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Basic Concepts: Business Economics - Coggle Diagram
Basic Concepts: Business Economics
Fundamentals of Economics
What is Economics
Social science on economic activities (earning + spending money)
Core problem: unlimited wants vs limited resources
Firms = production units (maximise profit)
Households = consumption units (maximise satisfaction)
Subject Matter
Wants to Efforts to Satisfaction
Consumption
Using goods/services to satisfy wants
Purpose of purchase decides consumption vs investment
Production
Creation of goods and services, creation of utility
Factors: Land, Labour, Capital, Organization
Exchange
Barter system problems: double coincidence of wants, indivisibility
Money solved these
Distribution
Micro distribution: factor pricing (rent, wages, interest, profit)
Macro distribution: sharing national income
Modern additions: employment, income, planning, international trade
Definitions of Economics
Wealth Definition
Adam Smith (Father of Economics), J.B. Say
Wealth of Nations, 1776
Criticised by Carlyle, Ruskin, Walras, Dickens
Called Gospel of Mammon, bread and butter science
Welfare Definition
Alfred Marshall, Principles of Economics, 1870
Study of mankind in ordinary business of life
Material + immaterial goods, man over wealth
Criticised by Robbins: incomplete, ignores harmful goods
Scarcity Definition
Lionel Robbins, 1932
Ends and scarce means with alternative uses
Points: unlimited wants, limited resources, alternative uses, choice
Merits: analytical, universal, positive science, neutral
Criticism: old wine in new bottle, ignores dynamics
Growth Definition
Samuelson, Economics: An Introductory Analysis, 1948
Adds time element and dynamic growth approach
Includes both welfare and scarcity definitions
Micro vs Macro
Term coined by Ragnar Frisch
Micro Economics
Greek Mikros = very small
Individual units: consumer, firm, industry
Called Price Theory
Scope: product pricing, factor pricing, economic welfare
Uses: understanding economy, welfare, managerial economics
Macro Economics
Greek Makros = large
Aggregates: national income, employment, total output
Gardner Ackley definition
Called Income and Employment Theory
Scope: output and employment, trade cycles, inflation, growth, distribution
Important from 1930 onwards
Nature of Economics
Science: cause-effect, observation, generalisation, testing
Art: system of rules for a given end (Keynes)
Science teaches to know, Art teaches to do
Positive science: what it is, no value judgment, Robbins
Normative science: what ought to be, value judgment, Marshall
Verdict: both Science and Art, both positive and normative
Methods
Deductive: general to particular, assumptions, static, classical economists
Inductive: particular to general, statistical/historical, dynamic, modern economists
Central Problems
What to produce
How to produce (labour vs capital intensive)
For whom to produce
Demand
Meaning
Desire + purchasing power + willingness to pay
Determinants
Price of the good
Price of substitutes (directly related)
Price of complements (inversely related)
Income of consumer (normal vs inferior)
Tastes and preferences
Population
Climate
Law of Demand
Price and quantity demanded are inversely related
Dx = f(Px)
Dn = f(Pn, Ps, Pc, Y, T)
Demand Schedule and Curve
Individual demand schedule
Market demand schedule = sum of individual demands
Why Demand Curve Slopes Down
Law of diminishing marginal utility
Substitution effect
Income effect
New buyers
Old buyers
Exceptions to Law of Demand
Giffen Paradox (Sir Robert Giffen, bread)
Speculation
Conspicuous goods (status, diamonds)
Shares and speculative market
Bandwagon effect
Veblen effect (high price means high quality)
Types of Demand
Price demand: Dx = f(Px), downward sloping
Income demand: Dx = f(y), up for normal, down for inferior
Cross demand: Dx = f(Py), up for substitutes, down for complements
Change in Demand
Extension and contraction: due to own price, same curve
Increase and decrease: due to other determinants, curve shifts
Consumer Behaviour
Consumption
Satisfaction of wants through goods and services
Determinants: present income, future income, wealth income
Consumer Surplus
Alfred Marshall
CS = Willing price minus Actual price
Derived from law of DMU
Law of Diminishing Marginal Utility
H.H. Gossen 1854, Gossen first law
Developed by Marshall
Total Utility = sum of Marginal Utilities
MU = change in TU, MUn = TUn minus TU(n-1)
TU max when MU = 0, TU falls when MU negative
Assumptions: homogeneous units, reasonable size, no time gap, constant tastes
Exceptions: rare goods, hobbies, misers, money and gold, reading books
Importance: value paradox, basis for economic laws, progressive taxation, wealth redistribution
Demand Forecasting
Expert opinion method
Survey of buyers intentions
Collective opinion method
Controlled experiments
Statistical method
Theory of Production
Meaning: creating goods for sale, creation of utility
Land
Gift of nature
Limited in supply
Immobile factor
Subject to diminishing returns
Differs in fertility
Labour
Physical and mental services for income
Inseparable from labourer
Perishable
Backward bending supply curve
Weak bargaining power
Differs in efficiency
Capital
Man made means of production
Supplies tools, machines and raw materials
Improves productivity, generates employment
Provides transport, pays advance wages
Entrepreneur
Initiates business
Decision making
Choosing technology
Innovation
Pays rewards, bears profit or loss
Law of Variable Proportions
Short run, some factors fixed
Developed by Marshall
TP, AP = Q/L, MP = dQ/dL
Stage 1: increasing returns, ends where MP = AP
Stage 2: diminishing returns, TP max, MP = 0, producer operates here
Stage 3: MP negative, TP falls
MP cuts AP at maximum AP
Reasons: non homogeneous factors, imperfect substitution, wrong combination
Law of Returns to Scale
Long run, all factors changed in same proportion
Increasing returns: specialisation, indivisible factors, volume discounts
Constant returns: indicator of turning point
Diminishing returns: management problems, limit to human factor, poor coordination, rising input prices
Variable Proportions vs Returns to Scale
Short run vs long run
One factor varies vs all factors vary
Factor proportion changes vs stays same
No change in scale vs change in scale
Production Function
Qx = A f(F1, F2, F3 ... Fn), A = efficiency or technology parameter
Short period: fixed factors (land, building) and variable factors (labour, raw material)
Long period: all factors variable, returns to scale
Means of Production
Meaning
Materials, tools and instruments used by workers
Idea from Karl Marx, mode of production
Labour theory of value, surplus value, exploitation, proletariat
Ownership
Capitalist: private ownership, market mechanism, high inequality, USA and Western Europe
Socialist: public or collective ownership, low inequality, Cuba, North Korea, China
Mixed: both, India, Brazil, Russia, Indonesia
Marx: bourgeoisie vs proletariat
Relations of Production
Social relationships between owners and workers
Marx and Engels, interaction with mode of production
Contrasted with forces of production
Capital as Produced Means of Production
Bohm Bawerk: capital is the produced means of production
Importance
Efficient factors mean more goods, better quality, lower price
Higher production means GDP growth
Growth raises standard of living
Introduction
Focus: Demand analysis + Cost analysis
Demand analysis purposes
Forecasting of sales
Manipulation of demand
Drives production, inventory, investment, cash budget, expansion plans
Cost analysis
Needed to plan production, investment, plant size
Multiple regression: C = a + bX1 + cX2 + u
C = total cost, X1 = output level, X2 = plant size, u = omitted variables
Utility, Wealth and Production
Utility
Measure of consumer scale of preference
Wealth
Personal wealth (only transferable goods count)
National wealth (common property, govt bond is a liability)
Wealth vs Welfare
Wealth = stock at a point of time
Income = flow over a period of time
Production
Creation of goods for sale in market
Inputs to Output
Production Possibility Curve
Also PPF, PP Boundary, Transformation Curve
Slopes downward, concave to origin
Slope = MRT = opportunity cost
Straight line PPC means constant opportunity cost
On curve = possible, beyond = impossible, below = unemployment
Shift of PPC = economic growth
Money
Widely accepted in exchange or settling debts
Customary money example: cowries in ancient India
Money supply: notes and coins, credit cards, travellers cheques
Income and Saving
Income = net inflow of purchasing power over time
Saving = Income minus Consumption
Market
System connecting buyers and sellers, not just a place
Functions: determine price, determine quantity
Market mechanism = totality of all markets
Capital Stock and Investment
Investment = increment in capital stock (reservoir and tap analogy)
Real investment vs Portfolio investment
Buying an existing share is not investment
Y = C + I, so C + S = C + I, hence S = I
Foreign investment means S is not equal to I
Gross investment: inventory + fixed
Net Investment = Gross Investment minus Depreciation
Elasticity of Demand
Meaning: degree of responsiveness of demand
Price Elasticity
Ep = (dq/q) / (dp/p) = dq/dp x p/q
Marshall and Joan Robinson definitions
Perfectly elastic, Ep = infinity, curve parallel to OX
Perfectly inelastic, Ep = 0, curve parallel to OY, salt and life saving drugs
Relatively elastic, Ep greater than 1, luxury goods
Relatively inelastic, Ep less than 1, necessities
Unitary elastic, Ep = 1, rectangular hyperbola, comfort goods
Income Elasticity
Ey = dq/dy x y/q
Same five values
Cross Elasticity
Ec = dqx/dpy x py/qx
Methods of Measurement
Percentage method
Total outlay method (expenditure rises, constant or falls)
Point method: Ep = Lower Segment / Upper Segment
Arc method for big changes in price and quantity
AR, MR and Elasticity
MR = P(1 - 1/e)
e = 1 means MR = 0
e greater than 1 means MR positive
e less than 1 means MR negative
e = infinity means MR = P
Firm should produce where e is greater than 1
Importance
Business pricing decisions
Monopolist price discrimination
Determination of factor prices
International trade and terms of trade
Government: declaring public utilities
Determinants
Nature of commodity
Availability of substitutes
Variety of uses
Possibility of postponement
Durable vs perishable goods
Supply and Equilibrium
Meaning of Supply
Part of stock offered for sale at a given price, market and time
Determinants
Price of the good
Goals of the firm
Input prices
Technology
Government policies
Expectation about future prices
Prices of other commodities
Number of firms
Natural factors
Law of Supply
Price and supply are directly related
Sx = f(Px, PI, T, W, GP)
Individual and market supply schedules
Exceptions
Land and agriculture goods, curve parallel to OY
Rare goods
Labour, backward bending supply curve
Change in Supply
Extension and contraction (own price)
Increase and decrease (other determinants, curve shifts)
Elasticity of Supply
Es = dq/dp x p/q
Five values, same as demand
Determinants: nature of commodity, time factor, facilities, cost of production, nature of inputs, risk taking
Equilibrium
Price where quantity demanded equals quantity supplied
Above equilibrium: excess supply
Below equilibrium: excess demand
Case 1: supply constant, demand changes, price moves same direction
Case 2: demand constant, supply changes, price moves opposite
Case 3: both change equally, price unchanged
Case 4: demand rises more than supply, price rises
Case 5: supply rises more than demand, price falls
Case 6: demand up and supply down, price rises
Cost of Production
Cost Function: C = f(Q)
Concepts of Cost
Real cost (Marshall): efforts and sacrifices
Economic cost = Explicit + Implicit + Normal profit
Explicit costs = accounting costs, recorded
Implicit costs = imputed costs of own factors, not recorded
Normal profit = minimum to keep entrepreneur in business
Opportunity cost = next best alternative forgone
Applications: factor prices, economic rent, consumption pattern, production plan, national priorities
Private cost vs Social cost, marginal external damage
Short Run Costs
Fixed costs: TFC parallel to OX, positive even at zero output
Variable costs: TVC starts from origin, zero at zero output
TC = TFC + TVC
AC = TC/Q = AFC + AVC, U shaped
AFC = TFC/Q, rectangular hyperbola
AVC = TVC/Q, U shaped
MC = change in TC / change in Q, U shaped
MC cuts AC at minimum AC
Long Run Costs
LAC is envelope or planning curve, tangent to all SAC curves
LAC and LMC both U shaped
Economies of Scale
Internal Economies
Labour, technical, managerial, marketing
Financial, research and development
Transport and storage, risk bearing
Internal Diseconomies
Management, technical, risk bearing, marketing, financial
External Economies
Localisation or concentration
Disintegration or specialisation
Related information services
Producers organisation
External Diseconomies
Rising input prices
Pressure on infrastructure
Exhaustible natural resources
Diseconomies of disintegration
Internal economies and diseconomies make LAC U shaped
External economies shift LAC down, diseconomies shift LAC up
Revenue
TR = P x Q
AR = TR/Q, always equals price
MR = change in TR / change in Q
Perfect competition: AR = MR, parallel to OX
Imperfect competition: AR and MR slope down, MR below AR