CA – Foundation CA- Intermediate CA- Final

CA-FOUNDATION
CRASH COURSE MATERIAL

Business Economics
Chapter 1 – Introduction to Business Economics

By Prof. Shashi Kiran.M

Advait Learning 9353164696 / 8660386382

www.advaitlearning.com
 Business Economics

Chapter -1
INTRODUCTION TO BUSINESS ECONOMICS
The term ‘Economics’ owes its origin to the Greek word ‘Oiko’ (Household) ‘nomia’
(Management) meaning it is an ART of ‘household management’.

The Economics was born with the publication of Adam Smith’s book “An inquiry in to the
Nature and Causes of the wealth of the nation” in the year 1776. Adam Smith is known as
the father of Economics. Till 19th Century, economics was known as “political economy”

(Father of Modern Economics –A. Marshall)

These two fundamental facts that

(i) Human beings have unlimited wants; and

(ii) The means of satisfying these wants are relatively scarce form the subject matter of
Economics.
Economics is, thus, the study of how we work together to transform scarce resources into
goods and services to satisfy the most of our infinite wants and how we distribute these
goods and services among ourselves.

Meaning of Business Economics

Business Economics is the problem of rational business decision making, i.e. selecting an
appropriate alternative at right time to achieve organisational goals

Decision Making involves

• Evaluation of feasible alternatives

• Rational Judgement on basic information
• Choice on available productive resources, i.e. Land/Labour/Capital/Organisation
Which are limited and can be employed in alternative uses.
Therefore, more effective alternative must be chosen & less effective alternative
must be rejected.

Business Economics is used for rational business decision making which fills the gap
between Economic theory & Business practices.

Which integrates economic theory with business practices, it is the process of business
decision making through economic tools like Demand, Supply, Cost, Price, Competition, etc.

Definition of Business Economics

Business economics may be defined as the use of economic analysis to make business
decision involving the best use of an Organisation’s scarce resources.

Joel Dean defines Business Economics in terms of the use of economic analysis in the form
of business policies. Business Economics is a component of applied economics as it includes
applications involving quantitative techniques such as linear programming, regression
analysis, capital budgeting, break even analysis & Cost analysis.

Prof.Shashi Kiran M page 2

 Business Economics

Nature of Business Economics

MICRO ECONOMICS: Micro economics is defined as the study of behaviour of
individual decision making units, such as consumers, resource owner and firms. It is also
known as Price Theory since its major subject matter deals with the determination of price
of commodities and factor. It includes:-

• Product Pricing
• Consumer behaviour
• Factor Pricing
• Behaviour of Firm
• Location of Industry

MACRO ECONOMICS: In macro Economics, we study the economic behaviour of

large aggregates such as the overall conditions of the economy such as total production,
total consumption, total saving and total investment in it. It includes:-

• National income and output.

• General Price level.
• Balance and price level.
• External value of money.
• Saving and investment.
• Employment and growth.

NATURE OF ECONOMICS

Under this, we generally discuss whether Economics is science or art or both and if it is a
science whether it is a positive science or a normative science or both.
Economics – As a science and as an art:
Often a question arises – whether Economics is a science or an art or both.

a) Economics is a science : A subject is considered science if it satisfies the below

conditions
• A Systematic body of knowledge
• Answers should be measurable
• Answers should be predictable
• There should be tools to measure answers
• Universally Acceptable

Economics satisfies all the above conditions except Universally Acceptable, The end
results in economics is not applicable for all the circumstances it will be subjective in
nature.
Example: Demand for an Audi car in India & America will not be same, but scientific
outcome such as H2O i.e., Combining 2 atoms of Hydrogen and 1 atom of Oxygen
will result to water in any part of an earth.

Hence, “Economics is not a pure science it is a partial science”

Prof.Shashi Kiran M page 3

 Business Economics

b) Economics is an art: Art is nothing but practice of knowledge. Whereas science

teaches us to know, art teaches us to do. Unlike science which is theoretical, art is
practical. If we analyse Economics, we find that it has the features of an art also. Its
various branches, consumption, production and public finance etc. provide practical
solutions to various economic problems. It helps in solving various economic problems
which we face in our day-to-day life.

Thus, Economics is both a science and an art. It is science in its methodology and art
in its application.

Economics as Positive Science and Economics as Normative Science

Normative Science
Positive Science
• It is a systematic body of knowledge
• It is a systematic body of knowledge
which concerns ‘WHAT OUGHT
which concerns ‘WHAT IT IS’
TO BE’
• Main objective is to establish
• Main objectives is to establish Ideals
Uniformity
• It is called as Prescriptive science, as
• It is called as Descriptive science, as
it gives suggestions along with
it describes the economic problem
describing the economic problem
and never gives suggestions
• It passes value judgements
• It does not passes value judgements
• Not concerned with facts
• Concerned with facts
• It suggests how things should be
• It explains cause & effect relationship

c) Pragmatic in approach – Micro economics is abstract and purely theoretical and

analyses economics phenomena under unrealistic assumptions. In contrast, Business
Economics is pragmatic in it’s approach and it tackles practical problems which the
firm faces in the real world.
d) Inter disciplinary in nature – Business Economics is interdisciplinary as it
incorporates tools from other disciplines such as mathematics, Management theory,
Accounting, Statistics etc.
e) Incomplete elements – such as general price level, income and employment level,
government policies, tax and interest rates, industries etc.
f) Based on Micro economics – Business economics is largely based on micro
economics. A business manager is largely concerned with the achievements of
objectives of his organisation. Since business economics is concerned with the decision
making aspects of individual establishments, it heavily relies on micro economics.

CENTRAL ECONOMIC PROBLEM

Human wants are unlimited and productive resources are scarce. An economics without scarcity is
not found in the real would. All wants can not be satisfied with the scarce productive resources for
the satisfaction of wants, so problem of use of scarce resources arise. This generally called the central
economic problems

Prof.Shashi Kiran M page 4

 Business Economics

Central Problem

Scarcity of Resources

Wants as unlimited Resources are limited

Resources have Alternative uses

Allocation of Resources

What to produce How to Produce For Whom to Produce What provision

should be made for
economic growth
Problems of Allocation of Resources:-

(i) What to produce - Human wants are unlimited and resources are limited to satisfy
human wants. The question arises what goods are to be produced and in what
quantity these goods to be produced.
(a) Durable / perishable goods
(b) Single / Multiple use
(c) Superior / Inferior goods
It is also known as problem of choice making.

(ii) How to produce- This problem is related to the problem of choice of technique for
producing a commodity. An economy has to choose between.
(a) Labour intensive technique and
(b) Capital intensive technique
The economy has to decide about technique of production on the basis of cost of
labour and capital. A labour surplus economy chooses labour intensive technique
and a capital surplus economy chooses capital-intensive technique.

(iii) For whom to produce – which determine the distribution of goods among the
various individuals like,
(a) class of society
(b) targeted customers
(c) their ability to purchase
to decide about the share of different people in the national goods and service.

(iv) What provision should be made for economic growth: A society would not like
to use all its scarce resources for current consumption only. This is because if it
uses all the resources for current consumption and no provision is made for future
Production, the societies’ production capacity would not increase. (Sustainable
development)

Prof.Shashi Kiran M page 5

 Business Economics

ECONOMIC SYSTEM
Economic system is defined as an arrangement by which the central problems of an
economy are solved.

1.1 CAPITALIST ECONOMY

Capitalism is a political economic system based on private property and private profit.
This type of system is also called laissez-faire or free market economy.

Main features are:

1. Private owner ship of property/ right to property : the right of private property
means that productive factors such as land, factories, machinery, mines, etc. are under
private ownership. The owners of these factors are free to use them in the manner in
which they like. The government may, however, put some restrictions for the benefit
of the society in general.

2. Freedom of enterprises. I.e Government interference is zero : This means that

everybody engages in any economic activity he likes. More specifically he is free to
set up any firm to produce goods.

3. Profit motive of production: In a capitalist economy it is the profit motive which

forces or induces people to work and produce, Price mechanism guides production
decisions. i.e. manufacturer will only produce those goods which intern has a demand
in economy.

4. Existence of Competition between producers: Competition prevails among sellers

to sell their goods and among buyers to obtain goods to satisfy their wants.
Advertisement, price-cutting, discounts, etc. are very common methods of
competition in a capitalist economy.

5. Consumer sovereignty is not restricted. i.e Choice making ability to a customer is

not restricted : this means people in a capitalist economy are free to spend their
income as they like. This is known as consumer sovereignty. Consumers are
sovereign in the sense producers produce only those goods which consumers wish to
buy.

6. In-equal distribution of Income: There is generally a wide gap of income between

the rich and the poor in the economy which mainly arises due to unequal distribution
of property in such economies.

Merits of Capitalist Economy

(i) Encourages economic activities

(ii) Maximum efficiency
(iii) Dynamic economy
(iv) Rapid economy growth

Prof.Shashi Kiran M page 6

 Business Economics

Demerits of Capitalist economy

(i) Unequal distribution of income and wealth

(ii) Business instability
(iii) Consumer exploitation
(iv) Misallocation of productive resources

1.2 SOCIALIST ECONOMY

Socialist economy is planned or command economy based on public ownership of
property and social welfare motive. Prices are determined by central planning
authority. Some of the socialist countries are Hungary, Poland. Yugoslavia, Bulgaria,
etc.

Main features are:

1. Public ownership of property or factors of production : The first essential

characteristic of socialism is that all the important and strategic means of production
are State-owned. However, it should not be taken to mean that private enterprise and
private property are totally dispensed with in such economies. They do exist; but
their relative importance is so insignificant that they can be easily ignored without
adversely affecting the model of socialism.There is collective ownership of all
means of production. As a result of social ownership, profit-motive and self-interest
are not the driving force of economic activity as it is in the case of a market
economy/ capitalistic economy. The resources here are used to achieve certain socio-
economic objectives.

2. No freedom of enterprise i.e. Complete role of Govt: Private enterprises should

only follow what CPA instructs, they cannot decide on their own. The right to
private property is limited as all property of the country is owned by the state.
Hence, No individual can accumulate excessive property as in the case of capitalism.

3. Social welfare motive: Social welfare becomes the guiding light in such a system.
Since all the enterprises are State-owned, no individual or private profit accrues. In
the State enterprises price policy is guided by the aims of social welfare rather than
by profit motive.

4. Planning mechanism guides production :

There is a central authority to set and accomplish socio-economic goals; that is why
it is called a centrally planned economy. Major economic decisions, such as what to
produce, when and how much to produce, etc., are taken by the central authority. All
the basic decisions pertaining to the working and the regulation of the economy in
such a system are taken by the Government/ CPA. The Government uses the tools of
economic planning as coordinating mechanism as also the one that takes economic
decisions. For this purpose, a central authority is set up

5. No competition: One of the basic tasks of economic planning is to avoid duplication

of efforts and wastage of resources. Since the State has the monopoly of production
and investment in socialism, it avoids all sorts of competition and rivalry as between
different production units. Recently, of course, some of the socialist countries have
been encouraging competition among State-owned enterprises themselves.
Prof.Shashi Kiran M page 7
 Business Economics

6. Absence of consumer’s sovereignty i.e., Choice making ability to consumer

Freedom from hunger is guaranteed but consumers’ sovereignty gets restricted by
selective production of goods by authority, The range of choice is limited by planned
production. However, within that range an individual is free to choose what he likes
most.

7. Restriction on freedom of occupation: The right to work is guaranteed but the

choice of occupation gets restricted because these are determined by some authority
on the basis of certain socio-economic goals before the nation

8. Equal distribution of Income: A relative equality of income is an important

feature. Among other things, differences are narrowed down by lack of opportunities
to accumulate private capital. Educational and other facilities are enjoyed more or
less equally; thus the basic causes of inequalities are removed.

Merits of socialist economy:

(i) Optimum utilization of resources

(ii) Satisfaction of consumers need
(iii) Equal distribution of income and wealth

Demerits of socialist economy:

(i) Inaccurate calculation of cost

(ii) Bureaucratic set-up
(iii) Concentration of power in government hands

1.3 MIXEDECONOMY
All economics are mixed economics, with elements of both market and command.
India is a mixed economy.

Main features are:

1. Ownership of property is both by private and public sector.

In mixed economy there is the co-existence of both private and public enterprise
,A sector in which both the government and the private enterprises have equal
access, and join hands to produce a commodity, leading to the establishment of
joint sectors.

2. Planned Economy: a mixed economy is a planned economy, i.e. an economy in

which the government has a clear and definite economic plan. Public sector
enterprises have to work according to a plan and to achieve the objectives laid
down. The government has also to create necessary atmosphere for the private
sector to develop on its own. Thus, it must prepare plans of development for both
the private and the public sector enterprises. Allocation of resources in a mixed
economy should be better since it attempts to combine the productive efficiency of
capitalism and distributive justice of socialism.

Prof.Shashi Kiran M page 8

 Business Economics

3. Balanced Regional Development: in a mixed economy balanced regional

development is expected. Public sector enterprises may be located in the backward
regions so as to ensure its development. Further by way of subsidies and other
incentives private sector may be lured to establish and develop industries in
backward regions.

4. A Dual System of Pricing exists: in a mixed economy, a dual system of pricing

exists. In private sector, prices of goods and factors of production are determined
through the free play of market forces of demand and supply. In public sector, the
state determines prices of various products. The state reserves itself the right to
keep different prices for public sector units and private sector units. The state may
also fix the prices of certain essential commodities which are used by the common
man. For example, in India, the prices of essential commodities like diesel, LPG,
are fixed by government. Overall planning is done by the State Authority called
Planning Commission in countries like India who have adopted mixed economy.

5. There is freedom of enterprise in the private sector but no freedom in the public
sector.
6. Private sector produces with profit motive and public sector with welfare motive.
7. In the private sector, price mechanism solves the basis problems whereas in the
public sector, the government guides the production decisions.
8. Competition exists but is limited to the private sector.
9. Consumer’s sovereignty exists.
10. Freedom of occupation exists.

Merits of Mixed Economy:

1. Mixed economy secures the merits of both capitalism and socialism while
avoiding the evils of both.
2. Mixed economy protects individual freedom. Under the system, individuals have
the freedom of consumption, choice of occupation, freedom of enterprise and
freedom of expression.
3. Price mechanism is allowed to operate under mixed economy.
4. Reducing the inequalities of wealth and class struggle is one of the aims of mixed
economy.
5. Economic fluctuations can be avoided due to centrally planned economy.
6. Mixed economy helps under-developed countries to have rapid and balanced
economic development.

De-merits of Mixed Economy

1. Mixed Economy is difficult to operate. Balancing and adjusting the public and
private sector is often difficult.
2. Excessive controls and heavy taxes are likely to prevail under mixed economy.
These will discourage production in the private sector.
3. Mixed economy is described by Schumpeter as “Capitalism in the oxygen tent”.
According to him it is only a trick of the capitalists to cheat the working class by
offering them some temporary advantage like social security, uplift of the
depressed classes, etc.

Prof.Shashi Kiran M page 9

 Business Economics

Features of Three Economics System

Features Capitalism Socialism Mixed Economy

1. Ownership of property Private Public Both public and private
ownership ownership ownerships.

2. Freedom of enterprise Exists No freedom Freedom in private sector but

no freedom in public sector
3. Motive of production Profit motive Social welfare Profit motive in private
sector and welfare motive in
public sector
4. Who governs Price Planning Both price mechanism and
production mechanism mechanism planning mechanism.

5. Competition Exists No competition Exists only in private sector

6. Distribution of income Very unequal Quite equal Considerable inequalities

exists
7. Role of government No role Complete role Full role in public sector and
limited role in private sector

Prof.Shashi Kiran M page 10