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Economic Concepts Relevant to Business

Demand/ Supply/ Production/ Distribution/ Consumption/

Consumption function/ Cost/ Price/ Competition/ Monopoly/ Profit/

Optimisation/ Marginal-Average/ Elasticity/ Macro and Micro analysis

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Economic concepts• In today’s context, can we find a business

paper/ magazine/ discussion without economic concepts?

• Heads of governments/ business leaders are talking primarily economic issues/ enhancing or exploring new economic areas of cooperation

• All conflicts between men/ states/ countries in future will be largely economic conflicts

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So..what?• Business moves where economy is sound;

and economy is sound where business happens.

• Stronger the nation economically, world gives greater weight to it

• Large market/ cheap labour/ qualified personnel/ stable interest rates and tax rates/ committed workforce/ low corruption/ law and order, etc. create good business climate

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1. Demand• Most widely used/ misused/ abused word of

economics• A person desperately needs blood/ life-saving

drug without which he is sure of getting deleted from population list. Can we take him as a person constituting “demand” for blood or LSD?

• Suppose there is one car agency. Can it consider all/ most of rich persons in a given locality who do not possess cars for “demand”?

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Demand…• Two conditions must be there:

– Willingness to buy– Ability to pay

• Both of them must exist simultaneously – Potential demand – Actual demand

• How accurate are demand forecasts? Reasons• Can any firm afford NOT to forecast?• Why recessions occur? What happens to the

output? Planned & unplanned inventory

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2. Supply• Production and supply• Supply refers to the amount of quantity of a good/

service willing and able to offer for sale by producers at a given price, during a given time and at a given place.

• Supply function relates quantity supplied with own price, related goods’ prices, Technology, input prices, weather/ Road conditions, transportation, movement restrictions, so on)

• Supply Curve shows a positive association between Qs and P, ceteris paribus.

• Difference between Output and Supply

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Shape of Supply Curve• The normal shape of supply curve is upward

slopping from left to right. It indicates, cost of production remaining constant/ decreasing, higher the price, larger is the profit. Hence, greater incentive to raise supply.

• Based on the time period, namely Market Period, short period, long period and secular period, shape of supply curve may be vertical, steeper or flatter.

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Market Clearance• Both demand and supply interact to

determine the market equilibrium

• Depending on which kind of market and time period, each force has its role on market.

• While demand and supply are influenced by a number of factors

• In very short run, supply is given, medium run there is some scope for increase and in long run, it is fully flexible.

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3. Consumption• An unavoidable human activity which

satisfies individuals by fulfilling wants-both economic and non-economic

• Goods and services possess utility or want satisfying quality in them

• Since goods and services cost us, we COMPARE the benefit (utility) and costs (price)

• Two laws of consumption– Diminishing utility– Equi-marginal utility

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Consumption function• An algebraic relationship between national

income and consumption spending that tells us what, for each possible level of national income, the level of consumption spending will be.

• What will be the level of consumption if income is zero?

• (Income on X axis, Consumption on Y axis and the linear curve has a positive intercept)– Marginal propensity to consume (MPC)– Psychological law of consumption

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4. Production• Conversion of inputs into output (Ag/ Ind/

Mfg)

• Creation of utility (services)

• Controversy to exclude/include services in GDP

• Traditional factors of production (L, L, C, O)

• How can production be increased?– Increasing one input keeping others same– Increasing all inputs

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Production..contd• Law of variable proportions (TP, AP, MP)

• Law of returns to scale (only MP)

• Quantitative example/ diagrams

• Applicability of these laws

• Assumptions:– State of technology remains constant– At least one factor must be kept constant– Contribution of fixed input does not get

influenced by varying factor

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How to interpret phases in law of variable proportions

• Increasing returns is the first phase

• Diminishing marginal returns

• Diminishing average returns

• Do we see the third stage in practice?– Reason-Technological improvement

• Measurement of factor efficiency in practice

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5. Distribution• What is the value of our GDP in rupees terms

at current prices for the year 2010-11?

• How to interpret that value?

• Distribution refers to sharing of the national product among the groups of individuals as factors of production.

• Factors of production/ factor payments

• Land, labour, capital, organization (features)

• Wages, rent, interest, and profit

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How payments get determined?

• The criteria are ideal (based on marginal product) / legal (wages determined as per laws in organized sector) / demand-supply factors (higher demand for labour provides it higher wage, vice versa)

• Profits get determined only towards the end.

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6. Cost• Cost in accounting sense is different from

cost in economic sense.• Money costs and real costs• Opportunity cost• Implicit cost & explicit cost• Short run versus long run • fixed Vs Variable Costs• Total/ Marginal/ Average cost and their

significance in subsequent analysis

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7. Price• Money value of all economic goods/

services. What are non-economic goods?• What is the basis for some goods to have a

price?• Factors that determine price

– Cost of production (all material inputs, other factors like transportation, tax, climate, etc)

– Demand (why gold price shot up to 6-year high?)

• Who monitors price level and why inflation is a major macro variable?

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8. Competition• In economics, competition is judged on the

basis of number of sellers in the market for a product or service

• A continuum from Monopoly to perfect competition

• Worldwide, the trend is to ensure greater competition

• What are merits and limitations of competition?

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9. Monopoly• In Greek, ‘Mono’ means single, ‘Poly’

means seller. • In contrast to PC, Monopoly is an

extremely imperfect competition• Monopoly is a market form in which a

single producer/ firm supplies a good/ service which has no close substitute.

• The monopolist is a price-maker• He can virtually decide to fix any price/

supply but not both of them simultaneously

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Features of Monopoly1. Single seller

2. No close substitutes

3. No variation between firm and industry

4. Entry is fully restricted

5. Product is unique

6. Huge profits is common phenomenon in LR.

7. But, Normal Profits/ occasionally even losses are not ruled out in short run

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10. Profit• Difference between total revenue and Total cost• Profit is reward for organizing other factors of

production and also for taking business risks• Profits arise in a dynamic world due to the

presence of uncertainty.• Do profits conflict with societal interest?• No. Primary responsibility of a business firm is to

ensure its own economic performance which is to utilize resources optimally.

• If a firm does not do so, no only it collapses, in the process, it ruins society also by adding to unemployment/ low demand for material inputs/ fall in investments, etc.

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11. Optimization• Fundamental rule of economics is to conserve

resources which are all scarce.• “Optimum” utilization is a relative term. It

depends on the existing know-how at a point in time.

• For instance, when the 2-stroke engines alone were there, a mileage of about 40-45 kmpl was a better utilization.

• Faster trains/ data transmission rates/ search engines on Internet, etc. are optimizing out time and cost.

• Division of labour and specialization lead to optimum use of resources

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12. Marginal and Average concepts

• The rate of increase matters to make some judgments about inputs

• Marginal product is the change in total product for a unit change in one input

• Average product talk about how efficiency in inputs is varying as one input gets added

• Declining average cost is good/ increasing average product is preferred

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13. Elasticity• Degree of responsiveness of some

dependent variable like demand/ supply/ output given some change in one of the variable input.

• It could be positive/ negative– Example of price elasticity of demand

• This concept is used in managerial economics to give us hint as to when the price needs to be reduced.

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14. Micro and Macro Analysis• Microeconomics deals with constituent

units of an economic system like– Consumer/ One firm/ price of a product/ wage

paid to workers in a firm/ etc.

• Macroeconomics deals with the aggregates like– National income, money supply, level of

employment, inflation, trade balance, public debt, etc.

• Both are complimentary and can not be substituted one for the other

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To sum up..• Good business climate is essential for economy to

flourish • Some economic concepts were discussed to

highlight their role in business• A business analysis remains incomplete without

proper use of relevant economic concepts• Economic activities/ Costs/ optimization/

elasticity/ micro and macro analyses were some concepts covered here that give enough clarity for the topics to be covered, and improve understanding of business in general.