PART 1

THE ECONOMIC & BUSINESS

ENVIRONMENT – SETTING
THE SCENE

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1 WHAT IS BUSINESS ECONOMICS?
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1. What is Business Economics?

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What is Business

The business of turning land, labour and capital

into a product or service sold to customers. This is
carried out by organizations that set themselves
clear aims.

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 Classifying business
Through an organization’s ownership and its
primary aim:

• Private sector business: Profit.

• Public sector organization: Perhaps to maximize

opportunities to access products and services like
roads, education and health care.

• Third sector organisation: To meet the needs of its

beneficiaries.

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Classifying business

• By size: Small, medium or large scale enterprises.

• By what products or services are produced.

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The Fundamental Questions of Society

What should be produced?

How should will products be produced?
Who will get the products?

Capitalist and communist economies have

different ways of deciding these questions.

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What is Economics?
Scarcity = limited nature of society’s resources.
Businesses allocate scarce resources among
competing uses, taking into account a range of
stakeholder wants and needs.

Governments get involved and most economies

are a mix of private and public ownership.

Economics is the study of how society manages

its scarce resources.

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 2. Thinking As an Economist

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 People make decisions
 The management of the scare resources is down
to people’s individual and group decisions.

 People want to get the most from scarce resources

whether they are buyers, producers or sellers.

 There are key principles about how people and

business make decisions.

 The economy is the collective interaction between

producers and consumers making and carrying out
those decisions.
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 Principle 1
Decision making involves trade-offs

 Getting the most from scarce resources means

facing different trade-offs such as:
• How to use your time.
• To decide as a business to employ more people or
more machines.
• Whether to have more capital or more consumer
goods.
• Whether to have more goods or a cleaner
environment.

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Principle 2
The cost of something is what you give up to get it

 The opportunity cost is whatever is given up to

obtain some item.
 It measures the value of what is foregone.

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Principle 3
Rational people and businesses think at the margin

 Marginal changes describe small incremental

adjustments.
 Many decisions are made at the margins.
 Firms are interested in the marginal costs.

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Principle 4
People and businesses respond to incentives

 People compare the costs and benefits when

making decisions.
 Decisions are made by
people as consumers,
businesses as suppliers and
governments as policy makers
 There can be unintended consequences from
decisions.

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 3. How People Interact

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Principle 5
Trade can make everyone better off

 Trade between two economies can make each

economy better off.
 Countries as well as businesses benefit from the
ability to trade with one another.
 Trade allows countries to specialize in what they do
best and to enjoy a greater variety of goods and
services.

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Principle 6
Markets are usually a good way to organize
economic activity

 Communist countries adopted central planning,

but these have been abandoned in favour of
markets.
 In a market economy, the decisions of a central
planner are replaced by the decisions of millions of
firms and households.
 In general, markets have promoted economic well-
being.
 Markets are not without their problems.
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Principle 7
Governments can sometimes improve market
outcomes

 Market failure is when the market on its own fails

to produce an efficient allocation of resources.
 Externalities are the uncompensated impact of a
person or firm’s action on the well-being of a third
party.
 Market power is when an economic agent is able
to influence market prices.
 Governments can intervene to improve markets.
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 4. How the Economy Works
as a Whole

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Principle 8
An economy’s standard of living depends on its
ability to produce goods and services

 Economic growth is the increase in the amount of goods

and services in an economy over a period of time.
 Gross domestic product per head is one useful indicator
of measuring living standards.
 The standard of living measures welfare based on the
amount of goods and services a person’s income can buy.
 Productivity is directly related to living standards.
 Boosting productivity raises living standards.

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Principle 9
Prices rise when the government prints too much
money

 Inflation measures the overall increase in prices.

 Printing money leads to price rises, because the
value of money falls.

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 Principle 10
Society faces a short-run trade-off between
inflation and unemployment

 In the short-run there is a trade off between

unemployment and inflation as shown in
the Phillips curve.
 Increasing the money supply and therefore inflation can
lower unemployment in the short-term.
 The short-term can last several years.
 The business cycle is the irregular and largely
unpredictable fluctuations in employment and output of
goods and services.

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 End of Chapter 1

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