Introduction to Business Economics and Basic Concepts
Domain 1 tests the economic way of thinking as applied to business decisions: scarcity and choice, opportunity cost, marginal and incremental reasoning, discounting, and the distinction between accounting and economic profit. Questions often ask you to classify a statement as positive or normative, or to identify implicit costs.
Core rules and concepts
- Resources are scarce, so every choice has an opportunity cost - the value of the next best alternative forgone.
- The marginal principle compares the extra benefit of one more unit with its extra cost; decisions should ignore sunk costs.
- The incremental principle applies to multi-unit changes such as a new order or a new plant.
- Equi-marginal reasoning allocates a limited budget so that marginal benefit per rupee is equal across uses.
- Discounting converts future cash flows to present value because money has a time value; risk and uncertainty must be handled explicitly.
- Positive economics is descriptive and testable; normative economics involves value judgements.
Worked example
A trader has revenue of ₹12,00,000 and explicit costs of ₹8,00,000. She uses her own savings of ₹2,00,000, which could earn 8% interest, and gives up a salaried job of ₹1,50,000. Accounting profit is ₹12,00,000 − ₹8,00,000 = ₹4,00,000. Implicit costs are ₹16,000 interest plus ₹1,50,000 salary = ₹1,66,000. Economic profit is ₹2,34,000. Because economic profit is positive, the business is viable; a negative figure would mean her resources earn more elsewhere.
Traps that cost marks
Do not count implicit costs as zero. Do not call normal profit a loss. Do not let a sunk cost influence a forward-looking decision. Do not confuse a positive statement with a normative one, or average cost with marginal cost.