The Business Environment

and Business Economics

ECONOMICS DEFINED

• Economics is the study of how the resources, land, labour, capital and enterprise are used or allocated by a country to meet its demands for goods, services and ideas, now and in the future.

• The resources are employed by businesses or firms and are also known as inputs to the production process, or factors of production.

Basic economics concepts

• Three main players of Business Environment– The Businessmen (Producers)– The Households (Consumers)– The Government

• Businesses produce goods & services• Households buy goods & services• Government manages the economy

Businessmen

Household Government

Business Economics

ScarceResources

UnlimitedWants

Wastage

Inefficiency

ECONOMICS: Basic Questions

1. Why some countries are rich and others poor.2. What are the ills of an economy.3. How to change the economic fortunes.4. Globalization5. What do markets do?6. What is the role of the governments.7. Three basic Problems:

a. What to Produce? b. How to produce and c. For whom to produce?

BUSINESS RESOURCES

• Land• Labor• Capital• Entrepreneurship (Management)

Resources are Scarce

Wants are unlimited

but

How Business Economics is Different from Economics?

The Business Environment

• What is business economics?– decision making in business

• external influences on the firm– the business environment

• internal decisions of the firm• the external effects of business decision making

• What do business economists do?– Describe business settings– Analyse businesses and buss environment– Recommend prescriptions for problems

The Business Environment

• Political / legal factors• Economic factors

– the microeconomic environment– the macroeconomic environment

• Social / cultural factors• Technological factors

BISINESS OUTPUTS

• Goods (Consumer and Producer Goods)– Consumer durable & non-durable goods

• Services

• Ideas (Can be bought and sold)

• Externalities (positive & negative)

TYPES OF BUSINESS ORGANIZATIONS

• Sole Proprietorship • Partnership

• Joint Stock Companies– Public Limited– Private Limited

• SMEs (A business employing 500 employees or fewer)

Unlimited Liability

Limited Liability

Industrial sectors

The economy of a country, and hence its businesses, are classified into three main categories: primary, secondary and tertiary.1. Primary sector Industries as agriculture, forestry, fishing, mining for coal, tin etc. and the extraction of other raw materials such as oil. In other words, it is concerned with the production and extraction of raw materials, which are classified as the resource land.

2. Secondary sector Manufacturing, the provision of energy and the construction industry; so it processes the output of the primary sector.The manufacturing sector of an economy has traditionally been perceived as the major creator of wealth and jobs and3. Tertiary sectorThe tertiary sector of the economy relates to the provision of services and is the fastest growing sector in many mature economies.

• Structure conduct performance– relationship between business structure and

business conduct (behaviour)• competitive markets and competitive behaviour

• limited competition and collusion

– relationship between business conduct and business performance

• different indicators for measuring performance

• profitability, market share, growth, etc.

The Determinants of Business Performance

The Determinants of Business Performance

• Internal aims and organisation– profit maximisation as the prime goal– other goals– distinction between owners and managers– importance of managers’ own objectives– “satisficing”

The Determinants of Business Performance

• Other factors affecting performance– internal structure– information– competence of management– quality of the workforce– systems

• information systems• motivation• technical systems• distribution systems• financial systems

WHAT IS MARKET ECONOMY?

• A market economy is an elaborate mechanism for coordinating people activities, and businesses through a system of prices and markets.

• It is a communication device to pool the knowledge and actions of diverse people.

• In a market economy no single person is responsible for production, consumption, distribution or pricing.

HOW DO MARKETS DETERMINE PRICES, WAGES AND OUTPUT?

What is PRICE and what does it do?• It is the value of good and services in terms of

money.• It represents the terms in which people and firms

voluntarily exchange different commodities.• It also serves as signals to producers and

consumers.• It influences the demand and supply of products. • Higher prices reduces consumer purchase and

encourages production and vice versa.• It tends to achieve Market Equilibrium.

How Markets Solve the Three Economic Problem?

Market economic problems are solved by matching the demand and supply in a market.

• Three economic problems to achieve market equilibrium are:– What goods and services will be produced.– How things would be produced.– For whom things are being produced.

1) WHAT GOODS AND SERVICES WILL BE PRODUCED?

• This is determined by the monetary votes of consumers.

• Firms in return get profits.– Firms abandon the areas where they face

losses.

2) How things are produced?

• It is determined by the competition among different producers.

• Firms try to lower the cost by adopting the most efficient manner for production.

• Technology also triggers competition.

3) For whom things are produced?

• It is dependent on the demand and supply in the market for factors of production.

• Factor prices.

A Picture of Prices and Markets

• Figure 2-1 explains how consumers and producers interact to determine prices and quantities for both inputs and outputs.

The Market System Relies on Supply and Demand to Solve the Trio of Economic Problems

THE INVISIBLE HAND

• Adam Smith’s Wealth Of Nations in 1776.

• “Markets would lead to the optimal economic outcome as individuals pursue their own self-interest”.

• RESERVATIONS OF THE INVISIBLE HAND– Monopolies and other forms of imperfect

competition.– Spillovers and externalities– Income distribution.

Trade, Specialization and Division of labor– Specialization occurs when people and

countries concentrate their efforts on a particular set of tasks.

– Division of labor is dividing production into a number of small specialized steps or tasks.

– Capital and land are also highly specialized.

Trade, Money, and CapitalTrade, Money, and Capital

TRADE

Advanced economies engage in specialization and division of labor which increase the production of labor, which increase the productivity of resources.

MONEY: THE LUBRICANT OF EXCHANGE

• It allows people to trade .• It is a medium of exchange.• It is a mean of payment in the form of

currency and checks used to buy things.• It facilitates trade.• Barter system• Government controls money supply

through central banks.

CAPITAL• It is a produced factor of production.• Land and labor are known as primary factors of

production.• By contrast, capital has to be produced before

one can use it.• Economic activity involves forgoing current

consumption to increase out capital. Every time we invest – building a new factory or road, increasing the stock of useful technical knowledge- we can enhancing the future productivity of our economy and increasing future consumption.

THE ECONOMIC ROLE OF GOVERNMENT

• The role of the government is important because no market is perfect.

• Government operate by requiring taxes, obey regulations and consume certain collective goods and services.

THREE MAJOR FUNCTIONS OF GOVERNMENT IN AN ECONOMY

1. Increase efficiency2. Promote equity3. Foster macroeconomics stability and

growth.

1st Government Function:Increase Efficiency

• Perfect competition• Invisible hand applies to economies in

which all markets are perfectly competitive.

• In perfectly competitive economies most desired output is obtained with minimum amount of input.

Reasons why perfect competition does not prevail

A) Imperfect Competition– Monopoly– When imperfect competition occurs the

society may move inside its PPF.– Imperfect competition leads to prices that rise

above cost and to consumer purchases that are reduced below efficient levels.

– The extreme case of imperfect competition is the monopoly.

– Government take steps to curb imperfect competition

B) Externalities

• It involves involuntary imposition of costs or benefits.

• “It occurs when firms or people impose costs or benefits on others outside the marketplace”

• Negative and positive externalities• Government regulations are designed to

control externalities.

C) Public Goods

• The polar case of a positive externality is a public good.

• Public goods are commodities which can be enjoyed by everyone and from which no one can be excluded

e.g. Military, public recreation places• Government must step in to encourage

public goods

2nd Government Function: Promote EQUITY

• Markets do not necessarily produce a fair distribution of income. A market economy may produce inequalities in income and consumption that are not acceptable to the electorate.

• Income inequality may be politically or ethically unacceptable.

Tools government can use to reduce inequality

• Progressive taxation.• Transfer payments• Subsidize consumption of low income

groups by providing them food stamps etc.

3rd Government FunctionMACROECONOMICS GROWTH AND STABILITY

• Business cycle• Monetary and fiscal policies• Economic growth• Table 2-1summarizes the economic role

played by government today.

The Production Possibilities in a Graph

Chapter 1 Figure 1-1PRODUCTION POSSIBILITY FRONTIES

Chapter 1 Table 1-1

The Production-Possibility Frontier

Chapter 1 Figure 1-2

Opportunity Costs

• The value of what must be foregone in order to undertake an activity– Consider explicit and implicit costs

• Examples:– Give up 2 hour of job to go to the movie.– Give up watching cricket match on TV to walk to

town.• Caution: NOT the combined value of all possible

activities– Opportunity cost considers only your best alternative – Opportunity costs and PPF.

Efficiency

• Effective use of economic resources to satisfy society’s needs and desires.

• Productive Efficiency: When a society cannot produce more of one good without making less of another good. – Economy is at PPF.– PPF depicts the substitution effect– Question of unemployed resources– Unemployment during Great Depression

Economic Growth Shiftsthe PPF Outward

Chapter 1 Figure 1-3

Economies Must Choose between Public Goods and Private Goods

Chapter 1 Figure 1-4

Investment for Future Consumption Requires Sacrificing Current Consumption (Promoting Savings)

How to read Graphs?Calculation of Slope for Straight Lines

Appendix 1A Figure 1A-3

Steepness Is Not the Same as SlopeSlope may be the same but steepness Different

Appendix 1A Figure 1A-4

Tangent as Slope of Curved Line

Appendix 1A Figure 1A-5

Different Slopes of Nonlinear Curves

Appendix 1A Figure 1A-6

Shift of Curves versus Movement along Curves

Appendix 1A Figure 1A-7

Scatter Diagram of Consumption Function Shows Important Macroeconomic Law

Appendix 1A Figure 1A-8

FORMS OF BUSINESS ORGANIZATIONS

Thanks