Business Economics Unit 1 PDF

Welcome To The World of Economics  Subject: Business Economics-I (Micro Economics) Topic 1: Basic Concepts of Economics Prepared by Prof. Vivek Datar (Subject Teacher)  Introduction to Economics  Economics is the study of how in...

Welcome To The World of Economics  Subject: Business Economics-I (Micro Economics) Topic 1: Basic Concepts of Economics Prepared by Prof. Vivek Datar (Subject Teacher)  Introduction to Economics  Economics is the study of how individuals, firms, and societies use resources to satisfy their needs and wants.  Basic Problem of Economics  Humans wants are Unlimited.  But we have Limited Resources – Land, Labour, Capital and Entrepreneur.  Resource Use  Choices The Central Economic Problem  All countries face the problem of scarcity as their resources are limited and resources have alternative uses.  Every economy be it capitalist, socialist or mixed has to deal with this central problem of scarcity of resources relative to the wants for them.  This is generally called ‘The Central Economic Problem’. To solve Central / Basic Economics problems we further divide it into The Central Economic problem is further divided into four basic economic problems. These are : ❖ What to produce? ❖ How to produce? ❖ For whom to produce? ❖ What provisions (if any) are to be made for economic growth?  WHAT TO PRODUCE –  Society has to decide whether to produce guns or butter, machines (capital goods) or cell phone (consumer goods).  It also has to decide in what quantity each of the good would be produced.  In nutshell, society must decide how much wheat, how many schools, how many meters of cloths etc. have to be produced.  HOW TO PRODUCE –  Society has to decide whether the goods and services are to be produced using labour intensive techniques or capital intensive techniques.  This choice would depend on the availability of different factors of production (i.e. labour and capital) and their relative prices.  For eg. Cotton can be produced using handloom, power looms or automatic looms. Production with handlooms involves use of labour and production with automatic loom involves use of more machines and capital.  It is in the society’s interest to use those techniques of production that make the best use of available resources. FOR WHOM TO PRODUCE –  A society cannot satisfy wants of all and thus it has to take an important decision ‘for whom’ it should produce.  It has to decide on who should get how much of the total output of goods and services i.e. How to distribute goods and services among members of society. WHAT PROVISION SHOULD BE MADE FOR ECONOMIC GROWTH –  A society has to decide how much saving and investment has to be made for future progress.  A society would not like to use all its scarce resources for current consumption only, as if it uses all resources for current consumption and no provision is made for future production, the society’s production capacity would not increase.  Goods Definition: Goods are tangible items that satisfy human wants. Goods are defined as items that satisfy human wants, provide utility or usefulness, and are scarce (have limited availability). An economic good must also be capable of being transferred from one person to another or produced and consumed.  Types of Goods:  1) Consumer goods, 2) Capital goods,  3) Durable Goods, 4) Non-durable goods  Examples: Food, clothing, cars, machinery.  Categorization of Goods in different way  1. Private goods A private good is something that provides a positive value and benefit to the consumer. These goods are also excludable, which means the consumer can prevent other, nonpaying consumers from benefiting from them. Examples of private goods include: Food, Clothes, Parking spaces, Seats on a plane  2. Public goods Public goods, also referred to as social or collective goods, are non-rivalrous and non-excludable. Anyone can benefit from this good without depreciating its value or preventing someone else from benefiting from it at the same time. Even if you didn't pay for a public good, you can still access it. Public goods include things like: Public hiking trails, Air, A country's national defense Street lights  Club goods Club goods, sometimes referred to as artificially scarce goods, are often excludable and non-rivalrous public goods. The Good is available for the public to benefit from, and it can keep its value no matter how many people consume it. However, the item is excludable because it allows consumers to bar other people from gaining its benefits if they don't pay for it. These items are artificially scarce because there is a financial gain in making them exclusive rather than the possibility of them running out. Examples of club goods include items like: Toll roads, Private parks, Cinemas  Common-pool resource goods A common-pool resource good is an item that's created as part of a resource system. This item can be natural or man-made. These goods are typically public, but they can become private or excludable. These goods differ from public goods because they have high consumption rates, which can impact their value. Some examples of common-pool resource goods include: Fishing grounds, Irrigation systems, Coal mines, Timber fields  Services  Definition: Services are intangible activities or benefits provided in exchange for payment.  Examples: Education, healthcare, banking, legal services.  Services are essentially intangible activities which are separately identifiable and provide the satisfaction of wants. We cannot keep it in stock. Their purchase does not result in the ownership of anything physical. Services involve an interaction to be realised between the service provider and the consumer.  Production  Definition: Production is the process of combining various inputs, both material (such as metal, wood, glass, or plastics) and immaterial (such as plans, or knowledge) in order to create output. Ideally this output will be a good or service which has value and contributes to the utility of individuals.  The area of economics that focuses on production is called production theory, and it is closely related to the consumption(or consumer) theory of economics.  Factors of Production:  - Land, Labor, Capital, Entrepreneurship  Consumption  Consumption, in economics, the use of goods and services by households.  Consumption is distinct from consumption expenditure,  Consumption is the purchase of goods and services for use by households.  Consumption differs from consumption expenditure primarily because durable goods, such as automobiles, generate an expenditure mainly in the period when they are purchased, but they generate “consumption services” (for example, an automobile provides transportation services) until they are replaced or scrapped.  Neoclassical (mainstream) economists generally consider consumption to be the final purpose of economic activity, and thus the level of consumption per person is viewed as a central measure of an economy’s productive success.  The study of consumption behaviour plays a central role in both macroeconomics and microeconomics. Macroeconomists are interested in aggregate consumption.  Microeconomists have studied consumption behaviour for many different reasons, using consumption data to measure poverty, to examine households’ preparedness for retirement, or to test theories of competition in retail industries.  Firm  Definition of a ‘firm’ in the field of economics is any company that seeks to make a profit by manufacturing or selling products or services – or both – to consumers.  For example, one of the most common uses of this term is for ‘law firms,’ which usually sell services in relation to the law.  Entrepreneurs working for themselves: A self-employed individual who owns and runs their own company. A private company: Typically small to medium in size (SME), these companies are usually owned by a small group of individuals and seek to maximize profits. A public limited company, or PLC: These are usually large companies that have floated on the stock market. Members of the public may buy individual shares in these companies and thus gain from any profits made. Co-operatives or social ventures: These are companies that don’t aim to maximize their profits, but rather seek to achieve goals for social or economical benefit. Companies owned by the government: In specific sectors, some of the largest companies are owned by the government. For example, state-owned postal services and utility companies.  Plant  Plant: A physical location where production or service activities take place.  a plant is an integrated workplace, usually all in one location. A plant generally consists of the physical capital, like the building and the equipment at a particular location that is used for the production of goods. A plant is also called a factory.  Though the word "plant" is sometimes used interchangeably with the words "business" or "firm," economists use the term strictly in relationship to a physical production facility, not the company itself.  So rarely is a plant or factory the sole subject of economic study. Rather, it is generally the business and economic decisions that take place surrounding and within the plant that are the topics of interest to economists. Industry:  A group of firms producing similar products or services.  An industry is a group of organizations involved in producing/manufacturing or handling the same type of product and service.  Industry refers to economic activities concerned with the production of goods, extraction of services and provision or services.  Classification of Industries  1. Raw material Agro-based industries, Mineral based industries Marine-based industries, Forest-based industries.  2. Size: Size of industries are measured by how much money is invested, employee count and goods produced. Small-scale industries: Small-scale industries have less capital and technology invested in them. There is often manual labour noticed here. Example, Basket weaving, pottery, and handicrafts. Large-scale industries: Largescale industries are the exact opposite of small-scale industries. Here the capital invested is large and advanced technology is in use here. Example, Automobiles and Heavy Machinery.  3. Ownership Private sector: Private industries are businesses that are owned and operated by an individual or group of individuals. Public sector: Public industries are owned and managed by the government. Example, Hindustan Aeronautics Limited (HAL) Joint sector industries: These industries are jointly operated by the state and individuals. Example, Maruti Udyog. Cooperative sector industries: Cooperative industries are operated by the suppliers, producers or workers of raw material. Example, Amul India.  Market  Definition: A market is any place or venue where buyers and sellers can exchange goods and services. A market may be physical, like a retail outlet, or virtual, like an online brokerage with no physical contact between buyers and sellers.  Some key characteristics of a market are the availability of an arena, buyers and sellers, and a commodity or other asset that can be bought and sold.  A market is any place or venue where buyers and sellers can exchange goods and services. A market may be physical, like a retail outlet, or virtual, like an online brokerage with no physical contact between buyers and sellers.  Some key characteristics of a market are the availability of an arena, buyers and sellers, and a commodity or other asset that can be bought and sold.  Types of Markets: 1) Physical Markets. 2) Virtual Markets. 3) Financial Markets: The blanket term "financial market" refers to any place where securities, currencies, and bonds are traded between two parties. i) Stock Market ii) Bond Market iii) Commodities Market iv) Derivatives Market 4) Black Market:  Black market refers to an illegal market where transactions occur without the knowledge of the government or other regulatory agencies. 5) Auction Market  An auction market brings many people together for the sale and purchase of specific lots of goods. The buyers or bidders try to top each other for the purchase price. The items for sale go to the highest bidder. 6) Regulating Markets  Other than Black markets, most markets are subject to rules and regulations set by governing body that determines the market’s nature. Economic Systems Overview  Definition: An economic system refers to the way a society organizes the production, distribution, and consumption of goods and services.  Types:  i) Capitalist  ii) Socialist  iii) Mixed Economy  Capitalist Economy  Definition: An economic system where private individuals and businesses own the means of production. Advantages:  Efficient allocation of resources.  Innovation.  Consumer choice. Disadvantages:  Income inequality.  Potential for monopolies.  Lack of public goods. Socialist Economy  Definition: An economic system where the government owns and controls the means of production.  Advantages:  Equitable distribution of resources  Focus on public welfare  Reduced inequality  Disadvantages:  Lack of incentives  Inefficiency  Limited consumer choice Mixed Economy  Definition: A combination of capitalist and socialist elements; both private and public sectors coexist.  Advantages:  - Balances efficiency with social welfare  - Reduced inequality  - Consumer choice  Disadvantages:  - Potential for government overreach  - Inefficiencies in public sectors  - Balancing act between interests  Comparison of Economic Systems  Capitalist:  Private ownership, market-driven decisions, high efficiency, low social welfare.  Socialist:  Public ownership, government-planned decisions, low efficiency, high social welfare.  Mixed:  Both public and private ownership, mixed decisions, moderate efficiency, moderate social welfare.  Evolution of Economics  Economics comes from the ancient Greek word “oikonomikos” or “oikonomia.” Oikonomikos literally translates to “the task of managing a household.”  Adam Smith was a Scottish philosopher,  Smith defined economics as “an inquiry into the nature and causes of the wealth of nations.”  British economist Alfred Marshall defined “Economics as the study of man in the ordinary business of life.”  Lionel Robbin, another British economist, defined economics as the subject that studies the allocation of scarce resources with countless possible uses.  Robbins said the following about the subject: “Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses.”  Modern Definition of Economics  The modern definition, attributed to the 20th-century economist, Paul Samuelson, builds upon the definitions of the past and defines the subject as a social science.  According to Samuelson, “Economics is the study of how people 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 persons and groups of society.”  Economics is a Science or Art.  Science is a systematic study of knowledge and fact which develops the correlation-ship between cause and effect.  Science is not only the collection of facts, all the facts must be systematically collected, classified and analyzed. Characteristics of any science subject  There are following, such as; (i) It is based on systematic study of knowledge or facts; (ii) It develops correlation-ship between cause and effect; (iii) All the laws are universally accepted. (iv) All the laws are tested and based on experiments; (v) It can make future predictions; (vi) It has a scale of measurement. Economics is a positive science or a normative science  Positive Science  Positive science deals with all the real things or activities. It gives the solution what is? What was? What will be?  It deals with all the practical things. For example, poverty and unemployment are the biggest problems in India.  The life expectancy of birth in India is gradually rising. All these above statements are known as positive statements. These statements are all concerned with real facts and information. Normative Science  On the contrary, normative science deals with what ought to be? What ought to have happened? Normative science offers suggestions to the problems.  The statements dealing with these suggestions are coming under normative statements. These statements give the ideas about both good and bad effects of any particular problem or policy.  For example, illiteracy is a curse for Indian economy. The backwardness of Indian economy is due to ‘population explosion’. Debate about it  Economists like Prof. Senior (classical economist) and Prof. Robbins, Prof. Freight-men (modern economists) claimed that economics is a positive science.  However, Prof. Pigou (classical economist). Prof. Marshall (neoclassical economist) etc. are of opinion that economics is a normative science. So Economics is Science or Arts  Economics is neither a science nor an art only. However, it is a golden combination of both.  According to Cossa, science and art are complementary to each other. Hence, economics is considered as both a science as well as an art.  Difference Between Economics and Business Economics Economics Business Economics Economics focuses primarily with Business Economics devotes with the the theoretical aspect. practical aspect. Scope of Business Economics is Scope of Business Economics is restricted. large. It is associated with concepts, associated with applications of the selected theories, models and building theories and to solve business problems theoretical framework. and help in decision making process. Economics has both micro and Business Economics is fundamentally macro aspects within its purview. micro-economic in nature. Economics is concerned with both Business Economics is essentially positive and normative economics. normative in nature. Economics Business Economics Economics studies the complex Business Economics endeavors to economic phenomena and rational solve real life complex business human behavior by developing problems. It selectively applies certain meaningful and consistent economic models with required assumptions, hypothesis and modifications to solve the business developing models. problems. Economics concentrates only the Business Economics deals with economic aspect of the problems some non-economic aspects of the problems along with the economic aspects. Economics has wider scope like Business Economics focuses on profit maximization, Utility the theory of profit only. maximization, distribution theories of wage, rent interest and welfare economics as well. Microeconomics Macroeconomics Microeconomics is the branch of Macroeconomics is the branch of Economics that is related to the Economics that deals with the study of individual, household study of the behaviour and and firm’s behaviour in decision performance of the economy in making and allocation of the total. resources. Microeconomics studies the Macroeconomics studies the particular market segment of the whole economy, that covers economy. several market segments. Microeconomics deals with Macroeconomics deals with various issues like demand, various issues like national supply, factor pricing, product income, distribution, employment, pricing, economic welfare, general price level, money, and production, consumption, and more. more. Microeconomics Macroeconomics It is applied to internal issues. It is applied to environmental and external issues. It covers several issues like It covers several issues like demand, supply, factor pricing, distribution, national income, product pricing, economic employment, money, general welfare, production, price level, and more. consumption, and more. It is useful in regulating the prices of a product alongside the It perpetuates firmness in the prices of factors of production broad price level, and solves the (labour, land, entrepreneur, major issues of the economy like capital, and more) within the deflation, inflation, rising prices economy. (reflation), unemployment, and poverty as a whole. Microeconomics Macroeconomics It is based on impractical It has been scrutinised that the presuppositions, i.e., in misconception of composition’ microeconomics, it is presumed that incorporates, which sometimes fails there is full employment in the to prove accurate because it is community, which is not at all feasible that what is true for feasible aggregate (comprehensive) may not be true for individuals as well. Definitions of Business Economics McNair and Meriam  “Business Economics consists of the use of economic modes of thought to analyse business situations.” Spencer and Seegelman.  “Business Economics (Managerial Economics) is the integration of economic theory with business practice for the purpose of facilitating decision making and forward planning by management.”  “Managerial economics is concerned with application of economic concepts and economic analysis to the problems of formulating rational managerial decision.” – Mansfield Nature of Business Economics  Economics has been broadly divided into two parts i.e. Micro Economics and Macro Economics.  MICRO ECONOMICS  It is the study of the behavior of different individuals and organisations within an economic system.  It examines how the individual units (consumers or firms) make decisions as to how to efficiently allocate their scarce resources. In this the focus is on a small number of or group of units rather than all the units combined and therefore it does not explain what is happening in the wider economic environment.  Concepts studied in Micro Economics: Product Pricing, Consumer Behaviour, Factor Pricing, The Economic Conditions of a section of people, Behaviour of firms, Location of Industry  MACRO ECONOMICS  It is the study of the overall economic phenomena or the economy as a whole, rather than its individual parts. In it we study the behavior of the large economic aggregates such as the overall level of output, total consumption, total saving and total investment and also how these aggregates shift over time.  It analyzes the overall economic environment in which the firms, governments and households make decisions.  It should be kept in mind that this economic environment represents the overall effect of the innumerable decisions made by millions of different consumers and producers.  Concepts studied under Macro Economics are :  National Income and National Output, The general price level and interest rates, Balance of Trade and balance of payments External value of currency, The overall level of savings and investment and The level of employment and rate of economic growth. SCOPE OF BUSINESS ECONOMICS:  There are two categories of business issues to which economic theories can be directly applied, namely:  1. Internal Issues or Operational Issues (Solved using Micro Economics)  2. External Issues or Environmental issues (Solved using Macro Economics) Internal Issues or Operational Issues (a) Demand Analysis and Forecasting (b) Production and Cost Analysis. (c) Inventory management. (d) Market Structure and Pricing Policies. (e) Resource Allocation (F) Profit Analysis (g) Risk and Uncertainty analysis. Macroeconomics applied to External or Environmental Issues The major macro-economic factors relate to: (a) The type of economic system. (b) Stage of Business Cycle. (c) The general trends in national income, employment, prices, saving and investment. (d) Social and Political Environment (e) Working of central banks and financial sector and capital market and their regulation. (f) Socio-economic organisations like trade unions, producer and consumer unions and cooperatives.  Limitations of Business Economics  The limitations of managerial economics are listed below: Business economics focuses on business analysis based on financial and costing data. The reliability of this data, therefore, depends on the accuracy of the financial accounting information. This analysis is based on historical information. But things change when new systems are introduced, and conclusions cannot be predicted from this previous information. Management controls are subject to the personal preferences of individual managers, which may influence to some extent, the final decisions of managers. It is a costly process as the company usually needs a certain number of managers to keep it functioning properly. The science of business management is relatively new and not fully developed. So, it can be ambiguous in certain scenarios. Importance of the study of Business Economics 1.Decision Making: Helps in making informed business decisions by analyzing economic data and trends. 2.Resource Allocation: Assists in the efficient allocation of scarce resources within the firm. 3.Cost Analysis: Aids in understanding and controlling costs, improving profitability. 4.Demand Forecasting: Enables accurate forecasting of demand for products and services. 5.Market Structure Analysis: Helps in understanding different market structures and their impact on business operations. 6.Pricing Strategies: Guides in setting optimal pricing strategies based on market conditions and competition. 7.Risk Management: Assists in identifying, assessing, and managing business risks. 8.Profit Maximization: Aids in strategies for maximizing profits through efficient production and marketing techniques. 9.Policy Formulation: Provides a basis for formulating policies related to finance, marketing, production, and human resources. 10.Competitive Advantage: Helps businesses gain a competitive edge by understanding economic forces and adapting accordingly. Business Economics and other related subjects Microeconomics: Focuses on individual economic units like consumers, firms, and markets. It analyzes how these entities make decisions and allocate resources. Macroeconomics: Studies the overall functioning of an economy, including issues like inflation, unemployment, economic growth, and monetary and fiscal policy. Managerial Economics: Applies economic theories and methodologies to business management, focusing on decision- making and problem-solving within firms. International Economics: Examines trade between nations, international finance, exchange rates, and the effects of globalization on economies.  Financial Economics: Looks at how resources are allocated in financial markets, including the study of investments, capital markets, and financial instruments. Industrial Economics: Analyzes the structure and performance of industries, market competition, and regulatory policies. Public Economics: Studies government policies and their impact on the economy, including taxation, government spending, and welfare economics. Development Economics: Focuses on the economic development of low-income countries, addressing issues like poverty, inequality, and economic growth strategies. Labor Economics: Explores the dynamics of labor markets, wage determination, employment, and labor policies. Environmental Economics: Examines the economic impact of environmental policies, the use of natural resources, and the costs and benefits of environmental conservation. Circular flow of income and output – Two sector  The circular flow of income and output is a model that describes the movement of money, goods, and services in an economy.  It illustrates the interconnections between different sectors and how they interact.  Two-Sector Model  Participants: 1. Households: Provide factors of production (labor, land, capital) and consume goods and services. 2. Firms: Produce goods and services and pay households for the factors of production.  Flows: Real Flow: Households provide factors of production to firms, and firms provide goods and services to households. Money Flow: Firms pay wages, rent, interest, and profits to households for the factors of production. Households use this income to purchase goods and services from firms. Assumption  1) neither the households save from their incomes, nor the firms save from their profits.  2) The government does not play any part in the national economy.  3) the economy neither imports goods and services, nor exports anything.  4) No foreign trade involved.  5) the flow of money that occurs in the functioning of a closed economy with no savings and no role of government. Three-Sector Model  Participants: 1.Households: Same role as in the two-sector model. 2.Firms: Same role as in the two-sector model. 3.Government: Collects taxes, provides public goods and services, and redistributes income.  Flows: Real Flow: Same as in the two-sector model, with the addition of public goods and services provided by the government to households and firms. Money Flow: In addition to the flows in the two-sector model: Households and firms pay taxes to the government. Government pays for public goods and services, transfers, and subsidies. Four-Sector Model  Participants: 1. Households: Same role as in the two-sector model. 2. Firms: Same role as in the two-sector model. 3. Government: Same role as in the three-sector model. 4. Foreign Sector: Engages in international trade and finance. Flows: ▪ Real Flow: Same as in the three-sector model, with the addition of exports and imports of goods and services between domestic and foreign sectors. ▪ Money Flow: In addition to the flows in the three-sector model: ▪ Households, firms, and government engage in financial transactions with the foreign sector, including payments for imports and receipts from exports. ▪ The foreign sector affects the economy through trade balance, foreign investments, and exchange rates.