Introduction to

Business Economics
 Objectives
• Explain What is Business Economics
• Describe the Purpose of Business Economics
• Explain the Principles of Business Economics
• List the Objectives of a Business Firm
• Describe the Role of Environmental Analysis in BE
• Explain Role of Cost Analysis in BE
• Explain the Classification of Market Structures
• Explain What is Demand
• Explain the Law of Demand
• Explain the Why Demand Curve has Negative Slope
• List the Exceptions to Law of Demand
• Explain Price Elasticity of Supply & Supply Curve
• Describe Determinants of Price Elasticity of Supply
• Explain How Managers can Apply BE
• List the Benefits of Business Economics
Introduction
• ‘Raymond Garments’ is a
large and reputed garments
manufacturing company.

• It has established a niche for

itself in the garments
industry and is a leader in its
industry and segment.

• In summer, it being an off-

season,Raymond announced
a huge ‘Off Season Sale’ and
offered a discount of 75% on
its winter wear collection.
 Introduction
• The Managers at Raymond
did not correctly forecast
such a huge demand and so
the company was not
prepared for the
overwhelming response of
the customers to this sale.

• The demand was so huge

that the company ran out of
its winter wear stocks and
could not fulfil all of its
customer’s demands.
Introduction

Now, let us see what

happened in winter?
Introduction
• In winter, owing to the
Christmas Season, the
discount on winter wear was
a nominal 20% as it was the
on-season.

• This time the Managers at

Raymond had taken care to
keep huge stocks ready for
meeting the demand of
customers in the on-season.
 Introduction
• However, owing to the
nominal discount, the
demand was far less than
what the Managers had
predicted.

• Raymond also incurred huge

losses due to the vast
amount of inventory of
winter wear that it had
maintained for the winter
season.
Introduction
• Hence, we can understand
that understanding the
concepts of demand and
supply and other concepts of
microeconomics are crucial
for the efficient working of
Managers to ensure the
smooth and successful
running of any business.
 Introduction
• This is where ‘Business
Economics’ can help
Managers as it is an
‘amalgamation of economic
theory with business
practices so as to ease
decision-making and future
planning by management.’

• Business Economics assists

the managers of a firm in a
rational forecasting of
demand and supply and
solving obstacles faced in
the firm’s activities.
Introduction
• Business Economics makes
use of economic theory and
concepts and helps in
formulating logical
managerial decisions.

• Business Economics is a
science dealing with
effective use of scarce
resources.
 Introduction
• It guides the managers in
taking decisions relating to
the firm’s customers,
competitors, suppliers as
well as relating to the
internal functioning of a
firm.

• Let us learn about

‘Introduction to
Business Economics’ in
detail.
 What is Business Economics?

• Business Economics can be defined as: ‘Amalgamation of

economic theory with business practices so as to ease
decision-making and future planning by management.’

• Business Economics assists the managers of a firm in a

rational solution of obstacles faced in the firm’s activities.
 Purpose of Business Economics
Business Economics is useful wherever there are scarce resources and it helps to
ensure that managers make effective and efficient decisions concerning customers,
suppliers, competitors as well as within an organization. The fact of scarcity of
resources gives rise to the following three fundamental questions:

What to produce? How to produce? For whom to

produce?

The purpose of use of Business Economics principles in a firm is to answer these

questions. Let us try to understand how a manager can use Business Economics
principles to answer the three questions.
Uses of Business Economics

The use of Business Economics

is not limited to profit-making
firms and organizations. But it
can also be used to help in
decision-making process of
non-profit organizations such
as hospitals, educational
institutions, etc. It enables
optimum utilization of scarce
resources in such organizations
as well as helps in achieving the
goals in most efficient manner.
Business Economics is of great
help in price analysis,
production analysis, capital
budgeting, risk analysis and
determination of demand.
Business Economics & Environmental Analysis
Business Economists should carry out a thorough analysis of the environment
of a business. Thus, Business Economists should analyze the four
environmental influences on a business such as:

Economic

Social

Political

Technological
 Industry Competition
• Role of Market Analysis in Business Economics
Hence, the competition faced by companies
has been classified based on the degree of
Brand Competition product substitution in the following
categories:

IndustryCompetition
Industry Competition

Product Competition
A competition in which a company considers
all companies making the same product or
Generic Competition class of products as its competitors is known
as an ‘Industry Competition’. For example:
Pepsi would consider all other soda
manufacturers as its competitors.
Role of Business Economics in Business Decisions
Business Economics helps in achieving business objectives by
making strategic business decisions as follows:

It helps to maximize organization’s response to

demands and opportunities.

It helps to overcome organization’s threats.

It helps to reverse organization’s weaknesses.

How Managers can Apply Business Economics?
Some of the ways in which a Manager can apply Business Economics are:

If a manager wants to increase the price of the

product due to increase in cost of production,
he should analyze the price elasticity of demand
for that product so that price rise is not
followed by substantial fall in the demand of
the product. It is the application of demand
analysis to the real world situation.

Managers should determine the price and output

with the acquaintance of market structures and
approaches pertinent for determination of price
and output in the given market setup.
BUSINESS ECONOMICS

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What is Economics?

 Wealth Definition: It is a science of earning and

spending wealth as defined by the Father of
Economics Adam Smith in his classic work :
‘An enquiry into nature and causes of the Wealth of
Nations.’
Criticism: Smith defined economics only in terms of
wealth and not in terms of human welfare.
However, now, wealth is considered only to be a
mean to end, the end being the human welfare.
Hence, wealth definition was rejected and the
emphasis was shifted from ‘wealth’ to ‘welfare’.
Welfare Definition: In the opinion of
Alfred Marshall it was study of mankind
in ordinary business of life.
Criticism: a) Marshall considered only
material things. But immaterial things,
such as the services of a doctor, a teacher
and so on, also promote welfare of the
people.
 Lionel Robbins gave us the most accepted scarcity-oriented
definition of Economics. He says
Economics is a social science which studies human behavior as a
relationship between unlimited wants
and scarce means which have alternative uses.
Criticism: Robbins does not make any distinction between goods
conducive to human welfare and
goods that are not conducive to human welfare. In the production of
rice and alcoholic drink, scarce
resources are used. But the production of rice promotes human
welfare while production of alcoholic
drinks is not conducive to human welfare. However, Robbins
concludes that economics is neutral
between ends.
 Growth Definition: Prof. Paul Samuelson defined economics as
“the study of how men and society
choose, with or without the use of money, to employ scarce
productive resources which could have
alternative uses, to produce various commodities over time, and
distribute them for consumption, now
and in the future among various people and groups of society”.
Samuelson appears to be the most satisfactory. However, in modern
economics, the subject matter of
economics is divided into main parts, viz., i) Micro Economics and
ii) Macro Economics.
Economics is, therefore, rightly considered as the study of allocation
of scarce resources (in relation to
unlimited ends) and of determinants of income, output, employment
and economic growth.
Business+ Economics

 Business Economics is
economics applied in
decision-making
 Link between abstract theory
and managerial practice.
 Analysis for identifying
problems, organizing
information and evaluating
alternatives.

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 Business Economics & Business
Decision-making

Decision Problem

Tools &
Traditional Business Economics Techniques
Economics
of Analysis

Optimal Solution to Business Problems

25
 Nature of Business Economics

Spencer and Siegelman point to the fact

that “Business Economics.. is the integration
of economic theory and business practice for
the purpose of facilitating decision-making
and forward planning by management.”

26
 Chief Characteristics of Managerial
Economics/Nature
 Business economics is micro-economic in character as
it concentrates only on the study of the firm and not on
the working of the economy.
 Business economics takes the help of macro-
economics to understand and adjust to the
environment in which the firm operates.
 Business economics is normative rather than positive
in character.
 It is both conceptual (theory) and metrical
(quantitative techniques).
 The contents of business economics are based mainly
on the “theory-of firm’.
 Knowledge of business economics helps in making wise
choices.

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Significance of Business
Economics
In order to enable the manager to
become a more competent model
builder, business economics provides a
number of tools and techniques.
Business economics provides most of
the concepts that are needed for the
analysis of business problems.
Business economics is helpful in
making decisions.
Evaluating choice of alternatives.

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Scope of BusinessEconomics

Following aspects constitute its subject matter:-

 Objectives of a Business Firm

 Demand Analysis and Demand Forecasting
 Production and Cost
 Competition
 Pricing and Output
 Profit
 Investment and Capital Budgeting and
 Product Policy, Sales Promotion and Market Strategy.

29
 Business Economics & Other
Disciplines

 Business Economics & Traditional Economics

 Business Economics & Operations Research

 Business Economics & Mathematics

 Business Economics & Statistics

 Business Economics & the Theory of Decision-

making
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FUNDAMENTAL CONCEPTS

31
Fundamental Concepts

Incremental Reasoning
Opportunity Cost
Contribution
Time Perspective
Time Value of Money – Discounting
Principle &
Equi-Marginal Principle

32
1.Incremental Reasoning
The two basic concepts in the incremental analysis are :
incremental cost and incremental revenue.
• Incremental cost may be defined as the change in total cost as a
result of change in the level of output, investment, etc
•Incremental Revenue is change in total revenue resulting from
change in level of output , price etc.
Use of Incremental Reasoning
While taking a decision, a manager always determines the
worthwhile ness of a decision on the basis of criterion that the
incremental revenue should exceed incremental cost.

33
Illustration:
The firm gets an order The addition to cost due
which can get it an to new order is the
additional revenue of Rs.
2000. The normal cost following:
of production of this Labour Rs.400
order is:
Materials 800

Labour Rs.600 Overheads 200

Materials 800 Full cost Rs.1400

Overheads 720  Firm would earn a net

Selling & 280 profit of Rs 2,000 – Rs.
administrati 1400 = Rs. 600 while at
on expenses first it appeared that the
firm would make a loss
Full cost Rs.2400 of Rs.400 by accepting
the order.

34
A course of action should be
pursued up to the point where its
incremental benefits equal its
incremental costs.

35
2.Opportunity Cost
• Opportunity cost, therefore, represents the benefits of revenue
forgone by pursuing one course of action rather than another.
For e.g:
(a) The opportunity cost of the funds employed in one’s own
business is the amount of interest which could have been earned
had these funds been invested in the next best channel of
investment
(b) The opportunity cost of using an idle machine is zero, as
its use needs no sacrifice of opportunities.

36
Opportunity Cost
•Opportunity cost includes both the explicit and implicit costs:-

Explicit costs are recognized in the accounts , e.g., the payments

for labour, raw materials, etc

Implicit (or imputed) costs are sacrifices that are not recorded in
accounting e.g. cost of capital supplied by owners of business.

37
 3.Contribution

•Contribution tells us about the contribution of a unit of output to

overheads and profit.
•It helps in determining the best product mix when allocation of
scarce resources is involved.
•It also indicates whether or not it is advantageous to accept a fresh
order, to introduce a new product, to shut down to continue with the
existing plant etc.
•Unit contribution is the per unit difference of incremental revenue
from incremental cost

38
 4.Time Perspective

Economists often make a distinction between short run and long run.
•Short run means that period within which some of the inputs
(called fixed inputs) cannot be altered.
•Long run means that all the inputs can be changed.
Economists try to study the effect of policy decisions on variables like
prices, costs, revenue, etc, in the light of these time distinctions.

39
 5.Discounting Principle
•The concept of discounting future is based on the
fundamental fact that a rupee now is worth more than a rupee
earned a year after.
•Unless these returns are discounted to find their present
worth, it is not possible to judge whether or not it is worth
undertaking the investment today.

Illustrations

Suppose a sum of Rs.100 is due after 1 year. Let the rate of

interest be 10% . We can determine the sum to be invested
now so as to produce the return (R) of Rs.100 at the end of 1
year. The present value of the discounted value of Rs. 100
will then be,

40
 R 100
V1    Rs.90.90
1  i  1.10
The same reasoning can be used to find the present value of longer
periods. A present value of Rs.100 due two years later would be,
Rs.100 Rs.100 Rs.100
V2     82.64
1  i  (1.10)
2 2
1.21
We can thus write the present worth of a stream of income spread over n
years (i.e R 1 , R 2 ...R n )as
R1 R2 R3 Rn
, , ............,
(1  i)  (1  i) 1  i 
2 3
1  i n
The sum of present values for n years would thus be
n
R1 R2 R3 Rn Rk
1  i n 
V    ............, 
(1  i)  (1  i) 2 1  i 3 k 1 1  i k

41
 6.The Equi-Marginal Principle

•The law of equi-marginal utility states that a utility

maximizing consumer distributes his consumption expenditure
between various goods and services he/she consumes in such
a way that the marginal utility derived from each unit of
expenditure on various goods and service is the same.
•This principle suggests that available resources (inputs)
should be so allocated between the alternative options that
the marginal productivity (MP) from the various activities are
equalized.
For eg. Suppose a firm has a total capital of Rs. 100 million
which it has the option of spending on three projects, A,B,
and C. Each of these projects requires a unit expenditure of
Rs. 10 million.

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 The Equi-Marginal Principle
Marginal Productivity (MP) Schedule of Projects A, B, and C

Units of Marginal Productivity (MP)

Expenditure
(Rs.10 million)
Project A Project B Project C

1st 50 40 35
2nd 45 30 30
3rd 35 20 20
4th 20 10 15
5th 10 0 12

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The Equi-Marginal Principle

The equi marginal principle suggests that a profit (gain) maximizing

firms allocates its resources in a proportion such that
MPA  MPB  MPC  ...  MP N

The equi - marginal principle can be applied only where

(i) firms have limited investible resources
(ii) resources have alternative uses and
(iii) the investment in various alternative uses is subject to diminishin g
marginal productivi ty or return.

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 Role of a Business Economist

 He studies the economic patterns at macro-level and

analysis it’s significance to the specific firm he is working
in.
 He has to consistently examine the probabilities of
transforming an ever-changing economic environment into
profitable business avenues.
 He assists the business planning process of a firm.
 He also carries cost-benefit analysis.
 He assists the management in the decisions pertaining to
internal functioning of a firm such as changes in price,
investment plans, type of goods /services to be produced,
inputs to be used, techniques of production to be employed,
expansion/ contraction of firm,
Continued….
In addition, a business economist has to
analyze changes in macro- economic
indicators such as national income,
population, business cycles, and their
possible effect on the firm’s functioning.
He is also involved in advicing the
management on public relations, foreign
exchange, and trade. He guides the firm on
the likely impact of changes in monetary
and fiscal policy on the firm’s functioning.
Relationship of Business economics
with other disciplines:
 Business economics and micro economics:
 Business economics is mainly micro
economic in character, making use of many
of the concepts and tools provided by micro-
economic theory. The concept of elasticity of
demand, marginal cost, market structures, the
theory of the firm and the theory of pricing of
micro-economics are fully made use of by
business economics
 Business economics and macro economics:
 Macro economics is concerned with
aggregates and macro economics concepts are
used in business economics in the area of
forecasting general business conditions. Both
micro and macro economics are closely related
to business economics. Business economics
draws from micro and macro economics, so
that it can apply these principles to solve the
day-to-day problems faced by businessmen.
Business economics and mathematics:
Business economics is becoming
increasingly mathematical in character.
Businessmen deal with various concepts
which are measurable. The use of
mathematical logic provides clarity of
concepts. It also gives a systematic
frame-work within which quantitative
relationship maybe analyzed.
 Business economics and statistics:
 Statistics is a science concerned with
collection, classification, tabulation and
analysis of data for some specified purpose.
 Business economics and accounting:
 Accounting is concerned with recording the
financial operations of a business firm.
Accounting information is one of the primary
sources of data required for business
economists for the decision-making purpose.
Business economics and operations
research:
Operations research is the,” application of
mathematical techniques in solving
business problems”. It deals with model
building that is construction of
theoretical-models that help the decision-
making process.