Introduction (Part - 2) - Nature & Scope of Business Economics CA CPT Notes | EduRev

Business Economics for CA Foundation

Created by: Sushil Kumar

CA CPT : Introduction (Part - 2) - Nature & Scope of Business Economics CA CPT Notes | EduRev

The document Introduction (Part - 2) - Nature & Scope of Business Economics CA CPT Notes | EduRev is a part of the CA CPT Course Business Economics for CA Foundation.
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Having understood the meaning of Micro and Macro Economics, we shall examine the nature of Business Economics:
Nature of Business Economics 
The economic world is extremely complex as there is a lot of interdependence among the decisions and activities of economic entities. Economic theories are hypothetical and simplistic in character as they are based on economic models built on simplifying assumptions. Therefore, usually, there is a gap between the propositions of economic theory and happenings in the real economic world in which the managers make decisions. Business Economics enables application of economic logic and analytical tools to bridge the gap between theory and practice.
The following points will describe the nature of Business Economics:

  • Business Economics is a Science: Science is a systematized body of knowledge which establishes cause and effect relationships. Business Economics integrates the tools of decision sciences such as Mathematics, Statistics and Econometrics with Economic Theory to arrive at appropriate strategies for achieving the goals of the business enterprises. It follows scientific methods and empirically tests the validity of the results.
  • Based on Micro Economics: Business Economics is based largely on Micro-Economics. A business manager is usually concerned about achievement of the predetermined objectives of his organisation so as to ensure the long-term survival and protable functioning of the organization. Since Business Economics is concerned more with the decision making problems of individual establishments, it relies heavily on the techniques of Microeconomics.
  • Incorporates elements of Macro Analysis: A business unit does not operate in a vacuum. It is affected by the external environment of the economy in which it operates such as, the general price level, income and employment levels in the economy and government policies with respect to taxation, interest rates, exchange rates, industries, prices, distribution, wages and regulation of monopolies. All these are components of Macroeconomics. A business manager must be acquainted with these and other macroeconomic variables, present as well as future, which may influence his business environment.
  • Business Economics is an art as it involves practical application of rules and principles for the attainment of set objectives.
  • Use of Theory of Markets and Private Enterprises: Business Economics largely uses the theory of markets and private enterprise. It uses the theory of the firm and resource allocation in the backdrop of a private enterprise economy.
  • Pragmatic in Approach: Micro-Economics is abstract and purely theoretical and analyses economic phenomena under unrealistic assumptions. In contrast, Business Economics is pragmatic in its approach as it tackles practical problems which the firms face in the real world.
  • Interdisciplinary in nature: Business Economics is interdisciplinary in nature as it incorporates tools from other disciplines such as Mathematics, Operations Research, Management Theory, Accounting, marketing, Finance, Statistics and Econometrics.
  • Normative in Nature: Economic theory has developed along two lines – positive and normative. A positive or pure science analyses cause and effect relationship between variables in an objective and scientific manner, but it does not involve any value judgement. In other words, it states ‘what is’ of the state of affairs and not what ‘ought to be’. In other words, it is descriptive in nature in the sense that it describes the economic behaviour of individuals or society without prescriptions about the desirability or otherwise of such behaviour. As against this, a normative science involves value judgements. It is prescriptive in nature and suggests ‘what should be’ a particular course of action under given circumstances. Welfare considerations are embedded in normative science.

Business Economics is generally normative or prescriptive in nature. It suggests the application of economic principles with regard to policy formulation, decision-making and future planning. However, if the firms are to establish valid decision rules, they must thoroughly understand their environment. This requires the study of positive or descriptive economic theory. Thus, Business Economics combines the essentials of normative and positive economic theory, the emphasis being more on the former than the latter. 

SCOPE OF BUSINESS ECONOMICS 
The scope of Business Economics is quite wide. It covers most of the practical problems a manager or a firm faces. There are two categories of business issues to which economic theories can be directly applied, namely:
(i) Microeconomics applied to operational or internal Issues
(ii) Macroeconomics applied to environmental or external issues 

Therefore, the scope of Business Economics may be discussed under the above two heads
(i) Microeconomics applied to operational or internal Issues
Operational issues include all those issues that arise within the organisation and fall within the purview and control of the management. These issues are internal in nature. Issues related to choice of business and its size, product decisions, technology and factor combinations, pricing and sales promotion, financing and management of investments and inventory are a few examples of operational issues. The following Microeconomic theories deal with most of these issues.

  • Demand analysis and forecasting: Demand analysis pertains to the behaviour of consumers in the market. It studies the nature of consumer preferences and the effect of changes in the determinants of demand such as, price of the commodity, consumers’ income, prices of related commodities, consumer tastes and preferences etc.
    Demand forecasting is the technique of predicting future demand for goods and services on the basis of the past behaviour of factors which affect demand. Accurate forecasting is essential for a firm to enable it to produce the required quantities at the right time and to arrange, well in advance, for the various factors of production viz., raw materials, labour, machines, equipment, buildings etc. Business Economics provides the manager with the scientific tools which assist him in forecasting demand.
  • Production and Cost Analysis: Production theory explains the relationship between inputs and output. A business economist has to decide on the optimum size of output, given the objectives of the firm. He has also to ensure that the firm is not incurring undue costs. Production analysis enables the firm to decide on the choice of appropriate technology and selection of least - cost input-mix to achieve technically effient way of producing output, given the inputs. Cost analysis enables the firm to recognise the behaviour of costs when variables such as output, time period and size of plant change. The firm will be able to identify ways to maximize profits by producing the desired level of output at the minimum possible cost.
  • Inventory Management: Inventory management theories pertain to rules that firms can use to minimise the costs associated with maintaining inventory in the form of ‘work-in-process,’ ‘raw materials’, and ‘finished goods’. Inventory policies affect the profitability of the firm. Business economists use methods such as ABC analysis, simple simulation exercises and mathematical models to help the firm maintain optimum stock of inventories.
  • Market Structure and Pricing Policies: Analysis of the structure of the market provides information about the nature and extent of competition which the firms have to face. This helps in determining the degree of market power (ability to determine prices) which the firm commands and the strategies to be followed in market management under the given competitive conditions such as, product design and marketing. Price theory explains how prices are determined under different kinds of market conditions and assists the firm in framing suitable price policies.
  • Resource Allocation: Business Economics, with the help of advanced tools such as linear programming, enables the firm to arrive at the best course of action for optimum utilisation of available resources.
  • Theory of Capital and Investment Decisions: For maximizing its profits, the firm has to carefully evaluate its investment decisions and carry out a sensible policy of capital allocation. Theories related to capital and investment provide scientific criteria for choice of investment projects and in assessment of the efficiency of capital. Business Economics supports decision making on allocation of scarce capital among competing uses of funds.
  • Profit Analysis: Profits are, most often, uncertain due to changing prices and market conditions. Profit theory guides the firm in the measurement and management of profits under conditions of uncertainty. Profit analysis is also immensely useful in future profit planning.
  • Risk and Uncertainty Analysis: Business firms generally operate under conditions of risk and uncertainty. Analysis of risks and uncertainties helps the business firm in arriving at efficient decisions and in formulating plans on the basis of past data, current information and future prediction.

(ii) Macroeconomics applied to environmental or external issues
Environmental factors have significant influence upon the functioning and performance of business. The major macro economic factors relate to:

  • the type of economic system
  • stage of business cycle 
  • the general trends in national income, employment, prices, saving and investment.
    Government’s economic policies like industrial policy, competition policy, monetary and fiscal policy, price policy, foreign trade policy and globalization policies
  • working of financial sector and capital market.
  • socio-economic organisations like trade unions, producer and consumer unions and cooperatives.
  • social and political environment. 

Business decisions cannot be taken without considering these present and future environmental factors. As the management of the firm has no control over these factors, it should fine-tune its policies to minimise their adverse effects.

SUMMARY 
  • An economy exists because of two facts, i.e. human wants are unlimited and the resources are scarce.
  • Economics is the study of processes by which the relatively scarce resources are allocated to satisfy the competing unlimited wants of human beings in a society.
  • The subject matter of Economics is divided into two parts – Micro and Macro Economics
  • Microeconomics examines how the individual units (consumers or firms) make decisions as to how to efficiently allocate their scarce resources.
  • Macroeconomics study the behaviour of the large economic aggregates, such as, the overall levels of output, total consumption, total saving and total investment and how these aggregates shift over time.
  • Business Economics integrates economic theory with business practice and relies on economic analysis in the formulation of business policies.
  • While Business Economics is basically concerned with Micro Economics, Macro economic analysis has got an important role to play. Macroeconomics analyzes the environment in which the business has to function.
  • Business Economics is a normative science which is interdisciplinary and pragmatic in approach.
  • There are two categories of business issues to which economic theories can be directly applied, namely: Microeconomics applied to operational or internal Issues and Macroeconomics applied to environmental or external issues.
  • Business Economics makes use of microeconomic analysis such as, demand analysis and forecasting, production and cost Analysis, inventory management, market structure and pricing policies, resource allocation, theory of capital and investment decisions, profit analysis and risk and uncertainty analysis.
  • Business Economics also considers Macroeconomics related to economic systems, business cycles, national income, employment, prices, saving and investment, Government’s economic policies and working of financial sector and capital market. 

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