Unit 1

Economics Concepts and Values

1.1 Introduction:

Economics is as ancient as the human race and as contemporary as nuclear science. At

the advent of the human race when men went out to hunt while others remained to defend

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 questions

the fire, or when commodities were traded for each other, simple economics formed the

basis of trade; and in modern age when globalization dominates the world trade

economics and the consequent benefits continue to state the rules.

The foundations of economics as a formal study were laid down by Adam Smith in The

Wealth of Nations in 1776. Since then the subject has developed rapidly and now there

are several specialized branches of economics in myriad fields. Since there is an

economic aspect to everything, economics as a study is extremely comprehensive. The art

and science of business also finds its basis in economics through what is known today as

Managerial Economics.

1.2 Resource allocation – The problem of Scarcity and Choice

All human actions are oriented towards satisfaction of wants. These wants range over day

today lives and long term goals and their achievements. However when human beings do

that, they realize that they are constantly juggling between plenty of wants and limited

means to achieve them. Besides one want satisfied almost always leads to a succession by

another. 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 describes

two important issues that human being deal with in all facets of life that of Scarcity and

Choice. Economics as a body of knowledge or study discusses how a society tries to

solve the human problems of unlimited wants and scarce means.

Let us define the terms scarcity and choice before arriving at a formal definition of

economics

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 scarce

resources between themselves. Economists are interested in describing these systems and

finding the best methods.

1.3 Concept of Economics

Alfred Marshall (1920) portrayed economics as, “…the study of mankind in the ordinary

business of life; it examines that part of individual and social action which is most closely

Scarcity and Choice

Are scarceHave alternative

uses

Are unlimitedRecur

MEANS ENDSsatisfy

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 and

wealth. Robbins (1932) describes economics as “…a social science that studies human

behavior as a relationship between ends and scarce means which have alternative uses.”

This perspective of economics brings out the essence of resource utilization and goal

achievement. Most of modern business orientations of efficiency and effectiveness are

captured by these propositions of Robbins. The Economist’s Dictionary of Economics

describes economics as “…the study of the production, distribution and consumption of

wealth in human society”. This point of view brings to the fore the involvement of

economic concepts and tools in various functions that economies perform. Some other

ideas that further strongly imply the scope of economics as a study are offered by

Heilbroner who states economics as“…the process by which society marshals and

coordinates the activities required for its provisioning”, and Samuels who talks about

economics as “…a process of valuation… That to behave and to choose is to engage in

valuation and thereby to participate in the social, socioeconomic, valuation process.”

1.4 The fundamental problems of an economy

All individuals, households, business firms, communities, nations - rich and poor alike -

confront scarcity. The fundamental economic problem is the appropriate use of limited

resources to produce the goods and services that we value most. Much of economics is

devoted to the study of how markets and prices enable society to solve the problems of

how, what and for whom to produce. Consider the following figure,

The above figure decomposes the issues of scarcity and choice into some fundamental

problems that the economy and its units face and the economic tools and techniques help

solve 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.

Goods and services

What?How much?

What combination?

How?How efficiently?

For whom?

How to distribute?

When?

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 Economics

The 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 material

means to satisfy wants has been a perpetual problem. Food and shelter are requirements

of human life. Other goods satisfy a range of human desires and give pleasure or utility to

individuals. Economics has contributed as a study of ways to deal with these issues and

challenges. The nature and scope of economics can, hence, be best described in following

points,

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 value

The concept of value and providing value to the customer is increasingly acquiring

significance in contemporary business environment. In economics, the value of a

commodity is understood as how much the commodity is worth relative to other

commodities 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 is

important in answering key questions in business like why goods and services are priced

as they are, how the value of goods and services comes about, and how to calculate the

correct 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 of

worth 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 of

demand or supply theories that have the inherent ability to be manipulated.

1.7 Areas of Economics

The study of economics can be classified into various specialized areas of studies.

However the most popular form of classification divides the study of economics into

Micro and Macro economics. This kind of a categorization owes its origin to the fact that

people, insitutions, and units in an economy inpact both in the individual capacity as well

parts of the economic system. This is why they need to be studied in individual capacity

as well as parts of economic interelationships and systems. Consider the following figure

which details out individual economic units,

Consider the following figure which details out the economy as a whole system,

The above figures describe two approaches to the study of economics. This distinction

has been largely due to the works of J.M.Keynes who viewed economic theory as micro

and 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

HOUSEHOLDS

BUSINESS

GOVERNMENT

REST OF THE WORLD

INDIVIDUAL ECONOMIC

UNITS

GOVERNMENT

HOUSEHOLDS BUSINESS

REST OF THE WORLD

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

and their economic behavior.

A study of the economic system as a

whole.

2. Microeconomics focuses on supply and

demand and other forces that determine

price levels for specific companies in

specific industry sectors.

Macroeconomics looks at economy-

wide phenomena such as Gross

domestic product (GDP) and how it is

affected by changes in unemployment,

national income, rate of growth, and

price levels.

3. Microeconomics takes a bottoms-up

approach to analyzing the economy

while macroeconomics. 

Macroeconomics takes a top-down

approach to analyzing the economy

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

of product and resource markets.

This places emphasis on the broad

macroeconomic aggregates and their

evaluation.

6. This studies individual income, output

level in individual sectors etc.

This is concerned with national income

and national output.

7. This may not concern itself with the This concerns itself with the

interrelationships between various

economic units.

interrelationships between various

economic units and their impact on the

economy as a whole.

8. This views individual economic units in

isolation with each other.

This does not view individual economic

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 actually

interdependent and complement one another since there are many overlapping issues

between the two fields. For example, increased inflation (macro effect) would cause the

price of raw materials to increase (micro effect) for companies and in turn affect the end

product's price charged to the public.

1.8 Managerial Economics – integrating economic theory with business decisions

Managerial economics is a branch of economics that applies microeconomic analysis to

specific business decisions. As such, it bridges economic theory and economics in

practice. It concerns with the application of economic principles and methodologies to

business decision problems. Contemporary business firms require the knowledge of

economics, its tools, and techniques on a vriety decision issues. Consider some of the

issues where the knowledge of managerial economics aids business managers,

1. Multiple Goals

A business firm may be confronted with a multiplicity of goals. Since it is technically not

possible to try to maximize simultaneously the values of multiple conflicting goals, the

decision 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 as

constraints on the pursuit of the primary goal. The object of the decision is to maximize

the value of the primary goal, subject to realization of satisfactory levels of subordinate

goals.

2. Multiple Strategies

With respect to any single goal, a business decision often involves multiple possible

courses of action, or strategies. If there were no alternatives, no decision would be

required other than selecting the goal for pursuit. The deliberate approach to decision

making involves the identification of all possible courses of action and the benefits and

costs likely to result from each of the alternatives. The rational choice is the alternative

that yields the greatest relative positives or the largest sum of net benefits (positives less

negatives), given the decision maker's set of preferences.

3. Marginal Changes

In many cases, the choices are not mutually-exclusive alternative courses of action; rather

they involve more or less of the same course of action. The range of possible alternatives

includes larger or smaller quantities to be selected. Typically, the decision problem is to

select some quantity that is an alternative to the present one. Assuming that the

alternative quantities are arrayed from smallest to largest, or vice-versa, choosing to shift

from one to another involves additions to or subtractions from benefits or costs.

Economists speak of such additions and subtractions as incremental changes, or marginal

changes if they are the smallest possible changes that can be made. The rational choice in

such cases is to make a quantitative change that will yield the greatest marginal benefit

relative to marginal cost.

4. Multiple Outcomes

Often the possible alternative courses of action can be identified, but each decision

alternative may have several outcome possibilities. If the decision maker can in some

meaningful sense assess the probability of the occurrence of each possible outcome, for

each of the alternative courses of action, he may then compute the expected value of each

alternative. Economic tools and techniques provide the requisite knowledge.

The application of economic tools and techniques to business decision making, summed

up in the study of Managerial Economics, can be described in the following figure,

Application of Economic

tools and techniques

The study of Managerial Economics

Business decision problems

Unlimited and constantly recurring goalsScarce resources having alternative uses

Optimal business solutions

1.9 Summary

Economics as a body of knowledge or study discusses how a society tries to solve the

human 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, what

and for whom to produce. Economics has contributed as a study of ways to deal with the

issues and challenges of humans and maximization of utility to individuals. This scope of

economics is exhibits through micro and macroeconomics, i.e., the study of economics

through evaluation of individual economic unit behavior (Microeconomics) and the

evaluation of economy as a whole (Macroeconomics). When these concepts and

techniques of economics are utilized in business decisions it leads us to the formal study

of 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 decisions

1.10 Self assessment questions

1) 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 above

7) According to economics choice relates to

i) Plenty of recurring wants

ii) Plenty of resources

iii) Plenty of economic units

iv) None of the above

8) Central problems of an economy imply

i) What to produce?

ii) How to produce?

iii) For whom to produce

iv) All of the above

9) Microeconomics is also called as

i) Price Theory

ii) Demand Theory

iii) Theory of income and employment

iv) Theory of factors

10) 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 above

12) 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.