Business Acumen II: Basic Economic Concepts
There is a surprising lack of overlap between what you learn in economics (my college and graduate school major) and what you learn in business. At the same time, I would say that a bit more of an overlap than is typical would be a good thing. Which is to say, businesspeople at all levels benefit from having a grasp of a short list of basic economic concepts.In addition to the notion that market prices and quantities in a market are determined by supply and demand (which are themselves driven by more or less market-specific factors that are important to identify for markets relevant to your business), here are the concepts I'd recommend everybody get a handle on:
Opportunity cost — the well-known principle that you cannot have your cake and eat it too. For example, if a company is trying to decide whether to invest in a new phone system, it will weigh the benefits of the new capabilities the phone system would provide, against the benefits of whatever alternate investment, perhaps a software upgrade, is foregone. So the opportunity cost of doing something is next best thing you could do instead.
Sunk costs — money that you've invested in something, e.g., research on a new pharmaceutical, that can in no way be recovered. It is a mortal sin to "throw good money after bad." In other words, if your research on the new drug is showing scant promise, you should not say, "We've spent so much. We've got to keep going." You should end the project and put further investment funds into something else that has a reasonable (risk-adjusted) promise of return.
Elasticity of demand — Should we maybe increase our price? Or maybe we should decrease it? How to tell? Pricing is a complicated issue, in large part because of uncertainty concerning how competitors will respond to changes. Still, it is important to understand the basic consideration of whether, at the current price, demand is elastic or inelastic. If demand is elastic, reducing the price will lead to such an increase in demand that overall sales revenue will rise (assuming nothing else significant changes, which may or may not be a safe assumption). Conversely, if demand is inelastic, raising the price will cause some dropoff in demand, but the dropoff will be small enough that sales revenue will increase (again, assuming no other significant changes).
Diminishing returns — Just because doing more of something, such as fertilizing a farm field, pays off in terms of increased production relative to the cost, you cannot assume that doing even more will also pay off. Eventually, as you add more and more fertilizer, the increased output is not worth enough to offset the cost of the added fertilizer.
Comparative advantage — the area in which a person, an organization, or even a country is especially productive. For instance, if a person's abilities, compared to other employees, are strongest in sales, it makes sense to have the individual concentrate on selling, rather than having him take on other functions, such as writing advertising copy. This holds even if the person has a flair for writing copy. If the person's comparative advantage is in selling, somebody else should be assigned to producing ads.
Monetary policy — a country's approach to managing its supply of money. For example, in the US, the Federal Reserve makes monthly decisions that play a central role in determining how rapidly the number of dollars in circulation will grow (both physical dollars and dollars on deposit in financial institutions). The growth rate of the money supply, in turn, influences interest rates and the inflation level.
Fiscal policy — the taxing and spending policies of a country's government. Views concerning the relationship between fiscal policy and business conditions are quite divergent. Wikipedia provides a brief overview.
Since discussions of economics are notorious for boring and/or frightening people, it is obviously important to address this particular area of business acumen in an engaging way -- but then that principle applies to every topic covered in your training.
Labels: Business acumen
posted by Karen Nelson @ 6:40 AM
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