1.

NATURE AND SCOPE OF BUSINESS ECONOMICS

NATURE OF BUSINESS ECONOMICS
Managerial economics is the youngest of all the social sciences. Since it originates from Economics, it has the
basis features of economics, such as assuming that other things remaining the same. This assumption is made
to simplify the complexity of the managerial phenomenon under study in a dynamic business environment so
many things are changing simultaneously. This set a limitation that we cannot really hold other things
remaining the same.
1. Normative:
• It focuses on prescriptive statements and self-established rules aimed at attaining the specified
goals of business.
• Economy should be based on value judgements and desirability.
2. Positive:
• It focuses on description; it aims at describing the matter in which economic system operates
with out staffing how they should operate.
Business economics, hence combines the essentials of normative and positive economic theories.

SCOPE OF BUSINESS ECONOMICS

The scope of managerial economics refers to its area of study. Managerial economics, provides management
with a strategic planning tool that can be used to get a clear perspective of the way the business world works
and what can be done to maintain profitability in an ever-changing environment.
1. Demand Analyses and Forecasting:
• A firm can survive only if it is able to the demand for its product at the right time, within the
right quantity.
• Understanding the basic concepts of demand is essential for demand forecasting.
• Demand analysis should be a basic activity of the firm because many of the other activities of
the firms depend upon the outcome of the demand fore cost.
• Demand analysis also highlights for factors, which influence the demand for a product. This
helps to manipulate demand.
2. Production and cost analysis:
• Production analysis is in physical terms. While the cost analysis is in monetary terms cost
concepts and classifications, cost-out-put relationships, economies and diseconomies of scale
and production functions are some of the points constituting cost and production analysis.
3. Profit Analysis:
• Profit making is the major goal of firms. There are several constraints here an account of
competition from other products, changing input prices and changing business environment
hence in spite of careful planning, there is always certain risk involved.
• Profit theory guides in the measurement and management of profit.
4. Capital or investment analyses:
Capital is the foundation of business. Lack of capital may result in small size of operations.
o The major issues related to capital analysis are:
• The choice of investment project
• Evaluation of the efficiency of capital
• Most efficient allocation of capital

2.ELASTICITY OF DEMAND
Elasticity of demand explains the relationship between a change in price and consequent change in amount
demanded. “Marshall” introduced the concept of elasticity of demand.

Elastic demand: A small change in price may lead to a great change in quantity demanded. In this case,
demand is elastic.

In-elastic demand: If a big change in price is followed by a small change in demanded then the demand in
“inelastic”.

Types of Elasticity of Demand:

There are three types of elasticity of demand:

1. Price elasticity of demand

2. Income elasticity of demand
3. Cross elasticity of demand

1. Price elasticity of demand:

It is the ratio of percentage change in quantity demanded to a percentage change in price.

Proportionate change in the quantity demand of commodity

Price elasticity = ------------------------------------------------------------------

Proportionate change in the price of commodity

A. Perfectly elastic demand:

When small change in price leads to an infinitely large change is quantity

demand, it is called perfectly or infinitely elastic demand. In this case E=∞

B. Perfectly Inelastic Demand

In this case, even a large change in price fails to bring about a change in quantity
demanded.

C. Relatively elastic demand:

A small change in price loads to a very big change in the quantity demanded. In
this case E > 1. This demand curve will be flatter.

D. Relatively in-elastic demand.

A large change in price leads to small change in amount demanded. Here E < 1
.Demanded carve will be steeper.
E. Unit elasticity of demand:

The change in demand is exactly equal to the change in price. When both are
equal E=1 and elasticity if said to be unitary.

2. Income elasticity of demand:

Proportionate change in the quantity demand of commodity

Income Elasticity = ------------------------------------------------------------------

Proportionate change in the income of the people

A. Zero income elasticity:

Quantity demanded remains the same, even though money income increases.
Symbolically, it can be expressed as Ey=0.

B. Negative Income elasticity:

When income increases, quantity demanded falls. In this case, income elasticity
of demand is negative. i.e., Ey < 0.

c. Unit income elasticity:

When an increase in income brings about a proportionate increase in

quantity demanded, and then income elasticity of demand is equal to one.
Ey = 1

d. Income elasticity greater than unity:

In this case, an increase in come brings about a more than proportionate increase
in quantity demanded. Symbolically it can be written as Ey > 1.

E. Income elasticity leas than unity:

When income increases quantity demanded also increases but less than
proportionately. In this case E < 1.

3. Cross elasticity of Demand:

Proportionate change in the quantity demand of commodity “X”

Cross elasticity = -----------------------------------------------------------------------

Proportionate change in the price of commodity “Y”

a. In case of substitutes, cross elasticity of demand is positive. Eg: Coffee and Tea

When the price of coffee increases, Quantity demanded of tea increases. Both are
substitutes.

b. Incase of compliments, cross elasticity

is negative. If increase in the price of one
commodity leads to a decrease in the
quantity demanded of another and vice
versa.

c. In case of unrelated commodities, cross elasticity of demanded is zero. A

change in the price of one commodity will not affect the quantity demanded of
another.

3. DIFFERNCES OF MICRO AND MACRO ECONOMICS

4. LAW OF DEMAND

Law of demand shows the relation between price and quantity demanded of a commodity in the market. In the
words of Marshall, “the amount demand increases with a fall in price and diminishes with a rise in price”.

A rise in the price of a commodity is followed by a reduction in demand and a fall in price is followed by an
increase in demand, if a condition of demand remains constant.

The law of demand may be explained with the help of the following demand schedule.

Price of Appel Quantity

Demand Schedule.
(In. Rs.) Demanded
When the price falls from Rs. 10 to 8 quantity demand increases from
10 1
1 to 2. In the same way as price falls, quantity demand increases on the
basis of the demand schedule we can draw the demand curve. 8 2

6 3

4 4

2 5
The demand curve DD shows the inverse relation between price and
quantity demand of apple. It is downward sloping.

Assumptions:

Law is demand is based on certain assumptions:

1. This is no change in consumers taste and preferences.

2. Income should remain constant.
3. Prices of other goods should not change.
4. There should be no substitute for the commodity
5. The commodity should not confer at any distinction
6. The demand for the commodity should be continuous
7. People should not expect any change in the price of the commodity

Exceptional demand curve:

Sometimes the demand curve slopes upwards from left to right. In this case the demand curve has a positive
slope.

Price

When price increases from OP to Op1 quantity demanded also increases from to OQ1 and vice versa. The
reasons for exceptional demand curve are as follows.

1. Ignorance:

Sometimes, the quality of the commodity is Judge by its price. Consumers think that the product is superior if
the price is high. As such they buy more at a higher price.

2.Speculative effect:

If the price of the commodity is increasing the consumers will buy more of it because of the fear that it increase
still further, Thus, an increase in price may not be accomplished by a decrease in demand.

3. Fear of shortage:

During the times of emergency of war People may expect shortage of a commodity. At that time, they may
buy more at a higher price to keep stocks for the future.

4. Necessaries:
In the case of necessaries like rice, vegetables etc. people buy more even at a higher price.

5. LAW OF SUPPLY
The law of supply is a fundamental principle of economic theory which states that, keeping other factors
constant, an increase in price results in an increase in quantity supplied. In other words, there is a direct
relationship between price and quantity: quantities respond in the same direction as price changes. This means
that producers are willing to offer more products for sale on the market at higher prices by increasing
production as a way of increasing profits.
In short, the law of supply is a positive relationship between quantity supplied and price and is the reason for
the upward slope of the supply curve

7. INFLATION:
In economics, inflation is a sustained increase in the general price level of goods and services in an economy
over a period of time. When the general price level rises, each unit of currency buys fewer goods and services;
consequently, inflation reflects a reduction in the purchasing power per unit of money. A chief measure of
price inflation is the inflation rate, the annualized percentage change in a general price index, usually
the consumer price index, over time. The opposite of inflation is deflation (negative inflation rate).
Money supply in inflation:
Supplying the money in the market is the sole responsibility of the central bank of the country (Reserve Bank
of India in case of India). RBI prints the currency and supplies money in the economy. Coins are minted by
the Ministry of Finance but circulated by the RBI in the whole country. Supply of money decides the rate of
inflation in the economy. If supply of money increases in the economy then inflation starts rising and vice
versa.
Quantity Theory
The quantity theory of money proposes that the exchange value of money is determined like any other good,
with supply and demand. The basic equation for the quantity theory is called The Fisher Equation because it
was developed by American economist Irving Fisher. In it's simplest form, it looks like this:
(M)(V) = (P)(T)
Where: M=Money Supply
V=Velocity of circulation (the number of times money changes hands)
P=Average Price Level
T=Volume of transactions of goods and services
Some variants of the quantity theory propose that inflation and deflation occur proportionately to increases or
decreases in the supply of money.

8. BUSINESS CYCLE
Business cycles are characterized by boom in one period and collapse in the subsequent period in the economic
activities of a country.
These fluctuations in the economic activities are termed as phases of business cycles.
The different phases of business cycles are shown in Figure-1:
There are basically two important phases in a business cycle that are prosperity and depression. The other
phases that are expansion, peak, trough and recovery are intermediary phases.
Figure-2 shows the graphical representation of different phases of a business cycle:

1. Expansion:
The line of cycle that moves above the steady growth line represents the expansion phase of a business cycle.
In the expansion phase, there is an increase in various economic factors, such as production, employment,
output, wages, profits, demand and supply of products, and sales.
In this phase, debtors are generally in good financial condition to repay their debts; therefore, creditors lend
money at higher interest rates. This leads to an increase in the flow of money.
In expansion phase, due to increase in investment opportunities, idle funds of organizations or individuals are
utilized for various investment purposes.

2. Peak:
The growth in the expansion phase eventually slows down and reaches to its peak. This phase is known as
peak phase. In other words, peak phase refers to the phase in which the increase in growth rate of business
cycle achieves its maximum limit. In peak phase, the economic factors, such as production, profit, sales, and
employment, are higher, but do not increase further.
The increase in the prices of input leads to an increase in the prices of final products, while the income of
individuals remains constant.

3. Recession:
As discussed earlier, in peak phase, there is a gradual decrease in the demand of various products due to
increase in the prices of input. When the decline in the demand of products becomes rapid and steady, the
recession phase takes place.
In recession phase, all the economic factors, such as production, prices, saving and investment, starts
decreasing. Generally, producers are unaware of decrease in the demand of products and they continue to
produce goods and services. In such a case, the supply of products exceeds the demand.

4. Trough:
During the trough phase, the economic activities of a country decline below the normal level. In this phase,
the growth rate of an economy becomes negative. In addition, in trough phase, there is a rapid decline in
national income and expenditure.
In this phase, it becomes difficult for debtors to pay off their debts. As a result, the rate of interest decreases;
therefore, banks do not prefer to lend money. Consequently, banks face the situation of increase in their cash
balances.

5. Recovery:
As discussed above, in trough phase, an economy reaches to the lowest level of shrinking. This lowest level
is the limit to which an economy shrinks. Once the economy touches the lowest level, it happens to be the end
of negativism and beginning of positivism.
This leads to reversal of the process of business cycle. As a result, individuals and organizations start
developing a positive attitude toward the various economic factors, such as investment, employment, and
production. This process of reversal starts from the labor market.

6. METHOD OF DEMAND FORECASTING

Several methods are employed for forecasting demand. All these methods can be grouped under survey method
and statistical method. Survey methods and statistical methods are further subdivided in to different categories.

1. Survey Method:

Under this method, information about the desires of the consumer and opinion of exports are collected by
interviewing them. Survey method can be divided into four type’s viz., Option survey method; expert opinion;
Delphi method and consumers interview methods.

a. Opinion survey method:

This method is also known as sales-force composite method (or) collective opinion method. Under this
method, the company asks its salesman to submit estimate of future sales in their respective territories.
these estimates are consolidated, reviewed and adjusted by the top executives.
This method is more useful and appropriate because the salesmen are more knowledge. They can be important
source of information. They are cooperative.

b. Expert opinion method:

Apart from salesmen and consumers, distributors or outside experts may also be used for forecasting. In the
United States of America, the automobile companies get sales estimates directly from their dealers. Firms in
advanced countries make use of outside experts for estimating future demand.

c. Delphi Method:

It is a sophisticated method to arrive at a consensus. Under this method, a panel is selected to give suggestions
to solve the problems in hand. Both internal and external experts can be the members of the panel. Panel
members one kept apart from each other and express their views in an anonymous manner. There is also a
coordinator who acts as an intermediary among the panelists. He prepares the questionnaire and sends it to the
panelist. At the end of each round, he prepares a summary report. On the basis of the summary report the panel
members have to give suggestions. This method has been used in the area of technological forecasting.

d. Consumers interview method:

In this method the consumers are contacted personally to know about their plans and preference regarding the
consumption of the product.

A list of all potential buyers would be drawn and each buyer will be approached and asked how much he plans
to buy the listed product in future. He would be asked the proportion in which he intends to buy. This method
seems to be the most ideal method for forecasting demand.

2. Statistical Methods:

Statistical method is used for long run forecasting. In this method, statistical and mathematical techniques are
used to forecast demand. This method relies on post data.

a. Time series analysis or trend projection methods:

A well-established firm would have accumulated data. These data are analyzed to determine the nature of
existing trend. Then, this trend is projected in to the future and the results are used as the basis for forecast.
This is called as time series analysis.

b. Barometric Technique:

Simple trend projections are not capable of forecasting. Under Barometric method, present events are used to
predict the directions of change in future. This is done with the help of economics and statistical indicators.
Those are (1) Construction Contracts awarded for building materials (2) Personal income (3) Agricultural
Income. (4) Employment (5) Gross national income (6) Industrial Production (7) Bank Deposits etc.

c. Regression and correlation method:

Regression and correlation are used for forecasting demand. Based on post data the future data trend is
forecasted. If the functional relationship is analyzed with the independent variable it is simple correction.
When there are several independent variables it is multiple correlation. In correlation we analyze the nature of
relation between the variables while in regression; the extent of relation between the variables is analyzed.
9. PERFECT COMPETITION & FEATURES
10. METHODS OF CONCEPTS OF RAISING FINANCE
▪ The scope of raising funds depends on the sources from which funds may be available.
▪ In both these forms of business organisations, long-term capital is generally provided by the owners.
▪ Fixed capital can be raised by way of loans from friends and relatives on the personal security of
owners.
▪ Generally short-term working capital needs are met partly by trade creditors (suppliers of materials
and goods) and loans from finance companies.
▪ Another method of securing both long and short-term finance is the reinvestment of profits earned from
time to time.
▪ In the case of companies, there are a number of methods of raising finance.