BUSINESSS ECONOMICS

Module 1
1. The nature and scope of economics- Relationship to other social sciences
2. Wealth and welfare
3. Scarcity and choice- how an economy is organised natural resources-
opportunity Cost
4. The nature of the firm
5. Entrepreneurship
6. The nature of profit- accounting profit and economic profit

Economics-Introduction
Etymologically, the term Economics comes from the Greek words oikos
(house) and nomos (management). Economics is, thus, the study of how we
work together to transform scarce resources into goods and services to satisfy
the most pressing of our infinite wants and how we distribute these goods and
services among ourselves.

In the present-day sense, Economics is a subject whose study helps individuals,

groups, nations and even international organizations make important choices for
material welfare, both short-term and long-term, under limitations or constraints
of resources. Under its widespread umbrella comes the individual or the
household going to the market, the firm trying to make profits, the village
growing into an industrial town, the less developed country striving for
development, multinational organizations and the world economy in general.

Two fundamental facts that the subject deals with,

(i) Human beings have unlimited wants; and

(ii) The means of satisfying these wants are relatively scarce.

 The numerous human wants are to be satisfied through the scarce

resources available in nature. Economics deals with how the numerous human

wants are to be satisfied with limited resources. Thus, the science of economics

centres on want - effort - satisfaction. Economics not only covers the decision

making behaviour of individuals but also the macro variables of economies like

national income, public finance, international trade and so on.

Definitions of Economics

Wealth Definition

Adam smith- Classical economists (1723 - 1790), in his book “An Inquiry

into Nature and Causes of Wealth of Nations” (1776) defined economics as

the science of wealth. According to him wealth was useful for the state and

society. He also explained how a nation’s wealth is created. He considered that

the individual in the society wants to promote only his own gain and in this, he

is led by an “invisible hand” to promote the interests of the society though he

has no real intention to promote the society’s interests.

Criticism: Smith defined economics only in terms of wealth and not in terms of

human welfare. Ruskin and Carlyle condemned economics as a ‘dismal

science’, as it taught selfishness which was against ethics. However, now,

wealth is considered only to be a mean to end, the end being the human welfare.

Hence, wealth definition was rejected and the emphasis was shifted from

‘wealth’ to ‘welfare’.
Welfare Definition

Alfred Marshall (1842 - 1924) wrote a book “Principles of Economics”

(1890) in which he defined “Political Economy” or Economics is a study of

mankind in the ordinary business of life; it examines that part of individual and

social action which is most closely connected with the attainment and with the

use of the material requisites of well-being”.

The important features of Marshall’s definition are as follows:

a) According to Marshall, economics is a study of mankind in the ordinary

business of life, i.e., economic aspect of human life.

b) Economics studies both individual and social actions aimed at promoting

economic welfare of people.

c) Marshall makes a distinction between two types of things, viz. material

things and immaterial things. Material things are those that can be seen, felt and

touched, (E.g.) book, rice etc. Immaterial things are those that cannot be seen,

felt and touched. (E.g.) skill in the operation of a thrasher, a tractor etc.,

cultivation of hybrid cotton variety and so on. In his definition, Marshall

considered only the material things that are capable of promoting welfare of

people.

Criticism:
a) Marshall considered only material things. But immaterial things, such as the

services of a doctor, a teacher and so on, also promote welfare of the people.

b) Marshall makes a distinction between (i) those things that are capable of

promoting welfare of people and (ii) those things that are not capable of

promoting welfare of people. But anything, (E.g.) liquor, that is not capable of

promoting welfare but commands a price, comes under the purview of

economics. c) Marshall’s definition is based on the concept of welfare. But

there is no clear-cut definition of welfare. The meaning of welfare varies from

person to person, country to country and one period to another. However,

generally, welfare means happiness or comfortable living conditions of an

individual or group of people. The welfare of an individual or nation is

dependent not only on the stock of wealth possessed but also on political, social

and cultural activities of the nation.

Welfare Definition

Lionel Robbins published a book “An Essay on the Nature and Significance

of Economic Science” in 1932. According to him, “economics is a science

which studies human behaviour as a relationship between ends and scarce

means which have alternative uses”.

The major features of Robbins’ definition are as follows:

a) Ends refer to human wants. Human beings have unlimited number of wants.
b) Resources or means, on the other hand, are limited or scarce in supply. There

is scarcity of a commodity, if its demand is greater than its supply. In other

words, the scarcity of a commodity is to be considered only in relation to its

demand.

c) The scarce means are capable of having alternative uses. Hence, anyone will

choose the resource that will satisfy his particular want. Thus, economics,

according to Robbins, is a science of choice.

Criticism:

a) Robbins does not make any distinction between goods conducive to human

welfare and goods that are not conducive to human welfare. In the production of

rice and alcoholic drink, scarce resources are used. But the production of rice

promotes human welfare while production of alcoholic drinks is not conducive

to human welfare. However, Robbins concludes that economics is neutral

between ends.

b) In economics, we not only study the micro economic aspects like how

resources are allocated and how price is determined, but we also study the

macro economic aspect like how national income is generated. But, Robbins has

reduced economics merely to theory of resource allocation.

c) Robbins definition does not cover the theory of economic growth and

development.
Growth Definition

Prof. Paul Samuelson defined economics as “the study of how men and society

choose, with or without the use of money, to employ scarce productive

resources which could have alternative uses, to produce various commodities

over time, and distribute them for consumption, now and in the future among

various people and groups of society”. The major implications of this definition

are as follows: a) Samuelson has made his definition dynamic by including the

element of time in it. Therefore, it covers the theory of economic growth. b)

Samuelson stressed the problem of scarcity of means in relation to unlimited

ends. Not only the means are scarce, but they could also be put to alternative

uses. c) The definition covers various aspects like production, distribution and

consumption. Of all the definitions discussed above, the ‘growth’ definition

stated by Samuelson appears to be the most satisfactory. However, in modern

economics, the subject matter of economics is divided into main parts, viz., i)

Micro Economics and ii) Macro Economics. Economics is, therefore, rightly

considered as the study of allocation of scarce resources (in relation to unlimited

ends) and of determinants of income, output, employment and economic

growth.

NATURE OF ECONOMICS

Similar to definitions of economics, there are a number of controversial

issues related to its nature. Some economists believe economics as a science,

while others have a notion that economics is a social science. Let us now

understand the true nature of economics.

Economics as a science: Science is a branch of knowledge that defines the

relationship between cause and effect. As results observed in science are

measurable and based on facts, economics also endeavours to find a relationship

between cause and effect and provides measurable results. Similar to science, in

economics, emphasis is laid on collecting relevant information, which is

categorised and analysed to reach conclusions.

Economics as a social science: Economics is also considered as social science

as it deals with studying the behaviour of human beings and their relationships

in a society. This is because the exchange of goods takes place within the

society and among different societies to satisfy the needs and wants of people.

Economics is an art: Art is a branch of study that deals with expressing or

applying the creative skills and imagination of humans to perform a certain

activity. Similarly, economics also requires human imagination for the practical

application of scientific laws, principles, and theories to perform a particular

activity.

Scope of Economics
 Earlier, the scope of economics was limited to the utilisation of scarce

resources to meet needs and wants of people and society. However, over the

years, the scope of economics has been broadened to many areas,

Behavioral uses psychological theories relating to emotions and social context

economics
to help understand economic decision making and policy. Much of
the work in behavioral economics focuses on the biases that
individuals have that affect the decisions they make.
Comparative examines the ways alternative economic systems function. What are
economic
the advantages and disadvantages of different systems?
systems

Econometrics applies statistical techniques and data to economic problems in an

effort to test hypotheses and theories. Most schools require
economics majors to take at least one course in statistics or
econometrics.
Economic focuses on the problems of low-income countries. What can be done
development to promote development in these nations? Important concerns of
development for economists include population growth and
control, provision for basic needs, and strategies for international
trade.
Economic traces the development of the modern economy. What economic
history and political events and scientific advances caused the Industrial
Revolution? What explains the tremendous growth and progress of
post—World War II Japan? What caused the Great Depression of
the 1930s?
Environmental studies the potential failure of the market system to account fully
economics for the impacts of production and consumption on the environment
and on natural resource depletion. Have alternative public policies
and new economic institutions been effective in correcting these
potential failures?
Finance examines the ways in which households and firms actually pay for,
or finance, their purchases. It involves the study of capital markets
(including the stock and bond markets), futures and options, capital
budgeting, and asset valuation.
Health analyzes the health care system and its players: government,
economics
insurers, health care providers, and patients. It provides insight into
the demand for medical care, health insurance markets, cost-
controlling insurance plans (HMOs, PPOs, IPAs), government
health care programs (Medicare and Medicaid), variations in
medical practice, medical malpractice, competition versus regula-
tion, and national health care reform.
The history of which is grounded in philosophy, studies the development of
economic economic ideas and theories over time, from Adam Smith in the
thought,
eighteenth century to the works of economists such as Thomas
Malthus, Karl Marx, and John Maynard Keynes. Because economic
theory is constantly developing and changing, studying the history
of ideas helps give meaning to modern theory and puts it in
perspective.
Industrial looks carefully at the structure and performance of industries and
organization
firms within an economy. How do businesses compete? Who gains
and who loses?
International studies trade flows among countries and international financial
economics
institutions. What are the advantages and disadvantages for a
country that allows its citizens to buy and sell freely in world
markets? Why is the dollar strong or weak?
Labor deals with the factors that determine wage rates, employment, and
economics unemployment. How do people decide whether to work, how much
to work, and at what kind of job? How have the roles of unions and
management changed in recent years?
Law and analyzes the economic function of legal rules and institutions. How
economics does the law change the behavior of individuals and businesses? Do
different liability rules make accidents and injuries more or less
likely? What are the economic costs of crime?
Public examines the role of government in the economy. What are the
economics economic functions of government, and what should they be? How
should the government finance the services that it provides? What
kinds of government programs should confront the problems of
poverty, unemployment, and pollution? What problems does
government involvement create?
Urban and studies the spatial arrangement of economic activity. Why do we
regional have cities? Why are manufacturing firms locating farther and
economics
farther from the centre of urban areas?

Topic II- Scarcity and choice 1. “SCHAUM’S OUTLINE SERIES”-DOMINICK SALVATORE

2. Karl E. Case, Ray C. Fair,Sharon M. Oster-Micro
Dr. Resmi C.P Econmics

The main problem of an economy is of economizing scarce resources. In this

sense economics is the study of the allocation of scarce resources to alternative
ends. The problem of scarcity arises because human wants are numerous and
the means to satisfy them are limited. This leads to the problem of choice-of
selecting alternative uses to which scarce resources can be put.

Economic resources-Non Economic Resources

 Economic resources or inputs refer to the services of the various types of

labour, capital equipment, land (or natural resources), and
entrepreneurship. In every society these resources are not unlimited in
supply but are limited or scarce, they command a price.

 Non-economic resources such as air, which is unlimited in supply and

free.
Prof. Lionel Robbins states that “Economics is about making choices in the
presence of scarcity”

 Scarcity refers to the limited nature of society’s resources.

• Scarcity is a relative concept and it necessitates choices.
• Making decisions requires trading-off of one goal against another

For this the economic system must solve five basic problems. They are:

1. What is to be produced and in what quantities?

The first central problem of an economy is to decide what goods and services
are to be produced and in what quantities. This involves allocation of scarce
resources in relation to the composition of total output in the economy. Since
resources are scarce, the society has to decide about the goods to be
produced. Wheat, cloth, roads, television, power, so on. Once the nature of
goods to be produced is decided on the basis of priorities or preference of the
society. If the society gives priority to the production of more consumer goods
now, it will have less in the future. A higher priority on capital goods implies
less consumer goods now and more in the future.

2. How to produce these goods?

The next basic problem of an economy is to decide about the techniques or

methods to be used in order to produce the required goods. This problem is
primarily dependent upon the availability of resources within the economy. For
example: If land is available in abundance, it may have extensive cultivation. If
land is scarce, intensive methods of cultivation may be used. The technique to
be used also depends upon the type and quantity of goods to be produced. For
producing capital good and large outputs, complicated and expensive machines
and techniques are required. On the other hand, simple consumer goods and
small outputs require small and less expensive machines and comparatively
simple techniques. Further, it has to be decided what goods and services are to
be produced in the public sector and what goods and services in the private
sector. But in choosing between different methods of production, those
methods should be adopted which bring about an efficient allocation of
resources and increase the overall productivity in the economy.

3. For whom are the goods produced?

The third basic problem to be decided is the allocation of goods among the
members of the society. How should the consumer goods be distributed? How
should the capital goods be distributed? The allocation of consumer goods
among the house holds takes place on the basis of exchange. Whosoever
possesses the means to buy the goods may have it. A Rich person may have a
larger share of the goods he requires, and a poor person may have lesser
quantities of the goods he needs. The allocation of capital goods takes place
according to the needs of individual industries, whether they belong to the
public sector or the private sector. Since the supplies of certain consumer and
capital goods are short in relation to their demand, the government also
intervenes to allocate them equitably through price controls, rationing or quotas.

4. How efficiently are the resources being utilized?

This is one of the important basic problems of an economy because having

made the three earlier decisions; the society has to see whether the resources
it owns are being utilized fully or not. In case the resources of the economy
are being idle, it has to find out ways and means to utilize them fully. If the
idleness of resources, say man-power, land or capital, is due to their mal-
allocation, the society will have to adopt such monetary, fiscal or physical
measurement whereby this is corrected.

5. Is the economy growing?

The last and the most important problem is to find out whether the economy is
growing through time or is it stagnant. If the economy is stagnant, the
economy must produce larger quantities of consumer and capital goods. This is
possible through a higher rate of capital formation which consists of replacing
existing capital goods with new and more productive ones by adopting more
efficient production techniques or through innovation. Economic growth
enables the economy to have more of both the goods.

What to Produce?
In a free-enterprise economy (Capitalists), the “what to produce” problem is solved by
the price mechanism. Only those commodities for which consumers are willing to pay a
price per unit sufficiently high to cover at least the full cost of producing them will be
supplied by producers in the long run. By paying a higher price, consumers can
normally induce producers to increase the quantity of a commodity that they supply per
unit of time. On the other hand, a reduction in price will normally result in a reduction
in the quantity supplied.
(c) In a mixed-enterprise economy such as ours, the government (through taxes,
subsidies, etc.) modifies and replaces the operation of the price mechanism in its function
of determining what to produce. The fundamental problems are solved partly by price
mechanism and partly by the state.
(d) In a completely centralized economy (Command economy/socialists/planned
Economy), the dictator, or more likely a planning committee appointed by the dictator
or the party, determines what to produce. In these economies resources, factories and
properties are owned by the state.

How to Produce?
In a free-enterprise economy, the “how to produce” problem is solved by the price
mechanism. Because the price of a factor normally represents its relative scarcity, the
best technique to use in producing a good or service is the one that results in the least
dollar cost of production. If the price of a factor rises in relation to the price of others
used in the production of the good or service, producers will switch to a technique which
uses less of the more expensive factor in order to minimize their costs of production .
 The opposite occurs when the price of a factor falls in relation to the price of others.
(c) In a mixed-enterprise economy, the operation of the price mechanism in solving the
“how to produce” problem is modified and sometimes replaced by a government action.
(d) In a centralized economy, this problem is solved by a planning committee.

Whom to Produce?
In the absence of government regulation or control of the economy, the problem of “for
whom to produce” is also solved by the price mechanism. The economy will produce
those commodities that satisfy the wants of those people who have the money to pay for
them. The higher the income of an individual, the more the economy will be geared to
produce the commodities the consumers want (if they are also willing to pay for them).
(c) In the name of equity and fairness, governments usually modify the workings of the
price mechanism by taking from the rich (through taxation) and redistributing to the
poor (through subsidies and welfare payments). They also raise taxes in order to provide
for certain “public” goods, such as education, law and other, and defence.

Nature of the Firm

A firm is a business unit engaged in the task of producing and selling of goods
or services. It is an association of individuals who have organized themselves
for the purpose of turning inputs into output. The firm organizes the factors of
production to produce goods and services to fulfil the needs of the households.
Each firm lays down its own objectives which is fundamental to the existence of
a firm.
The Major objectives of the firm are:
 To achieve the Organizational Goal
 To maximize the Output
 To maximize the Sales
 To maximize the Profit of the Organization
 To maximize the Customer and Stakeholders Satisfaction
 To maximize Shareholder’s Return on Investment
 To maximize the Growth of the Organization
Firms are established to earn profit, to keep the shareholders happy. To
increase their market share, they try to maximize their sales. In the present
business world firms try to produce goods and services without harming the
environment. Firms are not always able to operate at a profit. They may be
facing the operating loss also. Economists believe that firms maximize their
long run rather than their short run profit. So managers have to make enough
profit to satisfy the demands of their shareholders and to maximize their wealth
through the company.
Three varieties of firms (Profit earning firms)

Proprietorship: which is a firm owned by a single individual (the proprietor)

or perhaps by a family. Debts accrued by the proprietorship are the personal
responsibility of the proprietor.
Partnerships
Firms owned by several individuals who share profits as well as liabilities of
the firm according to a specified formula that varies by the relative
contribution and potential cost of each partner in the firm. Legal and
accounting firms are often organized as partnerships. Thus, if a partner in a
law firm steals a client’s money and disappears, the other partners may be
responsible for absorbing some portion of the loss.
Corporation
It is treated legally as a single entity owned by shareholders. Like a person, a
corporation can incur debt and is therefore responsible for repayment.
Hence, when the energy trader company Enron collapsed, the Enron
shareholders lost the value of their stock; however, they were not
responsible for repaying the debt that the corporation had incurred.
Moreover, company executives are also not financially responsible for debts
 of the corporation, provided they act prudentially. Corporations who shield
company executives and shareholders from fines and punishments are said
to offer “limited liability.

Non-profit firm

Non-profit firm is prohibited from distributing a profit to its owners. The

major advantage of non-profit firms is their tax-free status. Eg: Religious
organizations, academic associations, environmental groups, most zoos,
industry associations, government hospitals, credit unions (a type of bank),
labour unions, and charities are all organized as non-profit corporations.

Entrepreneurship
In the words of Stevenson and others, “Entrepreneurship is the process of
creating value by bringing together a unique package of resources to exploit an
opportunity.” According to A.H. Cole, “Entrepreneurship is the purposeful
activities of an individual or a group of associated individuals undertaken to
initiate, maintain or organize a profit oriented business unit for the production
or distribution of economic goods and services”. All activities undertaken by an
entrepreneur to bring a business unit into existence are collectively known as
entrepreneurship. It is the process of changing ideas into commercial
opportunities and creating values. In short, entrepreneurship is the process of
creating a business enterprise.

Features of entrepreneurship are summarized as follows:

1) It is a function of innovation.

2) It is a function of leadership.

3) It is an organization building function.

4) It is a function of high achievement.

5) It involves creation and operation of an enterprise.

6) It is concerned with unique combinations of resources that make existing

methods or products obsolete.

7) It is concerned with employing, managing, and developing the factors of

production.

8) It is a process of creating value for customers by exploiting untapped

opportunities.

9) It is a strong and positive orientation towards growth in sales, income, assets,

and employment.

Entrepreneurship can be defined by describing what entrepreneurs do. For

example: "Entrepreneurs use personal initiative, and engage in calculated risk-
taking, to create new business ventures by raising resources to apply innovative
new ideas that solve problems, meet challenges, or satisfy the needs of a clearly
defined market."

"Entrepreneurship involves bringing about change to achieve some benefit. This

benefit may be financial but it also involves the satisfaction of knowing you
have changed something for the better”.

"Entrepreneurship is essentially the act of creation requiring the ability to

recognize an opportunity, shape a goal, and take advantage of a situation.
Entrepreneurs plan, persuade, raise resources, and give birth to new ventures."

The nature of profit

Profit is the most important motive that governs the behaviour of business
firms. The profit analysis allows us to predict the behaviours of business firms
in the real world. Profit is one of the main data indicators to assess economic
firm quite well. It can be regarded as a proper indicator for decision-making.
Concept of profit is of applicable concepts in an economic unit. In simple sense
profit is the difference between total revenue and total cost of firm.
Application of profit for specific objectives as measurement criterion of
management efficiency, prediction criterion of future performance of the
enterprise or dividends in the future, measurement criterion of success rate of
the enterprise, basis of determining tax, basis of determining regulations for the
enterprise in order to supply public interests and finally evaluation criterion and
judgment about how to allocate resources by economists for profits which can
be plotted (Clyde, 2007).
Profit is an excess of revenues over associated expenses for an activity over a
period of time. Terms with similar meanings include ‘earnings’, ‘income’, and
‘margin’.
Lord Keynes remarked that ‘Profit is the engine that drives the business
enterprise’
Profits perform two important primary roles in such an economy.
First, profits serve as a signal to change the rate of output or for the firms to
enter or leave the industry.

Second, profits play a critical role in providing incentive to introduce

innovations and increase productive efficiency and take risks.

Profit differs from the return in three respects namely:

a. Profit is a residual income, while return is a total revenue
b. Profits may be negative, whereas returns, such as wages and interest are
always positive
c. Profits have greater fluctuations than returns

Accounting Profit

In accounting sense, profit is surplus of revenue over and above all paid- out
costs, including both manufacturing and overhead expenses.
Accounting profit = total revenue – explicit costs

Explicit costs are payments firms make to purchase resources (labor, land, etc.)

Economic profit (economic or pure profit)

The concept of ‘economic profit’ differs from that of ‘accounting profit’.

Economic profit takes into account the implicit or imputed costs. The implicit
cost is opportunity cost. Opportunity cost is defined as the payment that would
be ‘necessary to draw forth the factors of production from their most
remunerative alternative employment. Economic profit will always be lesser
when compared to accounting profit.

It should also be noted that the economic or pure profit makes provision
also for:
(a) Insurable risks,

(b) Depreciation, and

(c) Necessary minimum payment to shareholders to prevent them from

withdrawing their capital.

Pure profit may thus be defined as ‘a residual left after all contractual costs have
been met, including the transfer costs of management, insurable risks,
depreciation and payments to shareholders sufficient to maintain investment, at
its current level.

Thus:
Pure profit = Total revenue – (explicit costs + implicit costs)
Pure profit so defined may not be necessarily positive for a single firm in a
single year- it may be even negative, since it may not be possible to decide
beforehand the best way of using the resources. Besides, in economics, pure
profit is considered to be a short-term phenomenon-it does not exist in the long
run, especially under perfectly competitive conditions.

Opportunity cost

Alternatively, opportunity cost is the income foregone which a businessman

could expect from the second best alternative use of his resources. For example,
if an entrepreneur uses his capital in his own business, he foregoes interest
which he might earn by purchasing debentures of other companies or by
depositing his money with joint stock companies for a period.

Furthermore, if an entrepreneur uses his labour in his own business, he foregoes

his income (salary) which he might earn by working as a manager in another
firm. Similarly, by using productive assets (land and building) in his own
business, he sacrifices his market rent. These foregone incomes-interest, salary
and rent-are called opportunity cost or transfer costs. Accounting profit does not
take into account the opportunity cost.