Business Economics

Business Economics

By

Dr. K. ChitraChellam

Subject matter of economics:

Economics is a social science. It deals with man and his efforts to society his wants. He may work in the office or in factory. Wherever he works, he works to earn an income. With his income, he buys goods and services to satisfy his wants. Existence of human wants is the starting point of all economic activities.

            Lionel Robbins defines Economics as “Economics is the science which studies human behavior as a relationship between ends and scarce means which have alternative uses”.

            “Ends” refer to wants. Wants are unlimited in number (endless). When one want is satisfied, another want crops up. Since wants are unlimited, one is compelled to choose between the more urgent wants and less urgent wants. That is why economics is called a science of choice.

            Though wants are unlimited, the means to satisfy the wants are scarce. The term means refers to all those material and non-material goods that will satisfy wants. They include natural resources, consumer goods, money, time etc.

            The means or resources have alternative uses. That is, the means can be put to several uses.

            Thus scope of economics is “wants, efforts and satisfaction”.

                                                Wants

                          Satisfaction

                                                Efforts 

Main sub divisions of economics:

                                    Sub-Division of Economics

 

Consumption               Production                  Exchange                    Production

1) Consumption: Consumption is the end of all economic activities. Consumption refers to using of goods and services by man. Consumption deals with the study of the characteristics and kinds of human wants, consumer behavior and laws of consumption.

2) Production: Production is a means to the end of consumption. Production refers to production of goods and services by man. It deals with the study of factors of production, laws of production and problems of production.

3) Exchange: Exchange is the connecting link between production and consumption. It refers to exchange of goods and services between producers and consumers. Exchange deals with the study of price determination in different types of market conditions.

4) Distribution: Distribution refers to the pricing of the 4 factors of production, namely land, labour, capital and organization. It deals with the distribution of national income among the 4 factors of production in the form of rent, wages, interest and profit.

Business economics (or) Managerial economics:

 Business economics is the study of allocation of resources available to a firm to achieve the desired objective of profit maximization. Managerial economics or business economics is economics applied in decision-making. Business economics is concerned with analytical tools and techniques of economics that are useful for decision making in business.

Definition of Economics

Wealth definition:

Adam Smith is the Father of Economics. Adam Smith defines “Economics as the science of wealth”. He laid emphasis on material wealth. According to Adam Smith, the main purpose of all economics activities is to acquire as much wealth as possible.

Welfare definition:

Alfred Marshall defines “Economics as the science of material welfare”. He laid emphasis on man and his welfare. According to Alfred Marshall, economics is a practical science since it deals with man’s actions in the ordinary business of life, and studies how man gets his income, how he uses it and how he makes the best use of his resources.

Scarcity definition:

Professor Lionel Robbins defines Economics as the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses.

Nature of managerial economics (or) Business economics

1.      Managerial economics is pragmatic because it is concerned with analytical tools that are useful for decision making.

2.      It is micro-economic in character because it deals with the problems of individual business firms.

3.      It is a part of normative economics. It is prescriptive rather than descriptive in character.

4.      It is both conceptual and material in nature because it involves theory and measurement.

5.      It is an applied science because it is applied to problem solving at the level of the firm.

6.      It is used in the functional areas of business administration such as accounting, financé, marketing, personnel and production management.

Scope of Business economics (or) Managerial economics:

The scope of business economics covers the following aspects.

1.      Demand function and estimation

2.      Demand elasticity

3.      Demand forecasting

4.      Production function and laws

5.      Cost analysis

6.      Pricing and output determination in perfect competition, monopoly, oligopoly and monopolistic competition.

7.      Pricing policies and practices in business

8.      Profit planning and management

9.      Project planning and management

10.  Capital budgeting and management

11.  Linear programming

12.  Game Theory

13.  Government and business

Importance/uses of business economics:

1.      Business economics makes problem-solving easy in business

2.      It improves the quality and preciseness of decisions

3.      It helps in arriving at quick and appropriate decisions

4.      Business economics is applicable to several areas of business and management such as:

a.       Production management

b.      Inventory management

c.       Marketing management

d.      Finance management

e.       Human resource management (HRM)

f.       Knowledge management

5.      Business economics helps the firm in product designing, product planning and product improvement.

6.      It is much helpful to the management in case of forecasting. Business economics helps to prepare short-term and long-range forecast of general business activity.

7.      It helps the management on financial matters such as the financial requirements and the alternative arrangements of business finance.

8.      It helps the management in making a right choice of investment and helps the firm to get a fair return on investment.

9.      Business economics helps the management in business planning. It provides guidance for the correct and economical running of the organization.

Functions or Role of a Business Economist (Managerial Economist)

1.      A business economist is an economic advisor to a firm or businessman to take correct decisions.

2.      He helps the businessman to take decisions regarding the day-to-day affairs such as fixation of price, improvement in quality, location of output, expansion or contraction in output etc.

3.      He helps the management in business planning by providing guidance for the correct and economical running of the organization.

4.      He also helps the firm in product designing, product planning and product improvement by appraising consumer’s incomes, tastes and preference.

5.      He is much helpful to the management in case of forecasting. He prepares a short term and long range forecast of general business activity.

6.      He advises the management on financial matters such as the financial requirements and the alternative arrangements of business finance.

7.      He helps the management in making a right choice of investment and to get a fair return on investment.

Responsibilities of a Business Economist (or) Managerial Economist

1.      Business economist must possess a good knowledge of the firm, the market and business conditions. He must also know the dynamic changes that may take place in the economy.

2.      He should express his ideas to the business executives in a simple language and avoid technical terms.

3.      He should be well aware of the current (present) and changing trends in the national economy as well as international economy.

4.      He must be aware of the fast changing technological development, which may adversely  affect the business of the firm.

5.      He should have the knowledge of balance of payments position, exchange rates, import and export policies of the Government.

6.      He should have the right to discuss, criticize and make suggestions.

7.      He must be modest, firm and tactful.

Objectives of a modern business firm

The different objectives of a modern business firm are:

I.) Profit maximization:

Marginal revenue (MR) is the additional revenue to the total revenue by selling one more unit of a particular commodity.

            Marginal cost (MC) is the additional cost to the total cost by producing one more unit of the commodity.

            The firm can maximize its profits only at the point where its Marginal Revenue (MR) is equal to its Marginal Cost (MC)

            In practice, it is found that firms do not care to maximize profits. The reasons for limiting profits are (or) reasons for profit restriction:

            a) Firms are prepared to sacrifice profit maximization. They try to maximize their sales volume to attain industry leadership.

            b) Whenever a firm earns huge profits, the Government may intervene. To prevent Government intervention, the firm may follow of policy of profit restriction.

            c) In order to acquire and maintain customer goodwill, firms may fix low price for the commodity and restrict its profit.

            d) If the firms earn more profit, they have to pay higher wages to the labourers. To restrain wage demands by trade unions, firms restrict profit.

II) Sales Maximization:

According to William J.Baumol, every business firm aims at maximizing its sales revenue rather than its profit. Large firms do not maximize profits but try to maximize sales revenue at minimum profit.

Reasons for sales maximization:

a) Salaries and other slack earnings of the top managers are based on sales than profits.

b) The banks and other financial institutions are  willing to finance the firms with large sales.

c) Large sales give prestige to the sales mangers.

d) Large and growing sales strengthen the competitive position of the firm.

III) Growth Maximization:

 Growth maximization is also considered as a major objective of a modern business firm. According to Marshall, the goal of the firm is to maximize the rate of growth of the firm. That is to maximize the rate of growth of demand for the products of the firm and to maximize the growth of its capital supply.

IV) Utility maximization:

O.Williamson argues that managers pursue policies which maximize their own utility. This is because they believe that profit maximization  increases the utility of shareholders only. The Managerial utility include salary status, prestige, professional excellence. Salary is measurable and quantifiable. The others, namely power, status, prestige and professional excellence are non-pecuniary which are not quantifiable.

V) Satisfying Behaviour:

 According to Simon, the main objective of a firm must be to attain a satisfactory overall performance. The goals of the firm are set by the top management and approved by the Board of Directions. According to Simon, there are 5 main goals of the firm:

            a) Production goal: It is set by the production department to increase the production.

            b) Inventory goal: It is set by the sales and production department. The sales department wants an adequate stock of output for the customers.

            c) Sales goal and

d) increasing market-share goal

            These goals are set by the sales department to increase the sales.

            e) Profit goal: It is set by the top management to satisfy the demands of shareholders i.e., to pay dividend to the shareholders.

VI) Long-Run-Survival:

 K.W.Rothschild suggests that the primary motive of a firm is its long runs survival. He says that every firm must aim for a reasonable amount of profit for its expansion and survival. The firm must also aim at earning goodwill and good image in the eyes if the society.

VII) Welfare objectives:

Business firms provide welfare measures to the employees like better wages, better working conditions, better housing, medical facilities, education for the children of the employees and cultural activities. The business firms also provide welfare facilities to the society. They build hospitals, charitable institutions, schools, libraries, roads etc.

Fundamental concepts of business Economics: (Basic concepts)

            There are 5 fundamental concepts that help the management to take correct business decisions. They are:

I) The Incremental or Marginal concept:

 The incremental concept is easier to describe than to apply in practice. It estimates the impact of decisions on revenues and costs. Changes in production, sales, prices and other related decisions will create change in total revenues and total costs.

            Incremental cost is defined as the change in total cost resulting from any particular decision of the management. Incremental revenue is defined as the change in total revenue on account of that decision. A particular decision is acceptable and profitable only if it increases revenue and decreases cost.

II) The Time Perspective Concept:

The decisions made by firms may be classified into short-run and long-run. Short-run period refers to a period during which all the variable factors of production can be changed. In the short-run period fixed factors cannot be altered.

            Long-run period refers to a period during which both variable and fixed factors can be changed. It is the time in which a new plant can be erected.

            A decision made on the basis of short run considerations may become less profitable in the long run. For example, a firm can earn more profits in the short-run by charging a higher price during the period of scarcity but it will lose its customer’s goodwill in the long-run.

            Thus a firm, before taking decision must consider the short-run and long-run effects of such decision on cost, revenues, customers and also the image of the company.

III) The Discounting concept:

 This concept is applied in valuing the money received at different time periods. The mathematical techniques used for calculating the present value of money to be received in future is called discounting. The concept of discounting is useful in business for taking decisions regarding investments.

            The formula for computing the present value is :

            V=   X       V=Present value; X=amount to be received in future

                (1+r)n                                      (i.e., after 1 year or 2 years)

                           r = rate of interest; n=no.of years

 

Example: An individual is offered a gift of Rs.1,000 today and Rs.1,000 next year. Naturally, everyone would prefer Rs.1,000 today. Because we can earn some interest by investing this money. Suppose the rate of interest is 10%, we can earn an interest of Rs.1,000 and after one year the total amount would be Rs.1,100 (i.e., 1,000+100)

            Suppose the individual would like to receive Rs.1,000 in the next year, then Rs.1,000 at a future date (next year) is to be discounted at the rate of 10% (interest) to find out its present value.                 X=Rs.1,000; r=10%; n=1; v=present value

            V=  1000                ;                1,000            = Rs.909.09

                (1+0.10)­¹                            1.10     

            Thus the present value of Rs.1,000 which would be received after one year is Rs.909.09.

            Thus, we can say that a rupee to be received tomorrow is worth less than a rupee today.

IV)The opportunity cost concept: Opportunity cost is useful in baking decisions involving a choice between different alternative courses of action. Opportunity cost is the benefits foregone or sacrificed while selecting a particular alternative.

Example: A businessman has 2 alternatives (i) having a shop in the central place of the town after paying a pugaree (security) of Rs.10,000 and (ii) having a shop at the outskirts of the town without paying any pugaree but investing this amount of Rs.10,000 in his business.

            The business will select the first alternative. Because he will get additional earnings by having a shop at a central place rather than at the outskirts of the town. Here, the opportunity cost of having a shop at a central place is Rs.10,000 + amount of interest foregone thereon. The firm should keep the opportunity cost at the lowest level possible.

V) The Equi-Marginal Concept: The basic idea of equi-marginal concept is that resources should be allocated among various economic activities of the firm in such a way that the marginal benefits derived from each activity is the same.