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INTRODUCTION TO BUSINESS ECONOMICS
Meaning and Definition of Economics
Economics is a social science. Its basic function is to study how people- individuals, households, firms and nations- maximize their gains from their limited resources and opportunities. In economic terminology, this is called maximising behaviour or, more appropriately, optimizing behaviour. Optimizing behaviour is, selecting the best out of available options with the objective of maximizing gains from the given resources. Economics is thus a social science which studies human behaviour in relation to optimizing allocation of available resources to achieve the given ends.
Economics can be defined as “Economics is a social science that studies how society chooses to allocate its scarce resources, which have alternative uses, to provide goods and services for present and future consumption”.
Meaning and Definition of Business Economics
Business economics is often called as Managerial Economics or Economics for Firms or Economics for Executive. Business economics generally refers to the integration of economic theory with business practice. Economics provides tools; business economics applies these tools to the management of business. In simple terms, business economics means the application of economic theory to the problem of management. Business economics may be viewed as economics applied to problem solving at the level of the firm.
According to Spencer and Siegelman “Business Economics is the integration of economic theory with business practice for the purpose of facilitating decision making and forward planning by management”
According to Mc Nair and Meriam “Business Economics is to how economic analysis can be used formulating policies”.
Nature of Business Economics
- Micro- Economic in nature Micro-Economic is the branch of economics that deals with the individual units of an economy. These individual units may be a person or firm or a group of person or firms. Since business economics is concerned with the analysis of and finding optimal solution to decision making problem of business firm, it is essentially microeconomics in nature.
- Pragmatic Business Economics is a practical subject. Some places it avoids difficult abstract issues of economic theories, at some others, it incorporates complications ignores by economic theory in order to analyze the overall situation in ehich business decision making takes place.
- Related to Normative Economics
Economics can also be classified as positive or normative. Positive economics describes what is i.e., observed economic phenomenon. Normative economics on the other hand prescribes what ought to be, i.e., is distinguishes the ideal from the actual
- Conceptual in Nature Business economics is based on a sound framework of economic concepts. It aims to analyse business problems on the basis of established concepts.
- Utilizes some Theories of Macro-Economics When all individual matters are added-up and it becomes a matter of analyzing the problems of the economy or the nation as whole, we call it macro-economics. Business economics does not prescribes solutions to business problems in isolation. In order to arrive at logical outcomes, it takes place the help of some macroeconomic theories to understand the environment in which the firm operates.
- Problem-Solving in Nature Besides analyzing the managerial problems of business units, business economics aims at finding out optional solutions to the business problems of firms.
- Business Economics Deals with the Application of Economics Business economics is the branch of study which deals with economic theory and its application to business management. It helps them in managing business in a structured manner with the application of the principle of economics to managerial decision making. Some important aspects of economics theory applied to business management are; Demand analysis, production analysis and market analysis.
- Business Economics is the study if Allocation of Resources Resources allocation is key to managing business. In fact, theory of economics also deals with the problems of resource allocation like what to produce, how to produce and for whom to produce. Allocation of resources is wide concept which includes; Input allocation, Output allocation and Allocation of Funds.
- Interdisciplinary Business economics is a new discipline. Its techniques, tools, and contents emerge from different subjects, such as Economics, Management, Statistics ect. As such, it is the integrated form of multidiscipline.
Scope of Business Economics
- Demand analysis and Forecasting A business firm is an economic organization, which is engaged in transforming productive resources into goods that are to be sold in the market. A major part of business decision making depends on accurate estimates of demand. A forecast of future sales serves as a guide to management for preparing production schedules and employing resources.
- Cost and Production Analysis Cost estimates are most useful for management decision the different factors that cost variation in cost estimates should be given due consideration for planning purpose.
- Pricing decision, Policies and practices The various aspects that are dealt under it cover the price determination in various market forms, pricing policies, pricing, pricing method, differential pricing, productive and forecasting.
- Profit Management
- Business economics has led to the emergence of oligopoly, whereby few producers or firms formally collude with each other or form a cartel, and thus charge high prices and restrict output.
- There is an exploitation of workers by the undesirable activity of private business, due to unequal bargaining power of employers and workers.
- The limitation of micro economics and business economics can be classified into two broad categories. (i) Those requiring use of optimization techniques, and (ii) Those requiring supply-demand analyses to arrive at equilibrium solutions.
- Multinational corporations have given rise to cut-throat competition whereby closing the future prospects of small business enterprises.
- Focus only on firm’s internal management.
- There could be some other goals or criterion then efficiency or profit (i) Environment protection (ii) Humanism, Charity, (iii) Nationalisation or patriotism
Relationship of Business Economics with other Discipline
- Business economics and Statistics Statistical tools are a great aid in business decision-making. A good deal of business e course of economic events.
- Business Economics and Mathematics The major problem of business is how to maximise cost or how to maximise profit or how to optimise sales. Mathematical concepts and technique are widely used in economic logic with a view to find out answer to this question
- Business Economics and Accounting Accounting information is one of the principle source of data required by a business economic for a decision making purpose.
- Business Economics and operation Research Business economics depends heavily on the models and tools of operation research or quantitative techniques. Operation research is subject that consist of a number of models and analytical tools which are developed on the basis of interdisciplinary research for solving complex problems of planning and allocation of scarce resource primarily in defence industries
- Business Economics and Theory of Decision making Decision theory has been developed to deal with the problems of choice or decision making under uncertainty where they applicability of figures required for the utility calculus are not available.
- Business Economics and Economics Business economics has been described as economics applied to decision making it may be studied as a special branch of economics bridging and gap between pure economic theory and business practice. Business has two main branches Micro economics and Macro economics
- Micro economics Micro means small it studies behaviour of the individual units and small groups of such units. It is study of a particular firms, particular house holds, individual price, wages, income, individual industries and particular commodities
- Macro Economics
Macro means large. It deals with the behaviour of the large aggregate in the economy. The large aggregates are total saving, total consumption, total income, total employment, general price level, wage level, cost structure etc.
Objective of Business Firms
Entrepreneur’s main function is to bring together various factors of production, coordinate, supervise and manage them in order to produce goods and service for the firm so as to maximise profit. This is the principle objective of firm in perfect competition, monopoly, monopolistic competition and oligopoly markets. Primary objective of any organisation is to increase profit
Classification of Business Objective
Objective of a business can be classified as following categories on the basis of there nature
- Economic objectives , 2) Strategic and 3) Social Objective
I)Economic Objective
Economic objective of the business refer to the objective of earning profit and also other objectives that are necessary to pursued to achieve the profit objective which includes creation of customers, regular innovation and best possible use of available resource
Economic objective of a firm are as follows
- Profit maximization Profit is the life blood of business without which no business can survive in competitive market. Profit must be earned to ensure to survival of business, its growth and expansion over time according to traditional economic theory profit maximization is sole objective of a business firm. It means the largest absolute amount of money profit in given demand and supply condition. A firm will maximise its profit at that level of output at which the difference between total and revenue and total cost is maximum. Significance of profit maximization
- Profit is indispensible for firm’s survival
- Achieving firm ability to make profit
- Profit maximization has never been disproved in business
- Profit maximization objective has greater predictive power compared to other business objective
- Profit is more reliable measure of firm’s efficiency Criticisms of Profit maximization
- Profit Uncertain Profits are most uncertain for they accrue from the difference between the receipt of revenue and incurring of costs in the future. It is, therefore, not possible for firms to maximise their profits under conditions of uncertainty.
- No perfect Knowledge
- When sales are growing, employees can be given higher earnings and better terms of work.
- Growing sales over time prestige to managers, whereas profit goes into the pockets of shareholders.
- Managers prefer steady performance of profit rather than spectacular profit.
- Growing sales strengthen the power to adopt competitive tactics.
Criticism of Sales Maximisation
- Rosenberg has shown that it is difficult to specify exactly the relevant profit constraint for a firm.
- In the case of multi products, Baumol has argued that revenue and profit maximisation yield the same results.
- Another weakness of this model is that it ignores the interdependence of the prices of oligopolistic firm.
- The model fails to explain observed market situations in which price are kept for considerable time periods in the range of inelastic demand
- The model ignores not only actual competition, but also the threat of potential competition from rival oligopolistic firms.
- Maximization of Growth Rate This is a dynamic objective for affirm which is consistent with profit constraints i.e., a firm can attain maximum rate of growth with optimal net profit.
- Managerial Utility Maximisation Williamson argues that managers have discretion in pursuing policies which maximise their own utility after a minimum profit level is attained. A minimum profit level is necessary for job security of the manager.
The managerial utility function includes variables such as salary, security, power, status, prestige and professional excellence. Of these variables, only salary is measurable. Non- measurable variables are expressed in terms of expense preference to make them operational. The expense preference is the satisfaction derived out of certain types of expenditures and ready availability of funds
- Satisfactory Level of Profits The management generally is not even certain whether it is maximising profits of not; instead it aims merely at satisfactory profits.
II) Strategic Objective
Strategy is defined as the determination of the basic long-term objectives and goals of an enterprise and the formulation of an enterprise and the formulation of plans and the acquisitions, allocation and utilization of resources necessary to accomplish these objectives. Strategic objectives concerned mainly with the designing of business. The strategic objectives of the business are as follows.
- Long-Run Survival This is a long-term objective. Of course profitability is required for survival. But it need not be maximum profits but reasonable profits. It can survive only if it wins the goodwill of the
people by producing goods and services of good quality. A good name earned would help the firm to enjoy a bigger share of the market and this will enable it in its aspirations of survival over a long period.
- Market Leadership Each business firm tries to become a leader in the market. Efforts are made to maintain reputation, goodwill and dominance in market. Market leadership is usually understood in terms of the position of a given company within an industry or market, based on three factors. When determining whether a corporation can properly be referred to as a market leader, the profitability of the company will play a major role. Along with how profitable the company happens to be, the market share volume and value will also be considered.
- Market share Market share refers to share of a firm’s sales of a particular product in the total sales made by all firms in the market. The strength and success of a firm depends on market share. It is the percentage of an industry or market’s total sales that is earned by a particular company over a specified time period. Market share is calculated by taking the company’s sales over the period and dividing it by the total sales of the industry over a same period.
- Prevention of potential Entry Prevention of potential entry is suggested as another objective of the firms. The motive behind entry prevention is profit maximisation, securing of constant market share and avoidance of risk caused by unpredictable behaviour of new firms. Availability of attractive returns would entice new players into an industry.
- Desire for Liquidity The liquidity motive to be more important than that of profit maximisation. This refers to the desire of a firm to keep adequate amount of cash so that it can avoid a liquidity crisis. This is referred to as Banker Mentality, i.e., the fear of financial crisis and the fears of bankruptcy are very powerful factors in influencing the firm’s behaviour to keep adequate cash while pursuing profit.
- Building-Up Public Confidence for the Product This is an objective secondary to the objective of survival. The primary aim of some firms may be to build-up the customer confidence for its product and services.
III) Social Objectives
Being an important part of the country, every business must have the objective of fulfilling national and social aspirations. Social objectives are those objectives of business which are desired to be achieved for the benefit of the society. Since business operates in a society by utilising its scarce resources, the society expects something in return for its welfare. To fulfil the expectation of society is the social responsibilities of business.
- Concepts of Social Responsibilities According to K.R. Andrews, “Conceptually social responsibility may be taken to mean intelligent and objective concern for the welfare of the society”.
- Social responsibility of business towards different Interest Groups Business is responsible towards various interest groups. Business must fulfil its responsibility/obligation towards each of these groups.
- To pay government taxes honestly
- To avoid corrupting government employees.
- To discouraging the tendencies of concentration of economic power monopoly.
- To encourage fair trade practice.
- Responsibility towards society/ community The specific responsibilities of business towards the society are discussed below:
- Socio-economic objective
- Improvement of local environment
- Employment opportunities to the public
- Efficient use of Resources
- Welfare activities for weaker sections of the society.
- Business ethics.
DEMAND ANALYSIS
Meaning and definition of Demand
The concept of demand refers to the quantity of a goods or service that consumers are willing and able to purchase at various prices dealing a period of time. The demand in economics is something more than desire to purchase through desire is one element of it.
According to Benham, “The demand for anything, at a given price, is amount of it, which will be bought per unit of time, at that price”.
Features of Demand
- Desire and demand Demand is the amount of a commodity for which a consumer has the willingness and the ability to buy.
- Demand and price Demand is always at a price. Unless price stated the amount demanded has nomening
- Utility Demand depends upon utility of the commodity.
- Point of time The amount demanded must refer to some period of time
- Effective demand
Demand always means effective demand
- Flow concept
Demand is a flow concept ie, so much per unit of time
- Demand means dememand for final consumer goods.
- Desired quantity
Demand is a desired quantity .It shows consumers wish or need to buy the commodity Objective of demand analysis Objective of demand analysis are as follows
- Demand forecfasting
Forecasting of demand is the art of prediting demand for a product or a service at some future date on the basis of certain present and past behaviour pattern of some related events.
- Production planning Demand analysis is prerequisite for the production planning of a business firm.
- Sales forecasting
Sales forecasting is based on the demand analysis promotional efforts of the firm should be
based on sales forecasting
- Control of business For controlling of business it is essential to have a well conceived budgeting of costs and profit that is based on the estimation of annual demand ,sales and profit.
- Inventory Control A satisfactory control of business inventories,semi-finished goods ,finished good etc requires demand analysis.
- Growth and long term investment programs Demand analysis is necessary for determining the groath rate of firm and its longterm investment programs and planning.
- Economic planning and policy making Demand analysis helps to the planners and policy makers for a better planning and rational allocation of the countries productional resources.
Types of Demand
Types of demand are as follows
- Individual and market demand Quantity of a commodity which and indicidual is willing to buy at a particular price of the commodity during a specific time period,given his money income ,his taste and price of other commodities is known as individual demand for a commodity. The total quantity which all the consumers of a commodity are willing to buy at a given price per unit ,given their money income taste and price of other commodities is known as market demand for the commodity.
- Demand of a firm’s product and industry’s product The quantity of a firm’s produce that can be disposed of at a given price over a time period denotes the demand for the firm’s product. The aggregate of demand for the product of all the firms or an industry is known as the market demand for industry’s product.
- Autonomous and derived demand
- Market demand function It refers to the total demand for a goods or service of all the buyers taken together. Dx=f(px,pr,M,T,A,U) Where Dx=Quantity demanded for commodity x F=functional reaction Px=price of commodity x Pr=price of relative commodity /substitute M=money income of consumers T=taste of consumers A =advertisement effect U=unknown variable Determinants of demand
- Price of commodity The law of demand state that if other things remain the same,the demand of commodity inversely related to its price.It implies that a rise in price of commodity brings about a fall in purchase and vice versa.
- Income of the consumer When the income of the consumer increases they buy more and when income falls they buy less.A rich consumer demands more and more goods because his purchasing power is high.
- Taste and preference If a consumer develop a taste for a commodity they buy whatever may be the price .A favourable change in consumer preference will cause the demand to increase.
- Price of related goods The related goods are generally substitute and complementary goods.When a want can be satisfied by alternative similer goods they are called substitutes such as coffee abn tea.When commodities are compliment a fallin the price of one will cause of other to rise such as car and petrol.
- Advertisement and sales propaganda Advertisement helps in increasing demand by informing the potential consumers about the availability of the product.
- Consumers expectation Aconsumer expectation about the futire change in price and income may also affect in demand .if a consumer expect rise in price he buy large quantities and vise versa
- Growth of population With the increase in population ,people naturally demanded more goods for their survival.
- Weather condition
The demand for certain items purely depend on climatic and weather conditions.eg.Cold drinks
- Tax rate A highly taxed commodity will have a lower demand
- Avilability of credit
If there is availability of credit consumer try to spen more on consumer durasbles there by the demand demand for certain products increases.
- Pattern of savings If people begin to save more their demand will decrease.
- Circulation of money When more money circulates among the people more of a thing is demanded by the people because they have more purchasing power and vice versa
Law of demand
Law of demand explains the relationship between change in quantity demanded and change in price.It state that the higher the price lower would we the quantity demanded in the market and vice versa.
In other words the law of demand says tha t the price and quantity demanded are inversely related ,all other things being equal.
According to Marshel “The amount demanded increases with a fall in price and diminishes with the rise in prise@
Assumptions of law of demand
Assumptions are as follows
- Income level should remain constant Stability in income is an essential condition for the operation of the law of demand.
- Taste of the buyer should not change When tastes or fashion change people revise their preference.
- Price of other goods should remain constant The law of demand operate it is very necessary that price of other goods donot change
- No new substitute for the commodity With the availability of new substitute some buyer will be attracted hence the law of demand operates only whenthe marketbfor a commodity is not threatened by new substitute.
- Price rise in future should not be expected For the operation of law of demand it is necessary that there must not be any expectation of price rise in future.
- Advertising expenditure should remain same If the advertising expenditure of a firm increases the consumers may be tempted to buy more of its product, therefore advertising expenditure on the goods under consideration is taken to be constant. Demand schedule
Demand schedule is a table or chart which shows the relationship between price and demand of acommodity or service unit of time .If we list the different quantity of a commodity demanded at different price in the form of raw and column ,the resulting format is demand schedule
Based on the law of diminishing marginal utility According to this law when consumer buys more unit of commodity the marginal utility of that commodity continuous to decline. Therefore the consumer will buy more unit of that commodity only when its price falls.
Price effects Every commodity has certain consumers but when it price falls, new consumers starts to consuming it, as result of demand increases and with the increase in the price of product Many consumers will either reduce or stop its consumption and demand will be reduced.
Different income Group Ordinary people buy more when price falls and less when price rises. The rich do not have any effect on the demand curve because there are capable of buying the same quantity even at a higher price.
Different uses There are different uses of certain commodity and service that are responsible for the negative slop of demand curve.
Exception to the law of demand
The following are the important exception
- Some consumers measure the utility of commodity by its price, that is if the commodity is expensive they think that it has got more utility.
- Giffen goods-Sir Roberts Giffen; generally those goods which are considered inferior by the consumers and which occupy a substantial price in consumers budgets are called Giffen goods. E.g. wheat, Rice
- Necessities of life- normally the law of demand does apply on necessity of life such as food, cloth etc.
- Conspicuous necessities:- certain goods effects the consumption pattern of social group to which an individual belongs. These goods due to their constant usage have become necessities of life. E.g. cooking gas,
- Future expectation about price:- it has been observed that when the price are rising tents to buy large quantities of commodity.
- Ignorance effects:- in practice the house hold may demand larger quantities of a commodity even at a higher price, because it may be ignorant of the ruling price of the commodity.
- Outdated goods:- goods that go out of use due to advancement in the underline technology are called outdated goods.
Elasticity of demand
Meaning
The term elasticity of demand is used to denote a measure of the rate at which demand changes in response to the changes in price. We can say that it is the percentage change in quantity demanded divided by the percentage in one of the variable on which demand depends.
Types of elasticity of demand
They are;
Price elasticity of demand
Income elasticity of demand
Cross elasticity of demand
Advertising and promotional elasticity of demand
Price elasticity of demand It expreses the response of quantity demanded of goods ,to a change its price,given the consumers income,his tastes and prices of all other goods. According to prof.Lipsey “ elasticity of demand defined as the ratio of the percentage change in demand to the percentage in price” Thus price elasticity of demand is the ratio of percentage change in amount demand to a percentage change in price it may be written as , Price elasticity (EP)=% change in quantity demanded /% change in prices
Types or degree of price elasticity
Price elasticity of demand is classified in to 5 categories
- Perfectly elastic demand or E= In case of perfectly elastic demand the demand for a commodity changes even though there is no changing price.It also implies that with a small % change in price , the quantity demand would change indefinitely and so the seller would not change the price
- Perfectly inelastic demand or E= If the demand for a commodity does not change in spite of an increase or decrease in its price, the demand is perfectly inelastic.
- Unitary elastic demand or E= Price elasticity of demand is unity when the change in demand is exactly proportionate to the changes in price.The demand curve in this case is a rectangular hyperbola.
- Elastic Demand or E> 1 If the % change quantity demanded is greater than the % change change in price, price elasticity of demand is greater than one.This is known as elastic demand.
- In elastic demand or E< If the % change in quantity demanded is less than the % change in price, price elasticity of demand is less than one this is known as inelastic demand.
Determinants of price elasticity of demand
- Avilabilty of substitutes One of the most important determinant elasticity of demand for a commodity is the availability its close substitute. The higher the degree of the closeness of the substitute , the greater the elasticity of demand for the commodity.
- Position of a commodity in a consumers budgets The greater the proportion of income spend on a commodity , the greater will be the elasticity of demand and vice versa.
P1= Original price P2=new price Q1=original quantity Q2= new quantity
- Total outlay method In this case of total outlay method, price elasticity of demand is measured on the basis of change in total outlay or total expenditure in response to a change in the price of the commodity. Marshall maintains that elasticity of demand can be of three types.
- Unitary Elasticity:- if small changes in price total outlay unaffected, price elasticity of demand is unity.
- Elastic Demand:- if a small reduction in price increase total outlay or if small increase in price reduces total outlay, demand in elastic.
- Inelastic Demand:- if a small reduction in price leads to a fall in total outlay or if a small increase in price increases total outlay demand is inelastic
- Revenue Method Revenue refers to the sale proceeds of a firm. Elasticity of demand can be estimated if average revenue and marginal revenue are known. Average revenue is the price per unit of the commodity. Marginal revenue is the addition to total revenue by the sale of an additional unit of the commodity. EP= A/(A-M) EP= stands for elasticity of demand A=Stands for average revenue M=stands for marginal revenue
INCOME ELASTICITY OF DEMAND
Income elasticity of demand is defined as the percentage in the quantity demanded of a goods
divided by the percentage change in the income of the consumer.
Types of income elasticity of Demand
- High income Elasticity:- When the quantity demanded of goods increases by a larger percentage as compared with the income of the consumer, income elasticity of demand is high.
- Unitary income Elasticity:- When the percentage change in quantity demanded is equal to the percentage change in income, income elasticity of demand is unitary.
- Low income Elasticity:- when the quantity demanded of goods increases by a smaller percentage as compared with the income of consumer, income elasticity of demand is low.
- Zero income Elasticity:- When the quantity demanded of a goods remains unchanged upon the change of income, income elasticity of demand is zero.
- Negative income Elasticity:- When the quantity demanded of a goods falls in response to an increase in income, the income elasticity of demand is negative.
Cross Elasticity of Demand
A change in the demand for one goods in response to a change in the price of another goods
represents cross elasticity of demand of the goods for the latter goods.
EC=percentage change in purity demanded of goods A / Percentage change in price of goods B
The elasticity coefficients give significant results about the type of goods
- Substitute Goods: If cross elasticity of demand is positive, meaning that sale of X move in the same direction as a change in the price of Y, then X and Y are substitute goods.
- Complementary Goods When cross elasticity is negative, we know that X and Y “go together”; an increase in the price of one decrease the demand for the other. So, the two are complementary goods.
- Independent Goods A zero of near zero elasticity suggests that the two products being considered are unrelated or independent goods.
Advertising and promotional Elasticity of Demand
The promotional elasticity of demand is a measure of the responsiveness of demand for a
commodity to the change in outlay on advertisement and other promotional efforts.
EA= Percentage change in demand / percentage change in expenditure on advertisements and other promotional efforts
Significance /Uses of Elasticity of Demand
- Determination of price Policy: While fixing the price of this product, a businessman has to consider the elasticity of demand for the product. He should consider whether lowering of price will stimulate demand for his product and if so to what extent and whether his profits will also increase result thereof.
- Price Discrimination:
