Economic environment refers to the nature of economy (capitalist, socialist or mixed), economic policies of the government, markets for material, labor, capital, etc., business firms and institutions such as banks, insurance companies transport companies, etc. and level of income of the people.

The economic environment is greatly influenced by the government through fiscal policies, economic controls, industrial policy and import-export policy. For instance, if the government announces a cut in the excise duty on refrigerators, the sales of business firms manufacturing refrigerators will go up. Similarly, if the government allows liberal finance to export-oriented units at confessional rates, such units will get a boost.

The economic environment of a firm also includes the markets in which it buys and sells, raises funds, gets labour, etc. The business is invariably influenced by the conditions of various markets. For instance, if there is uncertainty in the capital market, it will not be advisable to issue shares and debentures to the public because of risk of under-subscription.

A few examples of impact of changes in economic environment on business are as follows:

(i)    Industrial licensing has been liberalized; license is mandatory only for six categories of industries.

(ii)    Entry of multinationals into the country has been made easier. This has reduced scarcity of goods and created competition for the Indian companies.

(iii)    Indian companies can raise funds in the foreign markets by issuing GDRs and ADRs.

(iv)    Private airlines have been allowed to run services on domestic and international routes.

(v)    Banking sector reforms have led to lower rates of interest on borrowings by the industrial and commercial organizations.

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