Business Economics: Definition, Characteristics and Scope

Let us make an in-depth study of the Business Economics. Read this article to learn about :- 1. Definition of Business Economics 2. Characteristics of Business Economics 3. Scope.

Definition of Business Economics:

The teaching of economics is, thus, an abstract theorization with little connection to business.

But theoretical models of economics are to be applied in business areas. Once theoretical models of economics are applied in business, the gap between economics and business gets minimised.

The branch of managerial economics or business economics has established links between business and economics.

Business economics is, thus, an applied economics. Economics is the study of human beings (e.g., consumers, firms) in producing and consuming goods and services in the midst of scarcity of resources. Managerial or business economics is an applied branch of organising and allocating a firm’s scarce resources to achieve its desired goals.

Managerial economics or business economics is economics applied in decision-making. Business economics, thus, interweaves economic principles and business. Business managers apply economic laws and principles while presenting business problems and their ways of solutions. Thus, business economics can be defined as the application of economic analysis to business problems faced by an enterprise. It provides a link between economic theory and the decision sciences in the analysis of managerial decision-­making. It relies heavily on traditional economics and decision sciences.

Identification of the problems and the solving of the problems are the two crucial elements of decision-making of a business firm. Business economists help business managers in making sound business decisions. Business success, in fact, greatly depends on appropriate business decisions. However, appropriate decision-making is not an easy job in this changing world.

On the basis of past knowledge and experience, business managers take business decisions and make future plans. But decision-makers are constrained by the ‘uncertainty’ of the real world where changes occur either in a hidden way or in an open way. In this changing but uncertain world, an accurate decision-making is impossible even if talents of top quality business economists are employed.

It is due to this uncertainty, prediction or estimation relating to the volume of sales of a product, cost of production, profit, etc., is more likely to be imperfect. In other words, against the backdrop of uncertainty and a changing world, business managers will have to anticipate changes so that the impact of unfavorable situations becomes insignificant. Thus, business decision-making is an art.

Cultivation of this art is made through economic principles. In this sense, managerial economics is an applied economics. It is concerned with the application of economic concepts and analytical tools to the process of decision-making of a business enterprise.

Thus, managerial economics or business economics is a ‘special branch of economics that bridges the gap between abstract economic theory and managerial practice. Through a process of application of the principles, concepts and tools of economics to solve the managerial problems of a business enterprise, business economists have greatly minimised the problem of uncertainty arising in business.

[An Illustration of the Relationship between Economic Theory and Business— Machlup’s Overtaking Analogy]

The application field of economic theory is popularly known as business economics or managerial economics. Can economic theory be applied in business practice efficiently? Fritz Machlup, in answering this question, gave an analogy between the behaviour of a motorist deciding whether or not to overtake on a two-lane highway and the behaviour of a profit- maximising firm. Overtaking decision of the motorist involves construction of a very complex set of equations.

While overtaking, the motorist must have a knowledge about the weight, power, speed of the vehicle being driven, the condition of the road, weather, information about the number of vehicles plying on the highway, and a set of assumptions about the behaviour and objectives of other drivers. Unfortunately, even the most expert and cautious drivers do not have all these information.

But the model-builder makes such unrealistic assumptions. Under the circumstance, the decision of overtaking in a two- lane highway seems to be next to impossible. In reality, all the drivers overtake dozens of times every day. Such overtaking decisions are deemed to be ‘correct’ only if accidents are not met with.

If we compare this behavioural overtaking decision of a motorist with that of the behaviour of a profit- maximising firm, we will reach the same conclusion. A profit-maximising firm assumes that it has perfect information about costs and revenue conditions. But that too is an unrealistic assumption.

Still they assume such and are always guided by profit-maximising motive. “Like the driver taking-the decision to overtake, managers ‘behave’ as if they had the relevant information, in which case they will behave like the profit- maximising model and that model will be a good predictor of their behaviour. ”

Characteristics of Business Economics:

Business economics is essentially concerned with the various decisions of a business enterprise. The unit of study of business economics is the firm. Thus, managerial economics studies decision-making behaviour of a firm or an industry. Microeconomics takes into account the behaviour of smaller economic agents, such as a firm or a consumer or an input owner.

It deals with the operation of a consumer, a firm involving the determination of price of a commodity, revenue, costs and, hence, profit levels, etc. Managerial economics is, thus, essentially microeconomic in character as it has its origin in theoretical microeconomics. Profs. H. C. Petersen and W. C. Lewis suggest that managerial economics should be thought of as applied microeconomics.

It is an application of that part of microeconomics focusing on those topics which are of great interest and importance to business managers. These topics include theories of demand, production and cost, profit-maximising model of the firm, optimal prices and advertising expenditures, government regulation, etc. Managerial economics is concerned with finding optimal solutions to business decision problems.

Secondly, economic concepts and principles of the ‘theory of firm’ are employed in business economics. Thus, in business economics, the main emphasis is given upon the firm, the environment in which the firm finds itself, and the business decision which firms have to take. In this sense, managerial economics is narrower in scope than pure economic theory.

Thirdly, broadly there are two main branches of economics—’positive’ economics and ‘normative’ economics. Positive economics deals with ‘description’ while normative economics deals with ‘prescription’. By building up propositions on the basis of a set of assumptions, positive economics tries to explain economic phenomenon.

Normative economics comments on the desirability of that phenomenon and suggests policy measures. Value judgments are, thus, pronounced in normative economics. In the words of Profs. Mote, Paul and Gupta: “Managerial economics is a part of normative economics as its focus is more on prescribing choice and action and less on explaining what has happened. Managerial economics draws on positive economics by utilizing the relevant theories as a basis for prescribing choices.”

Fourthly, business economics not only seeks to investigate and analyse how and why businesses behave as they do but also the implications of their actions and policies for the industry in which they operate and, finally, for the economy as a whole. In this business environment, both internal and external factors work.

Business economics seeks to analyse various internal and external constraints that businesses experience in their process of growth and survival, draw conclusions as to how and why businesses behave as they do. “Business economics therefore focuses on the issues relevant to a business and its operations, and to the business environment.” Thus, business economics is considered as applied economics. It casts away abstract economic theories. Managerial economists look at practical applications of theoretical models.

Finally, business economics is essentially microeconomic in character. In other words, macroeconomic theory has less relevance for managerial economics. Truly speaking, business economics should also deal with a wider environment—the macro-economy. Macro­economics is concerned with the behaviour of the economic system in totality. It studies the determination of aggregate national income, level of employment, general price level, the international balance of payments, etc.

It is true that aggregating economic trends or external economic factors do not directly affect business decisions of a firm. But what is true is that changing macro-economy not only influences aggregate or national income but also the demand for the product of a business firm. Efficient business managers must have awareness as well as keenness of studying and explaining macro- economic environment. In this sense, business economics cannot be devoid of macroeconomics.

Subject-Matter and Scope of Business Economics:

We know that managerial economics or business economics is applied microeconomics employed for the purpose of facilitating decision-­making and forward planning. As far as decision-­making and forward planning are concerned, one has to face the following problems:

Problem of resource allocation seems to be a pressing problem for any organisation. Resources are not plentiful. A firm has to organise scarce resources efficiently so that optimal outcomes are obtained. Such resource allocation problem includes production programming, transportation problem, etc. Non-optimal organisation of resources may spell disaster to any organisation.

Inventory and queuing are important problems to any firm. A firm has to hold an optimal level of stocks of raw materials and finished product so that business uncertainties can be minimised. Business managers must decide an optimal level of inventories. Such decisions are taken by firms after considering demand and supply conditions.

Since forward planning by management is essential, a firm must make decisions—whether new machines are to be installed or more professionals are to be employed. As most of the decisions cannot be implemented simultaneously, the firm manager must make a trade-off between decisions. Taking a particular decision out of a variety of decisions is known as queuing problem. A manager places or queues alternative decisions and picks up a right one. Price fixation is another interrelated problem connected with decision-making. A firm has to take up a right pricing decision.

Finally, the decision-maker faces investment problems for a variety of reasons. Truly speaking, any forward planning by management involves investment problems which are by nature knotty. Investment problems boil down to the problems of allocating resources over time. A firm has to make decision about the volume of investment. It must decide where to invest, when to invest. It must know the sources of funds, etc.

Anyway, business economics is concerned with decision-making and forward planning.

The scope of business economics (both micro and macro variety) is a wider one since it “uses the logic of Economics, Mathematics and Statistics to provide effective ways of thinking about business decision problems.” In view of this saying of Prof. D. C. Hague, we can argue that there are links between managerial economics and management science. In fact, the boundaries between the two subjects are not clear-cut but overlapping.

Managerial economics is largely an applied branch of microeconomics. Its macroeconomic content is not to be belittled. It uses the methods and techniques of microeconomics mostly in the field of management. As Haynes and William Warren state: “The relation of managerial economics to economic theory (of either the micro or macro variety) is much like that of engineering to physics, or of medicine to biology or bacteriology. It is the relation of an applied field to the more fundamental but more abstract basic discipline from which it borrows concepts and analytical tools.”

It is to be pointed out here that measurement without theory may lead to false precision and diagnosis while theory without measurement can hardly be operationally useful. Now we are in a position to explain the scope of business economics. By scope of (business) economics we mean the field of the subject, the boundaries that delimit and delineate the topics to be addressed.

Determination of the scope of the subject includes:

(i) Definition of the subject,

(ii) Subject matter of business economics,

(iii) Is business economics a positive or a normative science?

Since business economics is thought of as applied microeconomics, the scope of business economics includes:

i. Analysis, estimation and forecasting of consumer demand for a product;

ii. Analysis of cost and output;

iii. Determination of price of a commodity, work policy and business strategies of a business enterprise;

iv. Long-run planning decisions of a firm that studies capital budgeting and capital management.

Managerial economics now includes ‘operations research’—a mathematical technique to solve business problems.

Finally, we must say that there is a great deal of linkages between managerial economics and other disciplines and fields of study. It uses the logic of economics, mathematics and statistics. Managerial economics is related to management science or the decision sciences. Management science is concerned with techniques for improvement of decision-making.

Business economics is related to accounting. Accounting is essentially concerned with recording and analysing the financial activities of a business firm. To quote Prof. D. C. Hague: “The main task of management accounting is now seen as being to provide the sort of data which managers need if they are to apply the idea of managerial economics to solve business problems correctly; accounting data are also to be provided in a form so as to fit easily into the concepts and analysis of managerial economics.”

In view of the relationship between managerial economics and other disciplines, it may be called an art, and not a science. Though an art, decision-making in this uncertain world has become more perfect. Better choices, better prediction, etc., are likely to emerge because of the interaction among basic disciplines.

Thus, it is clear from the above discussion that managerial or business economics helps managers of firms, administrators of non-profit and profit-making hospitals, schools, colleges and universities to recognise how economic forces affect organisations. It applies economic theory and methods to business and administrative decision-making in both profit and non-profit sector.

Business economics links economic concepts with quantitative methods to develop tools for managerial decision-making. Business economics, thus, intends to bridge the gap that exists between economics and business management theory. This process is illustrated in Fig. 1.1.

Thus, business economics is closely linked with many disciplines (such as marketing, finance, management accounting, management science etc. in a business curriculum).