1

Economics and the

Business Environment
 The Firm as a Legal Entity
• The sole proprietor
– limited scope for expansion
– unlimited liability
• The partnership
• Companies
– limited liability
– public limited companies (plc)
• public issues of shares
• shares traded on the Stock Exchange
– private limited companies
– consortia
– public corporations
The Internal Organisation of the Firm

• U-form
 U-form business organisation

C h ie f e x e c u t iv e

P r o d u c t io n F in a n c e S a le s P u r c h a s in g
The Internal Organisation of the Firm

• U-form
– advantages
• direct control by central executive of the firm
• clear goals

– problems of large U-form firms

• co-ordination and communication costs
• distorted information
• decline in organisational efficiency
The Internal Organisation of the Firm

• M-form
 M-form business organisation

H e a d O f f ic e

D iv is io n 1 D iv is io n 2 D iv is io n 3

P r o d u c t io n F in a n c e S a le s P u r c h a s in g
The Internal Organisation of the Firm

• M-form
– advantages
• reduced length of information flows
• enhanced level of control
– problems
• bureaucracy and communication problems
• conflicts between divisions
• The flat organisation
• The holding company
– role of parent company and subsidiaries
 The Aims of the Firm

• Goals of the firm

• The traditional theory of the firm

• Alternative theories

– the divorce of ownership from control

– the development of the joint-stock company

– managerial objectives
 The Aims of the Firm

• The principal / agent relationship

– the principal – agent problem
– asymmetric information
– dealing with imperfect information
• monitoring
• incentives

• The goal of staying in business

– the willingness of firms to take risks
– problems of being over cautious
The External Business Environment

• PEST analysis
– Political / legal factors
– Economic factors
• the microeconomic environment
• the macroeconomic environment
– Social / cultural factors
– Technological factors
• Using PEST analysis
– relations between the four sets of factors
– importance of the economic factors
The External Business Environment

• Classifying industries
– Classifying production
• primary production

• secondary production

• tertiary production
 Output of industrial sectors
(as % of GDP)

Primary

2.8% Secondary

42.3%
54.9%

Tertiary

1974
 Output of industrial sectors
(as % of GDP)

Primary Primary

2.8% 5.8% Secondary

Secondary

23.3%
42.3%
54.9%
70.9%

Tertiary Tertiary

1974 2002
 Employment by industrial sector
(% of total employees)

Primary

3.4% Secondary

41.9%
54.7%

Tertiary

1974
 Employment by industrial sector
(% of total employees)

Primary Primary

3.4% Secondary 1.8% Secondary

18.4%

41.9%
54.7%
79.8%

Tertiary Tertiary

1974 2002
The External Business Environment
• Classifying firms into industries
– nature of an industry
– industrial sectors
– why classify firms into industrial sectors?
• helps in analysing trends
• identifying specific needs
• helps to understand relationships between firms
• Standard industrial classification
– nature of the system of classification
– sections, subsections
• divisions, groups and classes
Standard industrial classification: 1992
The External Business Environment

• Changes in the structure of UK economy

– expanding and contracting sections
• by output

• by employment
The Determinants of Business Performance

• Structure  conduct  performance

– relationship between business structure and
business conduct (behaviour)
• competitive markets and competitive behaviour
• limited competition and collusion

– relationship between business conduct and

business performance
• indicators for measuring performance
• profitability, market share, growth, etc.
The Economist's Approach to Business

• Tackling the problem of scarcity

– meaning of scarcity
– production and consumption
• role of the business economist
– study of consumer behaviour
– study of firms

– factors of production
• labour
• land and raw materials
• capital
The Economist's Approach to Business

• Demand and supply

– actual and potential demand and supply
– the role of firms in satisfying demand
– business economists’ study of the supply
process
• Macroeconomics and microeconomics
– macroeconomics
• the balancing of aggregate demand and supply
– microeconomics
• the balancing of the demand and supply for
particular products
The Economist's Approach to Business

• Microeconomics and choice

– What?
– How?
– For whom?
• Choice and opportunity cost
– the meaning of opportunity cost
– rational choices
– marginal costs and benefits
• Microeconomic choices and the firm