Business Economics

Economics
• Economics is a social science concerned with the production, distribution and
consumption of goods or services
• It studies how individuals, businesses, governments and nations make choices
about how to allocate resources
• Two major types of economics are
1. Microeconomics- focuses on the behavior of individual consumers and
producers
2. Macroeconomics- examine overall economies on a regional, national or
international scale
Broad classification of Economics

3. Positive Economics
• Positive economics is a stream of economics that focuses on the
description, quantification, and explanation of economic developments
• It relies on objective data analysis, relevant facts and associated figures
• Ex- Government-provided healthcare increases public expenditures
4. Normative Economics
• Normative economics based on opinions and values
• Ex- Pollution is serious economic problem
 Business Economics
• Economic activities ask certain question:
• What to produce?
• How to produce?
• How much to produce?
• How to price?
• Most of the decision making are under the conditions of imperfect knowledge
and uncertainty
• Decision making on those question is not straight forward and require lot of
expertise and methodology
• Therefore we require the business be equipped with proper methodology and
appropriate analytical tools and techniques
• Business economics meet these needs of the business by providing a large corpus
of theory and techniques
Business Economics and Managerial Economics
• Business economics is a field of applied economics that studies the financial,
organizational, market-related and environmental issues faced by corporations
• Managerial economics is a field of study within business economics that focuses
on the microeconomic factors that influence the decision-making processes
Nature of Business Economics
1. Business Economics is a science and an art
 Science is systematized body of knowledge which establish cause and
effect relationship
  BE integrate the tool of decision science such as mathematics, statistics
with economic theory to decide on the strategy
 Business Economics requires a lot of logical thinking and creative skills
for decision making or problem-solving
2. Business Economics is based on Micro Economics
 Business generally deal with the problems related to a particular
organisation
3. Business Economics is also based Macro Economics
 A business functions in an external environment such as taxation, interest
rate, exchange rate, fiscal and monetary policy
 Therefore, it is essential for managers to analyse all these are components
and their impact on the organisation
4. Business Economics is multi-disciplinary in nature
 Uses many tools and principles belonging to various disciplines such as
accounting, finance, statistics, mathematics, production, operation
research & HR
5. Business Economics is Pragmatic
 Practical and logical approach towards the day to day business problems
Importance of Business Economics
1. Helpful in planning, organizing and coordinating
2. Helpful in decision making
3. Helpful in cost control
4. Helpful in demand forecasting
5. Play an important role in cost analysis
6. Minimizing uncertainties
7. Helpful understanding external environment
Consumer Behaviour
• Theory of consumer behaviour analyses the forces behind consumer decision
• A person has a limited budget of ₹200, he can buy 2 pizza (₹100/unit) or he can
buy 10 chocolates (₹20/unit) or he can buy 1 pizza and 5 chocolates
• It is difficult to understand consumer preferences
• Consumer Behaviour theories help us to understand the buying pattern
Terms to understand Consumer Behaviour
 1. Utility
• Usefulness, enjoyment, satisfaction received from a product
• Total satisfaction received from consuming a good
2. Total Utility: Aggregate amount of satisfaction derived from consuming various
units of good
• TU s = U s1 +U s 2+ U s3

3. Average Utility: Utility derived from one unit of commodity

TU
• AU =
No . of units consumed
4. Marginal Utility: Added satisfaction a consumer gets from having one more
additional unit of good

• MU n= TU n−TU (n−1)

Utility measurement
• Utility can be measured only by ‘Ordinally’- J R Hicks, R G Allen
• Utility can be measured quantitatively or ‘Cardinally’- Walrus, Marshall
1. Cardinal Utility Analysis
 Utility can be scaled in numbers and measured based on ‘Utils’
 Otherwise known as Utility Analysis
 Utils known as ‘Units of Utility’
 Ex- Maruti has Utils of 1000 and Benz has 5000
2. Ordinal Utility Analysis
 Utility cannot be scaled in numbers but can be arranged in order of
preference
 Utility is measured by ranking of satisfaction
 Otherwise known as ‘Indifference Curve Analysis’
 Ex- Pizza > Noodles
Law of Diminishing Marginal Utility
• H H Gossen 1854
• Gossen’s First Law of consumption
• Popularised by Marshall
• As the consumption increases, utility derived from each successive units
decreases
 • ‘As the consumer uses more and more of specific commodity, utility derived from
each successive units goes on diminishing’
Assumptions:
• Homogenous commodities are used
• Consumption process takes place continuously
• Ceteris paribus
• Cardinal measurement of utility
• Standard units of consumption

Take Away- Law of Diminishing Marginal Utility

• TU keeps on increasing so long as MU is positive
• TU is maximum when MU reaches zero
• TU tends to diminishes when MU is negative
• MU from successive units diminishes and ultimately MU becomes negative
Practical Importance of Law of DMU
1. Diversification in Consumption and Production
 Repeated use of products may diminishes utility of the product
 Companies use product, design, packing modification keeping in mind of
this law
 Variety seeking behavior
2. Law of DMU is the basis of law of demand
 Consumers buy more units only when the price falls
 Law of Equi-Marginal Utility
• Gossen’s 2nd Law of Consumption, Law of Maximum Satisfaction, Law of
Substitution
• Extension to the law of Diminishing Marginal Utility
• It explains how a rational consumer allocates their limited income among various
goods to maximize total satisfaction
• A consumer distributes his money income among various goods such that the
utility per rupee spent on each good is equal
• It shows the relation between consumptions of two or more commodities and
what combination of these commodities will give optimum satisfaction
• Consumer is in equilibrium position when MU per money is same for all
commodities
Marginal Utility per unit of Money Spent
MU A MU B
• = = MU M
PA PB

• It tells you how much utility the consumer gets for each unit of money spent on
that good
• A rational consumer will allocate their income such that this ratio is equal across
all goods — this is known as consumer equilibrium
Assumptions- Law of Equi-Marginal Utility
• Consumer has perfect knowledge about alternate choice
• Utility is measured cardinally
• Consumer has fixed income
• Standard units of consumption
• Ceteris paribus- taste, habits, income, price of related commodities
Indifference Curve Analysis (Hicks and Allen)
• This approach is based on consumer preference
• It helps us understand how consumers make choices between different
combinations of two goods that give them the same level of utility
• IC analysis is a powerful tool to understand how consumers make choices
between different combinations of goods, aiming to maximize satisfaction within
their budget constraints
Assumption
 Consumer is rational and possess full information
  Consumer is able to rank all combination of good based on satisfaction
 Ordinal concept
 Ceteris paribus
Properties of IC
1. Downward sloping (Negative slope)
• To maintain the same satisfaction, if you consume more of one good, you must
consume less of the other
2. Convex to the origin
3. Higher IC means higher level of satisfaction
• Curves further from the origin represent higher levels of satisfaction
4. IC never touches X, Y axis
5. Indifference curves never intersect

Marginal Rate of Substitution

• The slope of the indifference curve is known as MRS
• Rate at which the consumer is willing to give up one good for another
• Eg- If the consumer values Pizza, he will be slower to give them up for
Fries
• Willingness of a consumer to replace Pizza over Fries as long as the Fries are
equally satisfying

dy MU x
• MRS xy = =
dx MU y
Interpretation of MRS:
• If MRS_XY = 2, the consumer is willing to give up 2 units of Y for 1 additional unit
of X
• At consumer equilibrium, MRS = price ratio (Px/Py)