ICAI Notes- Unit 1: Introduction- 1 - CA Foundation PDF Download

What is Economics about?

• The term ‘Economics’ owes its origin to the Greek word ‘Oikonomia’ which means ‘household’. 
• Till the 19th century, Economics was known as ‘Political Economy.’ The book named ‘An Inquiry into the Nature and Causes of the Wealth of Nations’ (1776) usually abbreviated as ‘The Wealth of Nations’, by Adam Smith is considered as the first modern work of Economics.
• Before we start with the meaning of Business Economics, it is important for us to understand what Economics is about. For this, consider the following situation:
  It is your birthday and your mother gives you ` 1000 as birthday gift. You are free to spend the money as you like. What will you do? You have many options before you, such as:
  Option 1: You can give a party to your friends and spend the whole money on them.
  Option 2: You can buy yourself a dress for ` 1000.
  Option 3: You can go for a movie and eat in a restaurant of your choice.
  Option 4: You can buy yourself a book and save the rest of the money
  What do you notice? You have many options before you. Given a choice, you would like to spend not only on your friends, but would also like to go for a movie, eat in a restaurant, buy a dress and a book and save some money. However, you cannot have all of them at the same time.
  Why? Because you have only `1000 with you. Had your mother given you ` 2000, you might have satisfied more of your desires. But, she has not. Now, you find yourself in a dilemma as to which of the above options to choose. You will have to go for one option or a combination of one or more options.
  What do you do? You evaluate the various alternatives and choose the one that gives you the greatest satisfaction. A similar dilemma is faced by every individual, every society, and every country in this world.
  Life is like that. Since we cannot have everything we want with the resources we have, we are forever forced to make choices. Therefore, we choose to satisfy only some of our wants leaving many other wants unsatisfied.
• These two fundamental facts:
  (i) ‘Human beings have unlimited wants’; and
  (ii) ‘The means to satisfy these unlimited wants are relatively scarce’ form the subject matter of Economics.
• Let us now examine what Economics studies about. Economics is the study of the processes by which the relatively scarce resources are allocated to satisfy the competing unlimited wants of human beings in a society. 
• Of course, the available resources will be efficiently used when they are allocated to their highest valued uses. Economics is, thus, the study of how we work together to transform the scarce resources into goods and services to satisfy the most pressing of our infinite wants and how we distribute these goods and services among ourselves.
• This definition of Economics, with the narrow focus on using the relatively scarce resources to satisfy human wants, is the domain of modern neo-classical microeconomic analysis. Despite being correct, it is incomplete as it brings to our mind the picture of a society with fixed resources, skills, and productive capacity, deciding on what specific kinds of goods and services it ought to produce with the given resources and how they ought to be distributed among the members of the society. However, two of the most important concerns of modern economies are not fully covered by this concept.
• Today, we find that the productive capacity of modern economies has grown tremendously. Population and labour force have increased, new sources of raw materials have been discovered, and new and better plant and equipments have been made available on farms and in factories and mines. 
• Not only has the quantity of available productive resources increased, their quality has also improved substantially. 
• Better education and newly acquired skills have raised the productivity of labour force, and has led to the discovery of completely new kinds of natural resources such as shale gas and new alternative sources of energy. 
• Also, we know that the resulting growth in production and income has not been smooth. There have been periods in which output not only failed to grow, but also actually declined sharply. During such periods, factories, workers and other productive resources have remained idle due to insufficient demand.
• Economics, therefore, concerns itself not just with the crucial concern of how a nation allocates its scarce productive resources to various uses; it also deals with the processes by which the productive capacity of these resources is increased and with the factors which, in the past, have led to sharp fluctuations in the rate of utilisation of these resources.
  
  Question for ICAI Notes- Unit 1: Introduction- 1

  Try yourself:

  What is the subject matter of Economics?

  • A.

    The study of how resources are allocated to satisfy unlimited wants.
  • B.

    The study of how to maximize profits in a business.
  • C.

    The study of how to control inflation in an economy.
  • D.

    The study of how to achieve economic growth in a country.

  Explanation

  - Economics is the study of how relatively scarce resources are allocated to satisfy the competing unlimited wants of human beings in a society.
  - It focuses on the processes by which resources are transformed into goods and services to satisfy human wants.
  - Economics also examines how these goods and services are distributed among members of society.
  - The subject matter of Economics includes understanding how individuals, societies, and countries make choices due to the scarcity of resources.
  - It involves analyzing the efficient use of resources and the allocation of resources to their highest valued uses.
  - Economics is not solely concerned with production and distribution, but also with factors that affect the growth and utilization of productive resources.

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• In the day-to-day events, we come across several economic issues such as changes in the price of individual commodities as well as in the general price level; economic prosperity and higher standards of living of some countries despite general poverty and poor standards of living in others.
•  These are fundamental matters connected with economic analysis. The study of Economics will enable us to develop an analytical approach that helps us in understanding and analysing a wide range of economic issues. 
• It would also provide us with a number of models and frameworks that can be applied in different situations. The tools of Economics assist in choosing the best course of action from among the different alternative courses of action available to the decision maker. 
• However, it is necessary to remember that most economic problems are of complex nature and are affected by several forces, some of which are rooted in Economics and others in political set up, social norms, etc. The study of Economics cannot ensure that all problems will be appropriately tackled; but, without doubt, it would enable a student to examine a problem in its right perspective and would help him in discovering suitable measures to deal with the same.

Meaning of Business Economics

Mr. G. Ramamurthy, the CEO of Worldwide Food Limited, on completion of his presentation turned to his Board of Directors and raised the question “Well ladies and gentlemen, what you say? Shall we go into soft drink business?”
“Give us some time, Sir” remarked Swaminathan. “You are asking us to approve a major decision which will have long term impact on the direction of the company”.
“I understand your concern for the company but now the time has come for us to expand our business. Soft drinks market is growing fast and it is closely related to our core business: food” answered Ramamurthy.
“But competition from White Soft Drinks Ltd. and Black Nectar Ltd. is tough. They are already into this business for years” remarked another board member.
“That is right. But we must not forget that the statistics show that there is still room for growth in this market. And also, food business is near maturity.” Replied Ramamurthy.
“Don’t forget that even Swati Foods tried entering the soft drink market and failed miserably”, remarked Ashok Agrawal, another board member. “Moreover, the projections you are showing are based on last ten years’ data. What is the guarantee that the trend will continue? He questioned. “Also, we should not forget that Indians have become health conscious and who knows tomorrow what will people prefer?” He continued.
“Well friends, all your concerns are logical, and believe me; I have given much thought to these ‘ifs’ and ‘buts’. My people have spent many days analyzing all available data to arrive at a judgement. Our analysis indicates a strong possibility of earning above-average return on investment in this market, a return that will be more than what we are earning in food industry. We are already working on the details of production, cost, pricing, distribution, financing etc. I fear, if we wait for long, we will be missing an opportunity that may not come again for long. Let’s go ahead and make the most of it” remarked Ramamurthy.

What do you notice in the hypothetical example given above? The management of the company is faced with the problem of decision-making.

• As we are aware, the survival and success of any business depends on sound decisions. 
• Decision-making refers to the process of selecting an appropriate alternative that will provide the most efficient means of attaining a desired end, from two or more alternative courses of action. 
• Decision making involves evaluation of feasible alternatives, rational judgment on the basis of information and choice of a particular alternative which the decision maker finds as the most suitable. As explained above, the question of choice arises because our productive resources such as land, labour, capital, and management are limited and can be employed in alternative uses. 
• Therefore, more efficient alternatives must be chosen and less efficient alternatives must be rejected.
• The management of a business unit generally needs to make strategic, tactical and operational decisions. A few examples of issues requiring decision making in the context of businesses are illustrated below: Should our firm be in this business?

• Should the firm launch a product, given the highly competitive market environment?
• If the firm decided on launching the product, which available technique of production should be used?
• From where should the firm procure the necessary inputs and at what prices so as to have competitive edge in the market?
• Should the firm make the components or buy them from other firms?
• How much should be the optimum output and at what price should the firm sell?
• How will the product be placed in the market? Which customer segment should we focus on and how to improve the customer experience? Which marketing strategy should be chosen? How much should be the marketing budget?
• How to combat the risks and uncertainties involved?

Decision-making on the above, as well as similar issues, is not simple and straightforward as the economic environment in which the firm functions is highly complex and dynamic. The problem gets aggravated because, most of the time, decisions are to be taken under conditions of imperfect knowledge and uncertainty. Decision-making, therefore, requires that the management be equipped with proper methodology and appropriate analytical tools and techniques. Business Economics meets these needs of the management by providing a large corpus of theory and techniques. Briefly put, Business Economics integrates economic theory with business practice.
Business Economics, also referred to as Managerial Economics, generally refers to the integration of economic theory with business practice. While the theories of Economics provide the tools which explain various concepts such as demand, supply, costs, price, competition etc., Business Economics applies these tools in the process of business decision making. Thus, Business Economics comprises of that part of economic knowledge, logic, theories and analytical tools that are used for rational business decision making. In brief, it is Applied Economics that fills the gap between economic theory and business practice.
Business Economics has a close connection with Economic theory (Micro as well as Macro-Economics), Operations Research, Statistics, Mathematics and the Theory of Decision-Making. A professional business economist has to integrate the concept and methods from all these disciplines in order to understand and analyse practical managerial problems. Business Economics is not only valuable to business decision-makers, but also useful for managers of ‘not-for-profit organisations.

Definition of Business Economics

Joel Dean defined Business Economics in terms of the use of economic analysis in the formulation of business policies. Business Economics is essentially a component of Applied Economics as it includes the application of selected quantitative techniques such as linear programming, regression analysis, capital budgeting, break-even analysis and cost analysis.

Nature of Business Economics

• 

  Micro Economics is basically the study of the behavior of different individuals and organizations within an economic system. In other words, Microeconomics examines how the individual units (consumers or firms) make decisions as to how to efficiently allocate their scarce resources. Here, the focus is on a small number of or group of units rather than all the units combined, and therefore, it does not explain what is happening in the wider economic environment.
  We mainly study the following in Micro-Economics:
  (i) Product pricing;
  (ii) Consumer behavior;
  (iii) Factor pricing;
  (iv) The economic conditions of a section of people;
  (v) Behaviour of firms; and
  (vi) Location of industry.
• Macroeconomics is the study of the overall economic phenomena or the economy as a whole, rather than its individual parts. Accordingly, in Macro-Economics, we study the behavior of the large economic aggregates, such as the overall levels of output, total consumption, total saving, and total investment, and also how these aggregates shift over time. It analyzes the overall economic environment in which the firms, governments, and households make decisions. However, it should be kept in mind that this economic environment represents the overall effect of the innumerable decisions made by millions of different consumers and producers.
  A few areas that come under Macro Economics are:
  (i) National Income and National Output;
  (ii) The general price level and interest rates;
  (iii) Balance of trade and balance of payments;
  (iv) External value of the currency;
  (v) The overall level of savings and investment; and
  (vi) The level of employment and rate of economic growth.
• While Business Economics is basically concerned with Micro Economics, Macroeconomic analysis also has got an important role to play. Macroeconomics analyzes the background of economic conditions in an economy which will immensely influence the individual firm’s performance as well as its decisions. Business firms need a thorough understanding of the macroeconomic environment in which they have to function. For example, knowledge regarding conditions of inflation and interest rates will be useful for the business economist in framing suitable policies. Moreover, the long-run trends in the business world are determined by the prevailing macroeconomic factors.