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Economic Analysis – First in the Top-Down Approach

In the previous article, it was mentioned that fundamental analysis involves economic analysis, industry analysis, and company analysis. Let us start the module of Fundamental analysis with Economic analysis.

Why Economic Analysis is Important?

The owner or an investor of the company should be aware of the economy in which he is investing. Without economic analysis, it will be difficult for him in finding opportunities and growing the business.

What is Economics?

Now coming to the definition of economics. According to Wikipedia Economics is defined as a branch of social science that studies the production, distribution, and consumption of goods and services.

Based on the consumer requirements and their decisions of what to buy and what not to buy, the demand for goods and services increases and decreases. Consumer demand alters the production of goods. If the consumption is high it forces the companies to produce more and vice versa. The consumption of individuals depends on the distribution of wealth among the people in society.  Now if you once again read the definition of Economics in the above paragraph, you can get a clear picture in mind.

Major Branches of Economics

Economic Analysis

Microeconomics deals with buyers decisions, prices, production, and overall supply and demand on a smaller scale. In a simple manner, we can say that microeconomics deals with the free market. In a free market, individuals are allowed to make buying decisions independently with no restrictions, sometimes with minimal restrictions based on the legality of that country. Free market is based on the demand and supply of the people.

Unlike microeconomics, macroeconomics analyses the entire economy giving a bigger picture. Here the word entire economy refers to overall supply and demand and the factors( inflation, GDP, interest rates, investments, etc.,) affecting it.

Fiscal policy will be formulated by the government which deals with tax rates, government spendings. While Monetary policy deals with interest rates, money circulation in the country.

It is hard to explain all the factors in a single article. So, for now, I will go with the important ones that affect most of the businesses, people spendings, savings, investments.

Inflation

This is what increases the price of goods over a period of time. The number of products that you are buying now for Rs.2000 may decrease after a year with the same Rs.2000 note. The denomination of the currency didn’t change but the reason is raising inflation.

What causes Inflation?

The Problem in supply causes the cost-push inflation and if there is an issue in demand then it causes the demand-pull inflation. Cost-push inflation is due to raise in input costs (labour cost, raw material costs, etc.,). Demand-pull inflation is because of the high demand for the current supply.

Measurement of Inflation

The Wholesale price index (WPI) and the Consumer Price index (CPI) measures Inflation. Central banks use these indexes to monitor and regulate inflation.

Repo rate

Repo rate is the interest rate at which Reserve Bank lends out money to all the commercial banks.

If the central bank increases the repo rate, it is indirectly forcing the banks to increase the interest on the loans they give to people and corporates. Due to high interest rates, people and corporates stop taking loans. This slows down the economy. Usually, the central bank increases the repo rate to control inflation.

Reverse Repo Rate is the interest rate at which the central bank borrows money from commercial banks. Usually, the reserve bank does this to decrease the flow of money in the economy.

Per Capita Income

Per capita income indicates the people quality of living in a country. Increase in its value indicates the improvement in living standards. This value helps the business owners to develop their products suitable for the economy.

FDI Inflow

Foreign Direct Investors money is considered as hot money. If there is a high flow of hot money into an economy, it indicates the growth of the country. This helps in creating jobs, improving the technologies, offering new services and more. Most of the emerging countries allow the FDI to improve their economy.

Along with the above factors, unemployment rate, fiscal policies of the government, trade deficits helps the business owners and investors to plan their investments. They take all these factors while doing Economic analysis. If the required conditions are met then investors move to the next step i.e., Industry analysis. In the next article, I will write on industry analysis.

KEY TAKEAWAYS

  • The economic analysis involves analyzing both micro and macroeconomics.
  • Government formulates Fiscal Policies.
  • The Central Bank formulates Monetary Policies.
  • While performing analysis, the factors that affect micro and macroeconomics (Inflation, Deflation, Unemployment rate, the repo rate, savings, investments, FDI inflow, Per capita income, etc.,) should be taken into consideration.
  • Wholesale Price Index(WPI) and The Consumer Price Index (CPI) measures Inflation.
  • The economic analysis helps business owners to take key decisions along with changing economic factors in the country.

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