1
Economics and the
Business Environment
The Firm as a Legal Entity
• The sole proprietor
– limited scope for expansion
– unlimited liability
• The partnership
• Companies
– limited liability
– public limited companies (plc)
• public issues of shares
• shares traded on the Stock Exchange
– private limited companies
– consortia
– public corporations
The Internal Organisation of the Firm
• U-form
U-form business organisation
C h ie f e x e c u t iv e
P r o d u c t io n F in a n c e S a le s P u r c h a s in g
The Internal Organisation of the Firm
• U-form
– advantages
• direct control by central executive of the firm
• clear goals
– problems of large U-form firms
• co-ordination and communication costs
• distorted information
• decline in organisational efficiency
The Internal Organisation of the Firm
• M-form
M-form business organisation
H e a d O f f ic e
D iv is io n 1 D iv is io n 2 D iv is io n 3
P r o d u c t io n F in a n c e S a le s P u r c h a s in g
The Internal Organisation of the Firm
• M-form
– advantages
• reduced length of information flows
• enhanced level of control
– problems
• bureaucracy and communication problems
• conflicts between divisions
• The flat organisation
• The holding company
– role of parent company and subsidiaries
The Aims of the Firm
• Goals of the firm
• The traditional theory of the firm
• Alternative theories
– the divorce of ownership from control
– the development of the joint-stock company
– managerial objectives
The Aims of the Firm
• The principal / agent relationship
– the principal – agent problem
– asymmetric information
– dealing with imperfect information
• monitoring
• incentives
• The goal of staying in business
– the willingness of firms to take risks
– problems of being over cautious
The External Business Environment
• PEST analysis
– Political / legal factors
– Economic factors
• the microeconomic environment
• the macroeconomic environment
– Social / cultural factors
– Technological factors
• Using PEST analysis
– relations between the four sets of factors
– importance of the economic factors
The External Business Environment
• Classifying industries
– Classifying production
• primary production
• secondary production
• tertiary production
Output of industrial sectors
(as % of GDP)
Primary
2.8% Secondary
42.3%
54.9%
Tertiary
1974
Output of industrial sectors
(as % of GDP)
Primary Primary
2.8% 5.8% Secondary
Secondary
23.3%
42.3%
54.9%
70.9%
Tertiary Tertiary
1974 2002
Employment by industrial sector
(% of total employees)
Primary
3.4% Secondary
41.9%
54.7%
Tertiary
1974
Employment by industrial sector
(% of total employees)
Primary Primary
3.4% Secondary 1.8% Secondary
18.4%
41.9%
54.7%
79.8%
Tertiary Tertiary
1974 2002
The External Business Environment
• Classifying firms into industries
– nature of an industry
– industrial sectors
– why classify firms into industrial sectors?
• helps in analysing trends
• identifying specific needs
• helps to understand relationships between firms
• Standard industrial classification
– nature of the system of classification
– sections, subsections
• divisions, groups and classes
Standard industrial classification: 1992
The External Business Environment
• Changes in the structure of UK economy
– expanding and contracting sections
• by output
• by employment
The Determinants of Business Performance
• Structure conduct performance
– relationship between business structure and
business conduct (behaviour)
• competitive markets and competitive behaviour
• limited competition and collusion
– relationship between business conduct and
business performance
• indicators for measuring performance
• profitability, market share, growth, etc.
The Economist's Approach to Business
• Tackling the problem of scarcity
– meaning of scarcity
– production and consumption
• role of the business economist
– study of consumer behaviour
– study of firms
– factors of production
• labour
• land and raw materials
• capital
The Economist's Approach to Business
• Demand and supply
– actual and potential demand and supply
– the role of firms in satisfying demand
– business economists’ study of the supply
process
• Macroeconomics and microeconomics
– macroeconomics
• the balancing of aggregate demand and supply
– microeconomics
• the balancing of the demand and supply for
particular products
The Economist's Approach to Business
• Microeconomics and choice
– What?
– How?
– For whom?
• Choice and opportunity cost
– the meaning of opportunity cost
– rational choices
– marginal costs and benefits
• Microeconomic choices and the firm