Chapter 1 NATURE AND SCOPE OF BUSINESS

ECONOMICS UNIT 1

INTRODUCTION

1.0 INTRODUCTION

1.0.0 What is Economics about?

 Originated from the Greek word ‘Oikonomia’ which means ‘household’.
 Till 19th century Economics was known as ‘Political Economy’.
 First Modern work of Economics by Adam Smith is named as ‘An Enquiry into the
Nature and Causes of the ‘Wealth of Nations’ (1776) abbreviated as ‘The Wealth of
Nations’.
 There are two fundamental facts that can be concluded with the concept of Economics
:
(i) Human beings have unlimited wants ;and
(ii) The means to satisfy these unlimited wants are relatively scarce forms the
subject matter of Economics.

1.0.1 DEFINITION OF ECONOMICS

1.1 Economics is the study of the processes by which the relatively scarce resources are
allocated to satisfy the competing unlimited wants of human beings in a society.
1.2 This definition of Economics, with the narrow focus on using the relatively scarce
resources to satisfy human wants is domain of modern neo classical micro economic
analysis.

1.2.0 MEANING OF BUSINESS ECONOMICS

 Decision Making refers to the process of selecting an appropriate alternative that will
provide the most efficient means of attaining a desired end ,from two or more alternative
courses of action.
 It means evaluation of feasible alternatives, rational judgment on the basis of information
and choice of particular alternative which the decision maker finds as most suitable.
 As we know the question of choice arises because our productive resources such as land,
labour, capital and management are limited and can be employed in alternative
uses .Therefore more efficient alternatives must be chosen and less efficient alternatives
must be rejected.
 Business Economics also reffered as Managerial Economics refers to the integration
of economic theory with business practice.
 Business Economics applies tools of economics to make business decision making.
 It is Applied Economics that fills the gap between economic theory and business
practice.
 It has close connection with Economic Theory (Micro and Macro Economics), Operation
Research, Statistics, Mathematics and the Theory of Decision Making.
 Business Economics is also useful for managers of ‘not-for -profit’
organisations such as NGO and Voluntary Organisations.

1.3 DEFINITION OF BUSINESS ECONOMICS

 Business Economics may be defined as the use of economic analysis to make business
decisions involving the best use of an organisation’s scarce resources.
 Joel Dean defined Business Economics in terms of the use of economic analysis in the
formulation of business policies.
 Business Economics is essentially a component of Applied Economics as it includes
application of selected quantitative techniques such as linear programming ,regression
analysis ,capital budgeting ,break even analysis and cost analysis.

1.4 NATURE OF BUSINESS ECONOMICS

The following points will describe the nature of Business Economics:

 Business Economics is a Science - Science is a systematized body of knowledge which

establishes cause and effect relationships. Business Economics integrates the tool of
decision sciences such as Mathematics, Statistics and Econometrics with Economic
Theory to arrive at strategies to achieve business goals.

 Based on Micro Economics – Business Manager is concerned about achievement of the

predetermined objectives of his organization so as to ensure the long term survival and
profitable functioning of organization . Since Business Economics is concerned more
with the decision making problems it takes help of micro economics tools.
 Incorporates elements of Macro Analysis – Macro Economics elements like general
price level ,income and employment level in the economy and government policies
related to taxation ,interest rates, exchange rates, industries ,prices, distribution ,wages
etc. affects the business. Business Manager must be acquainted with these elements as
they influence business environment.
 Business Economics is an Art – It involves practical application of rules and
principles for attainment of set objectives.
 Use of Theory of Markets and Private Enterprises – Business Economics uses theory of
firm and resource allocation in backdrop of private enterprise economy.
 Pragmatic in Approach – Business Economics is practical in approach as it tackles
practical problems which the firms face in real world.
 Interdisciplinary in Nature – Business Economics uses tools from other subjects like
Mathematics ,Operation Research, Management Theory, Accounting,
Marketing,Finance,Statistics and econometrics.
 Normative in Nature – Economic Theory has developed along two lines – positive and
normative.
 POSITIVE :
 Positive and Pure Science analyses cause and effect relationship but does
 not involve any judgement.
 It states ‘what is’of the state of affairs.
 It is descriptive in nature and describes the economic behavior of individuals
or society without prescriptions about the desirability of such behavior.
NORMATIVE :
 It involves value judgments.
 It states ‘what should be’ a particular course of action under given circumstances.
 It is prescriptive in nature and in it welfare considerations are embedded.

1.5 SCOPE OF BUSINESS ECONOMICS:

There are two categories of business issues to which economic theories can be directly
applied, namely:
1. Internal Issues or Operational Issues (Solved using Micro Economics)
2. External Issues or Environmental issues (Solved using Macro Economics)

1. Internal Issues or Operational Issues (Solved using Micro Economics):

These are internal issues which arise within the organization and fall within the
purview and control of management.Eg. Product Decisions, Consumer’s Income,
Pricing and Sales Promotion, Financing and Management of Investments.The
following Microeconomic theories deals with most of these issues :
(a) Demand Analysis and Forecasting – It is the technique of predicting
future demand of goods and services on the basis of past behaviours
of factors which affect demand.
(b) Production and Cost Analysis – Production analysis enables the firm
to decide on the choice of appropriate technology and selection of
least cost input mix to achieve technically efficient way of producing
output, given the inputs. Cost analysis enables the firm to recognize
the behavior of costs when variables such as output, time period and
size of plant change.
(c) Inventory management – It pertain to rules that firms can use to
minimize the cost associated with maintaining inventory in form of
work in process, raw material ,finished goods using techniques like
ABC Analysis.
(d) Market Structure and Pricing Policies – Analysis of the structure of
market provides information about the nature and extent of
competition which the firms have to face.This helps in determining
the degree of market power which the firm commands and the
strategies to be followed in market management.Price theory explains
how prices are determined under different kind of market conditions
and assists the firm in framing suitable price policies.
(e) Resource Allocation – Business Economics with the help of
advanced tools such as linear programming helps in optimum
utilization of resources.
(f) Profit Analysis – Profit theory guides the firm in management and
 measurement of profits under conditions of uncertainty and also
helps in future profit planning.
(g) Risk and Uncertainty analysis – Analysis of risks and uncertainties
helps the business firm in arriving at efficient decisions and in
formulating plans on basis of past data ,current information and
future prediction.

Nature & Types of Business Decision

Nature of Business Decision

1. Goal-Oriented Process: Decision-making is a goal-oriented process. It aims at
achieving certain specific goals of the organisation.
2. Selection Process: Decision-making is a selection process in which best alternative
course of action is chosen from the given alternative courses of action.
3. Continuous Process: Decision-making is a continuous process because a manager is
required to take decisions continuously for different activities.
4. Art as Well as Science: Decision-making is considered both an art and a science.
5. Responsibilities of Managers: Decision-making is the responsibility of managers at
different levels of management.
6. 6. Positive as Well as Negative: Decision-making can be both positive and negative
i.e. it may be positive (to perform certain activities) or negative (not to perform
certain activities).
7. 7. Future Course of Action: Decisions are made for future course of action based on
the basis of past experiences and present conditions.

Types of Business Decision

 Production Decisions: Production is an economic activity which supplies goods and

services for sale in a market to satisfy consumer wants thereby profit maximisation is
made possible. The business executive has to make the rational allocation of
available resources at his disposal. He may face problems relating to best
combination of the factors to gain maximum profit or how to use different machine
hours for maximum production advantage, etc.

 Inventory Decision: Inventory refers to the quantity of goods, raw material or other
resources that are idle at any given point of time held by the firm. The decision to
hold inventories to meet demand is quite important for a firm and in certain situation
the level of inventories serves as a guide to plan production and is therefore, a
strategic management variable. Large inventory of raw materials, intermediate goods
and finished goods means blocking of capital.

 Cost Decisions: The competitive ability of the firm depends upon the ability to
produce the commodity at the minimum cost. Hence, cost structure, reduction of cost
and cost control has come to occupy important places in business decisions. In the
absence of cost control, profits would come down due to increasing cost. Business
decisions about the future require the businessmen to choose among alternatives, and
 to do this, it is necessary to know the costs involved. Cost information about the
resources is very essential for business decision making.

 Marketing Decisions: Within market planning, the marketing executive must make
decisions on target market, market positioning, product development, pricing
channels of distribution, physical distribution, communication and promotion. A
businessman has to take mainly two different but interrelated decisions in marketing.
They are the sales decision and purchase decision. Sales decision is concerned with
how much to produce and sell for maximising profit. The purchase decision is
concerned with the objective of acquiring these resources at the lowest possible
prices so as to maximise profit. Here the executive’s basic skill lies in influencing the
level, timing, and composition of demand for a product, service, organisation, place,
person or idea.

 Investment Decision: The problems of risks and imperfect foresight are very crucial
for the investment decision. In real business situation, there is seldom an investment
which does not involve uncertainties. Investment decision covers issues like the
decisions regarding the amount of money for capital investment, the source of
financing this investment, allocation of this investment among different projects over
time. These decisions are of immense significance for ensuring the growth of an
enterprise on sound lines. Hence, decisions on investment are to be taken with utmost
caution and care by the executive.

 Personnel Decision: An organisation requires the services of a large number of

personnel. These personnel occupy various positions. Each position of the
organisation has certain specific contributions to achieve organisational objectives.
Personnel decisions cover the areas of manpower planning, recruitment, selection,
training and development, performance appraisal, promotion, transfer, etc. Business
executives should take personnel decisions as an essential element

Managerial Decision Making Process

Decision making is crucial for running a business enterprise which faces a large number of
problems requiring decisions.

Which product to be produced, what price to be charged, what quantity of the product to be
produced, what and how much advertisement expenditure to be made to promote the sales,
how much investment expenditure to be incurred are some of the problems which require
decisions to be made by managers.

The five steps involved in managerial decision making process are explained below:

1. Establishing the Objective:

The first step in the decision making process is to establish the objective of the business
enterprise. The important objective of a private business enterprise is to maximise profits.
However, a business firm may have some other objectives such as maximisation of sales or
growth of the firm.
But the objective of a public enterprise is normally not of maximisation of profits but to
follow benefit-cost criterion. According to this criterion, a public enterprise should evaluate
all social costs and benefits when making a decision whether to build an airport, a power
plant, a steel plant, etc.

2. Defining the Problem:

The second step in decision making process is one of defining or identifying the problem.
Defining the nature of the problem is important because decision making is after all meant
for solution of the problem. For instance, a cotton textile firm may find that its profits are
declining.

It needs to be investigated what are the causes of the problem of decreasing profits. Whether
it is the wrong pricing policy, bad labour-management relations or the use of outdated
technology which is causing the problem of declining profits. Once the source or reason for
falling profits has been found, the problem has been identified and defined.

3. Identifying Possible Alternative Solutions (i.e. Alternative Courses of Action):

Once the problem has been identified, the next step is to find out alternative solutions to the
problem. This will require considering the variables that have an impact on the problem. In
this way, relationship among the variables and with the problems has to be established.

In regard to this, various hypotheses can be developed which will become alternative courses
for the solution of the problem. For example, in case of the problem mentioned above, if it is
identified that the problem of declining profits is due to be use of technologically inefficient
and outdated machinery in production.

The two possible solutions of the problem are:

(1) Updating and replacing only the old machinery.
(2) Building entirely a new plant equipped with latest machinery.

The choice between these alternative courses of action depends on which will bring about
larger increase in profits.

4. Evaluating Alternative Courses of Action:

The next step in business decision making is to evaluate the alternative courses of action.
This requires, the collection and analysis of the relevant data. Some data will be available
within the various departments of the firm itself, the other may be obtained from the industry
and government.

The data and information so obtained can be used to evaluate the outcome or results
expected from each possible course of action. Methods such as regression analysis,
differential calculus, linear programming, cost- benefit analysis are used to arrive at the
optimal course. The optimum solution will be one that helps to achieve the established
objective of the firm. The course of action which is optimum will be actually chosen. It may
be further noted that for the choice of an optimal solution to the problem, a manager works
under certain constraints.
The constraints may be legal such as laws regarding pollution and disposal of harmful wastes;
they way be financial (i.e. limited financial resources); they may relate to the availability of
physical infrastructure and raw materials, and they may be technological in nature which set
limits to the possible output to be produced per unit of time. The crucial role of a business
manager is to determine optimal course of action and he has to make a decision under these
constraints.

5. Implementing the Decision:

After the alternative courses of action have been evaluated and optimal course of action
selected, the final step is to implement the decision. The implementation of the decision
requires constant monitoring so that expected results from the optimal course of action are
obtained. Thus, if it is found that expected results are not forthcoming due to the wrong
implementation of the decision, then corrective measures should be taken.

Role of Business Economist:

Identifying various business problems: Various companies face many problems such as
labour problems, pricing problems, and other problems related to Government controls and
restrictions. The basic job of business economist is to identify various problems that are
uplifting a company, find out various reasons behind these problems, analyze their effects on
the functioning of the company and finally suggest rational alternative and corrective measures
to be taken by the management. Also, it’s his duty to design various course of action to
maintain & improve the existing systems.

Providing a quantitative base for decision making & forward planning: The business
economics with his vast experience has to provide a quantitative base for decision making,
policy making & forward planning in a business. Business economist helps to study the in-
depth knowledge of the various factors, controllable & non-controllable which influence the
working of a business unit. Business economist helps in planning, production & marketing
planning, employing the latest organizational model & develop management techniques to
maximize output & minimize operating cost of the firm.

Advisory to the company: The business economist advises the businessman on all economic
and non-economic matters. By virtue of business economist experience it helps to analyze
various problems related with volume of investment, sales promotion, competitive conditions,
financial positions, labour relation, and Government policies so that he it will help to secured
the business while doing every activity. Business economist must be in touch with fast
changing technological development and suggest the most suitable information technology to
be adopted by the company.

Knowledge about the environment factors which affects the business: In order to make the
business more viable and profitable the business economist should have a detailed knowledge
and information about the environment of a company.
Broadly speaking the environmental factors are divided in two parts:
1. Business Environment (External Factors)
2. Business Operations (Internal Factors)
Business Environment helps to study the all factors and forces and beyond the control of
individual business enterprises and its management which will help to maintained the business
as stable. Business operation helps to study those factors and forces, which operate, well within
the company and influence its operations which can minimize the cost of the business.
The Responsibilities of a Business Economist:

The term ‘responsibility’ refers to the obligations that a person has to perform to attain certain
objectives. With rapid expansion and diversification of business activities the responsibilities of
a business economist also has increased. The important responsibilities of a business economist
are:-
1) Reasonable profit: Profit maximization is the most important objective of any firm. The
success or the failure of any business firm will be assessed on the basis of its profit earning
capacity. Hence it is one of the major responsibility of a business economist to ensure a
reasonable amount of profit to a business enterprise.
2) Business forecasting: Most managerial decisions necessarily concern the future, which is
rather uncertain. So it is essential that business economist make successful forecasts. By
making best possible forecast and through continuous efforts. He should aim at minimizing the
risk involved in the business, if not it is possible to completely eliminate them. He must make
periodical studies and forecasts regarding the internal and external factors affecting the growth
and stability of the firm. Business forecast is like weather forecast. As such in the midst of
uncertainties the forecast should suggest how to withstand economic fluctuations.
3) To have contact with the data sources: A business economist should establish and maintain
contracts with various experts, marketing consultants and data sources to collect latest and
valuable information to take right decision at right time.
4) Technological development: A business decision is taken within the framework of
technology. So a business economist should keep in touch with the changing developments in
technology. A new substitute product of new technology may affect the existing product market
adversely.
5) Government policies: A business firm operates in the general economic and institutional
framework of the economy and government policies create a profound impact on business
condition. So a business economist has to have a full knowledge of the behaviour of the
economy and the impact of macroeconomic policies like monetary and fiscal policies on
business environment.
6) Finance: A business economist should advise the business man in financial matters.
Particularly regarding the availability of alternative sources of finance.
7) Location: A business economist should suggest the place that is economically suitable for the
starting the industry.
8) Objectives: A businessman has both short-term and long-term objectives. Sometimes the
achievement of short term objective (Profit maximization) comes in the way of the achievement
of the long-term objective (sales maximization). So a business economist should help the firm
in reconciling the conflicting ones.
9) To undertake Research Activities: Market research is common these days to know the
requirements of the customers.
10) Specific functions: K. J. W. Alexandar and Alexandar G. Kemp have listed specific
responsibilities for business economists. They are: a) Sales forecasting b) Economic analysis of
the industry. c) Production programmes. d) Advice on trade and public relations. e) Analysing
the changing economic situations in the country as well as abroad. f) Environmental forecasting