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 todays 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. 8

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 Monopoly
1. 2. 3. 4. 5. 6. Single seller No close substitutes No variation between firm and industry Entry is fully restricted Product is unique 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. 21

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.
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