Fall 21 Business Economics Week 1

Sloman Economics for Business

Chapter Summaries and notes
Chapter 1: The business environment and business economics
Business Issues (questions)
1. What do business economists do?
2. What is meant by the ‘business environment’?
3. How are businesses influenced by their national and global market environment?
4. How are different types of industry classified in the official statistics?
5. What things influence a firm’s behavior and performance?
What is business economics? What will you study in this text?
No country is an island unto itself. There are events and changes in the world that affect businesses all
over. Brexit may have implications for multinational firms operating in South Asia.
Business economists examine firms. Their environment, their decisions.
Firms are different from each other in many respects. But all firms have one characteristic in common:
they transform inputs into outputs.
Three components of firm decision making: The external influence on the firm (the business
environment), internal decision of the firm; the external effects of business decision making.

What do business economists do?

Three things: Description; Analysis; and Recommendation.

Section 1.1. The business environment

Political, economic, social/cultural and technological factors.
Economic factors are further divided into microeconomic factors and macroeconomic factors.
Three further factors can be included: environmental, legal factors, and ethical factors.
Pause for thought: Under which heading of a PEST or STEEPLE analysis would you locate training and
education? What about a tax on plastic bottles?
Box 1.1 A LIDL success story (Read yourself)
Box 1.2 The biotechnology industry (read yourself)

Section 1.2: The structure of industry

Classifiying production:

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1. Primary
2. Secondary
3. Tertiary
Trends in production over time. Deindustrialization.
Fourth division of production: Quaternary sector or knowledge based part of the economy.
Classifying firms into industries
International Standard industrial classification (ISIC)
Class Discussion: Changes in the structure of the Pakistan Economy:

Another classification used by financial markets particularly stock exchanges is Industry Classification
Benchmark https://www.ftserussell.com/data/industry-classification-benchmark-icb.

BOX 1.3
KSE adopts industry benchmark system
The Karachi Stock Exchange has adopted the ''Industry Classification Benchmark'' (ICB), a
jointly developed classification system launched by FTSE Group and Dow Jones Indexes, to
classify and analyse specific sectors of Pakistan''s stock market, using internationally
accepted standards.

According to a press release issued here on Friday, the ''Industry Classification Benchmark''
provides a comprehensive system with four levels of granularity - industry (10), supersectors
(19), sectors (41) and subsectors (114) and facilitates cross-border company comparison.

The ICB will replace KSE''s own classification system after a transition period in which KSE
will run both classification systems parallel to allow a smooth adoption process. The ICB is

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the standard used by major stock exchanges, data distributors, index providers, buy-side and
sell-side institutions, custodians and media organisations globally.

KSE joins other exchanges and global financial institutions which have integrated ICB into
their research, trading and investment workflows. These include Nasdaq, NYSE/Euronext, the
London Stock Exchange, the Swiss Exchange, Aegon, the International Monetary Fund and the
World Economic Forum, as also media outlets including The Wall Street Journal, the Financial
Times, CNBC and Dow Jones Newswires.

KSE Managing Director Adnan Afridi said on the occasion: "The KSE is extremely pleased to
adopt ICB methodology for classification of its listed companies. The growing interest of
international investors in Pakistan''s capital markets is both a reflection of the reforms
undertaken at the KSE and a requirement that we adopt global standard/best practices so
that all investors can make accurate/informed comparisons between listed securities at the
KSE and other exchanges.

The adoption of ICB will also assist in our efforts to introduce tradable sector indices as part
of our overall strategy to introduce derivative and structured products at the KSE." James
Cemprola, Managing Director of ICB, said: "By adopting well established global standards like
ICB, upcoming financial markets can strengthen their transparency, comparability and hence
draw the attention of international market participants.
From Business Recorder http://fp.brecorder.com/2009/09/20090912960322/
September 12, 2009.

Pause for thought: Given some examples of things we might learn about the likely behavior and
performance of business in an industry by knowing something about the industrial concentration of that
industry.

Section 1.3. The determinants of business performance

Structure-conduct-performance
Market structure influence firm behavior which in turn influence firm performance
Internal aims and organization: firm’s performance also depend on the internal aims and structure:
1. Internal structure
2. Information
3. The competence of management
4. The quality of workforce
5. Systems

Questions and problems

1. Go to the website of Business Recorder and search through the contents to find some weaknesses
of the ISIC scheme for Pakistan. (write no more than 500 words).

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2. A multi-national fast food chain is going to expand into Pakistani market. Identify some of the
cultural factors that you think company should consider in advertising its products.
3. Besides profit and sales, what other objectives might managers have and how would you expect
this to affect the price charged and output sold.
Chapter 2: Economics and the world of business
Business issues/questions
1. How do economists set about analyzing business decision making?
2. What are the core economic concepts that are necessary to understand the economic choices that
business have to make, such as what to produce, what inputs and what technology to use, where
to locate their production and how best to compete with other firms?
3. What is meant by opportunity cost? How is it relevant when people make economic choices?
4. What is the difference between microeconomics and macroeconomics?

Section 2.1 What do economists study?

Tackling the problem of scarcity
All economic agents face this problem: wants are more than resources. Relative to resources wants are
unlimited.
Firm’s perspective: production needs inputs, and inputs are limited.
Inputs: Labor, land and raw material, capital, and managerial talent.
Pause for thought: If we would all like more money, why doesn’t the government or central bank print a
lot more? Could this solve the problem of scarcity at a stroke?
Two key elements in satisfying wants are consumption and production. They correspond to demand and
supply when seen through the lens of market.
Demand and supply
Dividing up the subject: microeconomics vs macroeconomics

Section 2.2 Business economics: microeconomic choices

Microeconomics and choice
What, how, for whom, to produce goods and services? Issue at both individual and societal level.
Choice and opportunity cost
Rational Choices
Pause for thought: Assume that you are looking for a job and are offered two. One is more pleasant to do,
by pays less. How would you make a rational choice between the two jobs?
Marginal costs and benefits
Box 2.1: What, how, and for whom

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Microeconomic choices and the firm

Box 2.2 The opportunity costs of studying economics

Section 2.3: Business economics: The macroeconomic environment

1. Inflation
2. Balance of trade deficits
3. Recession
4. Unemployment
Macroeconomic policy and its effects on business
The circular flow of income
Box 2.3 Looking at macroeconomic data
Chapter 3: Business organizations
Business issues/questions
1. How are businesses organized and structured?
2. What are the aims of business?
3. Will owners, managers, and other employees necessarily have the same aim? How can those
working in the firm be persuaded to achieve the objectives of their employers?
4. What are the different legal categories of business and how do different legal forms suit different
forms of business?
5. How do businesses differ in their internal organization? What are the relative merits of alternative
forms of organization?

Section 3.1 The nature of firms

Complex production
The benefits of organizing production within firms
Idea of transaction cost
Factors determining transactions cost:
1. The uncertainty in framing contract;
2. The complexity of contracts
3. Monitoring contracts
4. Enforcing contracts
Goals of the firm
The divorce of ownership from control
Pause for thought: Make a list of six possible aims that a manager of a high street department store might
have. Identify some conflicts that might arise between these aims.
The principal-agent relationship
Some ways principles can reconcile the asymmetry of information

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1. Monitoring the performance for the agent

2. Establishing a series of incentives to ensure that agents act in the principal’s best interest.
Pause for thought: Identify a situation, where you as a consumer, are in a principle-agent relationship with
a supplier. How can you minimize the problem of asymmetric information in this relationship?
Staying in business
Pause for thought: Why is a firm facing little competition from rivals likely to have higher profits, but
also higher costs, than a firm facing intense competition?
Box 3.1: Exploiting asymmetric information

Section 3.2 The firm as a legal entity

1. The sole proprietor
2. The partnership
3. Companies
4. Consortia of firms
5. Co-operatives
6. Public corporations

Section 3.3 The internal organization of the firm

Pause for thought: Consider in what ways, technology might influence the organizational structure of
a business.
1. U(unitary) form
2. M (multi-divisional) form
3. The flat organization
4. The holding company
5. Other structures used by multinational companies
Review questions:
What problems are multinational corporations, as opposed to domestic firms, likely to have in respect
to organizing their business activity? What alternative organizational models might multinational
adopt? To what extent do they overcome the problems you have identified.
If a business is thinking of reorganization, why and in what ways might new technology be an
important factor in such considerations?

Key Ideas Week 1:

1. The behavior and performance of firms is affected by the business environment.
2. Scarcity is the excess of human wants over what can actually be produced. Market (or free
interaction of buyers and sellers through a competitive market determine the scarcity value of a
good). The price of a good is its scarcity value. Another value is the added value which is the
amount of resources gone into a thing. When a think become fashionable, it acquires value

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because of its relative scarcity. When a think is given more value e.g. higher education it is
valuable not because of scarcity but because due to its intrinsic usefulness e.g. clean air may not
have a market value but is useful for human beings.
3. Opportunity cost of something is what you give up to get it.
4. Rational decision making involves weighing up the marginal benefit and marginal cost of any
activity.
5. Transaction cost are incurred when firms buy inputs or services from other firms as opposed to
producing them themselves. They include the cost of searching for the best firm to do business
with, the costs of negotiating, drawing up, monitoring and enforcing contracts and the cost of
transporting and handing products between the firms.
6. The nature of institutions and organizations is likely to influence behavior. E.g. the objective of
profit maximization is too simplistic for organizations like hospitals and universities.
7. The principle-agent problem. Where people (principal) as a result of lack of knowledge, cannot
ensure that their best interest are served by their agents.
8. Good decision making requires good information. Where information is poor, or poorly used,
decisions and their outcomes may be poor. This may be the result of bounded rationality.