Business Economics :

Business economics is a discipline which deals with the application of economic theory to
business management. It deals with the use of economic concepts and principles of business
decision making. Formerly it was known as “Business Economics” but the term has now
been discarded in favour of Business Economics. Business Economics may be defined as the
study of economic theories, logic and methodology which are generally applied to seek
solution to the practical problems of business. Business Economics is thus constituted of that
part of economic knowledge or economic theories which is used as a tool of analysing
business problems for rational business decisions. Business Economics is often called as
Business Economics or Economic for Firms.
Definition of Business Economics: “Business Economics is economics applied in decision
making. It is a special branch of economics bridging the gap between abstract theory and
Business practice.” – Haynes, Mote and Paul. “Business Economics consists of the use of
economic modes of thought to analyse business situations.” - McNair and Meriam “Business
Economics (Business Economics) is the integration of economic theory with business
practice for the purpose of facilitating decision making and forward planning by
management.” - Spencerand Seegelman. “Business economics is concerned with application
of economic concepts and economic analysis to the problems of formulating rational
Business decision.” – Mansfield Nature of Business Economics:

• The primary function of management executive in a business organisation is decision

making and forward planning.
• Decision making and forward planning go hand in hand with each other. Decision making
means the process of selecting one action from two or more alternative courses of action.
Forward planning means establishing plans for the future to carry out the decision so taken.
• The problem of choice arises because resources at the disposal of a business unit (land,
labour, capital, and Business capacity) are limited and the firm has to make the most
profitable use of these resources.
• The decision making function is that of the business executive, he takes the decision which
will ensure the most efficient means of attaining a desired objective, say profit maximisation.
After taking the decision about the particular output, pricing, capital, raw-materials and
power etc., are prepared. Forward planning and decision-making thus go on at the same time.
• A business manager’s task is made difficult by the uncertainty which surrounds business
decision-making. Nobody can predict the future course of business conditions. He prepares
the best possible plans for the future depending on past experience and future outlook and yet
he has to go on revising his plans in the light of new experience to minimise the failure.
Managers are thus engaged in a continuous process of decision making through an uncertain
future and the overall problem confronting them is one of adjusting to uncertainty.
• In fulfilling the function of decision-making in an uncertainty framework, economic theory
can be, pressed into service with considerable advantage as it deals with a number of
concepts and principles which can be used to solve or at least throw some light upon the
problems of business management.
 E.g are profit, demand, cost, pricing, production, competition, business cycles, national
income etc. The way economic analysis can be used towards solving business problems,
constitutes the subject-matter of Business Economics.
• Thus in brief we can say that Business Economics is both a science and an art.
Scope of Business Economics: The scope of Business economics is not yet clearly laid out
because it is a developing science. Even then the following fields may be 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 divisions of business economics constitute its subject matter. Recently, Business
economists have started making increased use of Operation Research methods like Linear
programming, inventory models, Games theory, queuing up theory etc., have also come to be
regarded as part of Business Economics.
1.Demand Analysis and Forecasting: A business firm is an economic organisation which is
engaged in transforming productive resources into goods that are to be sold in the market. A
major part of Business decision making depends on accurate estimates of demand. A forecast
of future sales serves as a guide to management for preparing production schedules and
employing resources. It will help management to maintain or strengthen its market position
and profit base. Demand analysis also identifies a number of other factors influencing the
demand for a product. Demand analysis and forecasting occupies a strategic place in Business
Economics.
2.Cost and production analysis: A firm’s profitability depends much on its cost of
production. A wise manager would prepare cost estimates of a range of output, identify the
factors causing are cause variations in cost estimates and choose the cost minimising output
level, taking also into consideration the degree of uncertainty in production and cost
calculations. Production processes are under the charge of engineers but the business
manager is supposed to carry out the production function analysis in order to avoid wastages
of materials and time. Sound pricing practices depend much on cost control. The main topics
discussed under cost and production analysis are: Cost concepts, cost-output relationships,
Economics and Diseconomies of scale and cost control.
3.Pricing decisions, policies and practices: Pricing is a very important area of Business
Economics. In fact, price is the genesis of the revenue of a firm ad as such the success of a
business firm largely depends on the correctness of the price decisions taken by it. The
important aspects dealt with this area are: Price determination in various market forms,
pricing methods, differential pricing, product-line pricing and price forecasting.
4.Profit management: Business firms are generally organized for earning profit and in the
long period, it is profit which provides the chief measure of success of a firm. Economics
tells us that profits are the reward for uncertainty bearing and risk taking. A successful
business manager is one who can form more or less correct estimates of costs and revenues
likely to accrue to the firm at different levels of output. The more successful a manager is in
 reducing uncertainty, the higher are the profits earned by him. In fact, profit-planning and
profit measurement constitute the most challenging area of Business Economics.
5.Capital management: The problems relating to firm’s capital investments are perhaps the
most complex and troublesome. Capital management implies planning and control of capital
expenditure because it involves a large sum and moreover the problems in disposing the
capital assets off are so complex that they require considerable time and labour. The main
topics dealt with under capital management are cost of capital, rate of return and selection of
projects. Conclusion: The various aspects outlined above represent the 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 Economics consists of applying economic principles and concepts
towards adjusting with various uncertainties faced by a business firm.

Business Decision Making Process

Business decisions are often made under uncertainty and there comes the role of prediction
and forecasting. The theory of business economics, coupled with quantitative techniques
specific to economic data (called Econometrics) provide valuable insights about the decisions
to be made by producing accurate forecasts of key business variables like demand, price,
sales, manpower, inventories etc. It shows, based on objective analysis, what might be the
optimal strategy given the objectives and the constraints faced by the management.

Thus, the role of economics in business may be categorized in three functions. First, the
manager with exposure to economics may identify various problems hindering the growth of
the organization, explain why this is happening and analyse the possible effects in the short
and long run on the functioning of the organisation. S/he is capable of suggesting an
alternative action plan which is rational and implementable. Second, business economics,
based on quantitative analysis, can provide an objective basis for decision/policy making and
advance planning. Third, armed with the expertise on quantitative techniques along with the
knowledge of the theory of economics, managers with thorough exposure to economics
develops an acumen for analysis. It helps one to analyze various problems related to any
other domain apart from economic issues in business, be it sales promotion, volume of
investment, nature and extent of competition and analysing the competitors, or financial
positions, labour relation, Government policies. It takes into account several factors that
might affect the macro business environment and the repercussion on the industry/ sector, and
also the firm. Therefore, the contribution of the business economics in decision making may
be summarized in the following functions:

 Minimising risk and uncertainty

 Profit Planning and Control
 Demand and Sales Forecasting
 Measuring Efficiency
 Analysing effects of government policies

Marginal and Incremental Principle

This principle states that a decision is said to be rational and sound if given the firm’s
objective of profit maximization, it leads to increase in profit, which is in either of two
scenarios-

 If total revenue increases more than total cost.

 If total revenue declines less than total cost.

Marginal analysis implies judging the impact of a unit change in one variable on the other.

Marginal generally refers to small changes.

Marginal revenue is change in total revenue per unit change in output sold.

Marginal cost refers to change in total costs per unit change in output produced (While
incremental cost refers to change in total costs due to change in total output).

The decision of a firm to change the price would depend upon the resulting impact/change in
marginal revenue and marginal cost. If the marginal revenue is greater than the marginal cost,
then the firm should bring about the change in price.

Incremental analysis differs from marginal analysis only in that it analysis the change in the
firm's performance for a given managerial decision, whereas marginal analysis often is
generated by a change in outputs or inputs.

Incremental analysis is generalization of marginal concept. It refers to changes in cost and

revenue due to a policy change. For example - adding a new business, buying new inputs,
processing products, etc.

Change in output due to change in process, product or investment is considered as

incremental change.

Incremental principle states that a decision is profitable if revenue increases more than costs;
if costs reduce more than revenues; if increase in some revenues is more than decrease in
others; and if decrease in some costs is greater than increase in others.

Equi-marginal Principle

Marginal Utility is the utility derived from the additional unit of a commodity consumed. The
laws of equi-marginal utility states that a consumer will reach the stage of equilibrium when
the marginal utilities of various commodities he consumes are equal.

According to the modern economists, this law has been formulated in form of law of
proportional marginal utility. It states that the consumer will spend his money-income on
different goods in such a way that the marginal utility of each good is proportional to its
price, i.e.,

MUx/Px = MUy/Py = MUz/Pz

Where, MU represents marginal utility and P is the price of good.

Similarly, a producer who wants to maximize profit (or reach equilibrium) will use the
technique of production which satisfies the following condition:
MRP1/MC1 = MRP2/MC2 = MRP3/MC3

Where, MRP is marginal revenue product of inputs and MC represents marginal cost.

Thus, a manger can make rational decision by allocating/hiring resources in a manner which
equalizes the ratio of marginal returns and marginal costs of various use of resources in a
specific use.

Opportunity Cost Principle

By opportunity cost of a decision is meant the sacrifice of alternatives required by that

decision. If there are no sacrifices, there is no cost.

According to Opportunity cost principle, a firm can hire a factor of production if and only if
that factor earns a reward in that occupation/job equal or greater than it’s opportunity cost.

Opportunity cost is the minimum price that would be necessary to retain a factor-service in
it’s given use. It is also defined as the cost of sacrificed alternatives.

For instance, a person chooses to forgo his present lucrative job which offers him INR 50,000
per month, and organizes his own business. The opportunity lost (earning INR 50,000) will
be the opportunity cost of running his own business.

Time Perspective Principle

According to this principle, a manger/decision maker should give due emphasis, both to
short-term and long-term impact of his decisions, giving apt significance to the different time
periods before reaching any decision.

Short-run refers to a time period in which some factors are fixed while others are variable.
The production can be increased by increasing the quantity of variable factors. While long-
run is a time period in which all factors of production can become variable. Entry and exit of
seller firms can take place easily.

From consumers point of view, short-run refers to a period in which they respond to the
changes in price, given the taste and preferences of the consumers, while long-run is a time
period in which the consumers have enough time to respond to price changes by varying their
tastes and preferences.

Discounting Principle

According to this principle, if a decision affects costs and revenues in long-run, all those
costs and revenues must be discounted to present values before valid comparison of
alternatives is possible. This is essential because a rupee worth of money at a future date is
not worth a rupee today.

Money actually has time value. Discounting can be defined as a process used to transform
future dollars into an equivalent number of present dollars. For instance, $1 invested today at
10% interest is equivalent to $1.10 next year.

FV = PV*(1+r)t
Where, FV is the future value (time at some future time), PV is the present value (value at t0,
r is the discount (interest) rate, and t is the time between the future value and present value.

RELATIONSHIP OF BUSINESS ECONOMICS WITH OTHER DISCIPLINES

1. Business Economics and Statistics
Statistical tools are playing very important role in business decision-making. Statistical
techniques are used in collecting, processing and analyzing data, testing the validity of the
economic laws with the real economic phenomenon before they are applied to business
analysis. Probable economic events are the basis of a good business decision. Various
statistical tools Such as theory of probability, forecasting techniques etc., help the decision-
makers in the prediction of future economic events.

2. Business Economics and Mathematics

The main challenge of a businessman is how to minimize cost or how to maximize profit or
how to optimize sales. To find the answers of these questions, various mathematical concepts
and techniques are widely used in economic logic. The knowledge of geometry, trigonometry
and algebra is not only important but various mathematical tools and techniques such as
logarithms and exponentials, vectors, matrix, calculus, differential and integral are also
necessary for managerial economics.

3. Business Economics and Accounting

Various data are required by a managerial economist for the decision-making purpose.
Accounting details are included in data. For example, the profit and loss statement of a firm
gives details about the performance of the firm and guides the managerial economist to
prepare the future course of action-whether it should improve or close down

4. Business Economics and Operations Research

Models and tools of operations research or quantitative techniques are affecting the business
economics. Operations research is a subject that consists of a number of models and
analytical tools which are developed on the basis of inter-disciplinary research for solving
complex problems of planning and allocation of scarce resources, primarily in defense
industries.

Business economics has generalised and developed the models and tools of operations
research for the purpose of business decision-making. Linear programming models, inventory
models, game theory, etc. are a few tools that have originated in the works of operation
researchers.

5. Business Economics and Theory of Decision-Making

Decision theory has been developed to deal with problems of choice or decision- making
under uncertainty, where the applicability of figures required for the utility calculus are not
available. Economic theory is based on the assumptions of a single goal whereas decision
theory breaks new grounds by recognizing multiplicity of goals and persuasiveness of
uncertainty in the real world of management.

Role of a Managerial Economist

The role of managerial economist can be summarized as follows:

1. He/She studies the economic patterns at macro-level and analysis it’s significance to
the specific firm he is working in.
2. They have to consistently examine the probabilities of transforming an ever-changing
economic environment into profitable business avenues.
3. He/She assists the business planning process of a firm.
4. He/She also carries cost-benefit analysis.
5. They assists the management in the decisions pertaining to internal functioning of a
firm such as changes in price, investment plans, type of goods/services to be
produced, inputs to be used, techniques of production to be employed, expansion/
contraction of firm, allocation of capital, location of new plants, quantity of output to
be produced, replacement of plant equipment, sales forecasting, inventory forecasting,
etc.
6. In addition, a managerial economist has to analyze changes in macro- economic
indicators such as national income, population, business cycles, and their possible
effect on the firm’s functioning.
7. He/She is also involved in advicing the management on public relations, foreign
exchange, and trade. He guides the firm on the likely impact of changes in monetary
and fiscal policy on the firm’s functioning.
8. He/She also makes an economic analysis of the firms in competition. He has to collect
economic data and examine all crucial information about the environment in which
the firm operates.
9. The most significant function of a managerial economist is to conduct a detailed
research on industrial market.
10. In order to perform all these roles, a managerial economist has to conduct an elaborate
statistical analysis.
11. He must be vigilant and must have ability to cope up with the pressures.
12. He also provides management with economic information such as tax rates,
competitor’s price and product, etc. They give their valuable advice to government
authorities as well.
13. At times, a managerial economist has to prepare speeches for top management

Utility Concept: measures the level of satisfaction that a consumer receives from any basket
of goods. The levels show a ranking
U=F(x1,x2,x3, ….., xn), where the x ’s are quantities of n goods that might be consumed in a
period
Utility is an ordinal concept: the precise magnitude of the number that the function assigns
has no significance.
Marginal Utility
Marginal Utility: Rate at which total utility changes as the level of consumption rises.
Each new muffin makes you happier, but makes you happier by smaller and smaller amount.
The marginal utility: of a good, x, is the additional utility that the consumer gets from
consuming a little more of x when the consumption of all the other goods in the consumer’s
basket remain constant.
ΔU/Δx (y held constant) = MUx =∂ U/∂ x
ΔU/Δy (x held constant) = MUy =∂ U/∂ y n …or…the marginal utility of x is the slope of
the utility function with respect to x.
The principle of diminishing marginal utility: states that the marginal utility falls as the
consumer consumes more of a good