Theories of Public Expenditure

In the public policy study, we find that there are many theories that explain the causes of increasing government expenditure. Among many, I  just have selected four theories and discussed herein.

A. Wagner’s Hypothesis

Wagner’s hypothesis is propounded by Adolf Wagner. He, in his comprehension comparisons of different countries at different times shows that among progressive people, public expenditure increases regularly takes place in the activity of both the central and local government. This increament by the central and local governments constantly undertake new functions while performing both old and new responsibility more efficient and complete.

This law seeks to establish a functional relationship between the rate of economic growth and government activities. It shows that the government sectors grow faster than the economic expenditure. The scope of government activities would continue to increase both absolutely and relative income for many years. In the long-run economy secures growth in the public sector. This law is “explained” and “justified” by the pressure for social progress and resulting change in the sphere of private and public economy.

Wagner emphasized long term trend rather than short term changes in public expenditure. Moreover, he didnot explain the mechanism of increasing public expenditure. His study is based on the historical experiences, the precise quantitative relationship between the increase in public expenditure and the time taken. By this, it was not fixed in any logical or functional manner. His contention was that public expenditure had been increasing over the time that could not be used to predict its rate of increase in future. 

Wagner's law is to state that the state expenditure would increase at a rate slower than the national income though it had increased in a faster rate then in the past. Thus, in the initial stage of economic growth, the state find that it has to expand its activities quite fast in several fields like education, health, civic amenities, transport and so on. But when the initial deficiency is removed then the increase in state activities may be slowed down. Wagner argues that the causes of the relative growth of government expenditure are due to the following reason:

Social Progress: One of the most influential factors that was considered by classists is the social sector. This law argue that due to maintenance of law and order in the society and due to the participation of the state in the production of “ social product”, the government needs to spend more. But what they assume that investment does not go in vain. It finally terminates into the economic growth in the long run.

Expanding of Economy: Wagner talks about the expanding economy during the period of industrialization and the economic growth, At the mean time of these both situation government expenditure increases. He discused about the role of private sector which influences public expenditure decisions, for that he has presented following factors, which makes a public expenditure to rise:

a) The Income Effect

As real income increases, the effective demand for all kinds of goods and services also increases. But there is not so straight forward reaction. Increase in real income would not automatically induce one to bear a higher rate of tax in return for improved public services. As private income increases, wealth position of the individual improves. They faces scarcity lacks of goods and services in the quantity and quality approaches. And it demands more social goods and service and it increases government expenditure result in social imbalances.

b) The Population Effect

Population is the second factor that made a public expenditure to increase. With the growth of population and increases in the flow of real income occurring to individuals, this increases the rate of government outlay on the provision of public services to the population growing up.

c) The Urbanization Effect

Increase rate of urbanization is a major factor for the growing rate of public expenditure. There is also the possibility of external effects of an expenditure becoming more and more widely diffused as a consequence of the increase in the size of the urban community.

d) Technological Effect

Technological changes add to the prevailing magnitude of external effects. Hence it tends to increase significantly the need for greater public expenditure.

To sum up, Wagner’s hypothesis established the functional relationship between economic growth and the relative growth of public expenditure. 

Contribution to Social Sector

Over to the national emergencies, and wars government increases its expenditure, results in high increase in the tax. This abruptly changes the volume of expenditure ove the time period.

Criticism

·        Lack of Interdisciplinary Approach

·        Not Analytical

·        Ignore the Influence of War

·        It is not relevant to today’s Western’s countries.

B. Colin – Clark’s Critical limit of Taxation and Expenditure

Colin-Clark forwarded his view through “Public Finance and changes in the value of Money” about the growth of public expenditure. According to them, the share of government sector exceeds 25% of the total economic activity in the economy that results to inflation even in the balanced budget. In this connection his opinions are;

'When the government’s share of the aggregate economic activities reach the critical limit of 25%, the community behaviour pattern changes and people produce less since incentives are harmed by the fact that increasing proportions of additional income that must be paid under progressive tax system.

People become less resistance to various inflationary means of financing government expenditure which in turn reduces to government “aggregate supply". On the other hand, increased purchasing power tends to expand aggregate effective demand.

Inflation results from maladjustment between demand-supply under the condition of high employment of resources. The theory holds that by increasing taxes and restricting credit it is possible to cut down the expenditure of the private sector and thereby to accommodate increased public expenditure by releasing resources for private use. Therefore when it is asserted declare to be true that public expenditure beyond a specified limit will generate inflation. It seems to imply that the reduction of private expenditure in the account of personal consumption and private investment is either impossible or undesirable. If anyone of these contentions (disagreement) is conceded (admit to being true) it will be true that additional public expenditure will cause inflation in the economy.

Critical Limit of the Taxation 

If the question is simply how much taxes a government can possibly impose? the answer could be 100% of  NT+ bonus for all taxation in kind of all privately held national wealth. 100% taxes on income and wealth do not imply that the private sector will have nothing left for its own expenditure public expenditure, in this case, may mostly transfer payment.

The desirable level of taxation may not be determined numerically. But the economic capacity of the taxation should be answered. It may not be identical on both classical finance and the modern formation of fiscal policy.

The classical model postulates the view that the level of public expenditure is the resultant of the level of taxation. It means vice versa for the level of public expenditure has been claimed to have been determined by policy.

C. Stanley Please Hypothesis

An attempt to increase domestic saving by increasing performance is frustrated by the growth of current government expenditure which is casually related to tax effort. This is referred to as please effect or please hypothesis. This means that the countries which had pushed up their tax ratios over time had not necessarily increased their saving performance and that countries with high tax ratios were not necessarily high savers.

The primary role of fiscal policy is to increase the total flow of saving in an economy and also to provide for adequate flow of government funds for meeting the current expenditure of the government for eg: defence, road maintenance, school, books and suppliers.

Increased tax effect has been accepted almost universally has the way to do this. It is assumed that MPs of the private sector. It is a law that increased taxation of government will be used entirely to reduce government deficit or to increase its surplus.

Kirshnamurti (1968) in the WB, examines the relationship between saving and taxation of 35 developing countries in the cross-section analysis and for 12 developing countries in time series analysis. Countries study showing no association between taxation and savings. Similarly, cross-section the result reveals that taxation had the effect of discouraging private consumption and that positive effect of taxation in promoting aggregate saving had been neutralized by the behaviour of current expenditure in the public sector. This research is in support of please Hypothesis.

 Dziadek (1968) examines the relationship of taxation to saving for 13 out of 18 Latine American countries in which tax/GNP ratios increased between 1961 and 1966. It was found that please Hypothesis was supported in 7 countries out of the 13 where there had been an improvement in tax performance. As such he concludes that it is not to pass to generalize the relationship between tax performance and saving performance.

Vlatio(1967) in his examination of 20 African countries found that the increased in tax has a favourable effect in mobilizing domestic resources for development. Similarly, Morss(1969) concludes from his sample of 46 developing countries that the relationship was contrary to the evidence of please effect i.e. he found that on the average savings increased by 64% of any tax increased. This is against Please's hypothesis.

Finally, Eklwd(1969) found that the additional revenue is spent on non-developmental goods and services as the tax/GNP ratio increases, expenditure on social needs and defence have a priority and not economic services.

In support of his hypothesis please presents the case of Ethiopia and Peru later in IBRD WB NO 82 titles “The please effect revisited in 1970”. In the case of Ethiopia for eg. About 2/3 of additional government revenue ever the course of the last 5 years have been used to finance expenditure on defence and internal security. Except for education, only marginal additional funds have gone to finance development services such as agriculture, health etc.

In conclusion, please puts himself positively admitting that he is not against increased tax and realizes that fiscal policy possesses high potentiality for mobilizing savings. Please shows that the governments in developing countries raised the level of tax revenue in order to increase the rate of domestic saving through a higher level of public saving. This attempt has resulted in a higher increase in government consumption and a much lower increase in public saving through increased spending on public investment. It is known as “please effect”.

D. Peacock-Wiseman Hypothesis

Peacock and Wiseman analyze the process of growth of public expenditure in terms of three different but related concepts; displacement, inspection and concentration effects. By the empirical analysis of the data of Britain on public expenditure, they were able to establish the relative growth of public sector expenditure in that country occurred on “step-like” pattern rather than on “continuous growth” pattern. They have discussed this hypothesis under three effects separately.

a) Displacement Effect

The public expenditure increases and makes the inadequacy of the present revenue. Then a movement must take place so that the older level of expenditure and taxation to a new and higher level is the displacement effect. During the period of emergency or of major social disturbances such as war and depression that most of the upward steps in public expenditure had occurred. Displacement Effect is the process by which the previous lower expenditure levels were displaced by a new and higher level of expenditure.

b) Inspection Effect 

The inspection effect refers to the phenomenon whereby a direct consequence of the social emergency, public expenditure comes to increase which may be insufficient compared to the revenue of the government, creates the inspection effects. The government and people review the revenue position and to find the solution of the important problems that have come up with gently to attain the new level of tax tolerance. They are now ready to tolerate a greater burden of taxation and as a result, the general level of expenditure and revenue goes up. In such a way the new level of expenditure and revenue comes to stabilize at a new level till the new disturbance occurs to cause the displacement effect.

 c) Concentration Effect

The concentration effect also refers to the apparent tendency for central government economic activity to grow faster than that of the state and local level government. This is found fitted therein British economy but it is not needed to verify this to other countries. This concept is the evolution of expenditure undertaken at a different level of government and their tendency to be concentrated in central government. This usually happens when the country is experiencing economic growth.

The main concentration of Peacock-Wiseman hypothesis is that factors both endogenous and exogenous to the economic system exert a force influence on public sector institutions to increase their expenditure over a secular period and this increase occurs on a step-like basis and at a faster rate than the growth in aggregate economic activities.

Thank You

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Inflation Targeting and Nepalese Context

Abstract

Inflation targeting is a monetary policy regime. It involves the public announcement of medium-term numerical targets for inflation with an institutional commitment by the monetary authority to achieve these targets. Adoption of inflation targeting is not just a policy declaration. For that certain pre-requisites must be fulfilled. Focusing monetary policy on inflation does not imply that inflation targeting is indifferent to the performance of the real economy is simply incorrect. In Nepalese context, to switch monetary policy towards inflation targeting, central bank should have to fulfill pre-requisite first. Basically autonomy of central bank, public communication are the most important pre-requisite that Nepal must have to fulfill. Top of all the existing exchange rate system with Indian currency must be addressed so that economy can move towards inflation targeting.

Key words: Inflation Targeting, Monetary Policy Framework.

1. Introduction

Inflation targeting is a monetary policy regime has been used in monetary arena after 1990s. According to International Monetary Fund(IMF) inflation targeting involves the public announcement of medium-term numerical targets for inflation with an institutional commitment by the monetary authority to achieve these targets. Additional key features include increased communication with the public and the markets about the plans and objectives of monetary policymakers and increased accountability of the central bank for attaining its inflation objectives. Monetary policy decisions are guided by the deviation of forecasts of future inflation from the announced target, with the inflation forecast acting (implicitly or explicitly) as the intermediate target of monetary policy (Acharya, 2012).

Policymakers used to anchor their monetary policy by targeting a monetary aggregate, with expectation that controlling the demand for and supply of money, would enable them to bring down the rate of inflation. Unfortunately, monetary aggregate targeting proved unsuccessful because of instability in the money demand function. As a result to bring down the rate of inflation and to maintain it at a low level central bank adopted a policy with flexible exchange rate, is finally termed as Inflation Targeting Framework (ITF) (Freedman and Laxton, 2009).

The first country to formally adopt inflation targeting was New Zealand in December 1989. Since then, many countries have joined the club including both industrialized countries (such as Australia, Sweden, Switzerland, and the United Kingdom) and emerging economies (such as Brazil, Chile, Columbia, Czech Republic, Iceland, Israel, Mexico, Peru, the Philippines, Poland, and South Africa), with the US being the most recent addition to the list in January 2012. Many other countries are in the process of establishing a full inflation-targeting regime; while others, like European Central Bank (ECB) remain implicit targeters. Only three countries, Finland, Spain and Slovakia, have abandoned inflation targeting and this was due to their adoption of the euro which, as governed by the ECB (www.centralbanking.com). There are four Asian countries namely South Korea, Thailand, Philippine and Indonesia, has endorsed IT as a new monetary policy regime. (Ito and Hayashi, 2004).

The objective of this paper is to review the current situation of inflation targeting and its prospects in Nepal. This paper is organized as follows. After the brief literature review in section two, third section provides a glimpse of prospect analysis in Nepal. and final section concludes the work.

2. Literature Review

2.1 Pre-requisite of Inflation Targeting

Inflation targeting is a monetary-policy strategy that is characterized by an announced numerical inflation target, an implementation of monetary policy that gives a major role to an inflation forecast. It has been called forecast targeting, and a high degree of transparency and accountability. It means adoption of inflation targeting is not just a policy declaration. For that certain pre-requisites must be fulfilled. Major pre-requisites suggested in literature are discussed as below.

2.1.1 Sole Target

One of the most important pre-requisite for adopting the inflation targeting is the absence of another targeted nominal variable such as wages, level of employment or nominal exchange rate. Having more than one target may destroy the credibility of both anchors and there might be conflicts among the objectives. Before declaring inflation targeting target must be define very lucidly whether it is point or band. If bans then what should be the width of that band. Moreover time horizon and choice of the price index must be maintained very properly (Tutar, 2002).

2.1.2 Autonomy of Central Bank

Debelle et.al (1998) argued for independency of central. The independence does not mean the full independence but implies at least instrumental independence which permits greater discretion in the conduct of monetary policy and which mainly implies that the central bank cannot finance the government budget. In the same manner, the central bank should not be required to attain low interest rates on public debt or to maintain a particular nominal exchange rate. There should not be any political pressure on the central bank to raise the rate of economic growth in such a way that is inconsistent with the achievement of the inflation target.

2.1.3 Effectiveness of Monetary Policy

Having autonomy of central bank does not mean that there is effectiveness of monetary policy. Effectiveness indicates to establish stable relationship between the inflation outcomes and monetary policy instruments. According to Jonsson (1999) in inflation targeting regime, monetary authorities have to be able to model inflation dynamics in the country and to forecast the inflation to a reasonable degree. So, the monetary authorities should have access to policy instruments that are effective in influencing the macroeconomic variables.  

  

2.1.4 Accountability and Transparency of Central Banks

A notable feature is found in New Zealand, whereby the governor who must report on inflation performance twice each year, may be dismissed prior to the end of his five year term  if the inflation rate falls outside its specified target band (McCallum, 1996). This shows the accountability of the respective authority which is most important factors for inflation targeting countries. Aliyu and Englama (2009) also demand to be informed about the process and progress made by central bank.

The increased accountability of the inflation targeting enables the monetary authority to monitor and enhance the understanding of expectations. It also decreases the possibility of time inconsistency trap, which leads to deviations from monetary authority's long-term objective. Moreover, it provides a good benchmark that can easily be observed by the agents in the economy (Hazirolan, 1999).

By means of transparency, private sector agents can monitor and question the authorities. advice, analysis, and actions. So, this forces the authorities to get their analysis right. Since private sector agents can easily observe any myopic policy strategy under a transparent monetary policy framework, there are severe constraints to surprising the public (Hazirolan, 1999).

2.1.5 Development of Financial Institutions

Aliyu and Englama (2009) categorized the inflation targeters on the basis of development of financial institutions. Proper functioning of financial institutions leads to degree of succession of inflation targeting because instruments used by central banks transmitted through the financial institutions. Thus, sound bank and financial institutions as well as effective management of monetary and capital market is prominently expected to have on the respective economy. 

2.1.6 Flexible Exchange rate System

Debelle et.al (1998) and Mishkin (2000) strongly argues flexible exchange rate as a one of the most important pre-requisite for inflation targeting. If exchange rate system is fixed then it is impossible to any government to maintain both exchange rate as well as inflation under control. Thus, to attain desirable rate of inflation, exchange rate must be flexible.

2.1.7 Effective Communication

Effective communication increases transparency of the monetary policy strategy through communication with the public and the markets about the plans, objectives, and decisions of the monetary authorities (Miskin, 2000). This is possible if central bank makes public announcement about the policy of targeting so that to attain the targeted band or point. 

2.1.8 Macroeconomics Indicators

Aliyu and Englama (2009) expect to have stable employment situation, satisfactory growth on GDP, desirable BOP and proper regulation over public expenditure. Autonomy of central bank and proper coordination between monetary fiscal and financial policy leads towards the desirable macroeconomic situations.

2.2 Types of Inflation Targeting

Aliyu and Englama (2009) have identified three category of inflation targeting they are;

2.2.1. Full Fledge Inflation Targeting (FFIT)

When a country is ready to adopt IT as its single nominal anchor upon which macroeconomic stability would be achieved. Full Fledge IT (FFIT) is suitable in a country with a sound financial environment and transparency, accountability and highly committed central bank. These elements are desirable to the attainment of the goals of Full Fledge IT.

2.2.2 Electic Inflation Targeting(EIT)

When a country pursues IT along with other monetary policy objective in a stable financial environment Electic IT is suitable. However, in such a condition central bank is relatively less accountable and transparent.

2.2.3 Inflation Targeting Lite (ITL)

ITL category is suitable to those countries, which have a low profile due to lack of strong or credible macroeconomic environment. ITL adopting countries usually float their exchange rate and announce an IT. But they usually do not attain the stated inflation target. 

One of the important thing about the inflation targeting is that it is not just a framework, which only focuses on maintaining inflation within targeted band. It concerns about the fluctuation on output and employment. Focusing monetary policy on inflation, according to them, does not imply that traditional stabilization goals are ignored. The monetary policy makers under inflation targeting are indifferent to the performance of the real economy is simply incorrect. Central banks, which are responsible for inflation targeting, continue to be concerned with fluctuations in output and employment in all the countries they have studied. They have found that the output and employment continue to remain concerns of policy makers after switching to inflation targeting. In fact it can be seen in all the inflation targeting countries have invariably undertaken disinflation only gradually (Bernanke et. al. , 2011).  

3. Contextualization

Nepal Rastra Bank's Strategic Plan (2006-2010) has disclosed about inflation targeting in its Functional Strategies. Neither second strategic plan (2012-2016) has reported progress about inflation targeting nor any research has been archived in Nepalese context. One empirical study has been conducted by Acharya (2012) using ARDL to cointegration to evaluate feasibility of inflation targeting in Nepal. 

Central bank of Nepal has enacted Nepal Rastra Bank Act -2058 and has been continuously formulating monetary policy annually. By laws, central bank is considered as an autonomy institution but significant dominance has been made by fiscal policy. Due to this reason effective implementation of monetary policy always in limbo. It impact adversely on all fiscal, monetary as well as financial institutions.

Regarding the relation between real GDP on price level theoretically it is assumed that there is negative relationship between real GDP and Price Level. But in fiscal year (FY) 2010/11, when food production (it includes paddy, maize, millet, buckwheat, wheat and barley.) has increased by 10.87% and reached to 8606742 metric tons. Due to an increase in food production it was expected by using the general rule of economics a decline in price of those goods. At the same fiscal year the price of food and food products has increased by 13.4% (Economic Survey 2011/12). It means rise in production does not show negative relation with the price level in Nepal which contradict the theory (Acharya, 2012).

Empirical result suggested by NRB(2007), Ginting (2007) and Acharya (2012) found that wholesale price index of India has positive impact on Nepalese price level. This result shows that Nepalese economy import inflation from India. It may be due to high trade concentration with India, pegged with Indian currency and open boarder between these two countries.

Nepal has been facing the sharp appreciation of the US dollar in this two years. It is not because of export fluctuation but due currency fixed with Indian currency. Nepal has not faced any direct impact, so far, from the global financial crisis too. This is because, its financial market is not open to short-term portfolio investments from abroad. Exports will fall faster as competitiveness of Nepalese products is going lower as other countries producing similar goods face the downturn for their export to the industrial nations (Pokheral, 2009). This is one of the most restrictive situation in Nepal to switch towards inflation targeting.

4. Conclusion

To switch monetary policy framework towards inflation targeting, central bank should have to fulfill pre-requisite first. Basically autonomy of central bank in real sense and build up transparency as well as good public communication are the most important pre-requisite that Nepal must have to fulfill. Moreover, government should have to solve the structural problems and need to address on the problem of market imperfection to upgrade its macroeconomic indicators. Top of all the existing exchange rate system with Indian currency must be addressed so that economy can move towards inflation targeting. 

References

Acharya, Santosh. (2012). Feasibility of Inflation Targeting in Nepal. Unpublished Master Thesis, Central Department of Economics, Tribhuvan University, Nepal.

Aliyu, Shehu. U. R, and Englama. (2009). Is Nigeria ready for inflation targeting? Journal of Money, Investment and Banking. 11: pp.27-41.
Bernanke, S. Ben., and Mishkin, F.S. (1997). Inflation targeting : A new framework for monetary policy. Working Paper-5893, National Bureau of Economic Research, Massachusetts Avenues, Cambridge.

Central Banking. (2012). Available: .

Debelle, Guy., Masson, Paul., Savastano, Miguel., and Sharma, Sunil. (1998). Inflation targeting as a framework for monetary policy. International Monetary Fund.

Dotsey, M. (2006). A review of inflation targeting in developed countries. Business Review. Available: < www.philadelphiafed.org>.

Ministry of Finance. (2011). Economic Survey 2011/12. Kathmandu: Ministry of Finance.
Freedman, Charles., and Laxton, Douglas. (2009). Why inflation targeting? IMF working paper, WP/09/86, Research Department, IMF.

Gamayel, Edward. R., Jahan, Sarwat., and Peter, Alexandra. (2011). What can low income countries expect from adopting inflation targeting? IMF Working Paper, WP/11/276. Strategy Policy and Review Department.

Ginting, E. (2007). Is inflation in India an attractor of inflation in Nepal?. IMF Working Paper, WP/07/269. Asia and Pacific Department, IMF.

Hammond, Gill. (2011). State of the art of inflation targeting-2012. CBSS, Hand Book No. 29. Bank of England.

Hazirolan, U.(1999). Inflation Targeting: Japanese case and prospects for Turkey. Undersecreteriat of the Treasury, Ankara, Turkey, Mimeo.

Heikensten, Lars. (2011). Inflation targeting-the Swedish experience.(n.p.)

Ito, T., and Hayashi, T. (2004). Inflation targeting in Asia. Hong Kong: Hong Kong Institute for Monetary Research.

Jonsson, G. (1999).The relative merits and implications of inflation targeting for South Africa. IMF Working Paper WP/99/116, Washington D.C.

Kamal, M. (2010). Inflation argeting in Brazil, Chile and South Africa: An empirical investigation of their monetary policy framework. The William Davidson Institute, WP, No 1004. University of Michigan.

Lin, Shu., and Ye, Haichu. (2009). Does inflation targeting really make a difference? The other side of the story from developing countries.(p.n.).

McCallan, T, Bennette. (1996). Inflation targeting in Canada, New Zealand, Sweden, the United Kingdom and in general. NBER Working Paper Series, WP 5579. National Bureau of Economic Research, Cambridge.

Mishkin, F. S. (2000a). From monetary targeting to inflation targeting: Lessons from the industrialized countries. Graduate School of Business and National Bureau of Economic Research, Columbia University. New York.

Mishkin, F.S. (2000). Inflation targeting in emerging market countries. American Economic Reviews. 90(2): pp.105-09).

Mukherjee, S., and Bhattacharya, Rina. (2011). Inflation targeting and monetary policy transmission mechanism in emerging market economies. IMF Working Paper, WP/11/229. Middle East and Central Asia Department.

Nepal Rastra Bank. (2007). Inflation in Nepal. Nepal Rastra Bank, Baluwatar, Kathmandu Nepal.

Samimi, Ahamad., and Motameni, Mani. (2009). Political stability and of inflation targeting: New evidence. Australian Journal of Basic and Applied Sciences. 3(2): 1319-1322.

Tutar, Eser. (2002). Inflation targeting in developing countries and its applicability to the Turkish economy. MA Thesis of Economics, VPI and State University, Blacksburg, Virginia.

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Business (Managerial) Economics

CONCEPT OF BUSINESS ECONOMICS

A business is activities perform by any organization through utilizing its financial, human, technical and informational resources to achieve the pre determined objectives. In course of this action business organization must use its resources as efficiently as possible since they are limited in supply and there are costs in acquiring and using them. These include employees (known as labor), machinery and buildings (known as capital), and the land on which the buildings stand. Businesses also have the expertise of their top managers (known as entrepreneurs) who put the labor, capital and land together to produce the finished products most efficiently. Their purpose, amongst other things, is to ensure the business is profitable and grows. If losses are made over time the business will close. Hence, entrepreneurs must think about what and how the business produces, and its long term direction.

Economics is, therefore, the study of how the resources land, labor, capital and enterprise are used or allocated by a country to meet its demands for goods, services and ideas, now and in the future. The resources are employed by businesses or firms and are also known as inputs to the production process, or factors of production.

Investopedia has considered business economics as a field in economics that deals with issues such as business organization, management, expansion and strategy. This studies might include how and why corporations expand, the impact of entrepreneurs, the interactions between corporations and the role of governments in regulation. Business economics explains how the policy adopted by ministry of finance and central bank influence to the business and what kind of world business scenario should be understand so that to expand and build up resistance of own business is answered by the business economics. Basically the important of this subject is to the business managers so that to realize the reality and real practices in the economy and its impact on the business on the two way - positive and negative.

To deal with the role of business economics it is necessary to discuss about the outputs of business. In general, goods and services are considered as an output of any business. But in broad sense ideas and externalities are also included as an business output which in general is included in study. Here we will discuss four output of any business.

Goods

Businesses is known as producers or manufacturer of goods and services. Goods are classified by economists under two main headings, consumer goods and producer goods. Examples of consumer goods include cars, mobiles, chocolate bars, Levis, compact discs, and personal computers if used at home for personal or leisure use. The people who buy them are consumers, or customers and they live in households. In contrast, producer goods, as the name suggests, are used to produce other goods. Examples of producer goods include robots used on assembly lines to manufacture cars, personal computers used in offices for work purposes, and cement mixers on building sites. Many businesses are, therefore, the customers of other businesses which buy their output.

Services

Services consist of the provision of non-physical items. The list of services are endless. It includes knowledge provided by teacher, services given by doctors, entertainment given by the football match between India and Nepal, listening to a live concert, working out at your local gym, staying in a hotel, watching a video of the latest movie (as opposed to the video as a physical object), and so on. In each case, consumers are using or consuming a particular service which gives it a distinctive character compared with a good. A service is used up in the act of consumption although it may live in our memory such as the fond remembrance of dry picnic with friends. Businesses also provide services to other businesses and, in that sense, the latter are consumers of the former’s products. For example cleaning agencies employ staff to clean offices in the evening or early morning when the work force are not there.

Ideas

An idea is intellectual property which can also be bought and sold. Examples include the ideas in a novel or computer software. It is not easy to buy or sell.  Of course, the book and floppy disk containing the ideas are goods.

Externalities

The production process of a business also creates another type of output which occurs to society as a whole but whose effect may not be reflected in a company’s accounts. This type of output is called an externality and may be a benefit to society or a cost. It occurs as a consequence of either production by businesses or consumption by an individual or household. Pollution caused by a factory is the obvious example of an externality and it imposes a cost on society which is known as negative externality. Conversely there may be external benefits, e.g. enjoying a neighbor's garden full of flowers in summer.

Above four output will be possible if they passes through the certain production process. The production process is the use of raw materials or inputs or factors of production, to produce outputs of goods, services and ideas; it may also produce externalities. These inputs consist of: 

Land

This includes not just what its name suggests but also what is found on it and in it – forests and the timber obtained from them, minerals such as crude oil, natural gas and diamonds, and even the fish in the sea. The cost to be paid by employing land, defined in its widest sense, in the production process, is known as rent.

Labor

This is that part of the population who work. Approximately half the Japanese population are too old to work, ill and so unable to work. Though the pace of development of Japan is not declining. They are not worried about having large no of old population but worrying about how to manage the labor they are coming there in. How the work force is determined, and how the number of unemployed are used in economy will be discussed in this book.

Capital

This word is used for machinery, factories, computers, office blocks and information technology. Capital loses its value over time as buildings suffer wear and tear, and so need maintenance, whilst computers become technologically obsolete. So businesses have to set money aside to replace capital as it wears out or becomes technologically obsolete; this is known as depreciation. The term capital is found to distinguish  as a  liquid form (money) and machine. This money may be used to finance a new office block or a new factory. Alternatively it may be used to purchase shares in existing companies. Interest is the return earned from making capital available to a business. Finally, working capital is the term used to describe stocks of components and raw materials waiting to be converted into finished goods, and the finished goods themselves, held in warehouses, for example, waiting to be delivered to retailers for sale.

Enterprise

 Enterprise or entrepreneurship is the resource provided by the entrepreneur. It is the expertise he/she provides to combine the other resources most efficiently to produce the output of goods or services. It requires managerial, financial, inter-personal and strategic abilities if the business is to succeed. Famous examples of entrepreneurs are Binod Chaudhary, Chairman of CG Group, Rupert Murdoch, chairman of the News Corporation which owns publishing and broadcasting businesses around the world, and Bill Gates who co-founded Microsoft.

 

Scarcity of resources There is a limited supply of resources, i.e. they are scarce or finite, whereas the demand for goods and services produced from them is virtually infinite. This means resources have to be used by businesses and government as efficiently as possible to enable society to best supply what is needed to meet its own needs and demands. Every time a resource is used in one way it means that it cannot be used in other ways. Land used to build a by-pass cannot be used for housing, or as an industrial site, or left alone for the wildlife who live there. An economy therefore seeks to achieve allocative efficiency. This means that it wants to use its resources so efficiently that none are wasted. If it were to make any changes to their use no one could be better off except at the cost of someone else being worse off.

The costs of using resources

Each tutor at your university or college who teaches you is paid a salary or, if employed part time, a wage of between Rs. 4000 and Rs. 10000 per period. This is a cost for the university or college, called the historic cost. Similar costs apply to the use of other resources, as discussed above. For the economist, there is also a second cost to be taken into account, known as the opportunity cost. This is defined as the next best alternative foregone. For example your are learning here at college, because you have chosen to get education first, if you are not studying then you may be working as a assistant manager for a local marketing agency or bank. You forgone the income of working assistant manager so that to study at college. Here your opportunity cost is the tentative income of that post where you may have worked if not studying at college. So why does you study at college instead of working on  tutor teach when he/she could earn more money in business? The answer is that there are non-monetary returns, such as job-satisfaction, that provide sufficient benefit as to offer the best total return i.e. monetary and non-monetary.

RELATION OF BUSINESS ECONOMICS WITH TRADITIONAL ECONOMICS

Economics and Managerial Functions

Economics contributes a great deal towards the performance of managerial duties and responsibilities. Just as biology contributes to the medical professional and physics to engineering, economics contributes to the managerial profession. All other qualification being the same, managers with a working knowledge of economics can perform their functions more efficiently than those without it. The basic function of the managers of a business firm is to achieve the objective of the firm to the maximum possible extent with the limited resources placed at their disposal. It means economics is essentially the subject to study for the logic, tools and techniques of making optimum use of available resources to achieve the given ends.

In performing the function of manager, he has to take a number in conformity with the goals of the firm. Many business decisions are taken under the condition of uncertainty and risk. Uncertainty and risk arise mainly due to uncertain behavior of the market forces, changing business environment, emergency of competitors with highly competitive products, government policy, external influence on the domestic market and social and political changes in the country. The complexity of the present business world adds complexity to business decision making. However the degree of uncertainty and risk can be greatly reduced if market conditions are predicted with a high degree of reliability. The prediction of the future of the business environment alone is not sufficient. What is equally important is to take appropriate business and to formulate a business strategy in conformity with the goals of the firms.

Boumol has pointed out three main contribution of economic theory to business economics.

First, one of the most important thing which the economic theory can contribute to the management science is building analytical models which helps to recognize the structure of managerial problems, eliminate the minor details which might obstruct decision making and help to concentrate on the main issue.

Second, economic theory contributes to the business analysis 'a set of analysis method' which may not be applied directly to specific business problems, but they do enhance the analytical capabilities of the business analysts.

Thirdly, economics theories offer clarity to the various concepts used in business analysis which enables the managers to avoid conceptual pitfalls.

Business economics – How it differs from traditional economics?

Business economics uses largely the same concepts and terminology as economics and addresses many of the same issues. The students might therefore ask how and why a distinction is made between the two. Authors would argue that business economics is worthy of being distinguished and studied separately for a number of reasons. First and foremost, business economics specifically seeks to investigate and analyze how and why businesses behave as they do, and what the implications of their actions are for the industry in which they operate, and for the economy as a whole. Businesses are constrained in their operations by many factors, both internal and external. The internal factors include: the types of resources businesses use, their availability, and how they are combined together in the production process; the nature and levels of the costs businesses incur in producing their goods or services; and the extent to which growth can be achieved internally as opposed to by acquisitions or mergers.

Externally, businesses face constraints from the types of market in which they operate: how competitive are they, for example, and hence how easy to enter or leave; what is the level of demand for the products they produce, and the trends in this demand over time. Other constraints are from policies imposed by the government in relation to competition, minimum wages paid and so on. Additionally, businesses have to work within the constraints imposed on them by the economy. In times of economic recession, for instance, falling consumer demand due to reduced incomes and  rising unemployment may limit the ability of businesses to launch new products, diversify into new markets or even survive. Therefore, business economics seeks to analyze these constraints which face businesses, draw conclusions as to how and why businesses behave as they do, and analyze the implications of such behavior. Business economics also draws on a wide range of different theories from a variety of different disciplines of which economics is just one, albeit the main one. Economics has had a major impact on the development of other intellectual disciplines such as business strategy, organizational behavior, human resource management and marketing. All of these have drawn on it for parts of their theoretical content and, in turn, business economics draws on developments in these other areas.

Business and Economics

Business is an Economic Activity

An economic activities involves the task of adjusting the resources (means) to outputs (ends) or the ends to means. An economic activity may assume different forms such as consumption, production, distribution and exchange. The nature of business differs, depending upon the form of economic activities being undertaken and organized. For example manufacture is primarily concerned with production; the stock exchange business is mainly concerned with the buying and selling of shares and debenture; the business of government is to run the administration. The government may also own control and manage public enterprises. The business of banks is to facilitate transactions with short term and long term funds. These examples can be easily multiplied. The point to be noted is that each business has a target to achieve and for this purpose each business has some resources at its disposal. Sometimes the target has to be matched with the given resources and sometime the resources have to be matched with the given target. Either way the task of business is to optimize the outcome of economic activities.

A business Firm is an Economic Unit

A business firm is essentially a transformation unit, it transform inputs into outputs of goods and services or a combination of both. The nature of input requirements and the types of output flows are determined by the size, structure, location and efficiency of the business firm under consideration. Business firms may be different sizes and forms. They may undertake different types of activities such as mining, manufacturer, farming trading transport, banking etc. The motivational objective underlying all these activities is the same viz., profit maximization in the long run. Profit is essentially a surplus value- the value of outputs in excess of the values of inputs or the surplus of revenue over the cost, a business firm undertakes transformational process to generate this surplus value. The firm can grow future if the surplus value is productively invested. Firm therefore carefully plans the optimum allocation of resources to get optimum production. The entries process of creating, mobilization and utilization of the surplus constitutes the economic activity of the business firm.

Business Decision Making is an Economic Process

Decision making involves making a choice from a set of alternative courses of action. choice is at the root of all economic activity. The question of choice and evaluation arises because of the relative scarcity of resources. If the resources had not been scared an unlimited amount of ends could have been met. But the situation of resource constraint is very real. A business firm thinks seriously about the optimum allocation of resources because resources are limited in supply and most resources have alternative uses. The firm therefore intends to get the best out of given resources or to minimize the use of resources for achieving a specific target. In other words when inputs is the constraining factor, the form's decision variable is the output. And when output is the constraining factor then the firm's decision variables is the input. Whatever may be the decision variable, procurement or production, distribution or sale, output or input, decision making is invariably the process of selecting the best available alternative. That is what makes it an economic pursuit.

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