Basic Economic Tools in Business Economics

1.Opportunity Cost 2.Time Value Of Money

3.Marginalism4.Incrementalism

Opportunity Cost

Opportunity Cost is what you give up because you choose to do something else .

Everything you do has an Opportunity Cost .

The opportunity cost of a given sum of money can never be zero.

The cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benefits you could have received by taking an alternative action.

Example of Opportunity Cost

Tony buys a pizza and with that same amount of money he could have bought a Coke and a hot dog. The opportunity cost is the Coke and hot dog.

At the ice cream parlor, you have to choose between mango and strawberry. When you choose mango, the opportunity cost is the enjoyment of the strawberry.

For a farmer choosing to plan corn, the opportunity cost would be any other crop he may have planted, like wheat

David decides to quit working and got to school to get further training. The opportunity cost of this decision is the lost wages for a year.

Time Value Of Money One of the fundamental ideas in economics is that a

rupee tomorrow is worth less than a rupee today. The time value of money is the value of money with the

given amount of the interest on inflation occurred over a amount of time.

The ultimate principal suggest that a certain amount of money today as different buying power that the same amount of money in the future.

There is an opportunity to earn interest on the money and because inflation will drive prices up thus changing the value of money.

Example

Suppose a person is offered a choice to make between a gift of Rs.100 today or Rs.100 next year. Naturally he will choose the Rs.100 today. This is true for two reason . First ,the future is uncertain and there may be uncertainty in getting Rs.100 if the present opportunity is not availed of. Secondly , even if he is sure to receive the gift in future, today Rs.100 can be invested so as to earn interest say at 8% so that one year after the Rs.100 of today will become Rs.108 .

Another way of saying the same thing is that Rs.100 one year hence is not equal to Rs.100 of today but less than that.

Marginalism When the resources are scare, manager have to be careful

about utilizing each and every additionally unit of resources or input. For example if one has to decide whether an additional man-hour or machine-hour is to be used ,it is necessary to ascertain what is the additional output expected from it. For all such additional magnitudes of output or return, economists use the term “marginal”.

It is a theory of economic, that attempts to explain the goods and services by reference to their secondary or marginal utility

For example = why the price of diamonds is higher than that of water . When resources are limited manager have to carefully decide about utilizing each and every additional unit of resources.

Incrementalism Incremental concept involves estimating the impact

of decision alternatives on cost and revenue, emphasizing the changes in total cost and total revenue resulting from changes in prices ,product, procedures, investments or whatever may be at stake in the decision. The two basic component of incremental reasoning are: incremental cost and incremental revenue.

Incremental cost may be defined as the change in total cost resulting from a particular decision.

Incremental revenue is the change in total revenue resulting from a particular decision.

ExampleIf a firm decides to go for computerization of market information, the additional revenue it earns will be termed incremental revenue and the extra cost of setting up computer facilities will be termed incremental cost.