Business Economics: Introduction to Basic Concepts

BUSINESS ECONOMI CS  Introduction Economics deals with the day to day activities of human beings life. In all, human beings are gratified (or) enjoy the economic activities such as consumption, production, exchange and distribution. In simple terms economics is con...

BUSINESS ECONOMI CS  Introduction Economics deals with the day to day activities of human beings life. In all, human beings are gratified (or) enjoy the economic activities such as consumption, production, exchange and distribution. In simple terms economics is concerned with the aspects of human behaviour.  Introduction The term Economics is derived from the two Greek words “Oikos ‟ (means house) and “Nomos” (means manage). If these two words are merged “Oikonomia” it gives the meaning household management. In the earlier period, economics is linked with politics. So the earlier economist called economics as a “political economy”. This subject name was changed from “political economy” to “economics” by Alfred Marshall.  Introduction There are four important definitions of economics to understand the basic concept of economics. They are: Wealth Definition –Adam Smith Welfare Definition – Alfred Marshall Scarcity Definition- Lionel Robbins Growth Definition – Paul. A. Samuelson  Adam Smith was a Scottish economist and philosopher who was a pioneer in the thinking of political economy. Seen by some as "The Father of Economics", he wrote two classic works, The Theory of Moral Sentiments (1759) and An Inquiry into the Nature and Causes of the Wealth of Nations (1776). The latter, is considered his magnum opus and the first modern work that treats economics as a comprehensive system and an academic discipline. Smith refuses to explain the distribution of wealth and power in terms of God's will and instead appeals to natural, political, social, economic, legal, Adam Smith environmental and technological factors and the interactions among them. Among other economic theories, the work introduced Smith's idea of absolute advantage.  WEALTH DEFINITIONS The classical economists defined economics as the science of wealth. Adam Smith in his famous book, “An Enquiry into the Nature and Causes of the Wealth of Nations”, which was published in 1776, described economics systematically. Definition Adam Smith “Economics is an enquiry into the nature and causes of the wealth of nations” Adam Smith  Alfred Marshall was an English economist and one of the most influential economists of his time. His book Principles of Economics (1890) was the dominant economic textbook in England for many years. It brought the ideas of supply and demand, marginal utility, and costs of production into a coherent whole. Marshall desired to improve the mathematical rigour of economics and transform it into a more scientific profession. In the 1870s he wrote a small number of tracts on international trade. Although Marshall took economics to a more mathematically rigorous level, he did not want mathematics to overshadow economics and thus make Alfred Marshall economics irrelevant to the layman. Accordingly, Marshall tailored the text of his books to laymen and put the mathematical content in the footnotes and appendices for the professionals.  WELFARE DEFINITIONS Neo-classical economists like Alfred Marshall, Cannan, A.C. Pigou have defined economics in terms of welfare. Therefore, their definitions are described as “Welfare Definitions”. Alfred Marshall in his famous book “Principles of Economics” published in 1980 laid stress on material welfare rather than wealth. He changed the very concept of economics. Definitions “Economics is a study of mankind in the ordinary business of life. It examines that part of individual and social actions which are most closely connected with the attainment and use of material requisites of Alfred Marshall well-being.” ~ Alfred Marshall  Lionel Robbins was a British economist, and prominent member of the economics department at the London School of Economics (LSE). He is famous for the quote, "Humans want what they can't have." Robbins' 1932 and 1935 book is considered one of the most important methodological statements on economics L. ROBINSON  SCARCITY DEFINITIONS In 1932, Lionel Robbins brought out his famous book entitled “An Essay on the Nature and Significance of Economics science” and introduced “The scarcity definition ‟ of economics. He has criticized the “Welfare definitions‟ given by Marshall, Pigou and others. He has laid more emphasis on the scarcity of means rather than on the objectives or ends. Definition “Economics is a science which studies human behaviour as a relationship between ends and scarce means which have alternative uses”. L. ROBBINS Robbins definition is based on the following facts: i) Economics is a Science ii) Wants are unlimited  Paul A Samuelson was an American economist who was the first American to win the Nobel Memorial Prize in Economic Sciences. When awarding the prize in 1970, the Swedish Royal Academies stated that he "has done more than any other contemporary economist to raise the level of scientific analysis in economic theory. More than any other contemporary economist, Samuelson has helped to raise the general analytical and methodological level in economic science. He has simply rewritten considerable parts of economic theory. Paul A Samuelson  GROWTH DEFINITION Modern economics is growth oriented. The growth economics is the major concern of all economic theories. The modern economists describe economics as follows: Definitions “Economics is the study of how men and society end up choosing, with or without the use of money, to employ scarce productive resources that could have alternative uses, to produce various commodities and distribute them for consumption, now or in the future, among various persons and groups in society. It analyses the costs and benefits of improving patterns of resource allocation” Paul A Samuelson Paul A. Samuelson ​ Economic circle According to Lionel Robbins, wants are unlimited but means to satisfy them are limited. So man makes efforts to earn money or income and by spending money he satisfies his wants. The satisfaction of one want gives birth to another. For the satisfaction of these wants man again makes efforts, earns money and again obtains satisfaction by spending it on the required goods. In this way, the endless economic circle of wants Efforts, Wealth, Satisfaction starts and goes on forever and that is what constitutes the subject matter of economics. ​ Economic Activities Economic activities are those activities of human beings which are performed mainly to earn income. The income is not earned just for the purpose of earning but to buy goods and services to satisfy human wants. Boulding has classified the economic activities relating to the subject matter of economics into the following four groups: i) Consumption ii) Production iii) Exchange iv) Distribution ​ Parts of Economics Some economists have classified the subject matter of economics into the following two parts i) Microeconomics Microeconomics is the study of individual events. In microeconomics, we study the individual economic activities. Product pricing, factor pricing and theory of economic welfare are to be studied in this branch of economics. ii) Macroeconomics Macroeconomics is the study of aggregates. The subject matter of macroeconomics covers the analysis and behaviour of the whole economic system in its totality. It deals with national income, employment level, price level, money, banking, economic development, and so on. ​ Definition of Business Economics Business Economics is defined as “the integration of economic theory with business practices for the purpose of facilitating decision-making and forward planning by management”. According to McNair and Meriam, Business Economics, or Managerial Economics, consists of the use of economic modes of thought to analyze business situation. Business Economics is, thus, that part of economics that can be conveniently used to analyze business problems to arrive at rational business decisions. Basic Concept of Economics i) Utility ii) Value iii) Price iv) Wealth Utility refers to the satisfaction or pleasure that a consumer derives from consuming a good or service. It represents the perceived value or benefit that individuals attach to goods and services based on their preferences. Since utility is subjective, it varies from person to person depending on tastes, needs, and preferences. Key Points: Cardinal Utility: Historically, it was thought that utility could be measured in numeric terms, allowing comparison of satisfaction levels. Ordinal Utility: In modern economics, utility is treated as ordinal, meaning consumers can rank different bundles of goods based on their preferences but cannot precisely measure the amount of satisfaction. Marginal Utility: The additional satisfaction gained from consuming one more unit of a good or service. The Law of Diminishing Marginal Utility states that as more of a good is consumed, the additional satisfaction from each unit decreases. Example: Drinking water when thirsty provides high utility, while drinking water when already hydrated provides less utility. A consumer might say that a basket of bananas has a utility of 10, while a basket of mangoes has a utility of 20 ?? a consumer judges that pizza offers greater satisfaction than bread ?? Value refers to the worth or importance of a good or service, determined by its utility, scarcity, and the desires of individuals. While utility measures the satisfaction derived from a good, value is more related to the broader market forces, such as how much individuals are willing to exchange or sacrifice for a good. Key Points: Value in Use: The inherent usefulness or satisfaction derived from a good (e.g., a pair of shoes has high value in use because it helps to protect feet). Value in Exchange: The worth of a good based on how much it can be traded for in the market (e.g., a rare painting may have high value in exchange due to its uniqueness). Example: Water has high value in use but low value in exchange because it is abundant in most places. However, diamonds are the opposite—they are of low value in use but have high exchange value due to their rarity and desirability. Price is the amount of money that is required to purchase a good or service. It reflects the value of a good in terms of money and is determined by the interaction of supply and demand in the market. The price of a good or service influences consumer behavior and production decisions by firms. Key Points: Market Price: The price at which a good or service is bought and sold in a competitive market. Demand and Supply: Price is determined by the forces of demand (consumer willingness to pay) and supply (the amount producers are willing to offer at different prices). Price Elasticity: The responsiveness of the quantity demanded or supplied of a good to a change in its price. Example: If the price of onions rises, consumers may reduce their consumption, while producers may supply more to take advantage of the higher price, depending on the market conditions. Wealth refers to the accumulation of valuable resources or assets by individuals, firms, or societies over time. It includes all tangible and intangible items that can be owned, such as money, property, stocks, bonds, and other forms of assets. The concept of wealth is central to economics as it determines the economic well-being of individuals and nations. Key Points: Personal Wealth: Refers to the assets owned by an individual, such as real estate, savings, and investments. National Wealth: The total assets owned by a country, including natural resources, infrastructure, and the productive capacity of its economy. Wealth Distribution: The way in which wealth is shared among individuals or groups in society. Unequal wealth distribution can lead to economic disparities. Example: A person who owns a house, cars, and stocks is considered wealthy because these assets hold monetary value and can be used to generate income or provide security. Goods are physical objects or products that are produced, bought, and consumed to satisfy human needs or desires. Goods can be classified in different ways depending on their characteristics and use. Key Points: Consumer Goods: Goods that are directly used by consumers to satisfy their personal needs (e.g., food, clothing, electronics). Capital Goods: Goods used to produce other goods and services (e.g., machinery, tools, buildings). Durable Goods: Goods that last for a long time and are not consumed quickly (e.g., cars, furniture). Non-Durable Goods: Goods that are consumed or used up quickly (e.g., food, beverages, toiletries). Example: Food is a consumer good because it is consumed directly to satisfy hunger, while machinery is a capital good used to produce more goods in a factory.  Summary of Basic Concepts: These concepts form the backbone of economic analysis and help explain how individuals and societies make choices, allocate resources, and achieve their desired outcomes in a world of scarcity.  Market system functions in a random manner because it is not governed by any fundamental laws of the market  Market system functions in an orderly manner because it is governed by certain fundamental laws of market known as: law of demand and law of supply  CONCEPT OF DEMAND In economics, demand has a particular meaning distinct from its ordinary usage. In common language demand and desire are treated as synonyms. A poor man who wishes to have a car, his wish or desire for a car will constitute the demand for car ??  CONCEPT OF DEMAND In economics, demand has a particular meaning distinct from its ordinary usage. In common language demand and desire are treated as synonyms. In economics, demand comprises of three things: (i) Desire of commodity; (ii) Sufficient money to purchase the commodity; and (iii) Willingness to spend money to purchase that commodity. This understanding makes it clear that a want or a desire does not become a demand unless an individual has ability to purchase and willingness to satisfy it.  CONCEPT OF DEMAND Important characteristic of demand is that: demand for a commodity is always in reference to a particular price. Demand has no meaning unless it is related to price. Further, demand always means demand per unit of time. In other words, demand for a good at a particular price is the amount of it which will be brought at a particular point of time. Demand of a commodity is influenced by several factors such as desire of the consumer for a commodity, income of the consumer, the prices of substitute and complementary commodities etc. It is worth noticing that demand of an individual is different from the market demand. Individual demand refers to the quantity of a commodity that a particular person is willing to purchase at a given price over a period of time, say per day, per week, per month etc. Market demand is the total quantity that all the users of a commodity are willing to buy at a given price over a period of time. In other words, market demand is the sum of individual demands for a particular product.  DETERMINANTS OF DEMAND Demand for a good by a consumer can vary in response to several factors such as its own price, prices of other related goods, income of the consumer, tastes and preferences of the consumer etc. Symbolically, Dx = f(Px , PY , Y, T,…) Where Px is the price per unit of good X, PY , the prices of the related goods, Y is the income of the consumer, T represents the tastes and preferences of the consumer  DETERMINANTS OF DEMAND i) Price of the Commodity: The first determinant of the demand for a good is its own price. The consumer compares the marginal utility expected from a good with its price and decides whether it is worth buying or not. A fall in the price induces the consumer to buy more of the good and an increase in the price causes a fall in demand.  DETERMINANTS OF DEMAND i) Prices of Related Commodities: Prices of related commodities also affect the demand of the commodity (say X). There are two ways in which a good can be related to another good: Substitute goods: If the price of a substitute good, Y increases, the demand for that good falls and the consumer wants to by more of X instead. In contrast, if the price of the substitute good falls the consumer increases the demand for that good and hence wants to buy less of X. It has positive cross price effect. Complement goods: If the price of a complementary good, Y increase, the demand for that good falls so does the demand of its complement X. In the same way, a fall in the price of a complementary good causes an increase in the demand for X. It has negative cross price effect.  DETERMINANTS OF DEMAND Level of Income: The demand for a good is also affected by the levels of income of the consumer. With an increase in income the consumer wants to buy more of a good. However, if the good is considered an ‘inferior’ one, he is expected to reduce its demand when his income increases.  DETERMINANTS OF DEMAND Expected Change in Price: If price of a good is expected to increase, demand for that good also increases and vice-versa. A consumer wants to buy a good before its price goes up and will postpone its purchase if price is expected to fall.  DETERMINANTS OF DEMAND Other Factors: Other factors which affect the aggregate market demand for a good include the size of population, the marketing and sale campaigns by the suppliers, the ‘selling expenses’ incurred by the sellers, the tastes and preferences of the buyers, and distribution of income and wealth. For example, the richer sections are likely to spend a smaller proportion of their incomes on basic necessities and a larger proportion on luxuries and durable consumer goods.  LAW OF DEMAND According to the law of demand, other things being equal, if price of a commodity falls, the quantity demanded of it will rise, and if price of the commodity rises, its quantity demanded will decline. It implies that there is an inverse relationship between the price and quantity demanded of a commodity, other things remaining constant. In other words, other things being equal, quantity demanded will be more at a lower price than at higher price. The law of demand describes the functional relationship between price and quantity demanded. Among various factors affecting demand, price of a commodity is the most critical factor. Thus, demand of a commodity is mainly determined by the price of commodity.  DEMAND SCHEDULE A demand schedule is a tabulated statement that indicates the different quantities of a commodity that would be demanded at different prices. Demand schedule is of two types: – Individual Demand Schedule – Market Demand Schedule  DEMAND SCHEDULE Individual Demand Schedule: A hypothetical demand schedule is given in Table 1. A demand schedule has two columns, namely – price per unit of the good (Px) – quantity demanded per period (Dx) The demand schedule is a set of pairs of Table 1: Individual A’s Demand values of Px and Dx Schedule for Commodity X DEMAND SCHEDULE Table 1 presents the individual demand schedule. It is observed that as the price of commodity X increases the demand for commodity X starts declining. For instance, at price Rs. 10 per unit, 6000 units are demanded. When the price of commodity X increases to Rs. 60, the demand for commodity X declines to 1000 units. Similarly, one can read the table in reverse order and arrive at the conclusion Table 1: Individual A’s Demand that as price of good declines, its demand Schedule for Commodity X decreases. This inverse relationship between price and quantity gives the law of demand.  DEMAND CURVE A demand curve is a graphic representation of the demand schedule. It is a locus of pairs of price per unit (Px) and the corresponding demand-quantities (Dx) Figure 2: Demand Curve of individual A  DEMAND CURVE Fig 2 shows demand curve, where X-axis measures quantity demanded and Y-axis shows prices. As the price increases from 10 to 60 the quantity demanded declines from 6000 to 1000, establishing a negative relation among the two. This also shows that the conventional demand curve, other things being constant, is downward sloping. Demand Curve of individual A MARKET DEMAND SCHEDULE Market demand schedule is the horizontal summation of individual demand schedules. Market Demand Schedule for Commodity X MARKET DEMAND CURVE Market demand curve can be derived graphically by horizontal summation of the individual demand curve at each price of commodity X. Market Demand Curve for Commodity X  Reasons for Negative Slope of the Demand Curve The Law of Diminishing Marginal Utility: This law provides that when a consumer buys additional units of a good, its marginal utility falls and consumer always compares the marginal utility of a good with the price to be paid for it; therefore, price which he is willing to pay for additional unit of a good falls. Increased Real Income: A fall in the price of a good increases the real income of the consumer. He is able to buy more of the good under question, or buy more of other goods. Similarly, an increase in the price of a good reduces his real income. In this case, the income effect leads to a reduction in the demand of the good. This factor also contributes to the downward slope of demand curve. For instance, a person ‘X’ has got Rs. 10,000 as the nominal income. Now the amount of goods and services he can purchase with those Rs. 10,000 is nothing but real income. So when the price of a particular commodity falls, the real income, i.e. the purchasing power of the consumer increases and that is how at decreased price consumer can buy more of a particular commodity.