Business

Economics
Authors:Bilciu Lavinia
Boldojar Ioana
Badescu Victor
Bledea Razvan

Contents
Introduction................................................................................................................ 2
Business Economics................................................................................................... 3
1.Demand function.................................................................................................. 3
2. Law of demand.................................................................................................... 4
3.Exception to the law of demand...........................................................................6
4. Law of Supply...................................................................................................... 7
5. Sales maximization theory.................................................................................. 9
Conclusion................................................................................................................ 12
References................................................................................................................ 13

Introduction
Planning and decision making is the principal function of an executive in a business
organization. Decision making is the process of selecting one action from two or more
alternatives, while the planning means the establishment of the plans for the future. The decision
making function will provide the most efficient means in order to obtain a desired goal. Once a
decision is made, plans are prepared, thus forward planning goes hand in hand with decision
making.
Uncertainty is a characteristic of the conditions in which the organizations work and take
decisions, which makes the decision making process more complicated. Managers are 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. Economic theory deals with a number of
concepts and principles relating, for example, to profit, demand, cost, pricing production,
competition, business cycles, national income, etc., which aided by allied disciplines like
Accounting. Statistics and Mathematics can be used to solve or at least throw some light upon
the problems of business management. The way economic analysis can be used towards solving
business problems, constitutes the subject matter of Business Economics.
The goal of this paper is to provide an insight in Business Economics and its vital role within an
organization.

Business Economics
Business economics is a branch of economics that applies analysis to specific business decisions.
Through the proper use of economic models in decision making, business economics solves
business and administrative problems by prescribing rules for improving managerial decisions.
Being a connection between traditional economics and economics in practice, business
economics can be used to meet short-run objectives and identify ways to achieve goals more
efficiently.

1.Demand function
Demand refers to the quantities of goods that consumers are willing and able to
purchase at various prices during a given period of time.
Qd = f (Po, Pc, Ps, Yd, T, A, CR, R, E, N, 0)

Po- price of the product

Pc-price of complements
Ps- price of subsitutes
Yd-disposable income
T- tastes
A-Advertising
CR- availability of credit
R- rate of interest( price of credit)
E- ecpectations
N- number of potential customers
O- other factors which may influence the demand for a particular product

In the case of the own price of the product, the relationship would be the higher the price the
lower the demand and vice versa. In case of the complements, if the price of the complementary
goods increases there would be a decrease in the demand level for both it and for the good that is
complementary to. In contrast if the price of a substitute good rises, then the demand for the
good that is substitute for will increase. For the fourth variable, the disposable incomes which are
the amount of money that people are willing to spend. The greater the level of the income is,
more people can afford to buy, and therefore there will be an increase in the level of demand.
Over a period of time tastes can change significantly, but this may incorporate a wide range of
factors, for example availability of alternatives, social pressures or changes in technology.

The levels of advertising represents the level of the own product advertising, together with the
substitutes and complements advertising. In general, the advertising for a good results with a
higher the demand for that good. Given the symbiotic relationship between the goods and its
complements, the higher the level of the advertising would be there will be an increase in the
level of demand for it and for the good which it is complementary to.
Variable CR stands for availability of credit while variable R stands for the rate of interest. The
expectations in the demand function may include expectations about price and income changes.
For example if a client expects an increase in a goods price, he may purchase that product in
advance in order to avoid paying a higher price, this will bring an increase in the level of demand
in the short term.
The number of potential customers will vary depending on the target market. The number of
potential customers may be a function of age or location.
The last variable of the function represents any other miscellaneous factors which may influence
the demand for a particular product.
Each product will have its own particular demand function depending on which of the above
variables influence the demand for it.

2. Law of demand
One of the most important building blocks of economic analysis is the
concept of demand. When economists refer to demand, they usually have in
mind not just a single quantity demanded, but a demand curve, which traces
the quantity of a good or service that is demanded at successively different
prices.
Therefore, the law of demand states that people tend to buy
more if the prices are low and the amount demanded falls if the
prices of a good rises. Evidence from economic studies supporting the law
of demand has shown that, assuming that all other things remain equal,
when the price of a good raises then the amount of its demand decreases.
By all other things which stay constant we referred to other five variables like
the income of the consumers, price of related goods and services, tastes or
preference of patters of consumers, expected price of the product in future
periods and the number of consumers in the market.

Demand for a particular product or service represents how much

people are willing to purchase at various prices. Thus, direct demand or
simply demand is a relationship between price and quantity per period of
time, with all other factors that affect consumer demand remaining constant.
Demand is represented graphically as a downward sloping curve with price
on the vertical axis and quantity on the horizontal axis (Fig. 3.1). It can also
be expressed in the most general form as the equation

Qd = f(P)
where the quantity demanded is a function of the price of the good, holding
all other variables constant.
The main reason economists believe so strongly in the law of demand
is that it is so plausible, even to the ones that are not economists. Indeed,
the law of demand is rooted in our way of thinking about everyday things.
Shoppers buy more tomatoes when they are in season and the price is low.
This is evidence for the law of demand: only at the lower, in-season price are
consumers willing to buy the higher amount available. Nobody thinks, for
example, that the way to sell a car that has been weak on the market is to
raise the asking price. Again, this shows an implicit awareness of the law of
demand: the number of potential buyers for any given car varies inversely
with the asking price.
For a better understanding we will take the example of the price of the
languishing cars that are to be sold on the market and represent the demand
in the form of a table (Table 3.1) and in a demand curve (Fig. 3.1).

Table 3.1. The demand schedule

Price (P)

Quantity (Q)

5000

100

4100

160

3200

220

2200

280

So, as it can be seen in the table, a decrease in the asking price of a

car generates more sales of the commodity. Furthermore, any change in

price causes a movement along the curve as shown in Figure 3.1. In this
case, a rise in price from 2200 to 3200 for example, results in a fall in
quantity demanded from 280 to 220.

Demand curve
6000
5000
4000

Price (P)

3000

Demand

2000
1000
0
100

160

220

280

Quantity demanded (Qd )

Figure 3.1 The demand curve

3.Exception to the law of demand

Generally the relationship between price and quantity is negative. This
means that the higher is the price level, the lower will be the quantity
demanded and, conversely, the lower the price the higher will be the
quantity demanded. This is a general rule that applies to most goods called
normal goods. As the price of a normal good increases people buy less of it
because they are usually able to switch to cheaper goods. An example is
butter, which can be substituted for margarine when the price of butter
increases. However there are certain goods that do not follow this general
rule. One such category of goods is called "Giffen goods". With "Giffen
goods", there are no cheap substitutes and these goods are so important to
the livelihood of the consumer that he devotes overwhelmingly more of his
income towards its purchase when the price increases. They are extremely
rare but one popular historical example of this phenomenon is potato during
the Irish potato hunger in the mid-19th century. It has also been suggested
that gasoline may be an example of a modern day "Giffen good".

Another example involves a new car wax, which, when it was

introduced, faced strong resistance until its price was raised from $.69 to
$1.69. The reason, according to economist Thomas Nagle, was that buyers
could not judge the waxs quality before purchasing it. Because the quality of
this particular product was so importanta bad product could ruin a cars
finishconsumers played it safe by avoiding cheap products that they
believed were more likely to be inferior. (Nagle, p. 67)
Other type of goods is those commodities which are used as
status symbols. It happens with some expensive commodities like
diamonds, air conditioned cars etc. which are used as status symbols to
display ones wealth. The more expensive these commodities become, the
higher their value as a status symbol and hence, the greater the demand for
them. The amount demanded of these commodities increase with an
increase in their price and decrease with a decrease in their price.

4. Law of Supply
Supply joins demand as one of the components of fundamental
commodity market analysis. Supply characteristics relate to the behavior of
firms in producing and selling a product or service.
The amount of a good or service offered for sale in a market during a
given period of time is called quantity supplied, which will be denoted as Qs.
The amount of a good or service offered for sale depends on an extremely
large number of variables. As in the case of the demand function all the
unimportant variables are ignored by the economists and only six of them,
which are the major ones, will be kept. These are: the price of the good itself,
the prices of the inputs, the prices of the goods related in production, the
level of available technology, the expectations of the producers concerning
the future price of the good and the number of firms or the amount of
productive capacity in the industry.
However, just as demand function, we will consider the direct supply
function or simply said supply function, which can be displayed
mathematically in functional form as

Qs = f(P)
which expresses the quantity supplied as a function of product price only, all
the other variables remaining constant.

Market supply is represented by an upward sloping curve with price on

the vertical axis and quantity on the horizontal axis as in Figure 4.1 or in the
form of a table as is can be seen below. A supply schedule (or table) shows a
list of several prices and the quantity supplied holding all other variables
constant. Table 4.1. shows four prices and their corresponding quantities
supplied.

Table 4.1. The supply schedule

Price (P)

Quantity (Q)

5000

300

4100

250

3200

200

2200

150

Figure 4.1. graphs the supply curve associated with the supply
schedule (table).

Supply curve
6000
5000
4000
Price (P)

3000

Supply

2000
1000
0
150

200

250

300

Quantity supplied (Qs)

Figure 4.1 The supply curve

An increase in price in most instances will result in producers wanting
to increase the quantity of a given product they will bring to the market;
therefore the relationship between the price and supply is positive. With
higher prices, the producers of goods and services will receive greater
profits. Greater profits will result in the means to expand production
increasing the supply. This increased supply will ultimately satisfy the
existing demand such that any additional production must be met with new
demand in order for the price increases to be sustained. The firms which
handle the manufacturers products are not free to set prices as they choose.
They can raise prices only if consumers are willing and able to pay more.
The law of supply, as was the case with demand, illustrates the
discipline of the marketplace. The market doesn't care what it costs you to
produce something. Lower prices are the market's signal to producers that
they have produced too much of something or that it is something
consumers do not want. To be a good marketer, you need to accept the
"discipline of the marketplace". A good marketer learns to produce for the
market.

5. Sales maximization theory

There are several ways to increase company value and its success on
the market over time. The most controversial ones are the profit

maximization and the sales maximization theories. Both theories imply a

large volume of sales; however the main difference between them is that the
profit maximization theory also assumes that the company will have a
reasonable profit margin. On the other hand, if applying the sales theory,
companies often sell at a loss in order to generate more revenues. Another
difference between the two theories is the time frame. The sales
maximization theory implies increasing revenues on the short-term, while the
profit maximization theory implies a long-run strategy of the company in
order to have a constant inflow of satisfied and loyal customers.
The sales maximization theory, which is closely related to the need to
increase demand, has been first developed by American economist William
Baumol in Business Behavior, Value and Growth (1959). In his book,
Baumol argued that the incentive based compensation of influential
employees may be strongly correlated to the sales maximization theory. The
incentive-based compensation is a remuneration system provided usually to
company executives, but also to sales force, through which the employee is
rewarded for an obtained productivity above prior established standards.
This systems importance is determined by the fact that, as it provides the
bonus incentives for management, it directly influences the economic
efficiency of the business. Thus, managers may be more interested to see a
significant increase in the companys revenues, rather than its profits and,
therefore, may be tempted to act in a different interest than that of the
stakeholders.
However, Baumol also argues that companies should choose a price
that will cover the cost of production, but will also produce a significant profit
margin. We consider that it is more important for companies to choose to
manufacture and sell a quantity of products that will ensure a satisfying
profit, even though it may not achieve sales maximization. The graph below
exemplifies how the sales maximization theory may lead to the highest
increase in revenues, which does not necessarily coincide with the maxium
profit. As such, a greater demand may not always have positive effects for
the company on the long-run.

Revenues, cost and profit

Max Total revenues

Max Profit

Total Costs

Total Revenues

Quantity 1 Quantity 2

Break-even point analysis

Quantity

In order to be able to establish the exact quantity that the company

must produce in order to cover all its costs and to obtain a reasonable profit,
managers must also understand the concept of break-even point of sales.
The break-even point can be defined as the point where the total costs
are equal to the total revenues. This point shows the minimum number of
units that the company must sell in order not to incur any losses. Selling
fewer units than indicated by the break-even point will lead to a negative
overall result of the company, while selling more will lead to profit, as can be
seen on the graph below.

Monetary units

Break-Even Point

Units

Costs

Sales

Profit

Loss

The break-even point can be computed by using the formula:

Total

BEPsales =

Costs

PriceVariable Unit Cost

The break-even analysis is one of the simplest formulas to use when

trying to establish the optimal quantity of products in order to cover both
variable and fixed costs. Its importance is enhanced by the fact that it can
facilitate the decision making process, when managers are trying to forecast
future demand and to adjust production accordingly. If, by applying the
formula, the manager discovers that the current sold quantity is below the
break-even point and the company is operating at a loss, he can take the
appropriate decisions in order to address the situation of the firm. Among the
available choices, we can mention deciding to discontinue a specific product,
improve its design, quality or its advertising, or to reduce its price in order to
increase demand on the market.

Conclusion
In conclusion Business Economics presents those aspects of traditional economics, which are
relevant for business decision making in real life. Moreover it incorporates ideas from other
disciplines such as psychology, sociology and others, if they are found relevant in decision
making. Business Economics helps in reaching a variety of business decisions and giving
answers to questions such as what products and services should be produced?, What inputs
and production techniques should be used? or How should the available capital be allocated?
Therefore the overall role of Business Economics is to increase the efficiency of decision making
in businesses to increase profit.

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