Unit 1 Economics Concepts and Values Objectives: After going through this unit, you will be able to explain: Use of economic tools and concepts in business decision making Meaning, nature, scope, and significance of managerial economics Concept of value Meaning, nature, and scope of managerial economics Micro and macroeconomics for mangers Structure: 1.1 Introduction 1.2 Resource allocation – The problem of Scarcity and Choice 1.3 Concept of Economics 1.4 The fundamental problems of an economy 1.5 Nature and Scope of Economics 1.6 Concept of value – Use value and Exchange value; Input theory of value; Value added 1.7 Areas of economics - Micro and Macro Economics 1.8 Managerial Economics – integrating economic theory with business decisions 1.9 Summary 1.10 Key words 1.11 Self-assessment questions1.1 Introduction:Economics is as ancient as the human race and as contemporary as nuclear science. Atthe advent of the human race when men went out to hunt while others remained to defend
the fire, or when commodities were traded for each other, simple economics formed thebasis of trade; and in modern age when globalization dominates the world tradeeconomics and the consequent benefits continue to state the rules.The foundations of economics as a formal study were laid down by Adam Smith in TheWealth of Nations in 1776. Since then the subject has developed rapidly and now thereare several specialized branches of economics in myriad fields. Since there is aneconomic aspect to everything, economics as a study is extremely comprehensive. The artand science of business also finds its basis in economics through what is known today asManagerial Economics.1.2 Resource allocation – The problem of Scarcity and ChoiceAll human actions are oriented towards satisfaction of wants. These wants range over daytoday lives and long term goals and their achievements. However when human beings dothat, they realize that they are constantly juggling between plenty of wants and limitedmeans to achieve them. Besides one want satisfied almost always leads to a succession byanother. Because goods and services are scarce, choices must be made. This, indeed,forms the basis of the study of economics. Consider the following figure, which describestwo important issues that human being deal with in all facets of life that of Scarcity andChoice. Economics as a body of knowledge or study discusses how a society tries tosolve the human problems of unlimited wants and scarce means.
satisfy ENDS MEANS Are scarce Are unlimited Have alternative Recur uses Scarcity and ChoiceLet us define the terms scarcity and choice before arriving at a formal definition ofeconomics • Scarcity implies that means or resources available are inadequate to satisfy all human wants and needs. • Choice implies the options available as a result of multiple wants and scarce means having alternative uses.These concepts imply that there is a deficiency of things in the world, clean-water, food,houses, roads, hotels, cars and so on. Humans devise systems to share out these scarceresources between themselves. Economists are interested in describing these systems andfinding the best methods.1.3 Concept of EconomicsAlfred Marshall (1920) portrayed economics as, “…the study of mankind in the ordinarybusiness of life; it examines that part of individual and social action which is most closely
connected with the attainment and with the use of the material requisites of wellbeing.”This highlights the fact that economics is perhaps a means for achieving prosperity andwealth. Robbins (1932) describes economics as “…a social science that studies humanbehavior as a relationship between ends and scarce means which have alternative uses.”This perspective of economics brings out the essence of resource utilization and goalachievement. Most of modern business orientations of efficiency and effectiveness arecaptured by these propositions of Robbins. The Economist’s Dictionary of Economicsdescribes economics as “…the study of the production, distribution and consumption ofwealth in human society”. This point of view brings to the fore the involvement ofeconomic concepts and tools in various functions that economies perform. Some otherideas that further strongly imply the scope of economics as a study are offered byHeilbroner who states economics as“…the process by which society marshals andcoordinates the activities required for its provisioning”, and Samuels who talks abouteconomics as “…a process of valuation… That to behave and to choose is to engage invaluation and thereby to participate in the social, socioeconomic, valuation process.”1.4 The fundamental problems of an economyAll individuals, households, business firms, communities, nations - rich and poor alike -confront scarcity. The fundamental economic problem is the appropriate use of limitedresources to produce the goods and services that we value most. Much of economics isdevoted to the study of how markets and prices enable society to solve the problems ofhow, what and for whom to produce. Consider the following figure,
What? How to How distribute much? ? For Goods What whom? and combination services ? How How? efficiently? When?The above figure decomposes the issues of scarcity and choice into some fundamentalproblems that the economy and its units face and the economic tools and techniques helpsolve them. These problems are: a) What goods and services should be produced? : The economy and its productive units have to make decisions regarding which goods and services to be produced so that scarce resources are utilized to produce those commodities which are needed. b) How many of each good (and service) should be produced? : Excessive production will only cause wastages which may be economically disastrous. So the right quantity of goods and services should be produced. c) What combination of goods and services to produce? : Resources are not only scarce, they have alternative uses. To have them invested in particular bundle of goods and services would imply forgoing another bundle. Correct choices have to be made for maximum satisfaction of maximum number of people. d) How should those goods be produced? : This relates to the process and systems of production. Any leakages or inefficiency in this regard will only cause wastage of scarce resources. e) When should those goods be produced? : Time is of great value. If commodities do not exist when and wherever they are needed to satisfy human needs and wants they loose their utility.
f) How to utilize its resources efficiently? : Technology underlying production processes should be continuously updated and advanced for efficient utilization of scarce resources. g) For whom to produce? : This is in context of the ultimate beneficiary of goods and services that need to be known before commodities are manufactured. h) How much of each good to distribute to each person? : Finally, once the beneficiaries are known distribution of benefits have to be such as to have maximum good of maximum number of people.1.5 Nature and Scope of EconomicsThe development of society can be described as the uncovering of new wants and needs -which producers attempt to supply by using the available factors of production.Archeological and written records of human existence suggest that obtaining the materialmeans to satisfy wants has been a perpetual problem. Food and shelter are requirementsof human life. Other goods satisfy a range of human desires and give pleasure or utility toindividuals. Economics has contributed as a study of ways to deal with these issues andchallenges. The nature and scope of economics can, hence, be best described in followingpoints, a) Economics as a study of the allocation of scarce resources: From a technical perspective, economics is the study of how various alternatives or choices are evaluated to best achieve a given objective. The domain of economics is the study of processes by which scarce resources are allocated to satisfy unlimited wants. Ideally, the resources are allocated to their highest valued uses. Supply, demand, preferences, costs, benefits, production relationships and exchange are tools that are used to describe and analyze the market processes by which individuals allocate scarce resources to satisfy as many wants as possible. This increasingly narrow focus is the domain of modern, “neoclassical,” microeconomic analysis.
This approach is typical of most economists and is referred to as orthodox economics.b) Economics as a study of provisioning: Economics as a study of provisioning is a social science and tries to understand the historical and philosophical context of the allocation problem. It is a study of the nature of the ends and processes as well as the means. The allocation problem is one aspect of the provisioning problem. If we are to study the allocation of resources to competing ends, what is the nature and origin of the ends (goals, objectives)? Individuals have goals. To what extent are these goals shaped by different forces in society? How do individuals’ objectives shape society? Why do individuals value some goods (or services) more highly than others? Are some goods more valuable to the functioning of society than others?c) Economics and its relationship with other disciplines: There is a general saying that, “If two or three economists are gathered together in one place, there you will find four or five opinions”. One reason is because economics is influenced by several academic disciplines such as sociology, politics, physics, chemistry, and the natural sciences. For instance, technological developments have influenced economic life and economic decisions cannot be solely based on economic factors. Government budgets have always been socio-political documents and international trade relations are a function of international relationships between nations. While the economist as a scientist is concerned altogether with the understanding of phenomena, nevertheless it has often happened that his conclusions have been helpful to statesmen in shaping the trade and industrial policies a nation Indeed the so-called father of political economy, Adam Smith, made his famous study of the subject for the purpose of discovering those policies of trade and production which were best adapted to enrich a nation.d) Methodology in economics: Business and economies, often, come across issues and challenges which, at times, can be solved/ supported with reference to facts,
and then there are other times when they cannot be purely referred to facts and require value judgments. Economics has both of these approaches inherent in its nature, when it is referred to as both a Positive science (supported with facts) as well as a Normative Science (supported with value judgments). Important methodological issues in economics have included: methodological individualism the relation of science to economics, discussed by J.S. Mill, J.M.Keynes andLionel Robbins; the role of simplifying assumptions, debated at length by M.Freidman and P. Samuelson; the role of a priori deduction, discussed by L.V.Mises; and the uses of the axiomatic method and formalization as represented in the work of K.Arrow, J.R.Hicks, and Amartya Sen. e) Economics for business: Physics is a science concerned with the laws governing the forces of nature. Engineering is a technical art aiming to utilize those forces to the advantage of man. Engineers built bridges, towers and roads long before they had mastered the science of physics. They worked by what is known as the rule of thumb, guessing and experimenting until they arrived at a satisfactory method, but they never could have constructed the marvelous machines and towering structures of today. The modern engineer must know physics as well as mathematics. In the same way, the science of economics is essential to the training of any person who wants to give his business talent the greatest possible opportunity for achievement. Business is the art whereby man produces wealth for the gratification of his wants; economics is the science which studies the laws and conditions under which wealth is and must be produced. A person unfamiliar with the principles of this science, unless he has most extraordinary ability, is at a disadvantage in modern competition and will have to be satisfied with small business affairs and small results.1.6 Concept of valueThe concept of value and providing value to the customer is increasingly acquiringsignificance in contemporary business environment. In economics, the value of acommodity is understood as how much the commodity is worth relative to othercommodities to an individual. Value of a commodity is evaluated in terms of its worth
(valuation) or assessed in terms of its value in the market (price). The concept of value isimportant in answering key questions in business like why goods and services are pricedas they are, how the value of goods and services comes about, and how to calculate thecorrect price of goods and services.In his analysis of value Marx has distinguished between Use value and Exchange value.He implies that commodities have a value, a use value, an exchange value, and a price,defined as follows, a) Value: The worth of a commodity in relation to other commodities. b) Use value: The intrinsic or inherent characteristics of commodity that enables it to satisfy consumer need. c) Exchange Value: The value that commodities acquire because they are traded in markets. d) Price: The numerical monetary value that is ssigned to a commodity in the market.Value is intrinsically related to the worth derived by the consumer. This measure ofworth is based purely on the utility derived from the consumption of a product or service.Utility derived value allows products or services to be measure on outcome instead ofdemand or supply theories that have the inherent ability to be manipulated.1.7 Areas of EconomicsThe study of economics can be classified into various specialized areas of studies.However the most popular form of classification divides the study of economics intoMicro and Macro economics. This kind of a categorization owes its origin to the fact thatpeople, insitutions, and units in an economy inpact both in the individual capacity as wellparts of the economic system. This is why they need to be studied in individual capacityas well as parts of economic interelationships and systems. Consider the following figurewhich details out individual economic units,
HOUSEHOLDS BUSINESS INDIVIDUAL GOVERNMENT ECONOMIC UNITS REST OF THE WORLDConsider the following figure which details out the economy as a whole system, GOVERNMENT HOUSEHOLDS BUSINESS REST OF THE WORLDThe above figures describe two approaches to the study of economics. This distinctionhas been largely due to the works of J.M.Keynes who viewed economic theory as microand macroeconomics. A generic definition of these two areas of economics follows, a) Microeconomics is an area of economics that evaluates how individuals, households, and firms within the large economic system make decisions to allocate limited resources to fulfill unlimited wants. It encompasses the study of behavior of individual economic units within the whole economic system. It places primary emphasis on the nature and functions of product markets, and
includes the study of factor markets and of the role of government in promoting greater efficiency and equity in the economy. b) Macroeconomics on the other hand, involves the study of sum total of economic activity as result of the functioning of the entire economic system. When individual economic units interact and perform they create the economic system as a whole. This system acts as both a result as well as a cause of economic behavior and decisions of individual economic units. This study places particular emphasis on national income and macroeconimc aggrgates, and also develops economic performance measures, economic growth, and international economics.Following table distinguishes between the Micro and Macro economics,S.N. Microeconomics Macroeconomics 1. A study of individual economic units A study of the economic system as a and their economic behavior. whole. 2. Microeconomics focuses on supply and Macroeconomics looks at economy- demand and other forces that determine wide phenomena such as Gross price levels for specific companies in domestic product (GDP) and how it is specific industry sectors. affected by changes in unemployment, national income, rate of growth, and price levels. 3. Microeconomics takes a bottoms-up Macroeconomics takes a top-down approach to analyzing the economy approach to analyzing the economy while macroeconomics. while macroeconomics. 4. This is often called as Price Theory. This is often dcalled as Theory of Income and Employment. 5. This places emphasis on the functioning This places emphasis on the broad of product and resource markets. macroeconomic aggregates and their evaluation. 6. This studies individual income, output This is concerned with national income level in individual sectors etc. and national output. 7. This may not concern itself with the This concerns itself with the interrelationships between various interrelationships between various economic units. economic units and their impact on the
economy as a whole. 8. This views individual economic units in This does not view individual economic isolation with each other. units in isolation with each other but as parts of a whole system.While these two studies of economics appear to be different, they are actuallyinterdependent and complement one another since there are many overlapping issuesbetween the two fields. For example, increased inflation (macro effect) would cause theprice of raw materials to increase (micro effect) for companies and in turn affect the endproducts price charged to the public.1.8 Managerial Economics – integrating economic theory with business decisionsManagerial economics is a branch of economics that applies microeconomic analysis tospecific business decisions. As such, it bridges economic theory and economics inpractice. It concerns with the application of economic principles and methodologies tobusiness decision problems. Contemporary business firms require the knowledge ofeconomics, its tools, and techniques on a vriety decision issues. Consider some of theissues where the knowledge of managerial economics aids business managers,1. Multiple GoalsA business firm may be confronted with a multiplicity of goals. Since it is technically notpossible to try to maximize simultaneously the values of multiple conflicting goals, thedecision makers have to choose one of the goals for primary pursuit. The other goals,expressed as minimum or maximum acceptable values, can then be regarded asconstraints on the pursuit of the primary goal. The object of the decision is to maximizethe value of the primary goal, subject to realization of satisfactory levels of subordinategoals.2. Multiple Strategies
With respect to any single goal, a business decision often involves multiple possiblecourses of action, or strategies. If there were no alternatives, no decision would berequired other than selecting the goal for pursuit. The deliberate approach to decisionmaking involves the identification of all possible courses of action and the benefits andcosts likely to result from each of the alternatives. The rational choice is the alternativethat yields the greatest relative positives or the largest sum of net benefits (positives lessnegatives), given the decision makers set of preferences.3. Marginal ChangesIn many cases, the choices are not mutually-exclusive alternative courses of action; ratherthey involve more or less of the same course of action. The range of possible alternativesincludes larger or smaller quantities to be selected. Typically, the decision problem is toselect some quantity that is an alternative to the present one. Assuming that thealternative quantities are arrayed from smallest to largest, or vice-versa, choosing to shiftfrom one to another involves additions to or subtractions from benefits or costs.Economists speak of such additions and subtractions as incremental changes, or marginalchanges if they are the smallest possible changes that can be made. The rational choice insuch cases is to make a quantitative change that will yield the greatest marginal benefitrelative to marginal cost.4. Multiple OutcomesOften the possible alternative courses of action can be identified, but each decisionalternative may have several outcome possibilities. If the decision maker can in somemeaningful sense assess the probability of the occurrence of each possible outcome, foreach of the alternative courses of action, he may then compute the expected value of eachalternative. Economic tools and techniques provide the requisite knowledge.
The application of economic tools and techniques to business decision making, summedup in the study of Managerial Economics, can be described in the following figure, The study of Managerial Economics Business decision Application problems of Economic Unlimited and tools and constantly recurring techniques goals Scarce resources having alternative uses Optimal business solutions1.9 SummaryEconomics as a body of knowledge or study discusses how a society tries to solve thehuman problems of unlimited wants and scarce means. Much of the study is devoted to
the study of how markets and prices enable society to solve the problems of how, whatand for whom to produce. Economics has contributed as a study of ways to deal with theissues and challenges of humans and maximization of utility to individuals. This scope ofeconomics is exhibits through micro and macroeconomics, i.e., the study of economicsthrough evaluation of individual economic unit behavior (Microeconomics) and theevaluation of economy as a whole (Macroeconomics). When these concepts andtechniques of economics are utilized in business decisions it leads us to the formal studyof Managerial economics.1.9 Key Words a) Scarcity implies that means or resources available are inadequate to satisfy all human wants and needs. b) Choice implies the options available as a result of multiple wants and scarce means having alternative uses. c) Economics: A social science that studies human behavior as a relationship between ends and scarce means which have alternative uses. d) Central Problems of an economy: The problems of how, what and for whom to produce. e) Microeconomics: This is an area of economics that evaluates how individuals, households, and firms within the large economic system make decisions to allocate limited resources to fulfill unlimited wants. f) Macroeconomics: This involves the study of sum total of economic activity as result of the functioning of the entire economic system. g) Managerial economics: This is a branch of economics that applies microeconomic analysis to specific business decisions1.10 Self assessment questions1) Discuss the role and significance of scarcity and choice in economic decision making?2) Explain the meaning and scope of economics as a formal study
3) What are the central problems of an economy? Explain the concept of efficiency and effectiveness in this context?4) Distinguish between macro and microeconomics and discuss their role in business decision making.5) Define the term “Managerial Economics”. Cite some ways in which managers use economic tools for better business performance.6) Scarcity implies that i) Resources are abundant ii) Resources are not available iii) Resources are scarce iv) All of the above7) According to economics choice relates to i) Plenty of recurring wants ii) Plenty of resources iii) Plenty of economic units iv) None of the above8) Central problems of an economy imply i) What to produce? ii) How to produce? iii) For whom to produce iv) All of the above9) Microeconomics is also called as i) Price Theory ii) Demand Theory iii) Theory of income and employment iv) Theory of factors10) Macroeconomics deals with the study of macroeconomic aggregates i) True ii) False iii) Neither true nor false iv) Can’t say
11) Managerial economics helps business in i) Decision making ii) Resource allocation iii) Choosing between multiple goals iv) All of the above12) Fill in the blanks: i) Economics is a social science that studies human behavior as a relationship between _____________ and scarce _____________ which have alternative uses. ii) Economics as a study of_____________ is a social science and tries to understand the historical and philosophical context of the allocation problem. iii) Value of a commodity is evaluated in terms of its _____________ or assessed in terms of its value in the _____________ iv) The most popular form of classification divides the study of economics into_____________ and_____________. v) The study of _____________ bridges economic theory and economics in practice. vi) With respect to any single goal, a business decision often involves multiple possible courses of action, or _____________. vii) The application of economic tools and techniques to business decision making is summed up in the study of _____________.
viii) Economics has two approaches inherent in its nature, when it is referred to as both a _____________- supported with facts- as well as a _____________ - supported with value judgments.