SATHYABAMA INSTITUTE OF SCIENCE AND TECHNOLOGY

School of Management Studies

BUSINESS ECONOMICS

(SBAA1103)

UNIT 1

Introduction
Political Economy is another name of Economics. “Polis “in Greek means a state. The term
Political economy means the management of the wealth of the state. The state is expected to
get maximum benefit for the society. The situation that prevails in real world. The means which
satisfy our wants are limited. Time and money are limited. Land ,labour and capital used for
production are limited. Science has increased our resources but our want also has increased.

• Two major factors are responsible for the emergence of economic problems. They are :

• The existence of unlimited human wants and

• The scarcity of available resources

• The numerous human wants are to be satisfied through the scarce resources available in
nature.

• Economics deals with how the numerous human wants are to be satisfied with limited
resources.

• Thus, the science of economics centers on want-effort-satisfaction.

• Economics not only covers the decision-making behavior of individuals but also the macro
variables of economics like national income, public finance, international trade and so on.
DEFINITIONS OF ECONOMICS
• Several definitions of Economics have been given. For the sake of convenience let us
classify the various definitions into four groups:

1. Science of wealth

2. Science of material well-being

3. Science of choice making and

4. Science of dynamic growth and development

1. Science of wealth
✓ Some earlier economists defined Economics as follows:
• “An inquiry into the nature and causes of the wealth of the nations’’ by Adam
Smith.
• “Science which deals with wealth" by J.B. Say.
✓ In the above definition wealth becomes the main focus of the study of Economics.
✓ This definition by Adam Smith ,is the first important and comprehensive definition.
✓ Science of wealth definition has two dimensions
✓ Meaning of wealth and

✓ Causes of wealth

Features of wealth definition

Characteristics
• It takes wealth into account only material goods
• Exaggerated the emphasis on wealth
• It inquires the causes behind creation of wealth
 Criticisms
• It considered economics as a dismal or selfish science
• It defined wealth in a very narrow and restricted sense
• It considered only material and tangible goods
• It gave emphasis only to wealth and reduced man to secondary place

2. Science of material well-being

✓ Under this group of definitions the emphasis is on welfare as compared with wealth in the
earlier group.
✓ Two important definitions are as follows:
• "Economics is a study of mankind in the ordinary business of life. It examines
that part of individual and social action which is most closely connected with the
attainment and with the use of the material requisites of well-being. Thus, it is on
the one side a study of wealth and on the other and more important side a part of
the study of the man", Alfred Marshall

✓ Second Definition: "The range of our inquiry becomes restricted to that part of social
welfare that can be brought directly or indirectly into relation with the measuring rod of
money “Pigou.
✓ In the first definition Economics has been indicated to be a study of mankind in the
ordinary business of life. By ordinary business we mean those activities which occupy
considerable part of human effort.
✓ The fulfillment of economic needs is a very important business which every man
ordinarily does.
✓ Professor Marshall has clearly pointed that Economics is the study of wealth but more
important is the study of man. Thus, man gets precedence over wealth.
✓ The second definition by Pigou emphasizes social welfare but only that part of it which
can be related with the measuring rod of money.
✓ Money is general measure of purchasing power by the use of which the science of
Economics can be rendered more precise.
Features of welfare definition
Characteristics
• It is primarily the study of mankind
• It is one side the study of wealth and other side the study of man
• It takes account ordinary business of life – it is not concerned with social, religious and
political aspects of man’s life
• It emphasizes on material welfare ie human welfare which is related to wealth
• It limits the scope of activities, to measurement in terms of money
Criticisms
• It considers economics as a social science rather than a human science
• It restricts the scope of economics to the study of persons living in organized communities
only
• Welfare in itself has a wide meaning which is not made clear in definition

✓ Their definitions are criticized on the following grounds.

(i) Economics is concerned with not only material things but also with immaterial
things like services of singers, teachers, actors etc. Marshall and Pigou chose to
ignore them.
(ii) Robbins criticized the welfare definition on the ground that it is very difficult
to state Which things would lead to welfare and which will not. He is of the view
that we would study in Economics all those goods and services which carry a price
whether they promote welfare or not.
3. Science of choice making
✓ Robbins gave a more scientific definition of Economics. (scarcity definition)
✓ "Economics is the science which studies human behavior as a relationship between ends
and scarce means which have alternative uses".

(i) Economics is a science: Economics studies economic human behavior scientifically. It

studies how humans try to optimize (maximize or minimize) certain objective under given
constraints.
For example, it studies how consumers, with given income and prices of the commodities, try to
maximize their satisfaction.
(ii) Unlimited ends: Ends refer to wants. Human wants are unlimited. When one want is
satisfied, other wants crop up. If man's wants were limited, then there would be no
economic problem.
(iii) Scarce means: Means refer to resources. Since resources (natural productive resources,
man-made capital goods, consumer goods, money and time etc.) are limited economic
problem arises.
If the resources were unlimited, people would be able to satisfy all their wants and there would be
no problem.
(iv) Alternative uses: Not only resources are scarce, they have alternative uses.
For example, coal can be used as a fuel for the production of industrial goods, it can be used for
running trains, it can also be used for domestic cooking purposes and for so many purposes.

✓ Robbins has made Economics a scientific study and his definition has become popular
among some economists.
✓ But his definition has also been criticized on several grounds. Important ones are:
(i) Robbins has made Economics quite impersonal and colorless. By making it a complete
positive science and excluding normative aspects he has narrowed down its scope.
(ii) Robbins' definition is totally silent about certain macro-economic aspects such as
determination of national income and employment.
4. Science of dynamic growth and development
• Professor Paul A Samuelson supported the views expressed by Robbins. There are many
common points in the definition of Robbins and Samuelson.
• He emphasized that the central issue to be dealt in economics is the problem of making
choice.
• Every individual has to allocate his scarce resources among alternative uses such that his
economic wellbeing gets maximized.
• A modern and modified definition is as follows:
• "Economics is the study of how men and society choose, with or without the use of money,
to employ scarce productive resources which could have alternative uses, to produce
various commodities over time and distribute them for consumption now and in the future
amongst various people and groups of society".
• Paul A. Samuelson - “The above definition is very comprehensive because it does not
restrict to material well-being or money measure as a limiting factor. But it considers
economic growth over time.

NATURE OF ECONOMICS
(a) Economics is a science: A subject is considered science if
✓ It is a systematized body of knowledge which studies the relationship between cause and
effect.
✓ It is capable of measurement.
✓ It has its own methodological apparatus. It should have the ability to forecast.
✓ If we analyze Economics, we find that it has all the features of science. Like science it
studies cause and effect relationship between economic phenomena.
✓ But it is to be noted that Economics is not a perfect science.
✓ This is because Economists do not have uniform opinion about a particular event.
✓ The subject matter of Economics is the economic behavior of man which is highly
unpredictable.
(b) Economics is an art:
✓ Art is nothing but practice of knowledge.
✓ Whereas science teaches us to know art teaches us to do.
✓ Unlike science which is theoretical, art is practical. If we analyze Economics, we find that
it has the features of an art also. Its various branches, consumption, production, public
finance, etc. provide practicality solutions to various economic problems.
✓ It helps in solving various economic problems which we face in our day-to-day life.
✓ Thus, Economics is both a science and an art.
✓ It is science in its methodology and art in its application.
✓ Study of unemployment problem is science but framing suitable policies for reducing the
extent of unemployment is an art.

ECONOMICS : POSITIVE OR NORMATIVE SCIENCE

• As Asimakopulos puts it “Positive economics can be defined as a body of systematized
knowledge concerning what is ,while normative economics tries to develop criteria for
what ought to be”
• Positive economics is mainly concerned with the description of economic events and it
tries to formulate theories to explain them.
• Normative economics gives more importance to ethical judgements. It is concerned with
the ideal rather than the actual situations.
• Statements on economics may be classified into positive statements and normative
statements.
• If there is disagreement over a statement, we can find out whether it is true or false by
verifying the facts.
• But when there is disagreement over a normative statement, we cannot settle the issue
simply by appealing to the facts.

• The questions like, in positive economics. Eg

• What are the policies that the government follow to reduce unemployment?
• What should you do to reduce inflation are questions?
• "Do higher minimum wages cause higher rates of youth unemployment?"
 • If we ask the questions like, Normative question Eg
• Should the government be concerned about unemployment than inflation? “Then it
is normative”
• "Are higher minimum wages better for young workers?"

MICRO-ECONOMIC ANALYSIS
✓ The subject matter of economics consists of two parts, namely Micro economics and Macro
economics.
✓ Ragnar Frisch. Who is among the first Nobel laureates in Economics coined these term.
Which are now universally used
✓ "Micro" is derived from the Greek word “Mikros" meaning small and
✓ "Macro" from "Makros" meaning large.
✓ In Micro–Economics we study the economic behavior of an individual, firm or industry in
the national economy.
✓ It is thus a study of a particular unit rather than all the units combined.
✓ We mainly study the following in Micro-Economics:
(i) Product pricing;
(ii) Consumer behavior
iii) Factor pricing;
iv) Economic conditions of a section of the people;
(v) Study of firms; and
(vi) Location of a industry

MACRO ECONOMIC ANALYSIS

✓ Macroeconomics is the study of aggregates; hence called Aggregative Economics.
✓ It is the analysis of the entire economic system, the overall conditions of an economy like
total investment and total production.
✓ In Macro-Economics, we study the economic behavior of the large aggregates such as the
overall conditions of the economy such as total production, total consumption, total saving
and total investment in it.
 ✓ It is the study of overall economic phenomena as a whole rather than its individual parts.
✓ It includes:
(i) National income and output;
(ii) General price level;
(iii) Balance of trade and payments;
(iv) External value of money;
(v) Saving and investment; and
(vi) Employment and economic growth.

Limitations of Economics

✓ Economics cannot predict the future events since its laws lack definiteness.
✓ It is difficult to check the schemes of social betterment or sovereign remedy to economic
ills
✓ It cannot give an idea of functioning of economy as a whole
✓ An individual industry may be flourishing but economy as a whole may be
languishing.
✓ Individual is ignored
✓ It is individual welfare which is the main aim of Economics.

RELEVANCE OF ECONNOMICS IN BUSINESS MANAGEMENT BUSINESS

ECONOMICS
✓ The terms Managerial Economics and Business Economics are used interchangeably.
✓ The term Managerial Economics is more in use nowadays.
✓ Managerial Economics is economics applied in business decision-making.
✓ Hence it is also called Applied Economics.
Definition of Business Economics
✓ In simple words, business economics is the discipline which helps a business manager in
decision making for achieving the desired results.
✓ In other words, it deals with the application of economic theory to business management.
✓ According to Spencer and Siegelman, Business economics is "the integration of economic
theory with business practice for the purpose of facilitating decision-making and forward
planning by management".
✓ From the above said definitions, we can safely say that business economics makes in depth
study of the following objectives:
(i) Explanation of nature and form of economic analysis
(ii) Identification of the business areas where economic analysis can be applied
(iii) Spell out the relationship between Managerial Economics and other disciplines
outline the methodology of managerial economics.

CHARACTERISTICSOF BUSINESS ECONOMICS

The following characteristics of business economics will indicate its nature:

1. Micro economics: Managerial economics is micro economic in character. This is so because it
studies the problems of an individual business unit. It does not study the problems of the entire
economy.
2. Normative science: Managerial economics is a normative science. It is concerned with what
management should do under particular circumstances. It determines the goals of the enterprise.
Then it develops the ways to achieve these goals.
3. Pragmatic: Managerial economics is pragmatic. It concentrates on making economic theory more
application oriented. It tries to solve the managerial problems in their daytoday functioning.
4. Prescriptive: Managerial economics is prescriptive rather than descriptive. It prescribes solutions
to various business problems.
5. Uses macro economics: Marco economics is also useful to business economics. Macro-economics
provides an intelligent understanding of the environment in which the business operates. Managerial
economics takes the help of macro-economics to understand the external conditions such as business
cycle, national income, economic policies of Government etc.
 6. Uses theory of firm: Managerial economics largely uses the body of economic concepts
and principles towards solving the business problems. Managerial economics is a special
branch of economics to bridge the gap between economic theory and managerial practice.
7. Management oriented: The main aim of managerial economics is to help the management
in taking correct decisions and preparing plans and policies for future. Managerial
economics analyses the problems and give solutions just as doctor tries to give relief to the
patient.
8. Multi disciplinary: Managerial economics makes use of most modern tools of
mathematics, statistics and operation research. In decision making and planning principles
such accounting, finance, marketing, production and personnel etc.
9. Art and science: Managerial economics is both a science and an art. As a science, it
establishes relationship between cause and effect by collecting, classifying and analyzing
the facts on the basis of certain principles. It points out to the objectives and also shows the
way to attain the said objectives.

Integrating of economic theory and principles in to the business

Business utilizes these theories in various decision making in business like:

1. Production Decisions
2. Financial Decisions
3. Human Resource Decisions
4. Distribution Decisions

Objectives of Business Economics:

1. Effective allocation of resources.
2. Integrating Economic Theories and Principles.
3. Profit or Wealth Maximization.
Difference between Economics and Business Economics

✓ Business Economics is limited in its scope, Economics has much wider scope.
✓ Business Economics integrates the economic theory, economics gives the particular theory..
✓ Business economics is micro in nature and Economics is macro in nature..
✓ Business Economics deals with theories like profit but Economics deals with theories like
✓ Profit, Wages, interest etc.,

UTILITY ANALYSIS
Meaning of Utility:
✓ The simple meaning of ‘utility’ is ‘usefulness’. In economics utility is the capacity of a
commodity to satisfy human wants.
✓ Utility is the quality in goods to satisfy human wants. Thus, it is said that “Wants
satisfying capacity of goods or services is called Utility.”
Kinds of Utility

• Utility are of three kinds:

• Marginal Utility,
• Total Utility,
• Average Utility
(i) Marginal Utility:
• Definition:
• Marginal utility is the utility derived from the last or marginal unit of consumption. It refers
to the additional utility derived from an extra unit of the given commodity purchased,
acquired or consumed by the consumer.
• It is the net addition to total utility made by the utility of the additional or extra units of the
commodity in its total stock. It has been said—as the last unit in the given total stock of a
commodity.
• According to Prof. Boulding—”The marginal utility of any quantity of a commodity is the
increase in total utility which results from a unit increase in its consumption.”
 For example:
• Suppose Mr. Shanker is consuming bread and he takes five breads. By taking first unit he
derives utility up to 20; second unit 16; third unit 12; fourth unit 8 and from fifth 2. In this
example the marginal unit is fifth bread and the marginal utility derived is 2. If we will
consume only four bread then the marginal unit will be fourth bread and utility will be 8.
(ii) Total Utility:
• Total Utility is the utility from all units of consumption. According to Mayers—”Total
Utility is the sum of the marginal utilities associated with the consumption of the successive
units.”
For example:
• Suppose, a man consumes five breads at a time. He derives from first bread 20 units of
satisfaction from 16, from third 12, from fourth 8 and from fifth 4 i.e., total 60 units.

(iii) Average Utility:

Average Utility is that utility in which the total unit of consumption of goods is divided by number
of Total Units. The Quotient is known as Average Utility. For example—If the Total Utility of 4
bread is 40, then the average utility of 3 bread will be 12 if the Total Utility of 3 bread is 36 i.e.,
(36 ÷ 3 = 12).
The following table will explain the point clearly:

It is clear from the above table that by the increasing use of any article Marginal and Average
Utility reduces gradually and Total Utility increases only up to that point where the Marginal
Utility comes to zero.
What Is Marginal Utility?
Marginal utility is the added satisfaction that a consumer gets from having one more unit of a good
or service. The concept of marginal utility is used by economists to determine how much of an
item consumer are willing to purchase. Positive marginal utility occurs when the consumption of
an additional item increases the total utility. On the other hand, negative marginal utility occurs
when the consumption of one more unit decreases the overall utility.
KEY TAKEAWAYS:
• Marginal utility is the added satisfaction a consumer gets from having one more unit of a
good or service.
• The concept of marginal utility is used by economists to determine how much of an item
consumers are willing to purchase.
• The law of diminishing marginal utility is often used to justify progressive taxes.
• Marginal utility can be positive, zero, or negative.

Types of Marginal Utility

• There are multiple kinds of marginal utility. Three of the most common ones are as follows:
Positive Marginal Utility:
• Positive marginal utility occurs when having more of an item brings additional happiness.
Suppose you like eating a slice of cake, but a second slice would bring you some extra joy.
Then, your marginal utility from consuming cake is positive.
Zero Marginal Utility:
• Zero marginal utility is what happens when consuming more of an item brings no extra
measure of satisfaction. For example, you might feel fairly full after two slices of cake and
wouldn't really feel any better after having a third slice. In this case, your marginal utility
from eating cake is zero.
Negative Marginal Utility:
• Negative marginal utility is where you have too much of an item, so consuming more is
actually harmful. For instance, a fourth slice of cake might even make you sick after eating
three pieces of cake.
Law of diminishing marginal utility

Dr. Marshall states the law thus:

✓ “The additional benefit which a person derives from a given increase of his stock of
anything diminishes with the growth of the stock that he has.”
✓ In this statement of the law, the word “Additionally” is very important. It is only additional
(marginal) benefit which decrease and not the total benefit.

✓ If a consumer takes more and more units of a commodity ,the additional utility he derives
from an extra unit of the commodity goes on falling.
✓ The law of diminishing utility is based on actual experience.
✓ It tells that the more and more of a thing you have, the less and less you want it.
✓ It explains the relationship between the price of a good and the satisfaction you get from
it.
✓ During summer, generally, there will be fall in the price of mangoes because they are
available in plenty. So there is diminishing utility.
✓ The law of diminishing marginal returns has universal application in agriculture, it means
that we cannot double the output by doubling labor and capital.
✓ The law applies to manufacturing industry also.

LAW OF EQUI-MARGINAL UTILITY

✓ The idea of equi-marginal principle was first mentioned by H.H.Gossen (1810- 1858) of
Germany. Hence it is called Gossen’s second Law.
✓ Alfred Marshall made significant refinements of this law in his ‘Principles of Economics’.
✓ The law of equi-marginal utility explains the behaviour of a consumer when he consumes
more than one commodity.
✓ Wants are unlimited but the income which is available to the consumers to satisfy all his
wants is limited.
✓ This law explains how the consumer spends his limited income on various commodities to
get maximum satisfaction.
 ✓ The law of equi-marginal utility is also known as the law of substitution or the law of
maximum satisfaction or the principle of proportionality between prices and marginal
utility.

Definition
✓ In the words of Prof. Marshall, “If a person has a thing which can be put to several uses,
he will distribute it among these uses in such a way that it has the same marginal utility in
all”.

Assumptions
1. The consumer is rational so he wants to get maximum satisfaction.
2. The utility of each commodity is measurable.
3. The marginal utility of money remains constant.
4. The income of the consumer is given.
5. The prices of the commodities are given.
6. The law is based on the law of diminishing marginal utility.

Limitations of the Law

1. Indivisibility of Goods
✓ The theory is weakened by the fact that many commodities like a car, a house etc. are
indivisible.
✓ In the case of indivisible goods, the law is not applicable.
2. The Marginal Utility of Money is Not Constant
✓ The theory is based on the assumption that the marginal utility of money is constant
✓ But that is not really so.
3. The Measurement of Utility is not Possible
✓ Marshall states that the price a consumer is willing to pay for a commodity is equal to its
marginal utility. But modern economists argue that, if two persons are paying an equal
price for given commodity, it does not mean that both are getting the same level of utility.
✓ Thus utility is a subjective concept, which cannot be measured, in quantitative terms.
4. Utilities are Interdependent
✓ This law assumes that commodities are independent and therefore their marginal utilities
are also independent. But in real life commodities are either substitutes or complements.
Their utilities are therefore interdependent.

IMPORTANCE OF THE LAW

1. It applies to consumption.
2. It applies to production
3. Distribution of earnings between savings and consumption
4. It applies to distribution
5. It applies to public finance
6. Expenditure of time