.read more added to the cost of goods or services through which it affects the economy. Another way wages affect the economy is by increasing wages, consuming power, and improving consumer spending.

#8 – Law and Policies

With change or modification in the law, the economy of the country changes. For example, if the government makes a law that should ban liquor in the country, it will affect companies dealing with it, their employees, and shopkeepers, which affects the economy at a broad level. Similarly, any policy made by the government will affect the economy.

#9 – Government Activity

Government activity also affects the economy. So, for example, if the government promotes any industry like insurance or medical or technology, it will encourage that sector that boosts its economy, overall supporting it.

#10 – Recession

A recession affects consumers’ purchasing power, forcing companies to drop their goods or services.

So, we can see how the above economic factors affect the economy.

Many other economic factors like unemployment, market, land, capital, science, and technology affect the economy. However, for the proper functioning of the country, the economy needs to be stable. At a macro level, one can see that with regular business with competitive earningsEarningsEarnings are usually defined as the net income of the company obtained after reducing the cost of sales, operating expenses, interest, and taxes from all the sales revenue for a specific time period. In the case of an individual, it comprises wages or salaries or other payments.read more.

Factors Affecting Development

Economic development is developed to raise the average standard of living in the country. Each of the below-given macro and micro economic factors influences the growth of the country. The following are economic factors affecting development.

#1 – Education and Training

Education is the most important tool in the development of the country. Education helps one grow and develop, resulting in the development of the economy. And skill training helps one develop oneself, which results in high wages and the development of the economy.

#2 – Natural Resources

Natural resources available like a tree, water, soil, oil, coal, metal, etc., affect the country’s growth as if resources are available in-country. Therefore, one will not pay for its export, and existing resources will help in job creation and increase the country’s wealthWealthWealth refers to the overall value of assets, including tangible, intangible, and financial, accumulated by an individual, business, organization, or nation.read more, improving the overall economy.

#3 – Power and Energy Resources

Power and energy resources are required for industry, companies, and countries. In addition, one can manufacture biogas and natural resources like petrol, coal, gas, etc. These powers are required for the country’s development and will affect the economy and develop it.

#4 – Transportation

Transportation has a crucial role in economic development as the circulation of one good or service good means of transport is required. If a country has good means of transportation, it will increase the reach of goods or services to consumers, which will result in the country’s economic development.

#5 – Communication

With the development of science and technology, consumers depended too much on technology. Therefore, communication helps in the company’s expansion and growth. These days, companies are using modes of communication like mobile, internet, etc., to promote their goods and services, which leads to an increase in sales and a resulting economic development. Many other economic factors examples help in economic development like technology, labor force, capital, etc. Economic growth Economic Growth Economic growth refers to an increase in the aggregated production and market value of economic commodities and services in an economy over a specific period.read moreis required for the country’s development unless, and until it has a strong economy, it will not become a developed country.

Frequently Asked Questions (FAQs)

1. What are the economic factors in PESTLE analysis? 

In a PESTLE analysis, economic factors refer to the macroeconomic conditions that affect a company or industry. These factors include interest rates, inflation, exchange rates, tax policies, economic growth, and other indicators. Understanding these factors is important for businesses to make informed decisions about their strategies and operations.

2. What are the economic factors affecting marketing activities? 

Economic factors can have a significant impact on marketing activities. For example, trends like recessions or economic growth can also impact consumer spending habits and attitudes toward spending. Other economic factors that can affect marketing activities include inflation, interest rates, exchange rates, and government policies related to taxation and trade.

3. What are the economic factors affecting health care?

Economic factors play a major role in the healthcare industry. Factors like income levels and insurance coverage can also impact access to healthcare. Additionally, economic factors such as inflation, labor costs, and market competition can influence healthcare costs and pricing. Finally, economic factors can also influence healthcare innovation and research, as funding for research and development is often tied to economic conditions and government policies.

This article is a guide to what are Economic Factors. Here, we explain its examples, and factors affecting business and development in detail. You may learn more about our articles below on accounting: –

Reader Interactions

Comments

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