Economic Analysis for Business Decision PDF

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Lesson - 1 Business Economics- Meaning, Nature, Scope and significance Introduction and meaning : Business Economics, also called Managerial Economics, is the application of economic theory and methodology to business. Business involves decision-making. Decision making means the process of selecting one out of two or more alternative courses of action. The question of choice arises because the basic resources such as capital, land, labour and management are limited and can be employed in alternative uses. The decision-making function thus becomes one of making choice and taking decisions that will provide the most efficient means of attaining a desired end, say, profit maximation.

Different aspects of business need attention of the chief executive. He may be called upon to choose a single option among the many that may be available to him. It would he in the interest of the business to reach an optimal decision- the one that promotes the goal of the business firm. A scientific formulation of the business problem and finding its optimals solution requires that the business firm is he equipped with a rational methodology and appropriate tools. Business economic meets these needs of the business firm. This is illustrated in the following presentation.

Economic

Decision

Theory and

problems in

Methodology

Business Business Economic Application of Economic Theory and Methodology to

solving Business problems

Optimal Solution to Business Problems

it may be that business economics serves as a bridge between economic theory and decision-making in the context of business. According to Mc Nair and Meriam, “Business economic consists of the use of economic modes of thought to analyse business situations.” Siegel man has defined managerial economic (or business economic) as “the integration of economic theory with business practice for the purpose of facilitating decision-making and forward planning by management.”

We may, therefore, define business economic as that discipline which deals with the application of economic theory to business management. Business economic thus lies on the borderline between economic and business management and serves as a bridge between the two disciplines. Nature of Business Economics : Traditional economic theory has developed along two lines; viz., normative and positive. Normative focuses on prescriptive statements, and help establish rules aimed at attaining the specified goals of business. Positive, on the other hand, focuses on description it aims at describing the manner in which the economic system operates without staffing how they should operate. The emphasis in business economics is on normative theory. Business economic seeks to establish rules which help business firms attain their goals, which indeed is also the essence of the word normative. However, if the firms are to establish valid decision rules, they must thoroughly understand their environment. This requires the study of positive or descriptive theory. Thus, Business economics combines the essentials of the normative and positive economic theory, the emphasis being more on the former than the latter.

Scope of Business Economics :

As regards the scope of business economics, no uniformity of views exists among various authors. However, the following aspects are said to generally fall under business economics. 1.

Demand Analysis and Forecasting

2.

Cost and production Analysis.

3.

Pricing Decisions, policies and practices.

4.

Profit Management.

5.

Capital Management.

These various aspects are also considered to be comprising the subject matter of business economic. 1.

Demand Analysis and Forecasting : A business firm is an economic organisation which transform

productive resources into goods to be sold in the market. A major part of business decision making depends on accurate estimates of demand. A demand forecast can serve as a guide to management for maintaining and strengthening market position and enlarging profits. Demands analysis helps identify the various factors influencing the product demand and thus provides guidelines for manipulating demand. Demand analysis and forecasting provided the essential basis for business planning and occupies a strategic place in managerial economic. The main topics covered are: Demand Determinants, Demand Distinctions and Demand Forecastmg. 2.

Cost and Production Analysis : A study of economic costs, combined with the data drawn from the

firm’s accounting records, can yield significant cost estimates which are useful for management decisions. An element of cost uncertainty exists because all the factors determining costs are not known and controllable. Discovering

economic costs and the ability to measure them are the necessary steps for more effective profit planning, cost control and sound pricing practices. Production analysis is narrower, in scope than cost analysis. Production analysis frequently proceeds in physical terms while cost analysis proceeds in monetary terms. The main topics covered under cost and production analysis are: Cost concepts and classification, Cost-output Relationships, Economics and Diseconomics of scale, Production function and Cost control.

3.

Pricing Decisions, Policies and Practices : Pricing is an important area of business economic. In fact, price is the

genesis of a firms revenue and as such its success largely depends on how correctly the pricing decisions are taken. The important aspects dealt with under pricing include. Price Determination in Various Market Forms, Pricing Method, Differential Pricing, Product-line Pricing and Price Forecasting.

4.

Profit Management : Business firms are generally organised for purpose of making profits

and in the long run profits earned are taken as an important measure of the firms success. If knowledge about the future were perfect, profit analysis would have been a very easy task. However, in a world of uncertainty, expectations are not always realised so that profit planning and measurement constitute a difficult area of business economic. The important aspects covered under this area are : Nature and Measurement of profit, Profit policies and Technique of Profit Planning like Break-Even Analysis.

5.

Capital Management : Among the various types business problems, the most complex and

troublesome for the business manager are those relating to a firm’s capital investments. Relatively large sums are involved and the problems are so complex that their solution requires considerable time and labour. Often the decision involving capital management are taken by the top management. Briefly Capital management implies planning and control of capital

expenditure. The main topics dealt with are: Cost of capital Rate of Return and Selection of Projects. Conclusion : The various aspects outlined above represent major uncertainties which a business firm has to reckon with viz., demand uncertainty, cost uncertainty, price uncertainty, profit uncertainty and capital uncertainty. We can therefore, conclude that the subject matter of business economic consists of applying economic principles and concepts to dea1 with various uncertainties faced by a business firm. Significance of Business Economics : The significance of business economics can be discussed as under : 1.

Business economic is concerned with those aspects of traditional economics which are relevant for business decision making in real life. These are adapted or modified with a view to enable the manager take better decisions. Thus, business economic accomplishes the objective of building a suitable tool kit from traditional economics.

2.

It also incorporates useful ideas from other disciplines such as psychology, sociology, etc. If they are found relevant to decision making. In fact, business economics takes the help of other disciplines having a bearing on the business decisions in relation various explicit and implicit constraints subject to which resource allocation is to be optimized.

3.

Business economics helps in reaching a variety of business decisions in a complicated environment. Certain examples are : (i)

What products and services should be produced?

(ii)

What input and production technique should be used?

(iii)

How much output should be produced and at what prices it should be sold?

4.

(iv)

What are the best sizes and locations of new plants?

(v)

When should equipment be replaced?

(vi)

How should the available capital be allocated?

Business economics makes a manager a more competent model builder. It helps him appreciate the essential relationship Characterising a given situation.

5.

At the level of the firm. Where its operations are conducted though known focus functional areas, such as finance, marketing, personnel and production, business economics serves as an integrating agent by coordinating the activities in these different areas.

6.

Business economics takes cognizance of the interaction between the firm and society, and accomplishes the key role of an agent in achieving the its social and economic welfare goals. It has come to be realised that a business, apart from its obligations to shareholders, has certain social obligations. Business economics focuses attention on these social obligations as constraints subject to which business decisions are taken. It serves as an instrument in furthering the economic welfare of the society through socially oriented business decisions.

Conclusion : The usefulness of business economics lies in borrowing and adopting the toolkit from economic theory, incorporating relevant ideas from other disciplines to take better business decisions, serving as a catalytic agent in the process of decision making by different functional departments at the firm’s level, and finally accomplishing a social purpose by orienting business decisions towards social obligations.

Lesson I The Fundamentals Of Managerial Economics

Reading Objective: At the end of the reading this chapter, the reader will be able to understand that economics is the study of mankind’s attempt to satisfy their unlimited wants with the help of limited resources. Economics maybe divided in to 1) Micro Economics and 2) Macro Economics 3) Monitory Economics and 4) Fiscal Economics. Micro economics deals with the basic principles of economics like law of demand, law of supply, consumption, production etc,. Managerial economics deals with the principles of micro economics as applied to managerial decision making. The reader may also be able understand the circle flow of economic activity. The circle flow is a chain in which production creates income, income leads to spending and spending in turn leads to production activity. Lesson Outline: Ֆ Why study Economics? Ֆ Managerial Economics Ֆ Nature of Managerial Economics Ֆ Circular flow of economic activity Ֆ Objectives of the firm Ֆ Review questions

Introduction People have limited number of needs which must be satisfied if they are to survive as human beings. Some are material needs, some are psychological needs and some others are emotional needs. People’s needs are limited; however, no one would choose to live at the level of basic human needs if they want to enjoy a better standard of living. This is because human wants (desire for the consumption of goods and services) are unlimited. It doesn’t matter whether a person belongs to the middle class in India or is the richest individual in the World, he or she wants always something more. For example bigger a house, more friends, more salary etc., Therefore the basic economic problem is that the resources are limited but wants are unlimited which forces us to make choices. Economics is the study of this allocation of resources, the choices that are made by economic agents. An economy is a system which attempts to solve this basic economic problem. There are different types of economies; household economy, local economy, national economy and international economy but all economies face the same problem. The major economic problems are (i) what to produce? (ii) How to produce? (iii) When to produce and (iv) For whom to produce? Economics is the study of how individuals and societies choose to use the scarce resources that nature and the previous generation have provided. The world’s resources are limited and scarce. The resources which are not scarce are called free goods. Resources which are scarce are called economic goods. Why Study Economics? A good grasp of economics is vital for managerial decision making, for designing and understanding public policy, and to appreciate how an economy functions. The students need to know how economics can help us to understand what goes on in the world and how it can be used as a practical tool for decision making. Managers and CEO’s of large corporate bodies, managers of small companies, nonprofit organizations, service centers etc., cannot succeed in business without a clear understanding of how market forces create both opportunities and constraints for business enterprises.

Reasons For Studying Economics: Ֆ It is a study of society and as such is extremely important. Ֆ It trains the mind and enables one to think systematically about the problems of business and wealth. Ֆ From a study of the subject it is possible to predict economic trends with some precision. Ֆ It helps one to choose from various economic alternatives . Economics is the science of making decisions in the presence of scarce resources. Resources are simply anything used to produce a good or service to achieve a goal. Economic decisions involve the allocation of scarce resources so as to best meet the managerial goal. The nature of managerial decision varies depending on the goals of the manager. A Manager is a person who directs resources to achieve a stated goal and he/she has the responsibility for his/her own actions as well as for the actions of individuals, machines and other inputs under the manager’s control. Managerial economics is the study of how scarce resources are directed most efficiently to achieve managerial goals. It is a valuable tool for analyzing business situations to take better decisions. Prof. Evan J Douglas

defines

Managerial

Economics

as

“Managerial Economics is concerned with the application of economic principles and methodologies to the decision making process within the firm or organization under the conditions of uncertainty” According to Milton H Spencer and Louis Siegelman “Managerial Economics is the integration of economic theory with business practices for the purpose of facilitating decision making and forward planning by management” According to Mc Nair and Miriam, ‘Managerial Economics consists of the use of economic modes of thoughts to analyze business situations’. Economics can be divided into two broad categories: micro economics and macro economics. Macro economics is the study of the

economic system as a whole. It is related to issues such as determination of national income, savings, investment, employment at aggregate levels, tax collection, government expenditure, foreign trade, money supply etc., Micro economics focuses on the behavior of the individuals, firms and their interaction in markets. Managerial economics is an application of the principles of micro and macro economics in managerial decision making. The economic way of thinking about business decision making provides all managers with a powerful set of tools and insights for furthering the goals of their organization. Successful managers take good decisions, and one of their most useful tools is the methodology of managerial economics. Nature Of Managerial Economics: 1. Managerial economics is concerned with the analysis of finding optimal solutions to decision making problems of businesses/ firms (micro economic in nature). 2. Managerial economics is a practical subject therefore it is pragmatic. 3. Managerial economics describes, what is the observed economic phenomenon (positive economics) and prescribes what ought to be (normative economics) 4. Managerial economics is based on strong economic concepts. (conceptual in nature) 5. Managerial economics analyses the problems of the firms in the perspective of the economy as a whole ( macro in nature) 6. It helps to find optimal solution to the business problems (problem solving) Managerial Economics And Other Disciplines Managerial economics has its relationship with other disciplines for propounding its theories and concepts for managerial decision making. Essentially it is a branch of economics. Managerial economics is closely related to certain subjects like statistics, mathematics, accounting and operations research.

Managerial economics helps in estimating the product demand, planning of production schedule, deciding the input combinations, estimation of cost of production, achieving economies of scale and increasing the returns to scale. It also includes determining price of the product, analyzing market structure to determine the price of the product for profit maximization, which helps them to control and plan capital in an effective manner. Successful mangers make good decisions, and one of their most useful tools is the methodology of managerial economics. Warren E Buffett, the renowned chairman and CEO of Berkshire Hathaway Inc., invested $100 and went on to accumulate a personal net worth of $30 billion. Buffett credits his success to a basic understanding of managerial economics. Buffett’s success is a powerful testimony to the practical usefulness of managerial economics. Managerial economics has a very important role to play by helping managements in successful decision making and forward planning. To discharge his role successfully, a manager must recognize his responsibilities and obligations. There is a growing realization that the managers contribute significantly to the profitable growth of the firms. We can conclude that managerial economics consists of applying economic principles and concepts towards adjusting with various uncertainties faced by a business firm. Circular Flow Of Economic Activity The individuals own or control resources which are necessary inputs for the firms in the production process. These resources (factors of production) are classified into four types. Land: It includes all natural resources on the earth and below the earth. Non renewable resources such as oil, coal etc once used will never be replaced. It will not be available for our children. Renewable resources can be used and replaced and is not depleted with use. Labour: is the work force of an economy. The value of the worker is called as human capital.

Capital: It is classified as working capital and fixed capital (not transformed into final products) Entrepreneurship: It refers to the individuals who organize production and take risks. All these resources are allocated in an effective manner to achieve the objectives of consumers (to maximize satisfaction), workers (to maximize wages), firms (to maximize the output and profit) and government (to maximize the welfare of the society). The fundamental economic activities between households and firms are shown in the diagram. The circular flows of economic activities are explained in a clockwise and counterclockwise flow of goods and services. The four sectors namely households, business, government and the rest of the world can also be considered to see the flow of economic activities. The circular flow of activity is a chain in which production creates income, income generates s...