BE UNIT I

ECONOMICS

INTRODUCTION
The English word economics is derived from the ancient Greek word oikonomikos—meaning the
management of a family or a household. Economics is the study of how individuals and societies make
decisions about way to use scarce resources to fulfil wants and needs. Economics deals with individual
choice, money and borrowing, production and consumption, trade and markets, employment and
occupations, asset pricing, taxes and much more.

As an individual, for example, you constantly face the problem of having limited resources with which to
fulfil your wants and needs. As a result, you must make certain choices with your money – what to
spend it on, what not to spend it on, and how much to save for the future. You'll probably spend part of
your money on relative necessities such as rent, electricity, clothing and food. Then you might use the
rest to go to the movies, dine out or buy a smart phone. Economists are interested in the choices you
make, and investigate why, for instance, you might choose to spend your money on a new mobile phone
instead of replacing your old pair of shoes. The underlying essence of economics is trying to understand
how individuals, companies, and nations as a whole behave in response to certain material constraints.

DEFINITIONS

1. Adam Smith‟s Definition:- Adam Smith, considered to be the founding father of modern Economics,
defines Economics as “the study of the nature and causes of nations‟ wealth or simply as the study of
wealth”. The central point in Smith‘s definition is wealth creation. He assumed that, the wealthier a
nation becomes the happier are its citizens. Thus, it is important to find out, how a nation can be
wealthy. Economics is the subject that tells us how to make a nation wealthy. Adam Smith‘s definition is
a wealth-centred definition of Economics.

2. Alfred Marshall‟s Definition:- Alfred Marshall also stressed the importance of wealth. But he also
emphasised the role of the individual in the creation and the use of wealth. He defines: “Economics is a
study of man in the ordinary business of life. It enquires how he gets his income and how he uses it.
Thus, it is on the one side, the study of wealth and on the other and more important side, a part of the
study of man”.

3. Lionel Robbins‟ Definition:- In his book „Essays on the Nature and Significance of the Economic
Science‟, published in 1932, Robbins gave a definition which has become one of the most popular
definitions of Economics. According to Robbins, “Economics is a science which studies human behaviour
as a relationship between ends and scarce means which have alternative uses”.

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SIGNIFICANCE OF ECONOMICS

1. Allows to know the basics of human needs, production, distribution, reuse and better use of
resources.

2. It provides the basis for exchange of goods and services between individuals, organizations and even
countries.

3. Generates systems, techniques and public policies to improve social welfare.

4. Help to set target prices of goods and services.

5. Adjust political, financial and even social imbalances.

6. Provides knowledge and techniques that prevent crises and help them out.

7. It uses econometric techniques to predict future economic conditions that could harm or benefit
certain situations in ascertain place, and how to maximize the benefits and problems mystify.

8. As you can see, economics is a science that encompasses us completely.

9. To be an expert in this field you can study a university degree in economics, in this course the student
will learn how the economy moves and how to generate the best social conditions.

MICRO AND MACRO ECONOMICS

The whole economic theory is broadly divided into two parts – Micreconomics and Macro
economics.These two terms were at first used by Ragner Frisch in 1933. But these two words became
popular worldwide and most of the economist using nowadays. The term ‗micro‘ and ‗macro‘ were
derived from Greek words ‗Mikros‘ and‗Makros‘ meaning ‗small‘ and ‗large‘ respectively. So micro
economics deals with the analysis of an individual unit and macro economics with economy as a whole.
For example, in micro economics we study how price of goods or factors of production are determined.
In macro economics we study what are the causes of high or low level of employment.So, according to
Edwin Mansfield – ―Micro economics deals with the economic behaviour of individual units such as
consumers, firms, and resource owners; while macro economics deals with behaviour of economic
aggregates such as gross national product and the level of employment.

Meaning of Micro – economics

The term micro was originated from Greek word ‗Mikros‘ which means small. Hence, microeconomics is
concerned on small economic units like as individual consumer, households, firms, industry
etc.Microeconomics may be defined as the branch of economic analysis which studies about the
economic behaviour of individual economic unit may be a person, a particular households, a particular
firm and an industry. The main objective of micro – economics is to explain the principles, problems and
policies related to the optimum allocation of resources. According to K. E. Boulding,

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―Microeconomics is the study of particular firm, particular households, individual price, wage, income
of the industry and particular commodity‖.

It is the study of individual tree not a whole forest. Hence, microeconomics tries to explain how an
individual allocates his money income among various needs as well as how an individual maximize
satisfaction level from the consumption of available limited resources. Microeconomics also explains
about the process of determination of individual price with interaction of demand and supply. It helps to
determine the price of the product and factor inputs. Therefore, it is also called as price theory or
demand and supply theory. Simply microeconomics is microscopic study of the economy.

Meaning of Macro - economics

The term macro- economics is derived from Greek word ― Makros‖, which means― big‖. Hence, macro-
economics studies not individual units but all the units combined together or the economy as a whole.
Since it studies the economy in aggregate. It studies national income, national output, general price
level, total employment, total savings, total investment and so on. It is also called ―aggregate
economics‖ or the ―income theory‖.

According to K.E. Boulding –‖ Macro- economics deals not with individual quantities but with aggregate
of these quantities, not with individual incomes, but with national income, not with individual prices but
with price level, not with individual output but with national output.‖

J.M. Keynes made and outstanding contribution in the development of macro- economics. It is also
known as Keynesian Phenomenon.

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B U S I N E SS E C O N O M I C S
INTRODUCTION
Business Economics, also called Managerial Economics, is the application of economic theory and
methodology to business. Business involves decision- making. Decision making means the process of
selecting one out of two or more alternative courses of action. The question of choice arises because the
basic resources such as capital, land, labor and management are limited and can be employed in
alternative uses. The decision-making function thus becomes one of making choice and taking decisions
that will provide the most efficient means of attaining a desired end, say, profit maximization. Different
aspects of business need attention of the chief executive. He may be called upon to choose a single
option among the many that may be available to him. It would be in the interest of the business to reach
an optimal decision- the one that promotes the goal of the business firm. A scientific formulation of the
business problem and finding its optimal solution requires that the business firm is he equipped with a
rational methodology and appropriate tools.

Economic theory underscores the fact that each firm in the industry operates under competitive
conditions and hence tries to operate more efficiently to withstand the competition. The indicator of
efficiency is profits. The assumption here is that each firm has one man as the owner and entrepreneur,
and that his sole aim is to maximize profits. As time passed, one man firms were replaced by
partnerships and giant companies and the structure of the firm changed to include the
owner/entrepreneur/shareholders on the one hand and that managers on the other. The responsibility
of the owners/entrepreneur/shareholders got bifurcated. The day to day affairs of the firm were looked
after by the managers and owners/entrepreneur/shareholders took organizational decisions aimed at
maximizing profits. The goals of the owners/entrepreneurs/shareholders are called organizational goals
while the goals of the managers are referred to as Business goals also known as operational goals.

DEFINITIONS

According to E. F. Brigham and J. L. Pappas, "Managerial Economics is the application of Economic

theory and methodology to business administration practise."

According to McNair and Meriam, "Managerial Economics consists of the use of Economic modes of
thought to analyse business situations."

According to M. H. Spencer and L. Siegelman, "Managerial Economics is the integration of economic

theory with business practise for the purpose of facilitating decision making and forward planning."

According to Hauge, "Managerial Economics is concerned with using logic of economics, mathematics &
statistics to provide effective ways of thinking about business decision problems."

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According to Joel Dean, "The purpose of Managerial Economics is to show how economic analysis can be
used in formulating business policies."

NATURE OF BUSINESS ECONOMICS

Business economics is, perhaps, the youngest of all the social sciences. Since it originates from
Economics, it has the basis features of economics, such as assuming that other things remaining the
same. This assumption is made to simplify the complexity of the Business phenomenon under study in a
dynamic business environment so many things are changing simultaneously. This set a limitation that we
cannot really hold other things remaining the same. In such a case, the observations made out of such a
study will have a limited purpose or value. Managerial economics also has inherited this problem from
economics.

The other features of managerial economics are explained as below:

(a) Microeconomics in nature: Business economics is concerned with finding the solutions for
differentmanagerial problems of a particular firm. Thus, it is more close to microeconomics.

(b) Operates against the backdrop of macroeconomics: The macroeconomics conditions of the economy
are also seen as limiting factors for the firm to operate. In other words, the managerial economist has to
be aware of the limits set by the macroeconomics conditions such as government industrial policy,
inflation and so on.

(c) Normative economics: Economics can be classified into two broad categories normally. Positive
Economics and Normative Economics. Positive economics describes ― what is‖ i.e., observed economic
phenomenon. The statement ― Poverty in India is very high‖ is an example of positive economics.
Normative economics describes ―what ought to be‖ i.e., it differentiates the ideals form

the actual. Ex: People who earn high incomes ought to pay more income tax than those who earn low
incomes. A normative statement usually includes or implies the words ‗ought‘ or ‗should‘. They reflect
people‘s moral attitudes and are expressions of what a team of people ought to do.

(d) Prescriptive actions: Prescriptive action is goal oriented. Given a problem and the objectives of the
firm, it suggests the course of action from the available alternatives for optimal solution. It does not
merely mention the concept, it also explains whether the concept can be applied in a given context on
not. For instance, the fact that variable costs as marginal costs can be used to judge the feasibility of an
export order.

(e) Applied in nature: ‗Models‘ are built to reflect the real life complex business situations and these
models are of immense help to managers for decision-making. The different areas where models are
extensively used include inventory control, optimization, project management etc. In Business
economics, we also employ case study methods to conceptualize the problem, identify that alternative
and determine the best course of action.

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(f) Offers scope to evaluate each alternative: Business economics provides an opportunity to evaluate
each alternative in terms of its costs and revenue. The Business economist can decide which is the
better alternative to maximize the profits for the firm.

(g) Interdisciplinary: The contents, tools and techniques of Business economics are drawn from different
subjects such as economics, management, mathematics, statistics, accountancy, psychology,
organizational behavior, sociology and etc.

(h) Assumptions and limitations: Every concept and theory of Business economics is based on certain
assumption and as such their validity is not universal. Where there is change in assumptions, the theory
may not hold good at all.

SCOPE OF BUSINESS ECONOMICS

The main focus of Business economics is to find the solution to Business problems for which the
Business economist makes use of the concepts, tools and techniques of economics and other related
disciplines.

1. Demand Analyses and Forecasting:

A firm can survive only if it is able to the demand for its product at the right time, within the right
quantity. Understanding the basic concepts of demand is essential for demand forecasting. Demand
analysis should be a basic activity of the firm because many of the other activities of the firms
depend upon the outcome of the demand forecast. Demand analysis provides:

a) The basis for analyzing market influences on the firms; products and thus helps in the adaptation
to those influences.

b) Demand analysis also highlights for factors, which influence the demand for a product. This helps
to manipulate demand. Thus demand analysis studies not only the price elasticity but also income
elasticity, cross elasticity as well as the influence of advertising expenditure. With the advent of

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computers, demand forecasting has become an increasingly important function of Business
economics.

2. Price determination:

Pricing decisions have been always within the preview of Business economics. Pricing policies are
merely a subset of broader class of Business economic problems. Price theory helps to explain how
prices are determined under different types of market conditions. Competition analysis includes the
anticipation of the response of competing firms‘ pricing, advertising and marketing strategies.
Product line pricing and price forecasting occupy an important place here.

3. Production and cost analysis:

Production analysis is in physical terms. While the cost analysis is in monetary terms. Cost concepts
and classifications, cost-out-put relationships, economies and diseconomies of scale and production
functions are some of the points constituting cost and production analysis.

4. Resource Allocation:

Business Economics is the traditional economic theory that is concerned with the problem of
optimum allocation of scarce resources. Marginal analysis is applied to the problem of determining
the level of output, which maximizes profit. In this respect, linear programming techniques are used
to solve optimization problems. In fact, linear programming is one of the most practical and
powerful managerial decision making tools currently available.

5. Profit analysis:

Profit making is the major goal of firms. There are several constraints here on account of
competition from other products, changing input prices and changing business environment hence
in spite of careful planning, there is always certain risk involved. Business economics deals with
techniques of averting of minimizing risks. Profit theory guides in the measurement and
management of profit, in calculating the pure return on capital, besides future profit planning.

6. Investment decisions:

Capital is the foundation of business. Lack of capital may result in small size of operations.
Availability of capital from various sources like equity capital, institutional finance etc. may help to
undertake large-scale operations. Hence efficient allocation and management of capital is one of the
most important tasks of the managers. The major issues related to capital analysis are:

1. The choice of investment project

2. Evaluation of the efficiency of capital

3. Most efficient allocation of capital

Knowledge of capital theory can help very much in taking investment decisions. This involves,
capital budgeting, feasibility studies, analysis of cost of capital etc.

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7. Forward planning:

Strategic planning provides management with a framework on which long-term decisions can be
made which has an impact on the behavior of the firm. The firm sets certain long-term goals and
objectives and selects the strategies to achieve the same. Strategic planning is now a new addition
to the scope of Business economics with the emergence of multinational corporations.

RELATIONSHHIP WITH OTHER DISCIPLINES

Many new subjects have evolved in recent years due to the interaction among basic disciplines.
While there are many such new subjects in natural and social sciences, Business economics can be
taken as the best example of such a phenomenon among social sciences. Hence it is necessary to
trace its roots and relationship with other disciplines.

1. Relationship with economics:

The relationship between Business economics and economics theory may be viewed from the point
of view of the two approaches to the subject Viz. Micro Economics and Marco Economics.
Microeconomics is the study of the economic behavior of individuals, firms and other such micro
organizations. Business economics is rooted in Micro Economic theory. Business Economics makes
use to several Micro Economic concepts such as marginal cost, marginal revenue, elasticity of
demand as well as price theory and theories of market structure to name only a few. Macro theory
on the other hand is the study of the economy as a whole. It deals with the analysis of national
income, the level of employment, general price level, consumption and investment in the economy
and even matters related to international trade, Money, public finance, etc.

2. Relationship with accounting:

Business economics has been influenced by the developments in management theory and
accounting techniques. A proper knowledge of accounting techniques is very essential for the
success of the firm because profit maximization is the major objective of the firm. Business
Economist requires a proper knowledge of cost and revenue information and their classification.

3. Relationship with mathematics:

The use of mathematics is significant for Business economics in view of its profit maximization goal
long with optional use of resources. The major problem of the firm is how to minimize cost, how to
maximize profit or how to optimize sales. Mathematical concepts and techniques are widely used in
economic logic to solve these problems. Geometry, Algebra and calculus are the major branches of
mathematics which are of use in Business economics.

4. Relationship with Statistics:

A successful businessman must correctly estimate the demand for his product. Statistical methods
provide and sure base for decision-making. Thus statistical tools are used in collecting data and
analyzing them to help in the decision making process. Statistical tools like the theory of probability
and forecasting techniques help the firm to predict the future course of events. Business Economics

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also make use of correlation and multiple regressions in related variables like price and demand to
estimate the extent of dependence of one variable on the other.

5. Relationship with Operations Research:

The development of techniques and concepts such as linear programming, inventory models and
game theory is due to the development of this new subject of operations research in the post-war
years. Operations research is concerned with the complex problems arising out of the management
of men, machines, materials and money.Operation research provides a scientific model of the
system and it helps Business economists in the field of product development, material management,
and inventory control, quality control, marketing and demand analysis.

7. Relationship with Computer Science:

Computers are used in data and accounts maintenance, inventory and stock controls and supply
and demand predictions. What used to take days and months is done in a few minutes or hours by
the computers. In fact computerization of business activities on a large scale has reduced the
workload of Business personnel.

Managerial Decision Making Process

Decision making is crucial for running a business enterprise which faces a large number of problems
requiring decisions.Which product to be produced, what price to be charged, what quantity of the
product to be produced, what and how much advertisement expenditure to be made to promote the
sales, how much investment expenditure to be incurred are some of the problems which require
decisions to be made by managers.

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The five steps involved in managerial decision making process are explained below:

1. Establishing the Objective:

The first step in the decision making process is to establish the objective of the business enterprise. The
important objective of a private business enterprise is to maximise profits. However, a business firm
may have some other objectives such as maximisationof sales or growth of the firm.But the objective of
a public enterprise is normally not of maximisation of profits but to follow benefit-cost criterion.
According to this criterion, a public enterprise should evaluate all social costs and benefits when making
a decision whether to build an airport, a power plant, a steel plant, etc.

2. Defining the Problem:

The second step in decision making process is one of defining or identifying the problem. Defining the
nature of the problem is important because decision making is after all meant for solution of the
problem. For instance, a cotton textile firm may find that its profits are declining.It needs to be
investigated what are the causes of the problem of decreasing profits. Whether it is the wrong pricing
policy, bad labour-management relations or the use of outdated technology which is causing the
problem of declining profits. Once the source or reason for falling profits has been found, the problem
has been identified and defined.

3. Identifying Possible Alternative Solutions (i.e. Alternative Courses of Action):

Once the problem has been identified, the next step is to find out alternative solutions to the problem.
This will require considering the variables that have an impact on the problem. In this way, relationship
among the variables and with the problems has to be established

In regard to this, various hypotheses can be developed which will become alternative courses for the
solution of the problem. For example, in case of the problem mentioned above, if it is identified that the
problem of declining profits is due to be use of technologically inefficient and outdated machinery in
production.

The two possible solutions of the problem are:

(1) Updating and replacing only the old machinery.

(2) Building entirely a new plant equipped with latest machinery.

The choice between these alternative courses of action depends on which will bring about larger
increase in profits.

4. Evaluating Alternative Courses of Action:

The next step in business decision making is to evaluate the alternative courses of action. This requires,
the collection and analysis of the relevant data. Some data will be available within the various
departments of the firm itself, the other may be obtained from the industry and government.

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The data and information so obtained can be used to evaluate the outcome or results expected from
each possible course of action. Methods such as regression analysis, differential calculus, linear
programming, cost- benefit analysis are used to arrive at the optimal course. The optimum solution will
be one that helps to achieve the established objective of the firm. The course of action which is
optimum will be actually chosen. It may be further noted that for the choice of an optimal solution to
the problem, a manager works under certain constraints.

The constraints may be legal such as laws regarding pollution and disposal of harmful wastes; they way
be financial (i.e. limited financial resources); they may relate to the availability of physical infrastructure
and raw materials, and they may be technological in nature which set limits to the possible output to be
produced per unit of time. The crucial role of a business manager is to determine optimal course of
action and he has to make a decision under these constraints.

5. Implementing the Decision:

After the alternative courses of action have been evaluated and optimal course of action selected, the
final step is to implement the decision. The implementation of the decision requires constant
monitoring so that expected results from the optimal course of action are obtained. Thus, if it is found
that expected results are not forthcoming due to the wrong implementation of the decision, then
corrective measures should be taken.

However, it should be noted that once a course of action is implemented to achieve the established
objective, changes in it may become necessary from time to time in response in changes in conditions or
firm’s operating environment on the basis of which decisions were taken.

Basic economic principles

Economic theory offers a variety of concepts which can be of considerable assistance to the managers in
decision-making practices. These tools are helpful for managers in solving business-related problems.
These are thus taken as guides in making decisions. The following arc the basic economic tools for
decision-making:

1.Opportunity cost principle

2. Incremental concept/principle

3. Principle of time perspective

4. Discounting principle

5. Equi-marginal principle.

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CONCEPT OF OPPORTUNITY COST

1.Both micro and macroeconomics make abundant use of the fundamental concept of opportunity cost.

2.In Managerial Economics, the opportunity cost concept is useful in decision involving a choice
between different alternative courses of action.

3.Resources are scarce, we cannot produce all the commodities. For the production of one Commodity
When you choose a particular alternative, the next best alternative must be given up. For example, if
you choose to watch cricket highlights in T.V., you must give up an extra hour study.

4.Thus the “opportunity cost” is the cost of something in terms of an opportunity forgone. In other
words, the opportunity cost of an action is the value of next best alternative forgone. commodity, we
have to forego the production of another commodity.

THE CONCEPT OF OPPORTUNITY COST INVOLVES THREE THINGS:

1. The calculation of opportunity cost involves the measurement of sacrifices.

2. Sacrifices may be monetary or real.

3. The opportunity cost is termed as the cost of sacrificed alternatives.

THE ECONOMIC SIGNIFICANCE OF OPPORTUNITY COST IS AS FOLLOWS:

1. It helps in determining relative prices of different goods.

2. It helps in determining normal remuneration to a factor of production.

3. It helps in proper allocation of factor resources.

INCREMENTAL CONCEPT

The incremental concept involves the estimation of the impact of decision alternatives on cost and
revenues that result from changes in prices, products, procedures, investment, etc,. Incremental
concept is closely related to the marginal cost and marginal revenues of economic theory. The two
major concepts in this analysis are;

i) Incremental cost

ii) Incremental revenue

Incremental cost denotes changes in total cost whereas incremental revenue means change in total
revenue resulting from a decision of the firm.

A decision is profitable only if;

1.It increases revenue more than cost

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2.It decreases some costs more than it increases others

3.It increases some revenues more than it decreases others

4.It reduces costs more than revenues.

Generally businessman holds the view that they ‘must make a profit on every job’ in order to make an
overall profit. With this concept, business may refuse orders that do not cover full cost (variable cost
and fixed cost) plus a provision of profit. This will leads to rejection of an order which prevents short run
profit. The following example will illustrate this point.

Suppose a new order is estimated to bring in an additional revenue of Rs. 10,000. the cost are estimated
as under;

Labour cost = Rs. 3000

Material cost = Rs. 4000

Overhead charges = Rs. 3600

Selling & Administrative cost = Rs. 1400

Full cost = Rs. 12,000

The order appears to be unprofitable for it results in a loss of Rs. 2000. However, suppose there is idle
capacity which can be utilized to execute this order. If order adds only Rs.1000 to overheads charges and
Rs. 2000 by way of labour cost because some the idle worker already on the payroll will be deployed
without added pay and no extra selling and administrative cost, Then the actual incremental cost is as
follow;

Labour cost = Rs. 2000

Material cost = Rs. 4000

Overhead charges = Rs. 1000

Selling & Administrative cost = Nil

Incremental cost = Rs. 7,000

Thus there is a profit of Rs. 3000. The order can be accepted on the basis of incremental reasoning.
Incremental reasoning does not accept all orders at prices which cover merely their incremental costs.

INCREMENTALISM AND MARGINALISM

• Incremental cost or revenue is similar to marginal cost or revenue concept. But there exist

some differences between incremental concept and marginal cost / revenue concepts.

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• In the marginal analysis, marginal revenue means the addition made to the total revenue by selling an
additional or extra unit of the output.

• But incremental revenue simply measures the difference between the old and new

revenues. It is not restricted to the effects of a change in price, change in output. It

measures the impact of decision alternative on the total revenue.

THE CONCEPT OF TIME PERSPECTIVE

The time perspective concept states that the decision maker must give due consideration both to the
short run and long run effects of his decisions. He must give due emphasis to the various time periods. It
was Alfred Marshall who introduced time element in economic theory. Marshall explained four market
forms based on time in economic theory i.e.,

• Very Short Period

• Short Period

• Long Period

• Very long Period or Secular Period

1. Very Short Period: Very short period refers to the type of competitive market in which the supply of
commodities cannot be changed at all. So in a very short period, the market supply is perfectly inelastic.
The price of the commodity depends on the demandfor the product alone.

2. Short Period: Short period refers to that period in which supply can be adjusted to a limited extent by
varying the variable factors alone. the market supply is relativelyelastic.

3. Long Period: Long period is the time period during which the supply conditions are fully able to meet
the new demand conditions. In the long run, all (both fixed as well as variable) factors are variable. the
market supply is perfectly elastic.

4. Very long Period or Secular Period: The very long run is a situation where technology and factors
beyond the control of a firm can change significantly.

THE DISCOUNTING PRINCIPLES

• Discounting principles talks about the comparison of money value between present andfuture time

• A rupee to be received tomorrow is worth less than a rupee today

• Whenever we make comparison between present and the future values of money, wealways discount
future value to make it comparable with the present value.

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• Example: Suppose there is a choice between receiving a gift of Rs. 1000/- today andRs.1000/- next
year, naturally everyone would prefer Rs.1000/- today.

• Even though if there is a certainty of receiving Rs.1000/- next year, we choose to get

Rs.1000/- today, as it can yield some interest during one year by investing.Explaining the discounting
principle is to ask how much money today would be equivalent toRs.100000 a year from now.Assuming
that rate of interest 12 per cent, we must discount the Rs.100000 at 12 per cent

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