CHAPTER

Introduction to
Business Economics
Meaning of Economics
Concept ofa Market Economy
Nature and Definition of Business Economics
Scope of Business Economics
Demand Analysis and Forecasting
Cost Analysis
Market Structure
Pricing Theory
Profit Analysis
Capital Budgeting
Differences between Business Economics and Economics
Contribution and Application of Business Economics to Business
Marketing and Sales Applications
Production and Personnel Applications
Financial Applications
Law Related Applications
Microeconomics and Macroeconomics
Microeconomics
Macroeconomics

MEANING OF ECONOMICS
Economics is concerned with the allocative decisions of individuals, households,
businesses and other economic agents operating in the society and how the society itself
(as a whole) allocates these resources.
 BUSINESS ECONOMIcs
As far as resources arc
concerned, they fall into four main
Labour, (iii) Capital and (i) categories-(i) Land
1. Land. In
Entreprencurs. (ii
Economics, as against the common meaning of land in
of nature are included.
Therefore, all natural resources such as land, everyday use, all git.
included in the definition of forests, minerals etc.gifts
ar.
land are
2. Labour. Labour
includes all human resources, mental and
acquired. physical, both inherited ana
3.
Capital. All those man-made aids to further
factories which are used
up in the process of
production, such as tools, machinery, and
being consumed for their own making other goods and services
rather than
sake, are known as capital.
4. Entrepreneur. The persons who
them along new lines are called organise the other factors of production and
new
products and new ways of entrepreneurs (or innovators). They take risks direct
oldmaking by introducing
Collectively, these resources are called
products.
These factors are used to make factors of production (or merely
are goods (or factors in short).
commodities) like television, air-conditioners
tangibie and services like
education,
goods and services is called health-care which
total output of etc. which are
goods and services is called its Gross intangible. The nation's
Domestic Product (GDP). The act of nation's
satisfy human wants is called production while the act of making
using these goods and services
consumption. to
Concept of a Market Economy
Market economy an is
Decisions in this systemeconomy marked by private
are undertaken ownership means of production.
of
In a market by
the free flow of market
economy, neither
forces.
planned manner concerning its any individual nor any institution
arrive at some kind day to day takes decision in a
of a solution to
information directly about the
functioning.
its central
Thus there is no
conscious effort to
which they wish to wants of the problems. Producers seldom collect
have from the consumers, and yet people any
for their market for get all the
commodities
products. Ordinarily sellers are not satisfying their wants. Producers
produce. The commodities worried about the also get
buyers
not much
bothered about the produced are invariably sold in the stocks of goods which
continues to get regular market. The consumer they
a
free market commodities
availability
which he wants to
of
necessities like bread, is also
butter, etc. He
guide its course,economy
is consume on a
self-organising'
the free market (that is, although there regular
is
basis. This shows that
Self Interest-The economy has a
high degree of
no
planner or operator to
is nobody to Guiding
guide the course ofMotive. The organisation).
question that
to the
great classical econonist the market, how is its crops up at this juncture is if there
1776, when everyone in a Adam Smith whose orderly operation ensured?
maximised. Thus, in a free market economy acts book The Wealth
of Nations
Accordins
in his self
looking at their interest carrymarket cconomy, the
appeared
interest, social benefit is n
out
production. They guiding motive is self automatically
want to interest. Producer
Richard G. Lipsey maximise their profits which
edition, 1999), p. 1. and
K. Alec tney
Chrystal, Principles of Economics (Oxford
University Press, NInuth
 5
INTRODUCTION
TOBUS INESS ECONOMICS
In other
if they produce the commodities which the consumers wish to buy.
do only
a n do the consumers
in their self-interest produce only those goods which
can

words, the producers

invisible hand.
This has been characterised by Adam Smith as the principle of
demand. of market
Characteristicsof Market Economies. The main characteristics
Main
are as follows:
oconomies that produce the above mentioned self-ordering
eco
seems best
self-interest buying and selling what 10
1. Individuals pursue their own
themselves and their families. and
incentives. Other things being equal, sellers seek high prices
2. People respond to
buyers seek low prices. their goods
to sell
which would-be sellers compete
3. Prices are set in the open market in which
of commodity that prevails in the market is one
to would-be buyers. The actual price a
commodities
of that commodity. Likewise, prices of all
equalises the demand for and supply the supply
which equalises the demand for and
are determined in a market economy.
The price
is known as its equilibrium price.
of a commnodity in the market For example,
exists like the market for any commodity.
4. Market for factors of production Workers 'supply such
services of labour for production purposes.
manufacturers 'demand' the
in the market jointly determine the
The demand for and supply of labour
services of labour. interest is determined by the demand for and supply
of loanable
rate. Similarly, the rat of
wage
funds in the capital market. institutions largely
a set of
All activ ities in the free market economy are governed by the
5. and freedom of contract as
and Chrystal regard private property
created by the State. Lipsey and contractual obligations are
The nature of private property
most important institutions.
enforced by the police and the
courts.
defined by the legislature and

BUSINESS ECONOMICS
NATURE AND DEFINITION OF
to
economic theory and methodology
Business economics is the application of
business firms.
decision-making problems faced by the
to apply economic in
analysis

definition shows that business economics is an attempt business practice to

This economic theory and
It integrates
theformulation of business policies.
business firms. The growth of the
field reflects the fact that much
facilitate decision making by world conditions, be used
can
modifications to fit real
with appropriate goals
ofeconomic theory, that are most likely to
lead to the realisation o f

decisions
bythe entrepreneurs in making
business economist attempts to
extract from economic theory
Set out by them. The enable the decision-maker
those concepts and techniques that
particularly microeconomics) economic theory that are
The concepts of
of the firm.
efficiently allocate the
resources
to
economics are the following
Widely used in business
(1) Demand and its elasticity
(2) Demand forecasting
(3) Production theory
 (4) Cost analysis
(5) Revenue concepts
(6) Price determination in different market structures like perfect competition, monopl
monopolistic competition and oligopoly
(7) Pricing methods in actual practice
(8) Break-even analysis
(9) Linear programming
(10) Game theory
(11) Product and project planning
(12) Capital budgeting and management
(13) Criteria for public investment decisions.
The above list shows that business economnics
provides most of the concepts, tools an-
techniques required by the businessmen for the analysis of business problems. The concepts a
demand and its elasticity, production and cost, market structure and
pricing, etc., all help th=
managers in understanding and tackling the business problems. Business economics helps th=
management in taking important business decisions regarding product mix, best possibl
production technique, least costly input-mix, the level of output and price, criteria to t
adopted for allocation of investment, allocation of budget for advertising, publicity, etc.
SCOPE OF BUSINESS ECONOMICS
Busines economics is concerned with the
techniques in order to help businessmen in taking
application of economic concepts, tools anm
of business economics covers a wide appropriate business decisions. The scop=
Demand analysis and
spectrum of economic theories and concepts like : (1
forecasting; (2) Cost analysis; (3) Market structure; (4) Pricing theor
(i.e., price determination in different market structures);
(i.e.,
(5) Profit analysis with specia
reference to break-even point; and
(6) Capital budgeting for investment decisions.
Demand Analysis and
Forecasting
From the-point of view of businessman, demand
purpose of determining the demand for his analysis and forecasting serve the bast
basic objective is to study the product. As far as demand analysis is concernea, its
demand function which
demand. From the point of view of an highlights the various determinants
individual
for a particular
commodity are (1) price of the consumer, the determinants of the den
prices of related goods, (4) tastes and commodity, (2) income of the consumet,
general, the focus is on the preferences, and (5) his
expectation about the nu ure.
n

assuming that other relationship

things remain the same.4
of the demand for a
commodity with
i t n its pric
particular consumers but also with the whole However, businessman is not only intcii d in
demánd which depends on, in addition to lot of consumers. Thus, his focus Is O el
composition of population, and (2) distribution the above
factors two more factors-(9)
an
of national
product (or national income
4 Other things remaining the same' is written
 T R
DUCTION
O D L
TO USINESS ECONOMICS 7
tries
such analysis,
Thebusinessman does not stop at demand analysis but, on the basis of is done
will be in future. This is due to the reason that all production
to orecast what demand
forecast for his
estimate the likely demand
or the future. Demand forecasting helps the producer to
fo
product
in future and take up production plans accordingly.

Cost Analysis
firm regarding
demana Jor oru
production uvill depend not only on the likely the
Decision of a
to ensure
viabilty
the cost of production of that good. This is necessary
good but also
on
worthwhile and profitable. Accordingly, cost
whether production will be
investment and test which includes
The businessman is generally concerned with private cost
crucial. on loans, (+)
analysis is the labourers, (3) interest payments
the materials, (2) wages of tax
(1) cost ot
raw
costs of machinery and depreciation, (6)
rent of the factory premises, (5)
repairing interest on his
for the work rendered by him,
to the producer
payments, (7) imputed payments the firm.
on his own buildings etc,
and (8) normal profits of
own capital, rent
cost while undertaking
to consider both money cost and opportunity obtain a
lt is also necessary
monetary sacrifice made to
is cost to the
equal total decisions.
business decisions. Money investment
of Obviously, this cost is crucial in making of the
particular level output.
account the opportunity
cost-i.e., the cost
take into
However, it is also necessary
to commodity, the
decision to produce some particular
While making a
that it has abandoned
opportunity foregone. the alternative commodity
consider the value of 1s
firm will always have to The value of the
alternative commodity
that it is now producing.
in favour of the commodity now producing.
the good that the firm is
the opportunity cost of which is the relationship
is the study of the cost function
The next step in cost analysis two factors: (1) the
production of
function depends on
between product and
costs. The cost
used in production.
It is also
for the inputs
the firm, and (2) the prices
paid by the firm functions are bound to
differ in the
view cost
the time element in
as
while some factors of
necessary to keep This is due to the r e a s o n that
with the long-run. are variable
short-run as compared
short-run, all factors of production
the
and some variable in and long-run cost
c u r v e s are
production are fixed short-run cost curves
in the long-run. Thus, in cost analysis,
discussed separately.

Market Structure structure is

in an economy.
Generally market
market structure
There types of
different (2) monopolistic competition,
(1) perfect competition,differ substantially from o n e
are

the following headings:

discussed under structures
These market different. Perfect
and (4) oligopoly. market forms will be
(5) monopoly, in different in the
the theory of pricing found in a pure form
another. Accordingly, which is seldom
economic theory the
case in the functioning of
Competition is a polar considerable help in
understanding number
However it is of which there are such
a large
real world. market structure in
It is defined as
a and sellers
capitalist economy. to influence the price (in
fact, all buyers
is in a position Moreover,
of firms that none of them
price takers and
not price makers). attached"
market are merely 'not
in a perfectly competitive homogenous so that buyers are
identical or
products of all
sellers are perfectly
to any seller in any way.
 ofsellers but thei.
there are a large number eir produe
competition also of this marl.
crucial element of
In monopolistic differentiation is a marke
not identical. In fact, product
sellers to build up brand loyalty so
so that consumers get strus
nat consum
enables rices for thei
their a
Product differentiation
producers to charge
different prices their
to specific brands enabling
a result, each producer
different

can have a
different price for
his product. orodues
produsy
one producer in.
market structure in which there is only
Monopoly is a on the supply of the prodtuc
the producer has complete control
Accordingly, curve of the indtet.
of the firm is the same as the supply stry.
condition, the supply curve

structure that is usually found is oligopoly.

This ia
In real world, the market
sellers is small and every seller influences and ic
a
structure in which the number of
a change in output or price by one firm
uen
by the behaviour of other firms. Accordingly,
reaction from other firms operating in the
market. Interdependence in decision-mobi.
it is usual to dis
characteristic of firms operating under oligopoly. Generally,
chief
between two types of oligopoly: (1) perfect or pure oligopoly, and (2)
(2) imperia
imperfea
sting
differentiated oligopoly. In the case of pure oligopoly, all firms produce identical Drod.
Therefore, consumer decisions to purchase the good of a particular producer are influencod
ced
the price considerations. Pure oligopoly is found in industries like iron and steel, alumin.
iniu
cement. In the cases of imperfect or ditferentiated oligopoly, different producers
goods which are similar but not identical. Oligopolies are also classified on the basi
collusion or absence of it. On this basis we have three types of oligopoly: (1) oligopoly
collusion (which involves the formation of a cartel), (2) oligopoly without collusion
oligopoly with tacit collusion.
and

Pricing Theory
Price of a commodity in the market is determined at the
is
point where demand for the prodi
equal to its supply. In conditions of perfect competition, since firms cannot alter this pri-
they accept it and adjust their level of production in order to maximise their
conditions of short-run, a firm can earn profit
incur a loss. However, in
supernormal profits or normal profits or could
ex
the long-run, freedom of entry and exit ensures that a firm can ea
only normal profits. For example, if some firms earn
some new firms will enter the industry in the long-run supernormal
and
profits in the shortu
other hand, if some firm is compete away the profits.
incurring losses in the short-run, it will exit the
long-run. All firms operating in the long-run can industry
therefore earn only normal profits. I
monopolistic competition since the various firms produce
and demand curves are not
identical. Acordingly, each firm
differentiated products, nc
product which will be different from the will determine a priCe
prices of the msb
ditference in these
prices may not be large. A firm differentiated products of other nt
competition in the market can earn operating under conditions of mon
normal profits) but in the profits in the short-run or incur losses (Or
that, just long-run it can
in perfect earn only normal
there is freedom of profits.
as
competition, This is due to
competition in the s
long-run. If there are entry and exit in n
firms, some new firms
will enter the supernormal profits in the short-run 1or isi
there are losses in the industry in the long-run and wean su its
short-run, the firm away thesc
The
remaining firms in the industry will incurring losses will exit the industry in ng
earn only normal profits. u
 BUSINESS EC
TO
DUCTION firm that
that
of a single
for and the supply
upply
demand of entry of
monopoly, it is the and danger
of no
Iconditions
I n c o n d i t i

Since there is no competition and the

of the product. in the short-run
he price
determines the profits both
can earn
a monopolist
long-run,
firms in the
newtirms types
production
of production

be types of various
different
in oligopoly. There can of different
strength
long-run.

Conditions areare diffic ficult ning

bargaining been
Conditions structure depending upon the models have
models
arrangements in market of economic
e conomic
in this
arrangements n a t u r e of collusion,
if any. A number different
oligopolists,
oligopolists and the
the patterns of firm
and different reaction
oligopolists e c o n o m i s t s assuming
oligopolistic
a_sumed that
if an
ditterent
model, it is its price,
huilt-up by etc. In the simplest However, if
it reduces
strength
bargaining raise their prices. assumption
their its rivals will not This particular
raise its price, lower their prices. corresponding8
decides to this action and will in the
react to discontinuity
will definitely in a finite
resulting known
somehow,
they demand curve
if price is
to a kink in the indeterminateness.
However,
leads This results
in price over a
substantial range.

marginal
curve.
remain fixed (or rigid)
it would
explains why
this model
The
of the firm.
Profit Analysis to be the sole objective
is assumed
In other words,
maxinmisation market.
profit nature of the the firm
economic theory, irrespective of the monopolistic,
In
this objective competitive
or
Given
attempts to realise imperfectly maximisation.
firm competitive, of profit
is perfectly single goal For
whether the market
keeping in
view the of the firm.
business activity determine the equilibrium must
conduct its easily data. First, we
will maximisation,
we c a n two sets of we
possess Second,
we must
this goal of profit position of the firm, a m o u n t s of
its output.
different is
the equilibrium information

firm e a r n s by selling
obtaining This
revenue the of output. amounts and
know how
much these various marginal
revenue

costs to produce and total cost, (2)

know how much it equilibrium
ofa
determining the
revenue
must
forms: (1) total For and
available to us
in three and average
cost. revenue

revenue marginal
and (3) average and data regarding
marginal cost, and total cost
revenue
total
firm,data regarding of the firm,
useful. determine the equilibrium
cost are total
marginal cost approach to c u r v e and
revenue
revenue-total
between total
If we use
the total vertical
distance to which
when the production
corresponding
maximum of
the profits will
be at the level
revenue-

This happens we use

the marginal
maximum. another. If
cost c u r v e is
the to o n e where marginal
are equal of output
these two
curves
at that level to profit
slopes of
maximum
the the profits
are
analysis, it
is this approach
cost approach, economic
marginal cost. In
to marginal
r e v e n u e is equal
adopted. The level of output
maximisation that
is mostly break-even point is important. break-even
the called the
the point of of firm,
vieaw a
not begin making
profits is
From losses but
does
firm avoids making
where a

point.
Capital Budgeting investment
decision making generaly
business decision making isbudgeting is
in capital
problem in "The problem
An important to W.W. Haynes, acceptance of the
budgeting. According
available to the
firm w i t h
known as capital alternatives,
investment
nne gf choosing among
10 those
with low
or negative ility
profitabilit.

of investment decision m

and rejection steps in

profitable
investments

requires
at least iiVe
a
forecast of the Cash
most
budgeting opportunities, (2) dise
complete study of capitalsearch for investment
converting
the cash flows in iffere
(1) the of
(3)
method
capital, and (5)
the sel
These steps
are:

from ecach
investment,
a
the cost of ectin
thatwill result method of computing
common
unit, (4) a
into a
years investment. The most commo
mon
protitable business firms.
of the most
different criteria
are used by the net present val
appraisal criterion, (2)
For investment period
three: (1) the payback
are the following
used criteria return criterion.
internal rate of
the
criterion, and (3)
ECONOMICS AND ECONOMICS
BUSINESS
DIFFERENCES BETWEEN
economics are as follows
business economics and
between
The main differences
abstract and theoretical models
is concerned with building
1. Economic theory concerned with the application-
this, business economics is
economic behaviour. As against economics th
business helps
Therefore,
economic principles to business problems.
businessmen in tackling everyday business problems.
branch of economics which studies the problems of individu=
2. Microeconomics is a
consumers or producers.
are households, families,
economic units-whether the units
against this, business economics is concerned with the problems of producers (
consider economics If we
businessmen). Therefore it is a small branch of microeconomics.
a whole, it has a much wider field of study and applications as even microeconomics is jus
one branch of economics.

3. The basic objective of businessmen is to maximise their profits. Therefore, the mai
focus of study of business economics is on the profit theory. As against this, microeconomic
studies theory of utility maximisation (in consumer behaviour), profit maximisation (i
producer behaviour), and distribution theories focusing on rent, wage and profit. In addition
welfare economics has also emerged as an important focus of
study in microeconomics.
4. Business economics is concerned with normative
microeconomics while traditiona
economic theory is concerned with both,
positive and normative economics. Posituv
economics focuses on explaining things 'as they are' while
with things 'as they ought to be'. Since
normative economics is concerne
business economics discusses what
business should pursue and how they should be
set, it is normative in
objectives
character.
5. Economic phenomena in the real world are
phenomena complex. Study and analysis of the*
is therefore very difficult. To make very
complexities of the real world by means of analysis
possible, economists try to reduce
models are prepared which are theoretical
abstractions. For this purpose econo mic

simplified
abstraction requires a set of meaningful representations of the real world. The
and consistent theore
simplification of the phenomena or behavioural assumptions, which aim a the
As against this, business economics pattern that the model is to stuudy
attempts to tackle real
life complex
designed
guided by the objectives of the firm and the
constraints within which itbusiness
blems

proDi
ons. For tht
5. W.W. Haynes, Managerial Econamics
functions. FO
 11
INTRODUCTION TO BUSINESS ECONOMICS
economics uses
Durpose of carrying out analysis and defining business behaviour, business
branches ot like mathematics, economics, statistics, operational
study
concepts of various
research, accounting ete.
economics and
The above discussion clearly brings out the differences in business
it clear that there is
At the same time, it also makes close relationship between
a
conomics.
many ways in which economics helps in the study of business economics
the two. There are economist is an expert
economics). According to William J. Baumol, "The
(or managerial builders with such
builder. Indeed there are few disciplines which produce model
model which the economic
one of the most important things
practice and such skill. This, I think. is in
science."6 The second important way
can contribute to the work of management
theorist a set of analytical
methods.
economic theory helps managerial science is by providing
which to management but rather
that it is not the final theorems that are important
Baumol argues can become a far
economist
more

he method ot reasoning.
He concludes that "a managerial
studies of economic analysis,
member of management
a group by virtue of his
helpful effective model builder and because
there he
because there he learns to become an
primarily him to deal with the
a very rich body of
tools and techniques which can help
acquires and a far deeper manner."
more rigorous, far more probing,
probiems of the firm in a far
ECONOMICS TO
CONTRIBUTION AND APPLICATION OF BUSINESS
BUSINES5S
required to be
specified by the firm, following steps
are
Once the managerial objectives are

decision:
aken in arriving at a
decision to be made.
1. An identification of the problem
or

2 A statement of allernative solutions to the problem.

and an analysis of those
A determination what data are relevant to the decision,
of
3 solutions.
data relative to the alternative
solution consistent with our firm's or agency's objectives."
4. The choice of the best
done in steps 3 and 4 rely
Truett, the analyzing and choosing
to the Trueett and As we
According tools and criteria of economic analysis.
and broadly accepted
eavily on standard these tools and criteria and their application
to specific
the definition of time
orogress through discover rules for decision makingapplied that are

economic problems of the firm, we

foundation in one of the most important
these rules have their
and again. In general, or incremental analysis.
in business economics-the marginal
economic tool used extensively incremental approach is that changes
in
of the marginal or
The underlying principle r e s o u r c e use, investment)
should be
controlled by the firm (output, price,
economic variables revenues than to its
costs-in other
add more to the firm's
indertaken anytime such changes
add to profit."9
Words, anytime they
Economics", American
Theory Contribute to Managerial
"What Can Econonic
William J. Baumol,
Economic Review, May 1961, pp. 143-4.
Ibid., p. 146. 5.
Managerial Economics (Ohio, 1988) p.
3. Lila J. Truett and Dale B. Truett,
.Ibid, p. 5.
Marketing and Sales Applications
Marketing and sales functions of a firm are closely linked to an analysis of Cono
the determinants of demand, what
demand. The economic theory provides insight into Cau
incomc elasticity, cross elasticity of demand etc. A
changes in demand, price clasticity,
with this knowledge, managerial economics tries to derive actual empirical estima
elasticities of demand which are then used by a firm in formulating its pricing policy an
purposes of predicting the size of a future market. Thus the use of applied demand theoryh
the businessmen in their marketing and sales functions.
According to Larry C. Peppers and Dale G. Bails, the effectiveness of the firm in fulf
its marketing and sales functions is generally reflected in its ability to charge a premiump
for its product or products. 1here are two aspects of the pricing decision made
businessman: customer resistance and competition. He has to weigh the advantages
higher unit price vis-a-vis the disadvantages of reduced unit sales. The concept
demand-price elasticity enable him to measure how consumer sensitivity to price chan
varies among products and among markets. Business economics also helps the businessmar
evaluating the probable reaction of competitors to changes in price, quality, service and oi
aspects of the total product. Finally, these same tools can help in quantifying the effectiven
of advertising and product differentiation policies as they relate to the demand for
product 10

Production and Personnel Applications

The production and personnel departments of a business unit have differ
responsibilities yet both of them require reasonably reliable estimates of demand because i
such estimates that will help in determining the monthly and weekly production schedu
inventory requirements and labour quotas. The economic concepts of production functiona
input-output relationships are also useful in business practices. The law of diminishing retu
the concept of economies of scale, calculation of labour productivity, marginal produciniy
all play an effective role in determining the production patterns of business firms.
knowledge regarding the productivity of labour is also crucial for the personnel department
it is this knowledge that will enable it to design appropriate pay packages. According
Peppers and Bails. "The goal of the user of managerial economics is to translate avere
productivity, marginal productivity, and production/cost functions into empr
measurements that can be used by managers in the production and personnel departmens
The practical significance of these measurement efforts is that they become part of tne
for making resource allocation decisions."11
ne
In addition to the above, the businessnian should also be in a position to deter
efficiency and flexibility of the production .process of his firm. Therefore, he should the t
position to understand the concepts of substitutability of factors of productuon,
benefis

implications of such substitution, diminishing returns, economies of scale, costs and oc

current inventory policies etc.-all belonging to the field of economic theory.

Decis
10. Larry C. Peppers and Dale G. Bails, Managerial Economics: 1heory and Applications
Marketing (New Jesey, 1987) p. 6.
11. Ibid, p. 7.
 CONOMICS
Financial Applications 13
Financial decisions of all units
economics of tinie and uncertainty. For(consumers as well as producers) are
among his present a deeply rooted in the
example, consumer has to divide his
requirements but also his
retirement planning is necessary and for (and his family's) future income not only
consumption and savings this purpose he must requirements. Therefore
judiciously.
that the cash tlow is such that Similar is the casc of a allocate his income between
long term financial business firm. It has to ensure
met by long-term tinancial
arrangements (say, 15 yearrequirements
(such as inventory tluctuations) loans) and
(say, for a new factory) are
that
credit).
are met
by short-term short-term requirements
arrangements (say a monthly line of
If the future were
certain,
marked with uncertainty and financial decision making would be easy. However, future is
trade-ofis' between the presenttherefore it becomes
and future necessary to decide about the 'financial
theory of time, risk and requirements. Business economics studies the
process of business firms.uncertainty
in detail which plays a crucial role in the
decision-making
Law Related Applications
Business economic
analysis and legal analysis are
whenever there is a
controversy concerning the failurecomplementary in nature. For example,
satisfactory outcome in terms of wages, prices, or other of a free market to provide a
both business economists and aspects affecting people's welfare-
failure on the firm. When lawyers will be called upon to
analyse the impact of the market
environmental guidelines are imposed
pollution or when antitrust statues or regulatory upon firms in a bid to reduce
of market power, the
business corporations must
guidelines/laws are passed to check the abuse
and legal carefully take into account the economic
consequences. Business economics will help in
market-power, predatory pricing practices, the composition defining the market structure,
of labour force etc. while
analysis will help in determining illegal actions such as collusion. legal
business economic theories and Together, through the use of
legal analysis, companies can achieve greater progress in
dealing with complex social issues involving environmental planning,
opportunities, anti-trust, regulation, and deregulation. equal employment

MICROEcONOMICS AND MACROECONOMICS

Economic theory is divided into two main branches of study : microeconomics
and
macroeconomics. The difference between the two would be clear from the
following
discussion.
Microeconomics
Microeconomics is concerned with a detailed analysis of the behaviour of individual
economic units be it consumers or producers. A producer (generally called a firm) is a
decision-making unit in production which can consist of either a person or a group oe persons
torexample, a corporation). Similarly, a consumer is a decision-making unit that also consists
of a person or a group of persons (for example, a family or a household). In the words of K.E.

Boulding
 14

is the study of particular firms, particul ECON

household indhy
Microeconomics

incomes,
individual
industries, parti
commodities."12
prices, wages,
include following: (;
the
The ficlds of study
in
microeconomics

and (i) elficiency in the

ueeCerice determina
distribution,

production
fiunction. (iin)
cconomists have been mainly concerned with
the
tors
ors of prM
For a long time,
The classical
economists
eory problem
emphasized the labou
determination.
made marginal uility
theoru oValalue y
h e basis. of their
economists va
value
Austrian
was carlier known
as the theory of nrie

Startedhe
microeconomic theory (which als
the theory of
behaviour. Nowadays utility analysis, indiffer
consumer

etc. are used extensively in the theory of n r i . curveindifference arted

theory of consumer surplus
important to remember
that microeconomics is concerned with the erminati
e prices
and not the general price level. The study of the latter comes under e
goods
The problem of production function is essentially the problem of col.
technique for production. We all know that "factors' can be used in varving 3 th
producing a particular commodity.
The producer will try to minimise costs propori
poni,
in view, will choose those factors of production whose relative prices are low and
high. This behaviour of the producers comes under the field of microeconomics produ
The issue of distribution of income different people and
national among different
of people is a very interesting field of study. We all are interested in knowing howth
of a person or a certain factor of production is determined and why is it higher arla
compared with the income of other people (or other factors of production). Microen
studies these problems.
econ
Enforcing efficiency in use of factors of production (or reducing inefficiency) is a
economic problem. Economists try to determine the conditions under which theprod
can be considered to be efficient. Pareto, Hicks, Kaldor and a number of other ecn
have done useful work in this field. Their efforts have
microeconomics known as Welfare Economics.
given birth to a new bra
Macroeconomics
Macroeconomics is concerned with the analysis of a total economic system. Accor
Bouiding,
"Macroeconomics deals not with the individual quantities as such but
aggregates of these quantities; not with individual incomes but with the nau
incomes; not with individual prices but with the price level; not with individual ou
but with the national output."13
Thus whereas microeconomics deals with individual economie units anda d
whole
analysis of their behaviour, macroeconomics deals with the analysis of the wr

cconomy. Therefore, microeconomics is concerned with broad economic ag

he
national income, aggregate consumption,
aggregate saving and investment n i
gencral price ievel in the economy, etc. It may be pointed out that micro

12. K.E. Boulding. A

Reconstruction of Economics, 1950. p. 3.
13. K.E.
Boulding Economic Analysis (London, 1955), pp. 237-8
INTRODUCTIONTO BUSINESS ECONOMICS 15

studies some aggregates, for instance, the supply of a

particular industry (which is aggregate of
firms), demand in a particular market (which is an aggregate of
these aggregate households) etc. However,
are
microscopic in characterwhen viewed in relation to the whole
economy.
For instance, total supply of all industries in an
economy will be a macroeconomic aggregate.
Similarly, demand of all goods (or consumption of all goods) in the
economy will be a
macroeconomic aggregate etc.
Today, macroeconomics is a well developed branch of Economics. It addresses itself to
the following two central problems of the
cconomy: (i) How are national income and
employment levels determined at a particular point of time and why do the economies pass
through the phases of boom and depression during a specific period of time ? and (ii) What
are the laws of economic
development ? To answer these questions, the economists divide the
discussion into the following parts
The Income Theory. This occupies a central
place in macroeconomic theory. The concept
of effective demand helps considerably in this
theory. Effective demand, in turn, is based on
the level of consumption, investment, government expenditure and balance of payments. On
account of this reason, the income theory includes in its ambit a discussion of
consumption
function, investment function, fiscal policy and a study of balance of payments at an
level.
aggregate
Theory of Trade Cycles. A free market does not progress consistently in a smooth
manner. It passes
through the phases of booms and depressions. Trade cycle theories analyse
these phenomena.
Theory of General Price Level. Whereas microeconomic theory is concerned with the
study of the relative prices of goods and services, macroeconomics is concerned with the
determination of the general price level in the economy. In other words, the analysis of
inflation and deflation comes under macroeconomics.
Theory of Growth. Interest in the problems of growth of underdeveloned countries is a
relatively new field in Economics. In the post-Second World War period R.F. Harrod and E.D.
Domar extended the Keynesian analysis (which was originally limited to a discussion of
short-run problems) to a discussion of the problems of long- run economic development.
Broadly speaking we have two approaches to the theory of development. The first approach
links the underdevelopment of the backward economies to the problems of capital formation.
The second approach views the problems of underdevelopment in Asian, African and Latin
American countries in a historical perspective- i.e., as a result of colonial exploitation of these
countries by metropolitan pOwers.

KEY POINTS
1. Economics is concerned with the allocative decisions of individuals, households, businesses and
other economic agents operating in the society and how the society itself (as a whole) allocates
these resources.
2. Market economy is an economy marked by private ownership of means of production.
Decisions in this system are undertaken by the free flow of market forces.
3. Business economics is the application of economic theory and methodology to decision-making
problems faced by the bus ess firms.
 16
SINESS ECONOMt.
4 p e ot business economics covers a wide spectrum of economic theories ana
Market structure
and conc
theorv analysis and forecasting, (ii) Cost analysis, (iin)
theory (i.e. price determination in different market structures), (v) Prolit analysis wit

5.
T o break-even point, and (vi) Capital budgeting for investment decisions. spe
There are some
there is a close
important differences between business economics and
economics.
ics. H.
Howe
6.
Business economics
relationship between the two.
helps in reaching business decisions in many way via (i)
4pplications,
(1) Law related (i) Production and personnel applications, (i1) eial
Financia rketing a
Marketino
applications
application
applications.
Microeconomics is the study of particular firms,
incomes, individual particular households, individual prices,
rices, wa
waa
8 industries, particular commodities.
Macroeconomics deals not with individual
guantities; not with individual quantities as such but with aggregates of
prices but with the incomes but with the national th
price level; not with individual incomes; not with individ
outputs but with the national
output.
?REVIEW QUESTIONS
1. Define Economics.
2. What is the
"Business economics concept of a market
tools of bridges the gap between economy ?
economic analysis in
in
classifying problems,abstract
comparing alternative courses theory and business
Outline the nature of action."
in
organising and evaluating practice. It us
and scope of
Business Economics
informationa
in the
3. light of this statement.
Distinguish between Economics and (IP
4.
4.
"Business economics Business Economics. University, BBA, December
integrates
making by business firms." economic theory and (P
University, BBA, December 201-
5. How does
the study of
Explain. business practice to 201
Explain your answer withBusiness (IP
University, facilitate decisio
6. Explain the
6.
Economics
the help of
nics help a
suitable a business BBA, December 200=
contribution and examples. (1P
(IP manager in decision
7.
1. Define and application of Business University, mak
making
naking
distinguish between Economics BBA, December 200
8 Explain briefly
8. Microeconomics
economics and
and Macr to b1s
busine 2002
(i) What do you mean Macroeconomics
acroeconomics.
by 'invisible hand'?
(ii) What is
equilibrium
price ?
(ii) What is a break-even
(iv) What is point?
capital budgeting?