BE/U1 Topic 1 Nature, Scope and Definition of Business Economics
Business economics is a field of applied economics that studies the financial, organizational, market-related, and environmental issues faced by corporations. Economic theory and quantitative methods form the basis of assessments on factors affecting corporations such as business organization, management, expansion, and strategy. Studies might include how and why corporations expand, the impact of entrepreneurs, the interactions among corporations, and the role of governments in regulation.
The Basics of Business Economics
Economics, broadly, refers to the study of the components and functions of a particular marketplace or economy, such as supply and demand, and the effect of the concept of scarcity. Within an economy, production factors, distribution methods, and consumption are important subjects of study. Business economics focuses on the elements and factors within business operations and how they relate to the economy as a whole.
The field of business economics addresses economic principles, strategies, standard business practices, the acquisition of necessary capital, profit generation, the efficiency of production, and overall management strategy. Business economics also includes the study of external economic factors and their influence on business decisions such as a change in industry regulation or a sudden price shift in raw materials.
Real World Example of Business Economics
There are various organizations associated with the field of business economics. In the United States, the National Association for Business Economics (NABE) is the professional association for business economists. The organization’s mission is “to provide leadership in the use and understanding of economics.” In the United Kingdom, the equivalent organization is the Society of Business Economists.
- Economic theory and quantitative methods form the basis of microeconomic assessments of factors affecting corporations.
- Business economics encompasses subjects such as the concept of scarcity, product factors, distribution, and consumption.
- Managerial economics is one important offshoot of business economics.
- The National Association for Business Economics (NABE) is the professional association for business economists in the United States.
Nature of Business Economics
(i) Business Economics is a Science
What is Science? It is simply a systematic body of knowledge which can establish a relationship between cause and effect. Further, Mathematics, Statistics, and Econometrics are decision sciences.
Business Economics integrates these decision sciences with Economic Theory to arrive at strategies to help businesses achieve their goals. Hence, it follows scientific methods and also tests the validity of the results. This is one aspect of the nature of business economics.
(ii) It is based on Micro Economics
We understand the basic difference between micro and macroeconomics. A business manager is certainly more concerned about achieving the objectives of his own organization. After all, this helps him in ensuring profits and long-term survival of the firm.
Business Economics is more concerned with the decision-making situations of individual establishments. Therefore, it depends on the techniques of Microeconomics.
(iii) It Incorporates Elements of Macro Analysis
Even though all businesses focus on their profitability and survival, a firm cannot operate in a vacuum. The external environment of the economy like income and employment levels in the economy, tax policies, etc., affects the firm. All these external factors are components of macro economy.
Therefore, a business manager has to take all such factors into consideration which may influence his business environment.
(iv) It is an Art
Business Economics is an art as it requires the practical application of rules and principle to achieve set objectives.
(v) Use of Theory of Markets and Private Enterprises
Business Economics primarily uses the theory of markets and private enterprises. It uses the theory of the firm and resource allocation in a private enterprise economy.
(vi) Pragmatic in Approach
Microeconomics is purely theoretical and analyzes economic occurrences under unrealistic assumptions. On the other hand, Business Economics is pragmatic in its approach. It tries to solve the problems which the firms face in the real world.
Business Economics incorporates tools from many other disciplines like mathematics, statistics, accounting, marketing, etc. Therefore, is in interdisciplinary in nature.
Broadly speaking, Economic Theory has evolved along two lines – Positive and Normative.
A positive or pure science analyzes the cause and effect relationship between variables in a scientific manner. However, it does not involve any value judgment. In simpler words, it describes the economic behavior of individuals or society without focusing on the desirability of such behavior.
On the other hand, normative science involves value judgments. It suggests a course of action under the given circumstances.
Usually, Business Economics is normative in nature. It offers suggestions for the application of economic principles while forming policies, making decisions, and planning for the future. However, firms must understand their environment thoroughly to establish decision rules. This requires the study of positive economic theory.
Therefore, we can say that Business Economics combines the essentials of both the theories while keeping more emphasis on the normative economic theory.
The Scope of Business Economics
- Microeconomics Applied to Operational Issues
As the name suggests, internal or operational issues are issues that arise within a firm and are within the control of the management. It is within the scope of business economics to analyze this.
Further, a few examples of such issues are choice of business, size of business, product designs, pricing, promotion for sales, technology choice, etc. Most firms can deal with these using the following microeconomics theories:
(i) Analyzing Demand and Forecasting
Analyzing demand is all about understanding buyer behavior. It studies the preferences of consumers along with the effects of changes in the determinants of demand. Also, these determinants include the price of the good, consumer’s income, tastes/ preferences, etc.
Forecasting demand is a technique used to predict the future demand for a good and/or service. Further, this prediction is based on the past behavior of factors which affect the demand. This is important for firms as accurate predictions help them produce the required quantities of goods at the right time.
Further, it gives them enough time to arrange various factors of production in advance like raw materials, labor, equipment, etc. Business Economics offers scientific tools which assist in forecasting demand.
(ii) Production and Cost Analysis
A business economist has the following responsibilities with regards to the production:
- Decide on the optimum size of output based on the objectives of the firm.
- Also, ensure that the firm does not incur any undue costs.
By production analysis, the firm can choose the appropriate technology offering a technically efficient way of producing the output. Cost analysis, on the other hand, enables the firm to identify the behavior of costs when factors like output, time period, and the size of plant change. Further, by using both these analyses, a firm can maximize profits by producing optimum output at the least possible cost.
(iii) Inventory Management
Firms can use certain rules to reduce costs associated with maintaining inventory in the form of raw materials, work in progress, and finished goods. Further, it is important to understand that the inventory policies affect the profitability of a firm. Hence, economists use methods like the ABC analysis and mathematical models to help the firm in maintaining an optimum stock of inventories.
(iv) Market Structure and Pricing Policies
Any firm needs to know about the nature and extent of competition in the market. A thorough analysis of the market structure provides this information. Further, with the help of this, firms command a certain ability to determine prices in the market. Also, this information helps firms create strategies for market management under the given competitive conditions.
Price theory, on the other hand, helps the firm in understanding how prices are determined under different kinds of market conditions. Also, it assists the firm in creating pricing policies.
(v) Resource Allocation
Business Economics uses advanced tools like linear programming to create the best course of action for an optimal utilization of available resources.
(vi) Theory of Capital and Investment Decisions
Among other decisions, a firm must carefully evaluate its investment decisions an allocate its capital sensibly. Various theories pertaining to capital and investments offer scientific criteria for choosing investment projects. Further, these theories also help the firm in assessing the efficiency of capital. Business Economics assists the decision-making process when the firm needs to decide between competing uses of funds.
(vii) Profit Analysis
Profits depend on many factors like changing prices, market conditions, etc. The profit theories help firms in measuring and managing profits under such uncertain conditions. Further, they also help in planning future profits.
(viii) Risk and Uncertainty Analysis
Most businesses operate under a certain amount of risk and uncertainty. Also, analyzing these risks and uncertainties can help firms in making efficient decisions and formulating plans.
- Macroeconomics applied to Environmental Issues
External or environmental factors have a measurable impact on the performance of a business. The major macroeconomic factors are:
- Type of economic system
- Stage of the business cycle
- General trends in national income, employment, prices, saving, and investment.
- Government’s economic policies
- Performance of the financial sector and capital market
- Socio-economic organizations
- Social and political environment.
The management of a firm has no control over these factors. Therefore, it is important that the firm fine-tunes its policies to minimize the adverse effects of these factors.