Chapter 1 NATURE AND SCOPE OF BUSINESS ECONOMICS

UNIT 1 INTRODUCTION

1.0 INTRODUCTION

1.0.0 What is Economics about?

 Originated from the Greek word ‘Oikonomia’ which means ‘household’.
 Till 19th century Economics was known as ‘Political Economy’.
 First Modern work of Economics by Adam Smith is named as ‘An Enquiry into
the Nature and Causes of the ‘Wealth of Nations’ (1776) abbreviated as ‘The
Wealth of Nations’.
 There are two fundamental facts that can be concluded with the concept of
Economics :
(i) Human beings have unlimited wants ;and
(ii) The means to satisfy these unlimited wants are relatively scarce forms
the subject matter of Economics.

1.0.1 DEFINITION OF ECONOMICS

 Economics is the study of the processes by which the relatively scarce
resources are allocated to satisfy the competing unlimited wants of human
beings in a society.
 This definition of Economics, with the narrow focus on using the relatively
scarce resources to satisfy human wants is domain of modern neo classical
micro economic analysis.

1.0.2 MEANING OF BUSINESS ECONOMICS

 Decision Making refers to the process of selecting an appropriate alternative
that will provide the most efficient means of attaining a desired end ,from
two or more alternative courses of action.
 It means evaluation of feasible alternatives, rational judgment on the basis
of information and choice of particular alternative which the decision maker
finds as most suitable.
 As we know the question of choice arises because our productive resources
such as land, labour, capital and management are limited and can be
employed in alternative uses .Therefore more efficient alternatives must be
chosen and less efficient alternatives must be rejected.
 Business Economics also reffered as Managerial Economics refers to the
integration of economic theory with business practice.
 Business Economics applies tools of economics to make business decision
making.
  It is Applied Economics that fills the gap between economic theory and
business practice.
 It has close connection with Economic Theory (Micro and Macro Economics),
Operation Research, Statistics, Mathematics and the Theory of Decision
Making.
 Business Economics is also useful for managers of ‘not-for -profit’
organisations such as NGO and Voluntary Organisations.

1.1 DEFINITION OF BUSINESS ECONOMICS

 Business Economics may be defined as the use of economic analysis to make
business decisions involving the best use of an organisation’s scarce resources.
 Joel Dean defined Business Economics in terms of the use of economic analysis
in the formulation of business policies.
 Business Economics is essentially a 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.

1.2 NATURE OF BUSINESS ECONOMICS

Economics has been broadly divided into two parts i.e. Micro Economics and
Macro Economics.

1.2.1 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.
 1.2.2 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.

NOTE :

Micro Economics as well as Macro Economics have an important role to play in Business Economics.
Macro Economics analyses the background of economic conditions in an economy which will
immensely influence the individual firm’s performance as well as its decisions. Business firms need a
thorough understanding of the macroeconomic environment in which they have to function.

For eg. Interest rates should be known as they are useful for the business economists in framing
suitable policies.

1.2.3 NATURE OF BUSINESS ECONOMICS :

The following points will describe the nature of Business Economics:

 Business Economics is a Science - Science is a systematized body of

knowledge which establishes cause and effect relationships.
Business Economics integrates the tool of decision sciences such as
Mathematics, Statistics and Econometrics with Economic Theory to
arrive at strategies to achieve business goals.

 Based on Micro Economics – Business Manager is concerned about

achievement of the predetermined objectives of his organization so
as to ensure the long term survival and profitable functioning of
organization . Since Business Economics is concerned more with the
decision making problems it takes help of micro economics tools.
 Incorporates elements of Macro Analysis – Macro Economics
elements like general price level ,income and employment level in
the economy and government policies related to taxation ,interest
rates, exchange rates, industries ,prices, distribution ,wages etc.
affects the business. Business Manager must be acquainted with
these elements as they influence business environment.

 Business Economics is an Art – It involves practical application of

rules and principles for attainment of set objectives.

 Use of Theory of Markets and Private Enterprises – Business

Economics uses theory of firm and resource allocation in backdrop
of private enterprise economy.

 Pragmatic in Approach – Business Economics is practical in approach

as it tackles practical problems which the firms face in real world.

 Interdisciplinary in Nature – Business Economics uses tools from

other subjects like Mathematics ,Operation Research, Management
Theory, Accounting, Marketing,Finance,Statistics and econometrics.

 Normative in Nature – Economic Theory has developed along two

lines – positive and normative.
 POSITIVE :
 Positive and Pure Science analyses cause and effect
relationship but does not involve any judgement.
 It states ‘what is’of the state of affairs.
 It is descriptive in nature and describes the economic
behavior of individuals or society without prescriptions
about the desirability of such behavior.

 NORMATIVE :
 It involves value judgments.
 It states ‘what should be’ a particular course of action under
given circumstances.
 It is prescriptive in nature and in it welfare considerations
are embedded.

 Business Economics requires both the concepts positive

and Normative in nature .It is normative as it suggest the
application of economic principles for policy formulation
and decision making .However it also need to understand
the environment thus involves study of positive theory .
  Thus, Business Economics combines the essentials of
Normative and Positive Economic Theory with emphasis
more on the former than the latter.

1.3 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)

1. Internal Issues or Operational Issues (Solved using Micro Economics):

These are internal issues which arise within the organization and fall within the
purview and control of management.Eg. Product Decisions, Consumer’s Income,
Pricing and Sales Promotion, Financing and Management of Investments.The
following Microeconomic theories deals with most of these issues :
(a) Demand Analysis and Forecasting – It is the technique of predicting future
demand of goods and services on the basis of past behaviours of factors
which affect demand.
(b) Production and Cost Analysis – Production analysis enables the firm to
decide on the choice of appropriate technology and selection of least cost
input mix to achieve technically efficient way of producing output, given the
inputs. Cost analysis enables the firm to recognize the behavior of costs
when variables such as output, time period and size of plant change.
(c) Inventory management – It pertain to rules that firms can use to minimize
the cost associated with maintaining inventory in form of work in process,
raw material ,finished goods using techniques like ABC Analysis.
(d) Market Structure and Pricing Policies – Analysis of the structure of market
provides information about the nature and extent of competition which the
firms have to face.This helps in determining the degree of market power
which the firm commands and the strategies to be followed in market
management.Price theory explains how prices are determined under
different kind of market conditions and assists the firm in framing suitable
price policies.
(e) Resource Allocation – Business Economics with the help of advanced tools
such as linear programming helps in optimum utilization of resources.
(f) Profit Analysis – Profit theory guides the firm in management and
measurement of profits under conditions of uncertainty and also helps in
future profit planning.
(g) Risk and Uncertainty analysis – Analysis of risks and uncertainties helps the
business firm in arriving at efficient decisions and in formulating plans on
basis of past data ,current information and future prediction.
2. 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.

Thus, Business decisions cannot be taken without considering these present and
future environmental factors.