Chapter 1: Nature and Scope of Business Economics PDF

# Chapter 1: Nature and Scope of Business Economics ## 1. Introduction The general definition of the study of Economics is individual and social choice in the face of scarcity. The law of scarcity implies that consumer's wants will never be completely satisfied. Economic problems arise due to two...

# Chapter 1: Nature and Scope of Business Economics ## 1. Introduction The general definition of the study of Economics is individual and social choice in the face of scarcity. The law of scarcity implies that consumer's wants will never be completely satisfied. Economic problems arise due to two reasons: * Unlimited wants * Scarce resources The term "Economics" owes its origin to the Greek word "Oikonomia" meaning household management. * Economics is a science that studies those activities which are concerned with the efficient consumption, production, exchange, and distribution of scarce means which have alternative uses. * The purpose of economics is to achieve maximum satisfaction of wants and increasing welfare as well as economic growth. ## 2. Meaning of Business Economics Business Economics is also referred to as Managerial Economics. It is an application of economic theory and methodology. * Every business involves decision-making, as survival and success depend on sound decisions. * **Decision-making** means the process of: * Evaluating various course of action * Making rational judgment on the basis of available information and * Selecting i.e. making choice of a suitable alternative by decision maker. * Decision making is not simple and straightforward. It has become very complex due to ever-changing business environment, growth competition, large scale production, big size of business houses, complex laws, cost awareness, etc. In other words, the economic environment in which the firm operates is very complex and dynamic. * Business Economics provides a scientific base to the professional management of a business activity. It provides tools like budgeting, market analysis, cost-benefit analysis, etc., which can be scientifically applied to take sound business decisions. Thus, Business Economics is a sub-branch of Economics which aims at the scientific application of economic knowledge, logic, theories, and tools to take rational business decisions. Thus, it is an APPLIED ECONOMICS. * Business Economics is closely connected with both viz. Micro Economic Theory as well as Macro Economic Theory. It is also useful to the manager of not-for-profit organizations. ## 3. Definitions of Business Economics * Business Economics in terms of the use of economic analysis in the formulation of business policies. Business Economics is an essential component of Applied Economics as it includes application of selected quantitative techniques such as linear programming regression analysis, capital budgeting, break-even analysis, and cost analysis. (Joel Dean) * "Business Economics is concerned with the application of economic laws, principles of methodologies to the managerial decision-making process within a business firm under the condition of risk and uncertainties." (Evan Douglas) ## 4. Types of Economics ### 1. Microeconomics Microeconomics is the study of a particular firm, a particular household, individual prices, wages, income, industry and particular commodity. Thus, it is a study of a particular unit rather than all the units combined. Microeconomics theory deals with the problem of allocation of resources. Under microeconomics, we study: * Theory of product pricing/ price theory * Theory of consumer behaviour * Theory of factor pricing * Study of a firm. ### 2. Macroeconomics Macroeconomics theory is that part of economics which studies the overall average and aggregates of the system, such as total production, total consumption, total saving, and total investment. Thus, macroeconomics is the study of overall phenomena as a whole rather than its individual parts. Macroeconomics deals with growth and development of resources. Under macroeconomics, we study: * Theory of national income, employment, and money * Theory of general price level * Theory of economic growth and development * Theory of international trade ## 5. Difference Between Microeconomics and Macroeconomics | Basis | Microeconomics | Macroeconomics | |-----------------------|-------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------------------| | Study of | It is a study of individual economic units. | It is a study of the ag economics as a whole and its aggregates. | | Deals with | It deals with individual income, individual prices, and individual output, etc. | It deals with national income, price level, national output, etc. | | Tools | Its main tools are demand & supply of a particular commodity. | Its main tools are aggregate demand and aggregate supply of the economy as a whole. | | Central Problem | Its central is price determination of commodities or factor of production. | Its central problem is determination of level of income and employment. | | Prices | Price determined under this are called "relative prices". | Price determined under this are called "absolute prices". | | Type analysis | It is partial equilibrium analysis. | It is a general equilibrium analysis. | | Scope | Its scope is limited. | It is wider in scope. | | Example | (a) Lock out in TELCO. (b) Finding the causes of failure of X and co. | (a) Per capita income. (b) Corporate income tax. (c) Economy growth. | ## 6. Nature of Business Economics ### 1. Business Economics is a science Science is a systematized body of knowledge which traces the cause and effect relationships. Business Economics uses the tools of Mathematics, statistics, and Econometrics with economic theory to take decisions and frame strategies. Thus, it makes use of scientific methods. ### 2. Based on Micro-Economics As Business Economics is concerned more with the decision making problem of a particular business establishment. Micro-level approach suits it more. Thus, Business Economics largely depends on the techniques of Micro-Economics. ### 3. Incorporates elements of Macro Analysis A business unit is affected by external environment of the economy in which it operates. A business is affected by general price level, level of employment, govt. policies related to taxes, interest rates, industries, exchange rates, etc. A business manager should consider such macroeconomic variables which may affect present or future business environment. ### 4. Business Economics is an art It relates with practical application of laws and principles to achieve the objectives. ### 5. Use of Theory of Market & Private Enterprise It uses the theory of market and resource allocation in a capitalist economy. ### 6. Pragmatic approach Micro-Economics is purely theoretical, while Business Economics is practical in its approach. ### 7. Inter-disciplinary in nature It incorporates tools from other disciplines like Mathematics, Statistics, Econometrics, Management Theory, Accounting, etc. ### 8. Normative in nature Economic theory has been developed along two lines: POSITIVE and NORMATIVE. | Positive science | Normative science | |--------------------|----------------------| | 1. Robbins | Alfred Marshal | | 2. What it is | What should be or ought to be | | | Based on ethics | | 3. Based on analysis, facts, realistic | | | 4. Will not pass value judgment | Will pass value judgment | | 5. Supports Neutrality | Does not support Neutrality | | 6. Descriptive in Nature | Prescriptive in Nature | A positive science or pure science deals with the things as they are and their CAUSE and EFFECTS only. It states 'what is?'. It is DESCRIPTIVE in nature. It does not pass any moral or value judgments. A normative science deals with 'what ought to be' or 'what should be'. It passes value judgments and states what is right & what is wrong. It is PRESCRIPTIVE in nature as it offers suggestions to solve problems. Normative science is more practical, realistic and useful science. ## 9. Scope of Business Economics The scope of Business Economics is wide. Economics theories can be directly applied to two types of business issues namely - ### 1. Micro-economics applied to operational or internal issues. Issues like choice of business size of business, plant layout, technology, product decision, pricing, sales promotion, etc. are dealt by Micro-economic theories. It covers: * Demand analysis and forecasting * Product and cost analysis * Inventory management * Market structure and pricing analysis * Resource allocation * Theory of capital and investment decisions * Profitability analysis * Risk and uncertainty analysis. ### 2. Macro-economics applied to environment or external issues. The major economic factors relate to -- * The type of economic system * The stage of business cycles * The general trends in national income, employment, price, saving and investment. * Government's economic policies * Working of financial sector and capital market * Socio-economic organizations * Social and political environment. These external issues have to be considered by a firm in business decision and frame its policies accordingly to minimize their adverse effects. ## 10. Central Economic Problem (scarcity) * What to produce? (capital goods, consumer goods) * How to produce? (capital use capital, labour use labourer) * From whom to produce? (poor or rich, in India it gives to poor for upliftment) * What provisions should be made for economic growth? * When are goods produced? * How much to produce? **(Not an economic problem)** ## 11. Economic System <start_of_image> Schematic representation of economic systems: ``` Economic system | +-- Capitalist economy | +-- Socialist economy | +-- Mixed economy ``` ### 1. Capitalist Economy **Features:** * Means of production are privately owned. * Freedom of enterprise & freedom of price choice * Allocation of resources is as per consumer preference * Entrepreneur are guided by profit motive. * Competition exist among producers * Capitalist economy use price mechanism as a principle motive **Merits:** * Greater efficiency & incentive to work hard * Faster economic growth possible * Consumer are benefitted because of good quality product * Higher standard of living * Innovation and technological progress **Demerits:** * Uneven distribution of income & wealth * Income inequality and social injustice * Exploitation of consumer and labour * Economic instability which may lead to depression * Creation of monopoly power **Other names for capitalist economy:** * Market economy * Market system * Free markets * Market mechanism * Price mechanism ### 2. Socialist Economy **Features:** * It is known as command economy, controlled economy, centrally planned economy * Collective ownership of means of production * Promote welfare of people * Lack of competition **Merits:** * Balance economic development * No class conflict * Economic fluctuation and unemployment are minimized * Right to minimum work * No exploitation of consumer & worker **Demerits:** * Corruption, Red tapism, results into inefficiency * No freedom of choice * Price are administered by state ### 3. Mixed Economy **Features:** * Combination of both capitalism and socialism * Freedom to join any occupation, trade or business * People are free to consume goods of their choice **Merits:** * Freedom of occupation * Encourages enterprise and Risk taking * Development of technology through R&D vaccine and UPI * Economic and social equality possible **Demerits:** * Poor implementation of plans * High level of taxes * Good level of corruption * Wastage of resources ## Points to Remember 1. Business Economics involves practical application of economic theory and has a multi-disciplinary approach. 2. Macro economics is also called as aggregate economics. 3. Capital budgeting, risk analysis, business cycle are within the scope of business economics. (Accounting standards is not a part of it) (Can be asked for add man out) 4. Larger production of capital goods would lead to higher production in future. 5. Social securities benefits, sickness benefits are found under both socialism mixed economy. 6. Science of wealth → Adam Smith 7. Science which deals with wealth of nation → Adam Smith 8. Science which deals with wealth → J.B. Say (Classical economics) 9. Growth and development definition → Paul Samuelson 10. Welfare oriented definition → Alfred Marshall, Pigou 11. Study of mankind → Alfred Marshall 12. Scarcity oriented definition → Robbins/Robinson ## Definition of Economics Economics is the study of processes by which relatively scarce resources are allocated to satisfy unlimited wants of human beings in a society.