Economic analysis for business

Definition

Economics is a science which studies the economic activities of man and of the community.

Economics is the social science that analyzes the production, distribution, and consumption of
goods and services.

According to Alfred Marshall, economic is defined as “the economic is study of mankind in the
ordinary business of life; it deals with man’s day to days life of his work, of his income and of
his expenditure”.

How economic problem arise?

 Man has unlimited wants or ends.

 The means to satisfy human wants are limited.
 Resources have alternative uses.
 We have to make a choice.

Scope of the economics

 Thus economics is not concerned so much with the analysis of the consumption,
production exchange and distribution of wealth as with a special aspect of human
behavior-that of allocating scarce means among competing ends.
  The subject matter of economics includes the daily activities of the household, of the
competitive business world and the administration of public resources in order to solve
the problem of scarcity of resources.
 The subject matter of economics includes the study of the problems of consumption,
production, exchange and distribution of wealth as well as the determination of the values
of goods, and services, the volume of employment and the determinants of economic
growth.
 It includes the study of the causes of poverty unemployment, under development,
inflation etc. and steps for their removal.

Fundamental problems of economics

 What to produce?
 How to produce?
 To whom to produce?

What to produce?

Every economy has only limited resources and cannot produce all goods accordingly it has to
choose between different goods and services.

 What goods and services should be produces

 What verities of each commodity
 How much of each verity of a commodity should be produced

How to produce?

In an economy has decided to produced certain goods and services, the economy has then to
decide how these goods and services will be produced.

 The extend of resources to the economy in term of natural resources, labor and capital.
 The quality or efficiency of the factors of production.
 The nature of technology available to the community.

Whom to produce?

The goods and services are produced for the people and more specifically for those who have
the necessary means to pry for them. “One cannot have everything one requires”. If that were
possible there will be no economic problems.
Functions of economy

 Production of goods and services.

 Consumption of goods and services.
 Growth

Types of economy

 Simple and complex economy

 Developed, underdeveloped and developing economy
 Capitalist socialist and mixed economy

Themes of economics

It exposes the behavior of the financial markets including interest rate and stock prices
It examines, the reason why some peoples or countries have high incomes while others
are poor and suggest way that the incomes of the poor can he raised without harming the
economy.
Studies business cycles the ups and downs of unemployment and inflation along with
policies to moderate them.
Studies international trade and finance and the impacts of globalization.
Looks at growth in developing countries and proposes way to encourage the efficient use
of resources
Asks how government policies can be used to pursue important goals such as rapid
economy growth, efficient use of resources, full employment, and price stability and a
fair distribution of income.

Scarcity and efficiency

Scarcity

Economics is the study of how societies use scares resources to produce valuable
commodities and distribute them with different peoples.

In this definition are two key ideas in economics

 Those goods are scare

 That society must use in resources efficiently

Scarcity- there is no demand. Consider a world without scarcity, if infinite quantities of every
goods world be produced or if human desire were fully satisfied.

People would not worry about striating out there limited incomes they could have everything
they wanted.
 Nobody is takes care of the government taxes, pollution, cost of laborer and health care.
Nobody is concerned about the distribution of income among different people or classes.

Suppose all the goods would he free like sand in the desert or sea water at the beach. All
prices would be zero and marketers would be unnecessary economics would no longer be useful
subjects.

Ours is a world of scarcity, full of economic goods, a situation of scarcity is one in which
goods are limited relation to desire

Efficiency

The given unlimited wants, it is important that an economy make the best use of its limited
resources that bring us to the critical notion of efficiency.

The efficiency denotes the most effecting use of the society resource in satisfying people need
and wants.

In economics we say that an economy is producing efficiently when it cannot make any one
economically better off without making someone else worse off.

The essence of economics is to acknowledge the reality of scarcity and then how to organize.
Society in a way which produce. The most efficient use of resources.

Society’s capabilities.

Each economy has a stock of limited resources like labor technical knowledge, factories, tools
and land energy. In deciding what and how things should be produce the economy is in reality
deciding how to allocate its resources among the thousands of different possible commodities
and services.

How many resources to allocate the productions,

Ex:- food items and factories

Faced with the endurable facts that goods as scare relative to wants and economy must decide
how to cope with limited resources.

Input

Inputs are commodities or services that are used to produce goods and services.

Output

Output is the various useful goods or services that result from the production process and are
either consumed or employed in further productions.
According to these factors of productions

 Land
 Labour
 Capital

Land

Land is the natural resources our productive process. Ex:- houses, factories, roads, sand, copper,
iron.

Labour

It consist of the human time spend in production Ex:- working in auto mobiles, factories, drilling
the land.

Capita

The money and other resources help the producer to improve the business. It is also task of the
economic development.

Production possibility frontier (PPF)

A production-possibility frontier (PPF), sometimes called a production-possibility curve or

product transformation curve, is a graph that shows the different rates of production of two
goods and/or services that an economy can produce efficiently during a specified period of time
with a limited quantity of productive resources, or factors of production. The PPF shows the
maximum amount of one commodity that can be obtained for any specified production level of
the other commodity (or composite of all other commodities), given the society's technology and
the amount of factors of production available.

An economy has a certain population and some millions of workers of various grades; it has
mastered certain techniques of production; it has certain resources in the form of land, water and
other natural resources. It has a certain number of inputs. The society has to decide how these
resources can be utilized to produce the various possible commodities. The society has to
discover its production possibility curve. The production possibility curve shows the maximum
output of any one commodity that the economy can produced and the resources utilized.

Concept

The production possibility curve tells us what assortment of goods and services the economy can
produce with the resources and techniques at its disposal. The concept of the production
possibility curve can be studied through table and a diagram.
Production possibilities is an analysis of the alternative combinations of two goods that an economy can
produce with existing resources and technology in a given time period. This analysis is often represented
by a convex curve.

A standard production possibilities curve for a hypothetical economy is presented here. This
particular production possibilities curve illustrates the alternative combinations of two goods--
crab puffs and storage sheds--that can be produced by the economy.

The Set Up

According to the assumptions of production possibilities analysis, the economy is using all resources with
given technology to efficiently produce two goods--crab puffs and storage sheds. Crab puffs are delicious
cocktail appetizers which have the obvious use of being eaten by hungry people, usually at parties.
Storage sheds are small buildings used to store garden implements, lawn mowers, and bicycles.

This curve presents the alternative combinations of crab puffs and storage sheds that the
economy can produce. Production is technically efficient, using all existing resources, given
existing technology. The vertical axis measures the production of crab puffs and the horizontal
axis measures the production of storage sheds.
The production possibilities curve should be compared with the production possibilities
schedule, such as the one presented to the left. A schedule presents a limited, discrete number of
production alternatives in the form of a table. The production possibilities curve, in contrast,
presents an infinite number of production alternatives that reside on the boundary of the frontier.
The production possibilities schedule is commonly used as a starting point in the derivation of
the production possibilities curve.

 The curve in the diagram marks the production possibility frontier and all points on the
curve represent production possibility.
 The points inside the curve are attainable combinations and those outside are unattainable
combination.
 Any point inside the curve represents and under-utilization of resources or under-
employment.
 A faller utilization will shift the curve outwards.
 Increase in the resources at the disposal of the firm will take it to higher production
possibility curve.

Micro economics

It refers to the branch of economics which studies economic problem of an individual person of
an individual firm.

External environment

 Suppliers of input(land, labour and material)

 Market intermediaries (agent, brokers, retailers, wholesaler, market, merchant, banking)

 Competitors
 Customers
Macro economics

It is the study of economic problem faced by a group of individual or of the firms taken together.
It is a study of aggregate it depends on national income, expenses, scarcity of income etc.

External environment

Economic environment (production, consumption, distribution)

Political and legal environment (foreign exchange management act (FEMA), foreign exchange
regulating act (FERA))

Social environment (upper level class, middle level, low level)

National environment (water, land, labour)

Demographic environment (age, income, gender, income, education, place of living)

Technological environment

Internal environment

Mission and objectives

Human resources

Distinction between micro economics and macro economics

1. Micro economics is concerned mainly with small segments of the total economy-
individual consumer and producer, groups of consumers and producers which are known
as markets or industries.

Macro economics is concerned with large segments of the total economy-total

employment, total consumption total investment and national product.

2. Micro economics is concerned with the determination prices of various commodities and
factors of production an allocation of resources among competing uses.

Macro economics focuses on the level of utilization of resources, particularly the level of
employment and the general level of process.

3. Micro economic analysis presents the microscopic view of the economy; the macro
economic analysis furnishes us with the macro scopic view of the economy.
4. Micro economics deals with economic affairs “in the small” it concerns with the
individual dimensions of economic life.
 Macro economics deals with economic affairs “in the small”, it concerns with the
individual dimensions of economic life.

5. Micro economics uses the technique of partial equilibrium analysis to study the process
of a particular commodity or service in any given market on the assumption of ceteris
paribus.

Macro economics, on the other hand, uses the technique of quasi-general equilibrium
analysis to study determination of the aggregate prices and output levels and fluctuations in these
aggregate magnitudes.

Role of government on the macro economy

In modern macroeconomics, the intervention by the government to influence economic activity

is well recognized. It is believed that instability is inherent in a free-market economy and further
that there is no any self-correcting mechanism to ensure stability at full employment level and
sustained economic growth. There are three types of economic policy that as used by the
government to influence the working of macro economy.

Fiscal policy
Monetary policy
Growth policies

Fiscal policy

Government spending policies that influence macroeconomic conditions. These policies affect
tax rates, interest rates and government spending, in an effort to control the economy.

The three possible stances of fiscal policy are neutral, expansionary and contractionary. The
simplest definitions of these stances are as follows:

A neutral stance of fiscal policy implies a balanced economy. this results in a large
tax revenue. Government spending is fully funded by tax revenue and overall the
budget outcome has a neutral effect on the level of economic activity.
An expansionary stance of fiscal policy involves government spending exceeding tax
revenue.
A contractionary fiscal policy occurs when government spending is lower than tax
revenue.

Methods of funding

Governments spend money on a wide variety of things, from the military and police to services
like education and healthcare, as well as transfer payments such as welfare benefits. This
expenditure can be funded in a number of different ways:
 Taxation
Seignior age, the benefit from printing money
Borrowing money from the population or from abroad
Consumption of fiscal reserves.
Sale of fixed assets (e.g., land).

All of these except taxation are forms of deficit financing.

Monetary policy

Monetary policy is the process by which the monetary authority of a country controls the supply
of money, often targeting a rate of interest to attain a set of objectives oriented towards the
growth and stability of the economy.

Monetary policy rests on the relationship between the rates of interest in an economy, that is the
price at which money can be borrowed, and the total supply of money. Monetary policy uses a
variety of tools to control one or both of these, to influence outcomes like economic growth,
inflation, exchange rates with other currencies and unemployment. Where currency is under a
monopoly of issuance, or where there is a regulated system of issuing currency through banks
which are tied to a central bank, the monetary authority has the ability to alter the money supply
and thus influence the interest rate (to achieve policy goals). The beginning of monetary policy
as such comes from the late 19th century, where it was used to maintain the gold standard.

Monetary decisions today take into account a wider range of factors, such as:

short term interest rates;

long term interest rates;
velocity of money through the economy;
exchange rates;
credit quality;
bonds and equities (corporate ownership and debt);
government versus private sector spending/savings;
international capital flows of money on large scales;
Financial derivatives such as options, swaps, futures contracts, etc.
 Monetary Policy: Target Market Variable: Long Term Objective:
Interest rate on overnight
Inflation Targeting A given rate of change in the CPI
debt
Interest rate on overnight
Price Level Targeting A specific CPI number
debt
The growth in money
Monetary Aggregates A given rate of change in the CPI
supply
The spot price of the
Fixed Exchange Rate The spot price of the currency
currency
Low inflation as measured by the gold
Gold Standard The spot price of gold
price
Mixed Policy Usually interest rates Usually unemployment + CPI change

Growth policies

General - Economic Growth

To help the economy grow, you will need, as Chancellor, to maintain the level of demand in the
economy. You can do this by using your fiscal policy and monetary policy to influence the level
of demand. If you find that the economy is growing too slowly then you can try to boost demand.
To do this you need to encourage spending and so you could either cut taxes or cut interest rates.
Either of these will help give people more money to spend, therefore boosting demand.
Alternatively, you could as a government spends more yourself - increase the level of
government expenditure. These policies are all called reflationary policies.

To increase growth you may therefore want to:

Cut taxes (direct taxes or indirect taxes)

Cut interest rates
Increase the level of government expenditure

However, tread carefully as you do this. Watch particularly the level of inflation, as if demand
raises too much, firms may not be able to increase production quickly enough and prices may
rise instead of output. If this happens, you may need to use deflationary policies. These would
simply be the reverse of the above:

Increase taxes
Increase interest rates
Cut the level of government expenditure

Externality
An externality arises when a pension engages in all activity that influences the well-being of a
bystander and yet neither pays nor receives any compensation for that effect. If that impact on
the bystander is adverse it is called negative externality; if it is beneficial, it is called a positive
externality.

Negative

A negative externality is an action of a product on consumers that imposes a negative side effect
on a third party; (aka- Social Cost). Many negative externalities (also called "external costs" or
"external diseconomies") are related to the environmental consequences of production and use.
The article on environmental economics also addresses externalities and how they may be
addressed in the context of environmental issues.

 Systemic risk describes the risks to the overall economy arising from the risks which the
banking system takes. That the private costs of banking failure may be smaller than the
social costs justifies banking regulations, although regulations could create a moral
hazard.[4]

 Anthropogenic climate change is attributed to greenhouse gas emissions from burning oil,
gas, and coal. The Stern Review on the Economics Of Climate Change says "Climate
change presents a unique challenge for economics: it is the greatest example of market
failure we have ever seen."[5]

 Water pollution by industries that adds poisons to the water, which harm plants, animals,
and humans.

 Industrial farm animal production, on the rise in the 20th century, resulted in farms that
were easier to run, with fewer and often less-highly-skilled employees, and a greater
output of uniform animal products. However, the externalities with these farms include
"contributing to the increase in the pool of antibiotic-resistant bacteria because of the
overuse of antibiotics; air quality problems; the contamination of rivers, streams, and
 coastal waters with concentrated animal waste; animal welfare problems, mainly as a
result of the extremely close quarters in which the animals are housed." [6][7]

 The harvesting by one fishing company in the ocean depletes the stock of available fish
for the other companies and overfishing may be the result. This is an example of a
common property resource, sometimes referred to as the Tragedy of the commons.

 When car owners use roads, they impose congestion costs on all other users.

 A business may purposely underfund one part of their business, such as their pension
funds, in order to push the costs onto someone else, creating an externality. Here, the
"cost" is that of providing minimum social welfare or retirement income; economists
more frequently attribute this problem to the category of moral hazards.

 Consumption by one consumer causes prices to rise and therefore makes other consumers
worse off, perhaps by reducing their consumption. These effects are sometimes called
"pecuniary externalities" and are distinguished from "real externalities" or "technological
externalities". Pecuniary externalities appear to be externalities, but occur within the
market mechanism and are not a source of market failure or inefficiency.[8]

 The consumption of alcohol by bar-goers in some cases leads to drinking and driving
accidents which injure or kill pedestrians and other drivers.

 Shared costs of declining health and vitality caused by smoking and/or alcohol abuse.
Here, the "cost" is that of providing minimum social welfare. Economists more
frequently attribute this problem to the category of moral hazards, the prospect that a
party insulated from risk may behave differently from the way they would if they were
fully exposed to the risk. For example, an individual with insurance against automobile
theft may be less vigilant about locking his car, because the negative consequences of
automobile theft are (partially) borne by the insurance company.

 The cost of storing nuclear waste from nuclear plants for more than 1,000 years (over
100,000 for some types of nuclear waste) is included in the cost of the electricity the
plant produces, in the form of a fee paid to the government and held in the Nuclear Waste
Fund. Conversely, the costs of managing the long term risks of disposal of chemicals,
which may remain permanently hazardous, is not commonly internalized in prices. The
USEPA regulates chemicals for periods ranging from 100 years to a maximum of 10,000
years, without respect to potential long-term hazard.

Positive

Examples of positive externalities (beneficial externality, external benefit, external economy, or

Merit goods) include:
 A beekeeper keeps the bees for their honey. A side effect or externality associated with
his activity is the pollination of surrounding crops by the bees. The value generated by
the pollination may be more important than the value of the harvested honey.

 An individual planting an attractive garden in front of his or her house may provide
benefits to others living in the area, and even financial benefits in the form of increased
property values for all property owners.

 A public organization that coordinates the control of an infectious disease preventing

others in society from getting sick.

 An individual buying a product that is interconnected in a network (e.g., a video

cellphone) will increase the usefulness of such phones to other people who have a video
cellphone. When each new user of a product increases the value of the same product
owned by others, the phenomenon is called a network externality or a network effect.
Network externalities often have "tipping points" where, suddenly, the product reaches
general acceptance and near-universal usage, a phenomenon which can be seen in the
near universal take-up of cellphones in some Scandinavian countries.

 Knowledge spillover of inventions and information - once an invention (or most other
forms of practical information) is discovered or made more easily accessible, others
benefit by exploiting the invention or information. Copyright and intellectual property
law are mechanisms to allow the inventor or creator to benefit from a temporary, state-
protected monopoly in return for "sharing" the information through publication or other
means.

 Sometimes the better part of a benefit from a good comes from having the option to buy
something rather than actually having to buy it. A private fire department that only
charged people that had a fire, would arguably provide a positive externality at the
expense of an unlucky few. Some form of insurance could be a solution in such cases, as
long as people can accurately evaluate the benefit they have from the option.
 A family member buying a movie or game will provide a positive externality to the rest
of the family, who can then watch the movie or play the game.

 An organization that purchases a large screen and projector will give benefits to those
who may use the screen for various purposes.

 Home ownership creates a positive externality in that homeowners are more likely than
renters to become actively involved in the local community. For this reason, in the US
interest paid on a home mortgage is an available deduction from the income tax.[9]

 Education creates a positive externality because more educated people are less likely to
engage in violent crime, which makes everyone in the community, even people who are
not well educated, better off.