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Business Economics Textbook – First Chapter

Ana Clara Carvalho Trivelato (2112469)
University Canada West
MBAR 661 – Consulting / Research Project – Section 06
Dr. Reihaneh Gaskari
March 24, 2023

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Abstract
This project aims to develop the first chapter of a textbook to be used in the Introduction
to Business Economics foundation course MBAF 504 offered at the University Canada West in
the Master of Business Administration program. MBAs are designed to prepare and develop
leaders, so the new insights will help MBA students (future managers) study and understand
economics more effectively, which in turn will assist them in succeeding in the course, program,
and in their professional and personal lives. For master's degree students from UCW as well as
all MBA programs and those involved in business, it will provide the necessary toolkit to be
prepared for the business environment in any specialization field. Accordingly, the chapter
should provide explanations of the economic contents relevant to managers and students,
clarifying concepts and introducing fundamental theories, taking into account the Canadian
business environment.

This research is crucial because there is a gap in the literature to be filled since Business
Economics textbooks are limited, and most were written in other parts of the world rather than
Canada. Hence, this new textbook aims to find the best resources to explain valuable economic
content. In order to collect and provide the economic information necessary, extensive research
was conducted, synthesizing and analyzing the scarce Business Economics literature published
by others. Since the collection of compiled data provided insight into the terminology and
concepts used in the field, the critical literature review ensured the effectiveness of the research.
Through a business decision-making perspective and an explanation of relevant economic
contents, this methodology ensured that the chapter developed satisfies the MBA students' needs.
Keywords: Textbook, Business economics, MBA

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Table of Contents
1.

Introduction ................................................................................................................. 5

2.

Business Economics.................................................................................................... 9
Definition of Economics ................................................................................................. 9
Definition of Business Economics ................................................................................ 11
Definitions of Microeconomics and Macroeconomics ................................................. 13
Importance of Economics ............................................................................................. 14

3.

Fundamental Economic Problem .............................................................................. 17
Scarcity ......................................................................................................................... 17
Production Factors ........................................................................................................ 19
The Economic Systems ................................................................................................. 21

4.

Importance of Business Economics .......................................................................... 23
Trade-Offs ..................................................................................................................... 23
Prices and Market ......................................................................................................... 25
Opportunity Costs ......................................................................................................... 26
Trade and Comparative Advantage .............................................................................. 27
Circular Flow Diagram ................................................................................................. 31
Production Possibilities Curve ...................................................................................... 32

5.

Economics and Business Decision............................................................................ 36
Rationality ..................................................................................................................... 36
Managers Decision-Making .......................................................................................... 37

6.

Supply and Demand .................................................................................................. 41

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Demand ......................................................................................................................... 42
Supply ........................................................................................................................... 44
Equilibrium ................................................................................................................... 46
7.

Evolution of Economic Thinking.............................................................................. 49
Pre-scientific phase ....................................................................................................... 49
Scientific phase ............................................................................................................. 50

Conclusion ........................................................................................................................ 53
References ......................................................................................................................... 55

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1. Introduction
Economics is an area of study that provides us with the knowledge and tools to analyze
and understand various aspects of the economy. Despite not having a formal education in
economics, one is constantly exposed to economic issues and decisions that affect their daily life.
These may include the determination of product prices, changes in interest rates, fluctuations in
exchange rates, unemployment, economic recessions, and globalization, which are frequently
featured in newspapers, news broadcasts, and conversations with acquaintances. Furthermore,
the study of economics is critical in making informed choices, such as whether to save for a
holiday or attend a concert. Additionally, the subject is relevant in understanding the increase in
class size in Canadian institutions, the rising global consumption of fossil fuels, and how it may
be effectively addressed, particularly in terms of its environmental implications. It is also
pertinent in understanding the availability of summer jobs during the financial crisis and
recession of 2008. A comprehensive understanding of economics is thus indispensable in
offering answers to these and other related questions. Economics provides a valuable framework
for addressing critical societal concerns as well as more mundane issues affecting individuals.
Through the development of models and principles, economists have been able to gain insight
into a wide range of situations, from the practical and immediate, such as shifts in the real estate
market and rental prices, to more complex issues with far-reaching consequences. The main
objective of this book is to furnish readers with economic principles and models that can be
applied to a diverse array of problems. By doing so, this work aims to equip readers with the
tools necessary to understand better and address a wide range of economic challenges (Frank et
al., 2012).

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The discipline of economics is both old and new at the same time. Even though
economics has evolved as a result of changing societies, the same big questions remain, but with
some new concepts as a result of the world's new concerns. Thus, economics is not a set of static
facts or theories; instead, it is a set of practical principles. By studying economics, we are able to
view the world differently, understand people's behaviour and decisions, understand
governments' decisions - how much to tax or how to spend that tax, and understand businesses'
decisions - what to produce, what prices to charge, and what wages to pay. Having studied
economics, you will be able to apply this way of thinking, which will allow you to think more
analytically and solve problems more effectively (Mukherjee, 2019).
In the book's introductory chapter, the authors provide an overview of economics,
elucidating its core principles and emphasizing the importance of studying it. The first section
outlines the defining characteristics and essential definitions of business economics. The
following sections provide a comprehensive understanding of scarce resource allocation.
Describes the fundamental economic quandary and its formal definitions, namely scarcities,
explaining how the economic system works and the decision-making processes that determine
production (In economics, there are three main questions to be answered: what needs to be
produced? The answer to this question determines the type of product and how it needs to be
produced. This question determines the method of product production, as well as for whom we
will produce. The answer to this question also determines the distribution of goods and services
within the target society.). Furthermore, the third section discusses trade-offs, opportunity costs,
and business motivations. It examines the comparative advantage concept, which examines
individuals' specializations, and evaluates the costs and benefits of different options. Circular
flow diagrams and production possibilities curves illustrate these concepts.

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The fourth section will also teach us how to use marginal reasoning (rationality) to make
decisions and how managers from a wide range of business fields, including leadership,
marketing, finance, human resources, entrepreneurship, etc., use economic concepts and theories
to make their decisions. In the fifth section, we explore the evolution of economic thinking
throughout history and the supply and demand model.
Considering that resources are scarce in relation to demand, and managers are regularly
faced with trade-off situations, economics knowledge for managers is of outstanding importance.
Economics theories, terminologies, and overall understanding of this subject assist decisionmaking processes and improve reasoning. Moreover, the market may be considered the most
complex and crucial institution that affects the business environment. The economic concepts,
their applications, and analysis are highly relevant for graduate students who will exert
leadership positions shortly and have the need, opportunity, and power to influence business
decisions (Choudhary, 2021). Business Economics is essential not only because economics
affects every aspect of an individual’s life but it empowers the individual with analytical and
problem-solving skills.1 By being more analytical, this “economic way of thinking” help
business students be highly valued by employers and make better and more effective decisions.
These leaders’ decisions and skills are related to creating a competitive advantage for the
company and its success and profits. Moreover, since economic choices and issues are
everywhere, from small decisions to decisions made by large enterprises, this chapter is crucial

1

Practical Example. Examples of real-life questions Business Economics aims to address
include the following: Why the interest rate in Canada has increased after the COVID-19
pandemic? Why has Canada implemented a solid policy and programs to attract high-skilled
labour? Why has enrollment in Canadian universities risen in the last few years? Why has
Canada created good employment levels, with more than 150,000 new job positions in January
2023? (Deschamps, 2023).

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to equip students with economic knowledge focused on decision-making and business choices
(Sloman et al., 2018).

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2. Business Economics
This section will explain the basic definitions of economics and business economics as an
initial step in building the foundation for MBA students and people involved in business to
understand valuable economic content. Moreover, this section will present the differentiation
between macroeconomics and microeconomics and also discuss why it is essential to study the
content of this new textbook.
Definition of Economics
Many believe that economics is only concerned with money. Yes, this is true to a certain
point. Money plays a significant role in economics, including how much people earn and spend,
how much the goods cost, how much businesses can make, and the overall amount of money in
the economic system. However, money is essential only because of what it allows us to do,
serving like a tool; economics is more than that; it involves production and consumption. The
first is the process through which businesses convert inputs into outputs to make a profit or
achieve another goal. It comprehends how much the economy and the firm produce (individually
and collectively), the production methods and the number of workers employed. The second is
the process of fulfilling needs and desires, using products and services, which usually entails
buying the products and services. It includes how much people save and spend, how many of a
given good or service they purchase, what they select to buy, and how prices, advertising,
fashion, people's salaries, and other factors affect consumption (Sloman, Garratt, & Guest,
2018). Therefore, Viceconti & Neves (2013) define economics as the social science that studies
the production, circulation, and consumption of goods and services used to satisfy human needs.
Furthermore, economics comprehends a wide range of topics, such as remedies for global
recessions, social programs to deal with poverty and income insecurity, funding alternatives for

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health, measures to combat global climate change, economic development strategies for lowincome countries and regions, and many others. Although the origins of economics as a system
of thought are lost in antiquity, it was first defined as “the science that studies human behaviour
as a relationship between given ends and scarce means which have alternative uses” (Frank et al.,
2012). Moreover, a modern definition is “the study of how people make choices under conditions
of scarcity and the results of those choices for society” (Frank et al., 2012). Therefore,
economics focuses on how society allocates its limited resources, given that choices among
alternatives are necessary. For example, if an individual chooses to purchase a motorcycle, the
same funds cannot be used to pay for a more extended holiday abroad. Alternatively, a student
who enrolls for a course and wants to attend lectures cannot take a job during class times.
Usually, the allocation of resources is made through millions of households’ and businesses'
actions combined. Thus, economists research how people choose their actions, including how
much they work, what they buy, how much money they save, and how they invest. Economists
also research interpersonal interactions between individuals and firms (Mankiw, Taylor, &
Ashwin, 2013).
Economics as a social science often expresses its theories as abstract models based on
assumptions. John Maynard Keynes defined economics as a "science of thinking in terms of
models joined to the art of choosing models that are relevant." This happens because, to
understand the crucial variables and the essential parts, it is necessary to disregard unnecessary
abstract detail and select where to focus on. Hence, an economic model might be described as a
representation of economic reality emphasizing crucial variables and their relationships.
Furthermore, it is often assumed that human beings are rational in economic theories. Therefore,
a rational decision-maker has clear objectives and behaves logically to achieve them, being self-

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interested and acting to realize their interest. Adam Smith stated, "It is not from the benevolence
of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their
own interest" (Frank et al., 2012).
Definition of Business Economics
Mankiw, Taylor, & Ashwin (2013) report that the Greek word oikonomos, which means
one who administers a home, is where the English word economy originates. This may initially
seem strange, but there are many similarities between economies and businesses. A family needs
to make many decisions, such as: which activity each member will perform and what their return
is. Who prepares the dinner, or who goes to Costco to buy groceries? Who can repeat dessert?
Each family must allocate its scarce resources to its members, considering their abilities, efforts,
and needs (Mankiw, 2018). This broad field of study describes strategies for household resources
to increase their welfare to business resources to increase profits. A firm must make numerous
choices, such as how many employees to hire, what each person will do to contribute to the
company, how much each employee will be paid, how to be more productive, how many to
invest, how to manage cost, what products to produce, and many others. A business must
allocate limited resources among competing uses while considering various stakeholder
requirements and wishes. Many of the ideas that economists employ have immediate business
applications and relevance. Economics may be referred to as the science of decision-making.
Since businesses worldwide make millions of decisions daily, grasping the decision-making
process and the potential outcomes is crucial.
Therefore, Choudhary (2021) defines business economics as the study of efficiently
directing scarce resources to achieve an organizational goal. It analyses business situations via
the lens of economic theory. Moreover, it applies economic principles and methodologies to the

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firm's internal decision-making process under uncertain conditions. Mukherjee (2019) reports
that this process is likely to be imperfect due to uncertainty prediction (for example, the volume
of sales of a product, cost of production, profit, etc.). Therefore, business managers need to
anticipate changes to mitigate the impact of unfavourable situations. Since decision-making is
challenging due to the difficulty in predicting the future and the changes that are likely to occur,
business economics applies economic concepts and analytical tools to a business enterprise's
decision-making process. In this sense, managerial economics bridges the gap between economic
theory and administrative practice. Business economics interweaves economic principles and
business problems, integrating economic theory with business practices to facilitate decisionmaking and forward planning by management.
It uses a framework of analysis to arrive at informed decisions to maximize the firm's
objectives. Decisions taken while employing a framework of study are likely to be more
successful than decisions made from gut-feeling emotions. It applies economic tools to solve
problems at the firm’s level, extracting techniques and concepts that allow decision-makers to
allocate resources to the organization efficiently. Choudhary (2021) argues that collecting and
processing key information and data is crucial to make sound, informed, and better decisions.
Thus, by applying economic ideas, principles, models, and concepts to solve the problems of an
enterprise, business economists attempt to tackle the problem of uncertainty. Managerial
economists examine how theoretical models can be used in real-world situations, using them in
practical applications (Mukherjee, 2019).

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Definitions of Microeconomics and Macroeconomics
Sloman et al. (2016) state that macroeconomics and microeconomics, where macro
stands for large and micro stands for little, are the two main branches of economics that have
historically been studied.
•

Microeconomics: studies the individual parts that compose the economy. It is
interested in specific goods and services, analyzing the variables that change its
supply and demand. It analyzes business competitiveness and the benefits of trade. It
studies individual choices individuals made under scarcity and these choices’
implications for the behaviour of prices and quantities in individual markets. The
goal is to analyze the behaviour of individual economic units, such as firms, workers,
consumers, and investors.

•

Macroeconomics: studies the overall economy. As a result, it is interested in
aggregate supply and demand. While aggregate supply means the overall output of
goods and services of the economy, aggregate demand is concerned with all
economic spending, including that made by consumers, foreign buyers, the
government, and businesses that invest in capital or raw materials. It studies the
performance of national economies and the government policies used to try to affect
that performance. Macroeconomics tries to understand the determinants of the level
of national output, the employment and the inflation rate, the economy’s overall price
level, and the balance of trade.

A century ago, there was no separation between macroeconomics and microeconomics.
Alfred Marshall wrote, in the book Principles of Economics (1890), the "methodological
individualism”, insisting economics should explain why individuals behave as they do and

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acceptance of broad generalizations about groups of people hampers the understanding of
behaviour. However, when John Maynard Keynes published his book The General Theory of
Employment, Interest and Money in 1936, the macroeconomics branch emerged. It provided a
framework to discuss the Great Depression of the 1930s, in which the governments failed to
recover from the recession and high unemployment, and the previous theories could not explain
satisfactorily. Hence, macroeconomics started to develop in response to the perception that new
ways of thinking about the economy were needed (Frank et al., 2012).
Since business economics focuses on the firms and is concerned with finding optimal
solutions to firms’ decision problems, it is mainly associated with microeconomics discussions.
Business economics focuses on the firm, the environment in which it finds itself, and the
business decisions that firms must make. However, it is also crucial to analyze the
macroeconomic environment, given its impact on business. Therefore, efficient business
managers must be aware and able to explain the external and overall environment.2
Importance of Economics
Since Business Economics links managerial decision-making with economic theory, it
deals with the firm’s problem of allocating scarce resources among competing ends. The goal is
to optimize the firm’s decision-making, directly impacting its success. However, the rapid
technological progress, innovation and changes in production, transport, and communication, and
globalization made decision-making a complex task. Therefore, business economics uses
economic rational to effectively think and solve business decision problems (Mukherjee, 2019).

2

Practical Example. The following economic problems are primarily the objective of the
macroeconomics field of study: inflation, unemployment, and interest rates. On the other hand,
the next problem is mainly the objective of the microeconomics field study: why the demand for
toilet paper increased during the COVID-19 pandemic (Proctor, 2020).

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Considering that resources, in most business cases, are limited, and managers are regularly faced
with trade-off situations, economics knowledge for managers is of outstanding importance.
Economics theories, terminologies, and overall understanding of this subject assist decisionmaking processes and improve reasoning. Moreover, the market may be considered the most
complex and crucial institution operating and affecting the business environment. The economic
concepts and their applications, such as price, cost, profit, demand, competition, supply, etc., and
their consequent analysis are highly relevant for graduate students that will exert leadership
positions shortly and will have the need, opportunity, and power of influencing business
decisions (Choudhary, 2021).3
Pinho & Vasconcellos (2002) say that students must understand each economic concept
to preserve the logical coherence of analytical reasoning. Thus, Business Economics is essential
not only because economics affects every aspect of an individual’s life but it empowers the
individual with analytical and problem-solving skills. By being more analytical, this “economic
way of thinking” help business students be highly valued by employers and make better and
more effective decisions. These leaders’ decisions and skills are related to creating a competitive
advantage for the company and its success and profits. Moreover, since economic choices and
issues are everywhere, from small decisions to decisions made by large enterprises, this research

3

Practical Example. Why has Zellers chosen to relaunch its brand in Canada and open
twelve stores there? This question is directly related to business decision-making faced by
managers, in which economic knowledge is essential. Another question that might arise is why,
in the first place, Zellers chose to close its stores almost ten years ago in Canada. Both these
decisions involve many departments within an organization and many smaller and consequential
choices, such as what will be offered to the customers, what will be the price, how the product
will arrive to the customer, whether there will be enough demand for them, how many
employees does the company needs to hire to have an effective presence, etc. (Evans, 2023).

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is crucial to equip students with economic knowledge focused on decision-making and business
choices (Sloman et al., 2018).

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3. Fundamental Economic Problem
After the basic definitions are clarified, and the importance of economics and how it is
interviewed in many aspects of life are exposed, this section will discuss the central economic
problem. For that, the scarcity concept will be presented, a contradiction arising from unlimited
wants and limited resources. Due to this problem, economic agents are faced with decisions.
Therefore, this section aims to explain what is an economic system, including what are the
production factors and what are the production decisions inserted in it.
Scarcity
Economics studies the relationship humans have with each other in producing goods and
services necessary to satisfy the desires and aspirations of society. However, what occurs is that
human needs are infinite or unlimited. This is because the human being, by their very nature, is
never satisfied with what they already have; instead, they always aim for more. Conversely, the
productive resources (or production factors) that the society relies on to carry out the
manufacture of the goods and services (the extension of arable lands and other natural resources,
the volume of labour available to work and the quantity of machines and equipment that a
society owns) has a finite or limited character. Therefore, there is a contradiction. The wants and
needs of society are unlimited, while the resources to complete the production of goods and
services that should serve them are limited.
This leads to the following proposition: no matter how wealthy a society is (no matter
how much productive resources are available), the production factors will always be scarce to
manufacture all the goods and services that society wants. It means that society will have to
choose which goods and services should be produced. In the same manner, citizens, having a
determined wage or salary, cannot naturally consume all the goods and services desired but will

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need to choose which ones they can acquire and which are within their range of their income.
Sloman, Garratt, & Guest (2018) believe that most people would say "yes" if you asked if they
would want more money. However, they do not have this desire for their own reason; instead,
people desire to buy more things. The wants might change depending on one's wealth levels and
preferences. For example, in a developing nation, the desire could include access to water, good
education, and decent housing. Richer countries, such as Canada, may define differently their
desire, such as having a second automobile, taking vacations, and having more leisure time.
Moreover, Sá (2014) brings two types of scarcity force resource allocation choices:
purchasing power and time. The first happens when people want to buy more goods and enjoy
more services beyond what they are used to; they would need to increase their income or
sacrifice something to acquire other goods and services. The second type happens due to time
limitation, which forces the individual to choose, for example, between going to work or going
on vacation. Since time is limited, there is little time a day available to dedicate to satisfying our
activities or recreation.
Consequently, Economics is also often defined as a science that studies scarcity or the
science that studies the use of scarce resources in producing multiple goods society desires
(Viceconti & Neves, 2013).4 Vasconcellos & Garcia (2004) describe that scarcity, the
fundamental economic problem, forces society to choose between production alternatives and the
distribution of productive activity results to various groups in society. Sá (2014) indicates that
scarcity does not mean a lack of money, food, or goods. It is a problem between human desires

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Practical Example. Why does University Canada West - a Canadian university, allocate
forty students to the same Economics class instead of creating two classes of twenty students
each? One simplistic answer might be because labour (professors) and physical assets
(classrooms) are scarce compared to students' demand for that course.

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and the means available to satisfy them since human needs and wants are unlimited while the
resources available are insufficient to meet these needs. Hence, even if a good has a limited
supply, if it is not desired and there is no demand, it will not be scarce. In summary, the excess of
human desires over what can be actually produced is scarcity. Due to a lack of resources, it is
necessary to compare and decide between options, giving up others – making trade-offs
necessary.5 This decision involves opportunity cost, a concept that will be addressed in the next
section (Sá, 2014).
Production Factors
Resources are the factors or fundamental elements used in the production of goods and
services (Sá, 2014). They are characterized as production factors, which are usually classified
into three categories. Any good or service produced in the society results from these resources
combination:
1) Natural resources: land and raw materials
2) Labour: human resources
3) Capital: manufactured resources
Viceconti & Neves (2013) discuss that natural resources are considered only the nature
elements susceptible to being incorporated into economic activities. It is the physical space

5

Practical Example. While the fundamental economic problem is scarcity, a question that
arises is if all goods and services are scarce or if there is anything desired that is abundant. For
something to be considered abundant, its supply must exceed demand at a zero price. For
example, the Canadian government provides health care for free for its citizens, but it does not
mean it is abundant. On the contrary, it is scarce because there is a cost to the government and
taxpayers. Nonetheless, can water be considered abundant? The scarcity characteristic depends on
the location and the purpose of its use. For example, for producing crops in a rainy place can be
regarded as abundant. However, it is scarce if considering drier climates, where irrigation is
costly. Moreover, drinking water is also scarce because of the cost and procedures of cleaning
and filtering it (Sloman, Garratt, & Guest, 2018).

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where the production is developed and natural resources contained in it, such as oil, iron, coal,
and wood. The volume of these resources depends, among other factors, on technological
evolution, which determines the possibility of using raw materials and energy sources, advancing
territorial occupation, transport facilities, and the survey of stocks. Thus, a mineral resource in a
large forest, in which exploration is unfeasible due to a lack of transportation methods to carry it
into the big consumer centers, is not part of the economy's natural resources; therefore, it is not a
production factor.
The Labour production factor is the time used by people to produce the goods and
services. For that, it is considered the Economic Active Population of the society. A country’s
population is composed of its inhabitants. By subtracting, from the population, the people that
are not at working age (too young or too old), we would reach the concept of Active Population.
Furthermore, if from this, it is computed that only people seeking employment in the formal
labour market (excluding, for example, students and homemakers), the Economically Active
Population is obtained. Therefore, the EAP is composed of employed and unemployed people.
Hence, the quotient between the unemployed share of the EAP and its total is called the
economy's unemployment rate.
The Capital production factor corresponds to the goods of long-term duration used in the
production, including the set of buildings, machines, equipment, and facilities that the society
deploys to production. This set is called the capital stock of the economy. The current state of
technology restricts the productivity of this capital (Sloman, Garratt, & Guest, 2018). This means
more goods and services it will be able to produce. Note that the capital concept as the
production factor differs from the word capital used in everyday language, which is used to

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designate a monetary amount (or other financial assets) that one owns to initiate a specific
business.
The Economic Systems
An Economic System is the way society is organized to develop economic activities,
which are the activities of production, circulation, distribution, and consumption of goods and
services (Viceconti & Neves, 2013). Vasconcellos & Garcia (2004) complement saying that the
economic system is the political, social, and economic form in which the society is organized.
Moreover, this system is used by people seeking an improvement in the standard of living and
well-being. The fundamental elements of an economic system are:
A) The stock of productive resources or factors of production: human resources (labour
and entrepreneurial capacity), capital, land, natural reserves, and technology.
B) The complex of production units: formed by companies.
C) The set of political, legal, economic, and social institutions: which are the basis of the
organization of society.
Viceconti & Neves (2013) states that, given that human needs are unlimited and
productive resources are limited, any economic system would face three fundamental decisions,
also called fundamental economic problems.
1) What to produce: society will have to choose, within the range of production possibilities
available, which products and their respective quantities will be manufactured.
2) How to produce: society will also have to choose which productive resources will be used
in producing the chosen products, given the current technological level. The competition
between the different producers ends up deciding how the goods and services will be

22
produced. As these resources are scarce, it is always convenient for them to be used in the
most efficient way so that the production cost will be as low as possible.
3) To whom to produce: society will also have to decide how their members will participate
in the distribution of the production results. In other words, if everyone equally
participates in these results, or if not, which of them will be more or less benefited.
Income distribution will depend not only on the demand and supply in the market of
productive services - that is the determination of wages, land rents, interest, and benefits
of the capital but also on the initial distribution of properties and how it is transmitted by
inheritance (Vasconcellos & Garcia, 2004).
How will these problems be solved in a capitalist market economy, which is the
predominant form of economic system in the contemporary world, will be presented in the next
section.

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4. Importance of Business Economics
Mankiw (2018) argues that an economy is a group of people interacting with each other
while going on with their lives. As the behaviour of an economy reflects the behaviour of the
people that compose it, this section will start with studying key concepts and principles of
individual decision-making. Pindyck & Rubinfeld (2013) explained that the trade-offs in modern
market economies come from the flexibility and choice power to allocate scarce resources.
Trade-Offs
The first important point is that there is no free lunch. To get something we want, usually,
we need to relinquish something else we also like. It is necessary to trade off one goal against
another when making decisions. For example, an MBA student must decide how to allocate the
most precious resource – time. The student can study accounting or marketing all day or divide
the time between the two courses. For each hour the student dedicates to one subject, one hour
that could have been used to study another is relinquished. Moreover, for each hour the student
spends learning, she gives up one hour that could have been used to work or go skiing. Another
example is a couple deciding how to spend the family income. They can buy groceries and
clothes or pay for a family trip to Montreal. Each dollar spent on any of these things means they
have one less to spend on other things.
When people are in society, they face different types of tradeoffs. A classic example is
between guns and butter. The more society spends on national defence (guns) to protect the
borders from external aggressors, the less can be spent on consumer goods (butter) to improve
the internal standard of living. Another crucial trade-off is between the environment and highincome levels. The laws require firms to reduce pollution, which increases the production cost of
goods and services. Consequently, firms would have lower profits, pay fewer salaries, charge

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higher prices, or a mix of all these options. This generates a cost of reducing the incomes of the
business’s owners, workers, and customers (Mankiw, 2018).
Mankiw (2018) discusses that recognizing that people face trade-offs does not tell which
decisions they will take or would like to. A student should not abandon accounting studies
because this can increase the time available to study marketing. Society should not forget about
the environment because this may impair the material standard of living. Nevertheless,
recognizing the trade-offs is important because people can only make good decisions if
comprehends the available options.
Pindyck & Rubinfeld (2013) states that consumers have a limited income; therefore, they
need to maximize their well-being by trading off the purchase of more of some good for the
purchase of less of others. Also, they can trade off current for future consumption by saving
income. Workers' trade-offs can be shown in the choice of whether and when to enter the
workforce. Since the payment might vary depending on the skills and educational background,
one must choose between working more now or going for education, hoping to earn more in the
future. They must decide how many hours they will dedicate to work per week, reducing the time
available for leisure.
On the other hand, firms have limits on their production (what goods they can offer and
the resources necessary for it). For example, a company does not have abilities to produce
laptops; therefore, it decides to focus on car production. However, financial resources, the size of
the factory, and other constraints will impact the decision on how many types of vehicles to
manufacture. Also, if it wants to increase production, it would need to hire more workers,
increase the factory, or both.

25
Prices and Market
All trade-offs previously discussed are based on the prices that consumers, workers, and
firms face. Consumers chose to buy meat instead of chicken, in part, because of their preferences
and, in part, because of the prices. Alike, workers choose to work more, losing leisure time due
to the price they can earn for their productive effort and labour – the wage. Firms decide to hire
more workers or buy more machines based partly on the wage rates in the market and machine
prices. In a centrally planned economy, the government sets the prices; in a market economy, the
prices are determined by the interaction between consumers, workers, and firms. These
interactions occur in the markets. The market is the set of buyers and sellers that determine,
together, the prices of each good and service through their real or potential interactions. For
example, the cars’ prices are affected by the competition between the manufacturers and the
consumers’ demand.
Buyers comprehend the consumers that acquire goods and services and firms that acquire
labour, capital, and raw material to use in the production of goods and services. Conversely,
sellers are the firms that sell goods and services, the workers that sell their labour services, and
the resource owners that rent the land or commercialize mineral resources to the firms (Pindyck
& Rubinfeld, 2013).
The markets allow transactions between buyers and sellers. Therefore, the market is
perfectly competitive when there are many buyers and sellers so that no single buyer or seller
affects the price. For example, in agricultural products where thousands of farms produce flour,
no buyer or seller can affect, individually, the price significantly. In this case, the market price
will prevail. The flour price in Toronto or Vancouver is easy to measure and find. On the other
hand, other markets can be considered non-competitive when a single individual unit can affect

26
the price. Furthermore, when the market is not perfectly competitive, different firms charge
different prices for the same product. This can happen due to a firm wanting to win customers
from another or a firm’s consumers are loyal, allowing the firm to charge higher prices. In that
scenario, the market price will be an average of the prices (Pindyck & Rubinfeld, 2013).
Furthermore, Vasconcellos & Garcia (2004) states that a market economy (capitalist
system) is conducted by the market forces, prevailing free initiative and private property of the
production factors. The fundamental economic problems discussed in the previous section are
solved by price mechanisms through supply and demand in a market economy. In a centrally
planned economy, these issues are centralized and decided by a government entity after
evaluating the production resources available and the country’s needs.
Opportunity Costs
Pindyck & Rubinfeld (2013) explain that since people face trade-offs (due to their scarce
resources), decision-making requires comparing the costs and benefits of the possible
alternatives of action. However, an activity cost is usually not as straightforward as it might
appear initially. Therefore, it is essential to learn the opportunity cost to understand individual
choices and behaviour. Sloman, Garratt, & Guest (2018) explain that when faced with the tradeoffs discussed, there is a cost of the activity that is measured in terms of the best alternative
forgone, named opportunity cost. Frank et al. (2012) define it as “the value of what must be
forgone to undertake the activity” or “the value of everything that must be sacrificed to engage in
it”. For example, the time required for a trip to Whistler is the only time available to study for an
exam. Therefore, the trip’s opportunity cost, the value of what you must sacrifice to go for that
activity—is high, which leads to a potential decision of not going to Whistler. Another example
is if someone wants to go to the cinema, the total activity’s cost should include not only the

27
tickets but also the babysitting job would have to give up for that period.6 Therefore, the cost of
something is what you give in turn, what one must give up to get it – the true cost (Krugman,
Wells, & Graddy, 2014).
Vasconcellos & Garcia (2004) provide the following example of an economy with two
options: produce 20,000 machines and 30 tonnes of food or 15,000 machines and 45 tonnes of
food. Going from the first to the second option represents an opportunity cost of 5,000, which is
the number of machines foregone in order to produce 15 tonnes of food.
Trade and Comparative Advantage
Frank et al. (2012) argue that when two people or countries have different opportunity
costs for performing activities, it is possible to increase the total value of available goods and
services through trading with one another. Therefore, there is a general benefit if everyone
focuses on the activities in which their opportunity cost is the lowest. For example, if a family
wants to take care of all its needs, grow its food, producing its clothes, providing its own
entertainment, etc., it might be possible but will not be easy. Hence, trade allows people to divide

6

Practical Example. Imagine someone can either go to a nearby shopping mall in North
Vancouver to buy a PlayStation5 or travel to Delta and buy the same videogame for a lower
price. The North Vancouver mall offers the product for $800, while the Delta store sells it for
$600. The rational decision would be the one that provides the highest benefit compared to the
cost. Moreover, to assist in the reasoning, it is important to consider the Uber cost for the travel
alternative, which would be $50. If this was just a mathematical question, the person involved in
this case would be better off buying from the Delta store since its cost would be the videogame
plus the travel cost – a total of $650, which is still $150 cheaper than the first option. However,
let’s add one additional concept: the opportunity cost. Supposing the travel would take one hour
and a half and you work in the I.T. industry, and in this time, you could work on software
development and earn $250. Therefore, you are now faced with two alternatives: the first is to
buy at North Vancouver at $800 or travel to Delta and buy there for $650 plus the travel cost
($50) plus the $250 you gave up since you allocated your time to travel rather than work. It is
essential to notice that time is a scarce resource, and its allocation involves decision-making. In
that scenario, you would be better off buying from North Vancouver since it would be $50
cheaper.

28
the tasks, and one provides a good or service that the other wants in return for another good or
service, improving the standard of living (Krugman, Wells, & Graddy, 2014). This means that
specialization based on comparative advantage brings gains in the market exchange. On an
individual level, these comparative advantages might come from talent, education, training, or
experience. On a national level, it may derive from natural resources or differences in society
and culture (Frank et al., 2012).
Mankiw (2018) discusses that trade should not be seen as a sportive competition, where
one side wins and the other loses; instead, it can make everyone better off. It allows people to
focus and specialize in the activities that are better, and by trading, people can buy a greater
variety of goods and services at a lower cost.7 Krugman, Wells, & Graddy (2014) discuss that
people can get more of what they want by trading (which is possible in market economies) rather
than they could if they wanted to be self-sufficient. Varian (2010) provides the following
example: Tom can produce 4,5 kilos of fish or 9 kilos of coconut per hour, while John can
produce 9 kilos of fish or 4,5 kilos of coconut per hour. This means that John has a comparative
advantage in fish production and Tom in coconut production. Ideally, each would specialize in
what they are best at (lower cost) and trade in the market.

7

Practical Example. Eddie Greenspan is a great criminal defence lawyer in Canada. He
works to defend clients from varied types of accusations, such as drunk driving and murder. His
expertise allows him to handle many kinds of legal tasks. Therefore, let’s suppose he can write
his own will; for that, he would need one hour. Greenspan's second option is to hire another
attorney that would take two hours to do the will and charge $500. Moreover, Greenspan's
opportunity cost is $1,000 per hour since he could use that one hour to work on a client’s case
that pays a high amount. Hence, although Greenspan would complete the will quicker than the
other layer, he would be better if he chose the second option. This is true because he can make
$1,000 in the hour he saves by hiring someone else ($500) to do his will. In conclusion, he would
have $500 more than the first option allows (Frank et al., 2012).

29
Sloman, Garratt, & Guest (2018) says that when each good is produced at the minimum
cost and where individual people and firms get the maximum benefit from their resources, the
economy reaches efficiency. Consequently, since people are always looking to exploit
opportunities to be better off when this is not possible anymore (individuals cannot make
themselves better off by doing something different), the economy is in equilibrium. This
situation is reached through price changes, increasing or decreasing until no better opportunities
remain. Moreover, equilibrium is possible because people respond to incentives. For example,
people living in downtown Vancouver can trust that supermarket shelves will always be full.
This happens because if some merchants do not deliver, a considerable profit opportunity would
have been created for another merchant to do it; there would be a rush to supply food. Therefore,
the market ensures this availability. In that manner, inhabitants can focus on other tasks and jobs
without worrying about growing their food and living on farms. This is the power of trade,
giving gains to both parties (Krugman, Wells, & Graddy, 2014).
No institution guarantees economic efficiency. No government agents regulate if a doctor
produces potatoes instead of working in a hospital or if universities waste classrooms. The
efficiency happens due to an invisible hand. This means that incentives embedded in a market
economy ensure that the resources are usually well used. If a university is known for squeezing
students into a small classroom, it would see its enrollment being reduced. The market would
answer in a way that would induce the university to manage its resources efficiently. In a market
economy, individuals are free to choose what they consume and produce, leading to gains and
opportunities that are enjoyed mutually. Moreover, if there is any possibility that someone can be
better off, people will usually be able to take advantage of it. However, if there are any market
failures, individual pursuit of self-interest based on the market worsens society’s situation, which

30
means that the market result is inefficient. Therefore, government intervention might act to
correct this (Krugman, Wells, & Graddy, 2014).
Krugman, Wells, & Graddy (2014) argue that the economy’s resources are used
efficiently when employed in a manner that fully exploits all opportunities to make everyone
better. In other words, efficiency is achieved when all opportunities to make some people better
does not make other worse. In the university example, it is possible to make everyone better by
moving the class to a bigger room. Therefore, assigning the larger classroom would have meant
an efficient use of resources, while a smaller one meant inefficient. However, when the economy
is in equilibrium, the only way to make someone better is to worsen someone else. For example,
if all large classrooms were occupied, transferring one course to a larger one would mean
transferring another course to a smaller one (worsening its situation). Thus, when the economy is
efficient, it is producing the maximum gains from trade possible given the resources available
because there is no way to rearrange how resources are used in a way that can make everyone
better off.
Therefore, resources must be efficiently used to achieve society’s objectives.
Nevertheless, there is a trade-off between efficiency and equity. For example, a government
regulation that demands the allocation of parking spaces in parking lots for people with
disability. Although this may cause inefficiency (potential unused resources not fully exploiting
opportunities), it ensures a fairer life for those in need. Hence, policies that promote equity often
come at the cost of decreased economic efficiency and vice versa. Therefore, the resources
should be employed efficiently but must pursue society’s goals (Krugman, Wells, & Graddy,
2014).

31
Circular Flow Diagram
There are two fundamental economic agents in a market economy: productive units or
firms and consumer units or production factors owners. The productive units, or firms, produce
the goods and services using production factors (natural resources, labour, and capital) that its
owners concede in exchange for a remuneration – income. The owners of the production factors
(capitalists that own the capital, workers that own the labour force, and the people who are
owners of natural resources) use the income originating from the concession of their use to
companies to buy the goods and services that they produce and that meet their needs. The total
amount of these purchases is called expenditure. The firm is an economic agent different from
the capitalist, its owner, who is part of the family. The following diagram summarizes the
interactions between economic agents in an economic system (Viceconti & Neves, 2013).
Figure 1
Circular Flow Diagram

Note. Circular Flow Diagram. Adapted from “Introdução à Economia A” by L. Sá, 2014, Universidade
Federal do Amazonas, p. 162. Copyright 2014 by Universidade Federal do Amazonas.

32
From the economic agents' interactions, there are two simultaneous flows: monetary,
which is the result of the remuneration of the production factors (income) and real goods and
services, represented by the resulting production of employing the production factors (Sá, 2014).
Viceconti & Neves (2013) assert that the income, the remuneration paid by the firms to use the
production factors, is classified into categories:
•

Wages and salaries: remuneration of the production factor labour.

•

Interests and profits: remuneration of production factor capital.

•

Rent: remuneration of the owners of natural resources and capital goods lent.

The distribution of the benefits resulting from production (to whom to produce) will
depend on the quantity of each production factor used and the productivity (contribution) of
each. Therefore, in countries where non-qualified labour is abundant, and capital is scarce,
salaries tend to be lower and interest and profits higher. Qualified labour, for being scarce and
more productive, tends to receive higher remuneration. Moreover, the decision of which products
should be produced by the economy is made jointly for the consumer unities (that will constitute
the demand) and the productive units (that will supply the goods and services). The equilibrium
between these two forces is done in the market, where the prices and quantities traded are
determined. To answer the problem of how to produce will be given by the competition between
the producers, that should adopt a combination of production factors to provide the lowest
production cost (Viceconti & Neves, 2013).
Production Possibilities Curve
The Production Possibilities Curve (PPC) illustrates how the scarcity issue imposes a
limit on the production capacity of a society that will have to decide between production
alternatives. A country’s total production has a maximum limit, a potential production, or

33
product of full employment, where all the resources available are employed (all workers that
want to work are employed, and there is no idle capacity). For example, one economy only
produces machines (capital goods) and foods (consumer goods) and that they have the following
options:
Table 2
Production Alternatives – Machines vs Food
Production Alternatives Machines (thousands) Food (tonnes)
A

25

0

B

20

30

C

15

45

D

10

60

E

0

70

Note. Production Alternatives – Machines vs Food. Adapted from “Fundamentos da Economia”, by M.A.
Vasconcellos & M. E. Garcia, 2004, Editora Saraiva. Copyright 2004 by Editora Saraiva.

In the first alternative (A), all the production factors would be allocated to producing
machines; in the last (E), they would be allocated only to produce food; and in the intermediaries
alternatives (B, C, and D), the production factors would be distributed in the production of one
and the other. Therefore, the curve ABCDE indicates all the production possibilities of the
machines and food that this economy has. Any point in the curve means the economy operates at
total capacity, using all the available production factors. In point Y or any other point inside the
curve, the economy operates with idle capacity or unemployment; the production factors are
underutilized. Also, point Z represents an impossible production combination (25 thousand
machines and 50 tonnes of food) since the production factors and the technology this economy

34
has are insufficient to obtain this quantity of goods. This point exceeds this economy's potential
production capacity or full employment (Vasconcellos & Garcia, 2004).
Figure 2
Production Possibilities Curve

Note. Production Possibilities Curve. Adapted from “Fundamentos da Economia”, by M.A. Vasconcellos
& M. E. Garcia, 2004, Editora Saraiva. Copyright 2004 by Editora Saraiva.

Vasconcellos & Garcia (2004) state that shifting this PPC to the right means the country
is growing. This can occur due to the increase in the physical quantity of the production factors
or due to better employment of already existing resources. This might happen due to
technological progress, higher productivity and organizational efficiency of the firms, and
improvement in workforce qualification. Therefore, the expansion of production resources and
technological advancement that characterize economic growth shift the production possibilities
curve upwards and to the right, allowing the economy to obtain higher quantities of both goods.
Furthermore, the authors explain that the curve format (concave) is explained through the
fact that the opportunity costs are usually ascending since when there is a production increase of
a good, the production factors transferred from the other products are every time less apt to the

35
new objective. The opportunity cost is the lost quantity of one good that society needs to incur to
increase the production of another good. This means that each transfer is becoming more
complex and onerous. Equal increases in food production imply higher decreases every time in
machine production (Vasconcellos & Garcia, 2004).

36
5. Economics and Business Decision
After comprehending all the fundamental economic terminologies and concepts and
understanding that economic agents are faced with decisions, applying these ideas to the business
environment is essential. Therefore, this section will discuss the rationality of the choices and
how business economics can be found in managers' decision-making processes from varied
specialization fields within an organization.
Rationality
Frank et al. (2012) argue that economists use the cost-benefit principle as an abstract
model of how a rational person would select among competing options; therefore, this helps
understand, explain, and predict human behaviour. In that sense, economists believe in the
rationality of choices. This means that everyone considers the cost and benefits of various
activities; therefore, they choose the one that allows them to maximize their goal. Hence, for
consumers and employees, this implies choosing what maximizes their satisfaction. For
consumers, rational decision-making concerns choosing the items that give the best benefit
relative to cost, i.e., the best value for the money. Moreover, some of these decisions might be
made unconsciously, without being aware of such a process. It might be just an intuitive rather
than precise calculation (Sloman, Garratt, & Guest, 2018). Mankiw, Taylor, & Ashwin (2013)
define value for money as a situation where the satisfaction gained from purchasing and
consuming a product or service is greater than the amount of money one had to give up acquiring
it – the price.
For firms, it implies deciding what to manufacture and how much to maximize profit.
Consequently, a rational choice can be defined as a decision that involves weighing an activity's
benefit and opportunity cost to maximize the decision-makers goals successfully. For example, a

37
firm may decide to open a new factory line in Delta. The benefits can be expressed in the
revenues steaming from this new production line due to the extra quantity being sold. The costs
will be the labour, material costs, etc. Thus, rational decision-making weighs up the benefits and
costs, so it will be profitable to open this additional line only if the revenues are higher than the
costs. Furthermore, to assist in rational decision-making, economists use the marginal costs and
marginal benefits to calculate them. These are the costs and benefits of doing a little bit more or
less of something. In the factory decision, the decision-maker should not consider the
production's total costs and revenues but only the additional cars. Therefore, if additional cars
add more to the revenue than to the costs, producing them will be profitable (Sloman, Garratt, &
Guest, 2018). Frank et al. (2012) explain that the cost-benefit principle derives from the scarcity
problem: to get more of something usually means getting less of another option. Thus, the
individual, firm, or society should take action only if that action will bring extra benefits greater
than the additional costs. This difference is called an economic surplus.
Managers Decision-Making
Since business economics is economics applied to firms' problems, the rational decisionmaking concept must be used to analyze how rational managerial decisions are formulated.
According to Choudhary (2021), management is the efficient and effective directing, leading,
and controlling of a group of people toward common goals. In that regard, a firm has four main
types of decision-making. The first is how to allocate resources. The scarce resources must be
allocated efficiently to their respective uses to get maximized results and achieve the firm’s
goals. The second concerns inventory decisions about what levels of stocks of raw materials and
finished goods to hold over a period. This should consider demand and supply and is also related
to queuing problems about installing additional machines or hiring extra labour – consider

38
possible loss if does not undertake these activities. The third is pricing: which method to adopt to
calculate and fix the prices for the goods or services. This is especially important given that the
firm’s revenue comes from that decision, directly impacting its success. The fourth is the
investment decision: planning forward involves allocating scarce resources over time, such as
investing in new developments, how much to invest, sources of funds, etc. Mukherjee (2019)
adds that managerial decision-making involves product decisions since the company must decide
which product to produce and in what quantities. For that, it must estimate the demand for its
product.
Choudhary (2021) emphasizes that since business economics involves analyzing demand,
cost, pricing decisions, profit management, and capital management, it is linked with many
management fields.8 Because its goal is to solve the firm’s problems, it is interwoven with other
areas (Mukherjee, 2019). Mankiw, Taylor, & Ashwin (2013) provide examples of a firm’s
decisions in its different departments that utilize economic concepts.
Leadership: leaders must be aware of how to make decisions to maximize efficiency and
the firm’s benefits to achieve its goals. Therefore, economic concepts are crucial to guide

Practical Example. Let’s imagine a flower shop business. The owner, seeing that some
tulips would not resist the night and if he does not sell them in a couple of hours, the value of
these tulips would be zero. Therefore, the owner needs to go through a decision-making process
and choose whether to sell these tulips on the sidewalk near his small store or go to a restaurant
in downtown Vancouver to try to influence people on dates to buy the flowers. However, the
restaurant charges a fee of $25 to give the sales permission. Moreover, going downtown means
giving up time (valued at $10) plus the bus ticket to commute ($5). Hence, the total cost to sell
the flowers in the restaurant is $40. Since the owner has experience selling flowers downtown,
he forecasted the sales to be $50. Therefore, his estimated net profit is $10. Hence, to be better
off selling the flowers on the sidewalk, he would need to make more than $10 in revenue (Frank
et al., 2012). This simplified example shows how sales, marketing, and financial decisions are
interviewed with economic concepts and ideas.
8

39
managers in their tasks. Moreover, leaders must be prepared to make decisions under uncertainty
and risky conditions.
Marketing: market segmentation comes from the “for whom to produce” decision. It
involves acquiring and keeping customers and assigning marketing characteristics, such as
domestic buyers, foreign markets, low or high-income, etc. Also, it studies consumer behaviour,
including estimation, analysis, and forecasting of demand. Business economics assists in
answering questions, such as whether to conduct an advertising campaign and, if so, how much
to spend on it and when.
Finance: economics concepts, models, and theories assist in the cost, revenue, and pricing
analysis under different market conditions. Maximization of profits is usually the first goal of a
private company. Therefore, financial analysis is crucial. Moreover, it assists with capital
budgeting, rate of return of investments of a firm, and planning and control of capital
expenditure - what to invest in, what not to invest in, how much to invest, growth and expansion
analysis, etc. Since business economics is metrical in character, it helps estimate relationships,
predict quantities, and use them in decision-making and forward planning. Moreover, accounting
data and financial statements constitute the language of business; therefore, they are so close to
each other that "managerial accounting" has developed as a separate and specialized field.
Human resource: business economics assist in the scarce resources allocation decisions
concerning labour and employees – whom and when to hire or fire. Businesses are also interested
in how stakeholders choose, such as why some employees are not committed to their work or the
business's values.
Entrepreneurship: theories of market structure, consumer behaviour, economic agents,
and impacts of government decisions on the business are linked with this management field.

40
Business Analytics: Statistics and its methods help empirically test economic theory.
With its help, better decisions relating to demand and cost functions, production, sales, or
distribution are made.
Operations management: business economics assist in finding out the best of all
possibilities. Linear programming is an excellent aid in decision-making in business and industry
as it can help solve problems, such as determining facilities, machine and labour scheduling,
distribution of commodities and optimum product mix, production analysis, economies of scale,
etc.
Project management: business economics help in the evaluation of investment projects of
a company, allocation of resources, opportunity cost analysis, and cost control. Business
economics concepts are also found in deciding whether to pursue a project or not and calculating
its potential benefits.

41
6. Supply and Demand
Mankiw (2018) discusses that since economics is concerned with consumption and
production, it is also concerned with demand, supply, and the relationship between them.
Demand is linked to the “wants” of the scarcity problem. If everything were free, everyone
would demand anything they wanted. On the other hand, the supply is limited since it is linked to
resources. The total amount a firm can supply depends on the available resources and
technology. Therefore, as previously discussed, people's “wants” are greater than what can be
offered. Thus, potential demand exceeds the potential supply. Society must, then, find solutions
for dealing with this imbalance. This can be seen at individual levels (for example, cars or the oil
market) but can also be extrapolated to the overall economy - the aggregate (total) demand needs
to be balanced to aggregate (total) supply. This means that the overall expenditures in society
need to match the total production. Economics, therefore, studies how this match and balance
happens or not and how demand adjusts to supply and vice-versa.
To assist in these studies, economists use economic models. These models explain and
predict, in a simplified manner, the relationships that happen in the economy. Although
abstraction is not ideal, this is crucial to be able to focus on the variables relevant to the causes
and effects. The discussion about demand, supply, and price is one example of an economic
model. For that, general statements from observations can be made – called induction. Moreover,
models help to explain causes, predict, forecast, and draw conclusions. However, given the
complexity of reality, economists use the ceteris paribus assumption. This means that the
deductions can be assumed given that nothing else that could affect the conclusion has changed.
For example, given that the demand for cars has increased, cars’ prices will rise with the
assumption that the manufacturing cost did not change (Mankiw, 2018).

42
Demand
Consumer demand for a good or service increases when its price decreases and decreases
when prices increase. Hence, this relationship is expressed by a descending demand curve: the
smaller the price, the greater the quantity demanded. There are two reasons for this law of
demand. First, as prices, relative to other goods, rise, the demand for that product will drop given
that the consumers can buy other options and switch to substitute items - substitution effect.
Secondly, given that consumers' purchasing power is limited, when prices rise, consumers will
feel poorer since they cannot buy the exact quantities as before with the same amount of money.
On the contrary, when prices decrease, the quantity demanded increases because people can buy
more (income effect), and they will switch away from substitute items (substitution effect).
Consequently, the demand curve defines the number of goods or services consumers will
purchase within a price range they intend to pay. In the potatoes example, point E shows that at
$100 per kg, 100 tonnes will be demanded. If this price decreases to $80 per kg, the quantity
demanded increases to 200 tonnes - point D (Sloman et al., 2016).
Figure 3
Demand Curve

($ per kg)

Price

Total market
demand

A

20

700

B

40

500

C

60

350

D

80

200

E

100

100

Note. Demand Curve. Adapted from “Economics for Business”, by J. Sloman, D. Garratt, J. Guest, & E.
Jones, 2016, Pearson Education Limited, p. 54. Copyright 2016 by Pearson Education Limited.

43
Other determining factors besides price affect the demand. First, the income: when
income increases, people tend to buy more goods and services, increasing the demand.
Economics defines normal goods as those that, when there is an increase in income, their
demand also increases. However, goods whose demand decreases with increasing income are
called inferior goods (for example, when people become wealthier, they decrease their demand
for low-quality products). Secondly, tastes and preferences: consumer tastes and preferences
change over time, and what was once popular becomes outdated. Alternatively, when consumers
start to believe that they must have a good, demand can quickly increase. This might be affected
by advertising, fashion, health, etc. Therefore, the more desirable the goods, the higher their
demand. Third, the price and number of substitute goods: the lower the price of a substitute
good, the demand will shift towards it, decreasing the demand for the good people switched
from. Alternatively, when the price of one alternative product goes up, it increases the demand
for the other. For example, if the tea price drops, coffee demand might drop. Forth, the price and
number of complementary goods (consumed together): the higher the price of complementary
goods, the fewer will be bought, decreasing the demand. For example, if the PlayStation 5
increases its price, the demand for PS5 games will decrease. Fifth, future expectations: when
consumers expect a good or service’s price to rise, they tend to buy more now, increasing
demand. Sixth, income distribution affects demand: transferring income from the poor to the rich
might increase the demand for luxury goods (Sloman et al., 2016).

44
Figure 4
Demand Curve - Shifts

Note. Demand Curve. Adapted from “Economics for Business”, by J. Sloman, D. Garratt, J. Guest, & E.
Jones, 2016, Pearson Education Limited, p. 55. Copyright 2016 by Pearson Education Limited.

Choudhary (2021) argues that demand analysis, estimation and forecasting are crucial for
a business firm selling goods and services in the market. Many managerial decisions depend on
accurate estimates of demand to forecast future sales to prepare production and allocate
resources efficiently. Moreover, this directly impacts the organization’s success since it affects
the market position and profitability.
Supply
Sloman et al. (2016) explain the supply definitions, which is the quantity of a good or
service a producer or seller is willing to offer at each price in a certain period. The decision to
produce is guided by the principle of profit maximization, translated into the law of supply,
which states that when prices increase, the quantity supplied of goods and services will also
increase. Therefore, the supply curve is ascending because producers will be willing to offer
smaller quantities of goods or services, the lower their prices. This happens because, beyond a
given level of output, firms’ costs increase more quickly as they increase supply (for example,
employees must be paid overtime, and machines might be almost at full capacity); therefore, it

45
will only be worthwhile to produce more and bear these increased expenses if prices rise.
Another reason is that, with a price increase, the good becomes more profitable; hence,
businesses will be motivated to manufacture more of it by switching from less profitable goods’
production. Moreover, new producers will be motivated to enter the market, increasing the
market supply. When summing all individual offers of each producer, it represents the market
supply.
The amount of product that producers would like to offer at different pricing can be
shown in the supply curve. An increase in price from $60 to $80 per kg will increase the market
supply from 350 to 530 tonnes (Sloman et al., 2016).
Figure 5
Supply Curve

($ per kg)

Price

Total market
supply

a

20

100

b

40

200

c

60

350

d

80

530

e

100

700

Note. Demand Curve. Adapted from “Economics for Business”, by J. Sloman, D. Garratt, J. Guest, & E.
Jones, 2016, Pearson Education Limited, p. 56. Copyright 2016 by Pearson Education Limited.

Other factors beyond price also influence supply. First, the higher the cost of production, the
lower the firm’s profitability. The variable costs, such as wages and the price of materials, and
the costs of fixed assets, such as equipment and machinery, can increase the cost of production.
Thus firms would reduce output and switch to other products with lower costs. Secondly, the
technology advances allow cost reduction. For example, companies manipulate inventory more

46
efficiently, giving them the ability to handle larger inventories and reduce the cost. Third, the
profitability of alternative products: if the resources can be allocated to more profitable goods,
firms will switch their production, decreasing the supply of the less profitable item. For example,
potato supply might decrease if carrots provide higher profits (price rise but costs fall). Fourth,
future expectations: if there is an expectation that prices will rise, suppliers might temporarily
reduce their quantities sold to built stocks and sell with higher prices in the future. Fifth, the
number of sellers: supply might increase with more competitors in the market. Sixth, climatic
conditions: when the agricultural production of beans suffers from the weather, supply drops,
and prices rise. When a determinant of the supply changes, its curve shifts (Sloman et al., 2016).
Figure 6
Supply Curve – Shifts

Note. Demand Curve. Adapted from “Economics for Business”, by J. Sloman, D. Garratt, J. Guest, & E.
Jones, 2016, Pearson Education Limited, p. 58. Copyright 2016 by Pearson Education Limited.

Equilibrium
Combining the demand and supply analysis, it is possible to reach the actual price, and the
actual quantity bought and sold is determined in a free and competitive market. Sloman et al.
(2016) explain that the quantity produced and the market price are determined by the intersection
of supply and demand curves. Still, other factors besides price affect supply and demand;

47
whenever one of these factors changes, market equilibrium is affected. Market equilibrium is
when the price of a good or service reaches a value that equals the quantity demanded with the
quantity supplied in the market.9 At the intersection of these two curves, the equilibrium point in
the market is given.10
In the potatoes example, if the price was $ 20 per kilogram, demand exceeds supply by 600
tonnes (A − a). Consumers would be unable to obtain all they wanted; thus, they would be
willing to pay a higher price. Producers, unable or unwilling to supply enough to meet the
demand, would only accept a higher price. There is a shortage, and its effect will drive up the
price. There would still be a shortage at $40, which would force the price to increase.
Nevertheless, with that increase, the quantity demanded decreases and the quantity supplied
increases, progressively eliminating the shortage. On the other hand, if the price were $ 100,
supply would exceed demand by 600 tonnes (e − E). There would be a surplus, forcing the price

9

Practical Example. During the COVID-19 pandemic, with governments asking the
population to stay home, people changed its expectation towards the future. And, with changes in
expectations, the demand for some products changed drastically. This was the case with toilet
paper, which increased 250% in its purchases in Ottawa. The population's panic led to a shortage
of these products, and supermarket shelves were quickly emptied. The panic of a virus added to
rumours of a tissue shortage in Asia, and work-from-home policies changed people’s behaviour,
leading to increased demand. However, there was no supply problem; on the contrary,
production increased to meet the demand (Proctor, 2020).
10
Practical Example. House prices in Calgary rise when oil prices rise due to a change in
demand. Since oil production is critical to Calgary’s economy, when these corporations increase
their activities and operations, it attracts people to work there, to provide goods and services to
the oil industry, and to provide goods and services to meet the city's demographics expansion.
For example, the city would need more teachers to accommodate the children of these new adults
living in Calgary. Therefore, it has a high chance of offering higher salaries to attract the
necessary personnel, which means people will earn more money. Hence, the housing demand
will increase, changing the demand curve to the right due to a higher population and higher
salaries. Further, the house market equilibrium price and quantity will be higher than previously
(Frank et al., 2012).

48
down as competition would take place to sell the excess supplies. Even at $ 80, more were
supplied than consumers were willing and able to purchase, failing to clear the market.
Therefore, only one price is sustainable and would prevail where demand equals supply. At
an equilibrium price of $ 60 per kg, demand and supply are 350 tonnes (equilibrium quantity).
Thus, in point Cc, there is no shortage and no surplus in the market. If the price starts at any level
other than $ 60, it will tend to move towards it. If it is above $60, the surplus would drive the
price down (demand curve: from point D to C and supply curve: from point d to c). Hence, the
equilibrium price is the only price at which producers’ plans to supply exactly match the
consumers’ plans to buy (Sloman et al., 2016). Varian (2010) explains that the prices adjust until
the total demanded equals the total supplied.
Figure 7
Market Equilibrium

Price
($ per kg)

Total market
demand
(tonnes)

Total market
supply
(tonnes)

20

700 (A)

100 (a)

40

500 (B)

200 (b)

60

350 (C)

350 (c)

80

200 (D)

530 (d)

100

100 (E)

700 (e)

Note. Demand Curve. Adapted from “Economics for Business”, by J. Sloman, D. Garratt, J. Guest, & E.
Jones, 2016, Pearson Education Limited, p. 59. Copyright 2016 by Pearson Education Limited.

49
7. Evolution of Economic Thinking
Economic ideas are developed according to the social, age, and place conditions from
where they emerge. Therefore, they are strictly related to their context. For educational purposes,
below is a concise explanation of the evolution of economic thinking and its main characters (Sá,
2014).
Pre-scientific phase
This phase was composed of three periods: Greek Antiquity, Middle Ages, and
Mercantilism.
In Greek Antiquity, the term economics was utilized for the first time by Xenofontes and
was related to private goods management. In Greek, economics is translated to oikonomia, with
oikos meaning home and nomo meaning law. The Greek and roman authors did not create a
proper economic theory. Instead, they were concerned with practical aspects of the house
administration or factors related to the money from economic transactions. Therefore, they
developed some economic ideas related to taxes, tariffs, and transportation networks.
In Middle Ages, between the 5th and 15th centuries, economic thinking was oriented and
guided by Christian morality. The church recognized the manual and intellectual work dignity.
Moreover, they advocated the fair price - a price charged based on the actual cost, which is the
sum of materials and labour, without any increase. Additionally, the church condemned the
interest charges, called usury.
Mercantilism’s period was from 1450 to 1750. They were the first to study economics
from a structured perspective, even with some divergent thinking. Some of their leading thinkers,
William Petty and Cantillon, discussed that the wealth of a country was measured by their
precious metal inventory. Therefore, they sought to establish the principles on how stimulating

50
and fostering foreign trade would ensure the savings and stocks of these metals. They defended
the idea that the country and government should intervene in the economy. William Petty
anticipated many classic economic concepts and emphasized the importance of labour division
importance. Richard Cantillon developed crucial theories regarding foreign trade, and some
consider him the modern economy founder.
Scientific phase
Physiocracy was a school from the end of the 18th century and taught that agriculture was
the main wealth source and that economic activities were exclusively dependent on the laws that
govern nature. Another lesson from the Physiocrats was that the excess of agricultural production
was what allowed trade development and growth. Those who produced just for survival purposes
were considered poor. Furthermore, they argued that the government should not intervene in the
trade. Their main thinker was François Quesnay, a physician responsible for the notions of
organs, flows, and circulation, medicine and biology concepts that are used in economics.
The Classic School (late 18th - early 19th century) consolidated Economics as its own
scientific area of study. The classics laid the foundation of economic liberalism, a current of
thought who defended total economic freedom to the private initiative develop without the
government influence. Their goal was to explain the reasons for the countries wealth. The
economic liberalism argued that the free competition between companies would regulate the
market transactions, which would trigger a decrease in the prices and would benefit the
technological innovations that improve the quality of the product and increase the production
rhythm. The main thinkers were Adam Smith, David Ricard, John Stuart Mill, and Jean-Baptiste
Say. Adam Smith, the author of Wealth of Nations, was a philosopher and economist that had

51
great influence on the European bourgeoisie since he attacked the mercantilist economic policy.
His ideas were crucial for the development of capitalism in the 19th and 20th centuries.
The Marxism School (1818-1883) was based on Karl Marx's fundamentals, a critic of the
capitalist system. This school described capitalism of the big cartels (commercial agreements) e
the rising conflict between capital and labour. For Marx, capitalism does not possess the
correction mechanisms for its own failures; therefore, the system would generate economic
crises that would frequently happen, generating concentration or centralization of capital. Small
and fragile organizations would be eliminated in every crisis. Karl Marx presented the
foundation ideas for the Socialist Revolution, which impacted world history. The socialist
government system was adopted by Russia, China, and Cuba.
The Neoclassic School (1870-1929) worked on Economics analysis using intensive
mathematics and allocation and distribution to diverse places. Its members, who followed these
ideas, asserted that the foundation of the economic conduct of the human being was the scarcity
of resources in the face of unlimited needs and urges. The main thinkers were Marshall, Walrs,
Schumpeter, Pareto, Pigou, and Edgeworth.
Keynesian School, as an example of the most recent phase of the economic thinking
evolution, it has as its main author John Maynard Keynes (1883-1946). In his book, The General
Theory of Employment, Interest and Money, published in 1936, he criticized Say’s Law, which
argues that the supply creates its own demand; therefore, an increase in production would turn
into income additions for workers and entrepreneurs, who, lately, spend money when buying
goods and services. The Effective Demand Principle developed by Keynes denies Say’s Law,
showing that not all income turns into additional consumption. Keynes’s principle refers to a
situation in which the demand creates its own supply. In other words, if there is demand, the

52
firms want to produce, and it is necessary the government intervention through a public spending
policy. For Keynes, the classics (liberals) believed in the self-correcting principles of the market.
However, they did not know and present solutions for the crises. Keynes demonstrated that the
markets do not have natural self-correcting forces. Furthermore, he advocated the notion that
changes in the income (wealth) depend on private expenditure decisions (effective demand),
especially investment decisions (Sá, 2014).

53
Conclusion
This chapter gave a taste of what business economics is and explained how crucial this
knowledge is for business managers, providing examples of varied situations where these
economics concepts can be used and applied. Therefore, economics can be considered a
decision-making science. Given that the wants and needs are unlimited and the resources are
scarce, everyone needs to decide on how to allocate the limited resources. Hence, economists
make assumptions about behaviour to understand how individuals and businesses make decisions
and analyze how economies work. With economic models, theories can be formulated to assist in
predictions. In this context, each consumer decision communicates to a company how the
consumer views their products: a purchase decision is favourable, while a purchase of a rival
product sends a message that consumers value the other product more. Collectively, these
individual decision-making influences if the business is thriving. On the other hand, businesses
must understand these messages' reasons to improve and respond to changes. Therefore,
businesses also make decisions - ranging from simple ones, such as whether to order from one
supplier or another, to complex decisions on how to meet consumer needs more effectively. For
that, businesses will weigh up the costs and benefits of each decision. Businesses’ decisions can
be categorized into three types: investment in productive capacity, growth and expansion, and
acquiring and keeping customers. These decisions will trigger the need for other consequential
decisions (Mankiw, Taylor, & Ashwin, 2013).
In summary, the fundamental lessons were discussed, primarily how the decision-making
process occurs and how people, businesses, and governments behave to increase their utility
through rationality, comparing marginal benefits and costs. In that discussion, key concepts and
terminologies were presented, such as the fundamental economic problem of scarcity, trade-offs

54
among alternatives, and the opportunity cost - the cost of any action measured in terms of
foregone opportunities. Furthermore, the fundamental interactions in the economy were
discussed, permeating topics such as the mutual benefit of exchange and trade, the definition of
the market, the comparative advantage concept, the connections between economic agents
through the circular flow diagram, and how the quantity demanded and supplied in a market
economy trend towards equilibrium. In the following chapters, the discussion will be more indepth, developing other relevant topics to provide the students with insights about business,
markets, and economies.

55
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