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Lesson - 1 Business Economics- Meaning, Nature, Scope and significance Introduction and meaning : ( Author : Dr. M.S. Khanchi ) Business Economics, also called Managerial Economics, is the application of economic theory and methodology to business. Business involves decision-making. Decision making means the process of selecting one out of two or more alternative courses of action. The question of choice arises because the basic resources such as capital, land, labour and management are limited and can be employed in alternative uses. The decision-making function thus becomes one of making choice and taking decisions that will provide the most efficient means of attaining a desired end, say, profit maximation.
Different aspects of business need attention of the chief executive. He may be called upon to choose a single option among the many that may be available to him. It would he in the interest of the business to reach an optimal decision- the one that promotes the goal of the business firm. A scientific formulation of the business problem and finding its optimals solution requires that the business firm is he equipped with a rational methodology and appropriate tools.
Business economic meets these needs of the business firm. This is illustrated in the following presentation.
Economic Decision Theory and problems in Methodology Business
Business Economic Application of Economic Theory and Methodology to solving Business problems
Optimal Solution to Business Problems
it may be that business economics serves as a bridge between economic theory and decision-making in the context of business.
According to Mc Nair and Meriam, “Business economic consists of the use of economic modes of thought to analyse business situations.”
Siegel man has defined managerial economic (or business economic) as “the integration of economic theory with business practice for the purpose of facilitating decision-making and forward planning by management.”
We may, therefore, define business economic as that discipline which deals with the application of economic theory to business management. Business economic thus lies on the borderline between economic and business management and serves as a bridge between the two disciplines.
Nature of Business Economics :
Traditional economic theory has developed along two lines; viz., normative and positive. Normative focuses on prescriptive statements, and help establish rules aimed at attaining the specified goals of business. Positive, on the other hand, focuses on description it aims at describing the manner in which the economic system operates without staffing how they should operate.
The emphasis in business economics is on normative theory. Business economic seeks to establish rules which help business firms attain their goals, which indeed is also the essence of the word normative. However, if the firms are to establish valid decision rules, they must thoroughly understand their environment. This requires the study of positive or descriptive theory. Thus, Business economics combines the essentials of the normative and positive economic theory, the emphasis being more on the former than the latter.
Scope of Business Economics :
economic costs and the ability to measure them are the necessary steps for more effective profit planning, cost control and sound pricing practices.
Production analysis is narrower, in scope than cost analysis. Production analysis frequently proceeds in physical terms while cost analysis proceeds in monetary terms. The main topics covered under cost and production analysis are: Cost concepts and classification, Cost-output Relationships, Economics and Diseconomics of scale, Production function and Cost control.
3. Pricing Decisions, Policies and Practices :
Pricing is an important area of business economic. In fact, price is the genesis of a firms revenue and as such its success largely depends on how correctly the pricing decisions are taken. The important aspects dealt with under pricing include. Price Determination in Various Market Forms, Pricing Method, Differential Pricing, Product-line Pricing and Price Forecasting.
4. Profit Management :
Business firms are generally organised for purpose of making profits and in the long run profits earned are taken as an important measure of the firms success. If knowledge about the future were perfect, profit analysis would have been a very easy task. However, in a world of uncertainty, expectations are not always realised so that profit planning and measurement constitute a difficult area of business economic. The important aspects covered under this area are : Nature and Measurement of profit, Profit policies and Technique of Profit Planning like Break-Even Analysis.
5. Capital Management :
Among the various types business problems, the most complex and troublesome for the business manager are those relating to a firm’s capital investments. Relatively large sums are involved and the problems are so complex that their solution requires considerable time and labour. Often the decision involving capital management are taken by the top management. Briefly Capital management implies planning and control of capital
expenditure. The main topics dealt with are: Cost of capital Rate of Return and Selection of Projects.
Conclusion :
The various aspects outlined above represent major uncertainties which a business firm has to reckon with viz., demand uncertainty, cost uncertainty, price uncertainty, profit uncertainty and capital uncertainty. We can therefore, conclude that the subject matter of business economic consists of applying economic principles and concepts to dea1 with various uncertainties faced by a business firm.
Significance of Business Economics :
The significance of business economics can be discussed as under :
- Business economic is concerned with those aspects of traditional economics which are relevant for business decision making in real life. These are adapted or modified with a view to enable the manager take better decisions. Thus, business economic accomplishes the objective of building a suitable tool kit from traditional economics.
- It also incorporates useful ideas from other disciplines such as psychology, sociology, etc. If they are found relevant to decision making. In fact, business economics takes the help of other disciplines having a bearing on the business decisions in relation various explicit and implicit constraints subject to which resource allocation is to be optimized.
- Business economics helps in reaching a variety of business decisions in a complicated environment. Certain examples are : (i) What products and services should be produced? (ii) What input and production technique should be used?
(iii) How much output should be produced and at what prices it should be sold?
Lesson - 2 Theory of Consumer’s Behaviour : Utility Analysis
(Author: Dr. M.S. Khanchi) The theory of consumer’s behaviour seeks to explain the determination of consumer’s equilibrium. Consumer’s equilibrium refers to a situation when a consumer gets maximum satisfaction out of his given resources. A consumer spends his money income on different goods and services in such a manner as to derive maximum satisfaction. Once a consumer attains equilibrium position, he would not like to deviate from it. Economic theory has approached the problem of determination of consumer’s equilibrium in two different ways: (1) Cardinal Utility Analysis and (2) Ordinal Utility Analysis Accordingly, we shall examine these two approaches to the study of consumer’s equilibrium in greater defait.
Utility Analysis or Cardinal Approach :
The Cardinal Approach to the theory of consumer behaviour is based upon the concept of utility. It assumes that utility is capable of measurement. It can be added, subtracted, multiplied, and so on.
According to this approach, utility can be measured in cardinal numbers, like 1,2,3,4 etc. Fisher has used the term ‘Util’ as a measure of utility. Thus in terms of cardinal approach it can be said that one gets from a cup of tea 5 utils, from a cup of coffee 10 utils, and from a rasgulla 15 utils worth of utility.
Meaning of Utility :
The term utility in Economics is used to denote that quality in a good or service by virtue of which our wants are satisfied. In, other words utility is defined as the want satisfying power of a commodity. According to, Mrs. Robinson, “Utility is the quality in commodities that makes individuals want to buy them.”
According to Hibdon, “Utility is the quality of a good to satisfy a want.”
Features :
Utility has the following main features :
(1) Utility is Subjective : Utility is subjective because it deals with the mental satisfaction of a man. A commodity may have different utility for different persons. Cigarette has utility for a smoker but for a person who does not smoke, cigarette has no utility. Utility, therefore, is subjective.
(2) Utility is Relative : Utility of a good never remains the same. It varies with time and place. Fan has utility in the summer but not during the winter season.
(3) Utility and usefulness : A commodity having utility need not be useful. Cigarette and liquor are harmful to health, but if they satisfy the want of an addict then they have utility for him.
(4) Utility and Morality : Utility is independent of morality. Use of liquor or opium may not be proper from the moral point of views. But as these intoxicants satisfy wants of the drinkards and opiumeaters, they have utility for them.
Concepts of Utility :
There are three concepts of utility :
(1) Initial Utility : The utility derived from the first unit of a commodity is called initial utility. Utility derived from the first piece of bread is called initial utility. Thus, initial utility, is the utility obtained from the consumption of the first unit of a commodity. It is always positive.
(2) Total Utility : Total utility is the sum of utility derived from different units of a commodity consumed by a household. According to Leftwitch, “Total utility refers to the entire amount of satisfaction obtained from consuming various quantities of a commodity.” Supposing a consumer four units of apple. If the consumer gets 10 utils from
(ii) Zero Marginal Utility : If the consumption of an additional unit of a commodity causes no change in total utility, marginal utility will be zero.
(iii) Negative Marginal Utility : If the consumption of an additional unit of a commodity causes fall in total utility, the marginal utility will be negative. Relationship between total utility and Marginal Utility : The relationship between total utility and marginal utility may be better understood with the help of a utility schedule and a diagram as shown below :
Table No. I No. of units Total Marginal Consumed Utility Utility
0 0 - 1 10 10
2 18 18 3 24 6
4 26 2 5 26 0
6 24 - 7 21 -
The relationship between total utility and marginal utility can be explained with the help of the above table and diagram based thereon.
- Total utility, initially, increases with the consumption of successive units of a commodity. Ultimately, it begins to fall.
- Marginal Utility continuously diminishes.
- As long as marginal utility is more than zero or positive, total utility increases, total utility is maximum when marginal utility is zero. It falls when marginal utility is negative.
- When marginal utility is zero or total utility is maximum, a poin of saturation is obtained.
Laws of Utility Analysis :
Utility analysis consists of two important laws
- Law of Diminishing Marginal Utility.
- Law of Equi-Marginal Utility. 1. Law of Diminishing Marginal Utility :
Law of Diminishing Marginal Utility is an important law of utility analysis. This law is related to the satisfaction of human wants. All of us experience this law in our daily life. If you are set to buy, say, shirts at any given time, then as the number of shirts with you goes on increasing, the marginal utility from each successive shirt will go on decreasing. It is the reality of a man’s life which is referred to in economics as law of Diminishing Marginal Utility. This law is also known as Gossen’s First Law.
According to Chapman, “The more we have of a thing, the less we want additional increments of it or the more we want not to have additional increments of it.”
According to Marshall, “The additional benefit which a person derives from a given stock of a thing diminishes with every increase in the stock that he already has.”
5 0point of Satiety 6 -
It is clear from the above Table that when the consumer consumes first unit of bread, he get marginal utility equal to 8. Marginal utility from the consumption of second, third and fourth bread is 6, 4 and 2 respectively. He gets zero marginal utility from the consumption of fifth bread. This is known as point of satiety for the consumer. After that he gets negative utility i.e. -2 from the consumption of sixth unit of bread. Thus, the table shows that as the consumer goes on consuming more and more units of bread, marginal utility goes on diminishing.
Pricing Decision :
A retailor’s price policy is a crucial positioning factor and must be decided in relation to its target market, its product and service assortments and its competition. This involved the decisions regarding the price lilies to be earned and overall markdown or sale policies:
Promotion Decision :
Retailers use the promotional tools - advertising, personal selling, sales promotion and public relations to reach. Customers Personal selling requires careful training of sales people in how to greet customers, meet their needs and handle their complaints.
THE FUTURE OF RETAILING :
Present scenario of retailing is that retailer’s margins are very low. They are able to survive on low margins due to remarkable capacity for thrift. In many traditional shops the family provides much of the labour. He performs several functions distribution, finance and risk taking. When there is keen competition, retailers tend to undercut each other. They compensate themselves by taking higher margins on other products, or by increasing the turnover.
WHOLESALING :
Wholesaling is the sale, and all activities directly related to the sale, of goods and services, to business and other organizations for (1) resale (2) use in producing other goods and services or (3) operating an organization.
Wholesalers buy mostly from producers and sell mostly to retailers, industrial consumers and other wholesalers.
NATURE AND IMPORTANCE OF WHOLESALING :
Here we will focus on firms engaged primarily in wholesaling. Retailers may also be occasionally be involved in wholesale transaction.
Manufacturers small or big cannot establish their own direct link with retailers or customers. It is not cost effective to them. At the other end of the distribution channel, most retailers and final users buy in small quantities and have only a limited knowledge of the market and source of supply. Thus there is gap, a wholesaling middleman can fill this gap by providing services of value to manufacturers and or to the retailers. Wholesaling brings to the total distribution system the economies of skill, scale and transactions.
Risk bearing : Wholesalers absorb risk of the manufacturers by taking title and bearing the cost of theft damage, spoilage and obsolescence. Market information:
Wholesalers give information to suppliers and customers about com- petitors new product and price developments.
Management services and advice : Wholesalers often help retailers train their sale clerks, improve store layouts and displays and setup accounting and inventory control systems.
TYPES OF WHOLESALERS :
Wholesalers can be broadly divided into three broad categories Merchant wholesaler, Agent wholesaling middleman and Manufacturers’ Sales facility.
Fig.9 - Types of wholesaling institutions :
Wholesaling Middleman Merchant Agent Manufacturers Sales Wholesa1ing Wholesalers facilities including including middleman, including
Full Service Manufacturers agents Branches Truck Jobber Brokers Offices Drop Shippers
Merchant Wholesalers :
A merchant wholesaler is independently owned business that takes title to the merchandise it handles. Merchant wholesalers include Full service, Truck jobbers, Drop Shippers.
Full service wholesalers :
Full service wholesalers provide a full set of services, such as carrying stock, using a sales force, offering credit, making deliveries and providing management assistance. They are either wholesale merchants or industrial distributors. Wholesale merchants sell mostly to retailers and provide a full range of services. Industrial distributors are merchant wholesalers that sell to producers rather than to retailers.
Truck Jobbers :
They perform a selling and delivery function. They carry a limited line of goods (such as milk, bread or snack food) that they sell for cash as they make their rounds of supermarkets, small groceries, hospitals etc.
Drop Shippers :
They operate in bulk industries such as coal and heavy equipment. They do not carry inventory or handle the product. Once an order is received, they find a producer who ships the goods directly to the customer.
Agent wholesaling middleman :
It is an independent firm that engaged primarily in wholesaling by actively negotiating the sale or purchase of products or behalf of other firms but that does not take little to the products being distributed.
Manufacturers Agents :
Agents represent buyers a seller on a more permanent basis. Manufacturers’ agents represent two or more manufacturers of related lilies. They have a formal agreement with each manufacturer covering prices, territories, order handling procedures, delivery and warranties and commission rates. They know each manufacturer’s product line and use their wide contact to sell the products.
Brokers :
A broker brings buyer and sellers together and assists in negotiations. The parties hiring them pay brokerage. They do not carry inventory, get
bananas the gain win be equal to EFGH. It is clear that (ABCD) < (EFGH), hence loss is more than gain.
Importance of the Law :
The importance of the law of equi-marginal utility can be explained as follows:
1. Consumption : If a consumer spends his income, as suggested by this law, on different commodities in such a way that the last unit of money spent on them yields him equal marginal utility, he will be getting maximum satisfaction out of his income. 2. Production : Every producer aims at earnings maximum profit. To achieve this objective he must utilize different factors of production in such a way that the marginal productivity of each factor is equal. 3. Exchange : Acting upon the law of equi-marginal utility, every person will go on substituting goods giving more utility for the ones giving less utility, till the marginal utility of all becomes equal. Exchange will stop at that point. 4. Distribution : It refers to the distribution of national income among the factors of production, i.e. land, labour, capital, etc. Distribution is done in such a way that in the long-run every factor gets its share out of national income according to its marginal productivity. 5. Public Finance : At the time of levying taxes, finance minister takes the help of this law. He levies taxes in such a manner that the marginal sacrifice of each tax-payer is equal. Then only it will have the lest burden on all tax-payers. To achieve this objective, a finance minister may substitute one tax for the other.
Criticism of the Law :
This law has been subjected to the following criticism.
1. Cardinal measurement of utility is not possible : Measurement of utility is not possible. How can a consumer say that he would get 10 utils
of utility from first apple and 8 utils, of utility from the second. Unless marginal utility is estimated, application of the law will remain dubious.
2. Consumers are not fully rational : The assumption that consumers are fully rational is not correct. Some consumers are idle by nature, and so to satisfy their habits and customs, they sometimes buy goods yielding less utility. Consequently, they do not get maximum satisfaction. 3. Shortage of Goods : If goods giving more utility are not available in the market, the consumer will have to consume goods yielding less utility. 4. Ignorance of the consumer : Consumer is ignorant about many things concerning consumption. Many a times, he is ignorant about the right price of the goods. He is ignorant about the less expensive substitutes that may be way available in the market. He is also ignorant about the different uses of goods. On account of this ignorance, the consumer fails to spend his income in a manner that may yield him maximum satisfaction. 5. Influence of Fashion, Customs and Habits : Actual expenditure of every consumer is influenced by fashion, customs, and habits. Under their influence, many a times the consumer buys more of such goods which give less utility.
Consequently, he buys less of those goods which give more utility. Hence he fails to spend his income according to this law.
6. Constant Income and Price : An important assumption of the law is that the income of the consumer and the price of the goods should remain constant. Income of the consumer is limited, as such he cannot increase his satisfaction beyond a particular limit. Likewise, prices being constant, he will get only as much of satisfaction as the amount of goods that he can buy with limited income. He cannot extend his satisfaction beyond this limit. 7. Change in the Marginal Utility of Money : The assumption that marginal utility of money remains constant is also unrealistic. In actual
