Economic Concepts used

in Business Decision
Making
 Opportunity Cost Principle
• Opportunity Cost of availing the best opportunity is foregone income expected from the second best
opportunity of using the resources.
• If there are no sacrifices then, there is no cost.
• Resources are scarce and these resources have alternative uses.
• Example: Suppose a firm has 100 million at its disposal.
(a) Expand the size of the firm - 20 Million.
(b) Setting up new production unit in another city – 18 million.
(c) Buying shares in other firms. – 16 million
• Difference between actual earning and its opportunity cost is called economic gain or economic
profit.
• Applicability of the opportunity cost is applicable to decisions on the use of financial resources by a
firm.
 Marginality Principle
• Marginal refers to the change in total quantity or value due to a one unit change in determinant.
• Example: MC = TCn – TCn-1
TCn = total cost of producing n units

TCn-1 = total cost of producing n-1 units.

Similarly MR = TRn - TRn-1

MR> MC – Profit Maximisation

MR<MC – Profit Minimisation

MR = MC – Equilibrium.

Profit of a firm is maximized at that level of output and sale where the cost of producing one additional unit equals
the revenue from the sale of that unit of output.
 Incremental Principle
Incremental principle is applied to business decisions which involve bulk production and a large increase in total
cost and total revenue. Such an increase in total cost is called incremental cost and increase in total revenue is
called incremental revenue.
Incremental Cost
• Increase in cost due to a business decision.
• Suppose firms decides to increase production. This decision increased the total cost of the firm from 100 million
to 150 million. 15 million is the incremental cost.
Incremental Revenue.
• Increase in revenue due to a business decision.
• Suppose after the installation of the new plant, sales increase and firms were able to sell more output. Firms
output increased from 130 million to 150 million. 20 million is the incremental revenue.

The use of incremental concept in business decisions is called Incremental Reasoning

 The Equi – Marginal Principle

• The law of equi Marginal utility states that a utility maximizing consumer distributes his
consumption expenditure between various goods and services he/she consumes in such a
way that the marginal utility derived from each unit of expenditure on various goods and
services is the same.
• This principle suggests that available resources (inputs) should be allocated among the
alternative options that the marginal productivity gains (MP) from the various activities
are equalized.
• A profit maximizing firm will allocate its resources in a proportion such that
MPA = MPB = MPC ……. = MPN
 Discounting Principle
• According to this principle, if business decision affect all the costs and revenue in the long
run, it must be discounted to present values before valid comparison of alternative is
possible.
• Rupee worth of money at a future date is not worth a rupee today.
• Money has time value
• Discounting can be defined as a process used to transform future dollars into an equivalent
number of present dollars.
• Future Value = Present Value * ( 1 + discount(interest) rate)
Future value = Time at some future date
 Time Concept
• Time concept or perspective refers to the duration of time period extending
from the relevant past and foreseeable future taken in view while taking a
business decision.
• Relevant past refers to the period of past experiences and trends which are
relevant for business decisions with long run implications.
• Business decisions have different time perspectives. Short term or long term.
• Business decision makers must assess and determine the time perspective of
business propositions well in advance and make decisions accordingly.