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Economics for Buiness
Introduction An owner of a business needs to know what its resources are. Then he needs to understand the decisions that must be taken in order to run the business successfully. Economics helps a person to make decisions in a better way. Gaining knowledge regarding the economic principles is essential for an owner of a business.
Economics is the social science concerned with how individuals, institutions and society make optimal choices (McConnell & Brue, 2006). It is therefore extremely important that we understand the economic principles that help us in making the right choices. The content of this coursework contain many principles that allow us to make the best choices.
LO 1: Understanding the nature of economic resources and that their finite supply creates the need for business organizations to make choice.
This is a branch of economics that studies the economic aggregates. The main focus is the grand totals here e.g. it looks at the total amount of spending of the economy which is the aggregate demand and it also looks at the total output of the country which is the aggregate supply (Sloman & Sutcliffe, 2004).
It focuses on a much smaller level such as the study of individual units e.g. the pattern of production of a particular product such as a couch (Sloman & Sutcliffe, 2004). Business generally acts at the microeconomic level but they also get affected by what happening in the overall economy.
Scarcity and Opportunity cost:
Scarcity is the excess of human wants over what the actual resources at disposal can produce. People want more than what they actually have and the resources to generate them are not available. This is the problem of scarcity. Due to the problem of scarcity a person has to make a choice. A choice involves making a sacrifice. You must forgo one or many options for the one than you actually take e.g. marking a single option out of a possible 5 for a multiple choice question answer, the remaining 4 options would be the opportunity cost for the one that you choose or choosing to buy 2 pizzas over 1 KFC burger would make the KFC burger as the opportunity cost for pizzas. Opportunity cost is the cost of any activity measured in terms of the best alternative forgone.
Economic arrangement for solving the problem of scarcity:
The demands made by the human beings are unlimited but the output produced by the economy is limited. There is a significant imbalance between the demand and supply. In order to solve this problem of scarcity the proposal put out is that the demand must be made equal to the supplies. This can be done through the following.
The demand must be curtailed
The supply must be increased to match the demand
Use a combination of the above
If the demand of potatoes is too high then the government could increase the supply of potatoes by planting more potatoes or in order to reduce the demand the price of potatoes could be increased or the combination of both could be used. Solving the problem of scarcity depends d epends upon the decisions made.
LO 2: Understand the concept of market equilibrium and be able to use supply and demand analysis to examine how the prices are established in a market
Equilibrium and the supply and demand model:
The supply model shows the different quantity of output and different prices. The demand model shows the different quantity of goods demanded at varying prices. The equilibrium point is the point where the supply and the demand curve meet one another i.e. the quantity demanded is equivalent to the quantity produced.
This equilibrium point shifts with the changes in the market condition which the following table illustrates. Cha hang nge e in suppl ply y
Change in dema mand nd
Increase Decrease Constant Constant
Constant Constant Increase Decrease
Effect on equi uillibr briium price Decrease Increase Increase Decrease
Effect on equilibrium quantity Increase Decrease Increase Decrease
The government has to generate revenues and in order to do that it has to levy taxes on the public. The burden of the tax is barred by the public and the suppliers. The taxes charged have an impact on the market as well which can be seen from the following graph.
The increase in tax causes an upward shift in the supply curve. Raising the equilibrium price and reducing the quantity supplied. Understanding the following is also important. •
When the demand is price inelastic, tax ensures a large price increase and consumers bear more of the tax. When the demand is price elastic, the tax causes a smaller price increase and producers bear more of the tax (Nellis & Parker, 2002).
The government may also provide benefits to the general public and suppliers by bearing the cost of resources. Its impact can be seen from the following graph.
Due to subsidies the supply curve shifts downwards and equilibrium price is reduced from $30 to $ 20 and the equilibrium quantity is increased from 1000 units to 1100 units.
This is the minimum price set for a particular product. The product cannot be sold for below that price in a country legally (McConnell & Brue, 2006). Its impact can be seen from the following graph.
The diagram shows what would be considered to be legal and illegal if the price floor is set. Pf is the price floor set and the equilibrium is below that point. This creates an imbalance in the market. The supply is higher than the demand hence a surplus of products supplied exists.
This is the maximum price that can be set s et for a product and its graph is as follows.
The price of the product cannot exceed the price ceiling set (McConnell & Brue, 2006). That would be illegal to do so. In this case the equilibrium is above the price ceiling set. The supply is much less that quantity demanded which creates a shortage of the good.
Positive and negative externalities:
There are parties that can be seen as the outsiders to an economic transaction as they have no direct link to the transaction taking place. But if we observe at a larger level somehow or the other these third parties also get affected by the transactions taking place. This leads to externalities. If the third party gains an advantage due to such transactions then it is a positive externality and if it faces a disadvantage due to such an activity then it is a negative externality. Examples of positive externalities include building infrastructure, creating social awareness to a class. Now the direct learning would be of the class but the benefit would be taken by the entire society. Examples of negative externalities can be promoting terrorism. This might be taught to a few people but the negative impact is faced by the whole society. Another example could be the chemical waste that is dumped by the companies. These externalities show that the overall impact of an activity is not shown on the supply and demand curve. Otherwise the curves would be shifting depending upon the extent and direction of the externality. E.g. the demand curve should be showing a higher demand level if the benefits of positive externalities were
incorporated in it.
LO3: Understand the Concepts of elasticity of demand and supply and their application within the decision making process
This shows the variation in the quantity demanded of the product due to the change in price. It can be greater than 1, equal to 1 or less than 1. The demand is said to be elastic if greater than 1, if its equal to 1 then the demand is unit elastic and its inelastic if it’s less than 1 (Nellis & Parker, 2002).
This shows the variation of supply that is caused by the change in price of the product.
This show the extent to which the quantity demanded of the product changes when the real income of the people change. This can be used to classify goods as luxury, inferior or normal goods which will be illustrated below.
The cross price elasticity of demand shows the relationship between two product i.e. what impact does the change in price of one product has on the quantity demanded of the other product.
Normal goods can simply be defined as the goods whose demand rises as the income raises e.g. wheat. The demand is there at low incomes as well but it rises with the rise in real income. Inferior goods are the good whose demand falls as the income of the people
increases. An example of an inferior good could be a cheap margarine or raw potatoes. Substitute goods are the goods that can replace one another. If price of one good rises the demand for the other would fall e.g. if price of tea falls then the demand of coffee would drop. Complementary goods are goods that are consumed together (Sloman & Sutcliffe, 2004). If price of one goes up then the demand for the other good would also decrease e.g. if the price of blue ray movie player goes up then the demand for blue ray disks would decrease as well.
Using elasticity for business decisions:
Business has to be aware of what impact the change in price of the product would bring upon the sales and profitability of the business. The total revenue of the business is Quantity sold multiplied by sale price. The business needs to know what impact the price change would have on the quantity sold. If the product being produced has an price elastic demand then the business might not want to increase the price and that might reduce the units sold significantly reducing the overall profits of the business.
This table helps us in understand the decision that the business can take due du e to elasticity.
LO 4 : Understanding the economic theory of costs, the distinction between short run and long run costs, economies and diseconomies of scales and their impact on the business.
The fixed cost is the cost that does not change with the number of output units produced. The variable cost on the other hand is the cost that varies with the number of units produced e.g. If a 100 units are produced in a factory with the rent cost of 1000 £ with a labor cost of 2 £ per unit. The labor cost is variable cost while the rent cost is fixed and the total cost will be the sum of the two costs.
Average cost Is the per unit cost of the product produced. E.g. If 2000 £ is the total cost of producing 100 units then the average cost is 20 £ per unit Marginal cost is the cost of producing one extra unit for the business. The business should only produce an extra product if the marginal revenue is greater than the marginal cost.
The following diagram shows the relationship between the short run and the long run cost curves.
In the short run at least one factor of production related to the firm is fixed e.g. the number of factories that can be set up by the company. The curve A, B and C are individual short run average cost curves of the company.
In the long run the no factor of production is variable for the firm. It can go on to add new factories as well. In such a case the long run average cost curve for the company is formed by joining the minimum points of short run average cost curves as that would be the optimal path for the company. In this case that is curve D. This shows the relation between the short run average cost curves and the long run average cost curve.
Economies and diseconomies of scale:
Economies of scale means that the unit production costs will fall and the efficiency and profits would improve for the company. This happens to a limit only. After the minimum point of the long range average cost curve the firm starts to face the diseconomies of scale. In diseconomies of scale the cost of production increase as the scale of production increases (Sloman and Sutcliffe, 2004).
The business has to be able to look at it the condition that it is in and assess whether it will face economies or diseconomies of scale if it expands and take a decision accordingly.
LO 5: Understanding the nature and characteristics of different market structures and how these structures effect business conduct and performance
Market structures and output decision by the firm:
The monopolist is the lone producer of a good in the market and he would want to maximize his profit by producing a low quantity of product and still be able to sell it at a much higher price. For a firm the following equation applies when it wants to maximize its profit.
For a firm operating in a perfect competition the marginal revenue would be replaced by the price being offered as the firm would not alter the price much in the perfect competition.
If the same firm that worked under a monopoly and now switched to a perfect competition then it would produce a larger quantity at a lower price. The monopolist would use the similar policy in the long run while in perfect competition the firms are to produce at the bottom of their LRAC curve (Sloman & Sutcliffe, 2004).
The following table comprehensively illustrates the different market structures that exist and tell about their main features.
market Perfect competition Monopolistic competition Oligopoly
firms Very many
entry U nrestricted
Product U ndifferentiated Rice and wheat Differentiated Restaurants and buildings Differentiated Cars, cement and undifferentiated Unique Drug prescriptions
The firms have to take decisions in accordance to the market structure in which the function in. If a firm is operating in a perfect competition then it cannot interfere in the pricing decision. It just has to take the price from the market. The monopolist on the other hand would be able to take decisions regarding pricing with more freedom.
LO 6: Understanding the role and importance of the banking and finance sector in the successful operation of the business.
Role of the central and commercial banks:
The central banks are also known as the “banker’s bank”. They are said to perform similar function for the banks that the commercial banks perform for the general public and businesses (McConnell & Brue, 2006). The commercial banks deposit money and provide loans to the general public. The central bank provides loans and deposits money on behalf of the commercial banks.
The central bank is responsible for issuing currency in the country and they provide the guidelines under which the commercial banks of the country function. The central bank acts as the supervisor to the banks, it controls the money supply and it also sets out the reserve requirements for the banks. Their decisions are usually at the macroeconomic level and have a significant impact on the business being conducted in the country.
The commercial banks function according to the policy given by the state bank and them deposit money and provide loans to the business. They provide other services as well such as leasing and financial advising. They provide easier mode of payments as well which makes it easy to run a business.
Inflation and deflation:
Inflation is the rise in the level of prices. Suppliers have the liberty to increase the prices of goods being supplied in the period of inflation. The value of the countries money decreases with inflation and it becomes difficult to buy goods and services for the public. In order to make the business function the price of the product has to rise and decision regarding quantity produced being made.
Deflation is the decrease in the overall prices of goods. This can even go on to lead towards a downward spiral. The price of the goods are decreased and firm have to cut costs to earn profits but even after reducing costs the demand for goods is still low due to high unemployment. It is a sign of weakness for the economy.
The monetary policy and the interest rate:
The central bank controls the money m oney supply of the country. It prints new currency curr ency and withhold it when it wants to. The central bank uses the money supply as a tool to control the economy. It might try to reduce the money supply in order to counter inflation. The interest rate could be used to control the money supply as well. If the bank increases the interest rate then it is difficult for companies to obtain finances and hence the investments are reduced. The business should
keep a close eye on the monetary policy of the country as it has an impact on the decision that can be made.
In this coursework many essential elements of the study of economics were discussed with respect to business and how these concepts can be used to influence the decisions of the business was looked upon by using examples. A business must be aware of its economic environment and take decisions that suit the business. Economics provides a better understanding of the technical logics for taking a decision which were expressed in this course work. Rational and effective decision making can be the difference between a successful business and the one the shuts down quickly.
References McConnel, C.R., & Brue, S.L., 2006. Economics Economics:: Principles, Problems and Policies, 17th ed. Nellis, J.G., & Parker, D., 2002. Priniciples of Business Economics. Economics. Sloman, J., & Sutcliffe, M., 2004. Economics for Business, 3rd ed.