What business leaders need to know about the economy

Many business leaders have taken at least one economics course, but most of them have learned the wrong part of economics, at least the wrong part for someone running a business. A little attention to the business impacts of economic analysis can help an executive or small business owner better understand how the external environment affects sales and costs.

Much of the teaching of economics goes from theory to the public policy implications of that theory. Thus, macroeconomics integrates with fiscal and monetary policy to stabilize the economy. Microeconomics is found in discussions of rent control, minimum wage, and antitrust policy. The focus on politics is odd given that few students will go on to become policy makers, but many will work for businesses or nonprofit organizations that face fluctuating revenues and costs.

There is a rich body of knowledge that can help in making business decisions. On the macroeconomic side, some sectors are more sensitive to economic cycles (commodities, for example) and others are less so (healthcare). Some industries rebound sooner after a recession (housing) and others later (commercial equipment). Business leaders would do well to study the past cycles of their industries, examining the degree of cyclicality and the timing of sales increases and declines.

The microeconomic theory of supply and demand is well understood by most experienced businessmen, but elasticities are crucial in practical situations. Take, for example, the increase in oil prices. The supply does not seem to respond to higher prices as the blackboard sketches show. But most economics courses address the issue of how long it takes for supply and demand to balance. It turns out that the demand for oil can increase rapidly when incomes and industrial production increase. However, increasing oil supply requires many years of exploration, drilling and building pipelines. In the meantime, prices are skyrocketing, only to come back down after the new offer is put into service.

Economics teaches the importance of decision-making at the margin. The old paradox of why diamonds are more valuable than water, despite being less necessary for life, was explained years ago by reframing the issue as the value of an extra diamond. compared to an additional gallon of water. Likewise, business decisions should not be devolved to a simplistic matter such as print advertising or online advertising. Instead, good marketing analysts compare the value of an extra dollar of print advertising to the value of an extra dollar of online advertising.

Scarcity underlies the whole subject of economics. Management gurus speak at conferences about the many things business leaders should add to their to-do lists. But a leader’s time is a scarce resource, often the most critical of a company’s scarce resources. The allocation of that time – for the boss as well as for first-level managers – makes the difference between success and failure. Scarcity in its many ramifications is a small element of economics that plays a huge role.

Most of the economics that business leaders need are taught in Principles of Economics. Understanding the subject well enough to pass a final exam is just the beginning. The entrepreneur must be able to apply the basic principles in an immediate and intuitive way. Advanced courses are valuable for reinforcing basic principles.

Many professors of economics are rightly proud of the favorable impact their profession has had on economic policy in the past, as well as the potential gains from better policy in the future. But most students will not become policy makers; instead, they will be involved in business or other undertakings subject to market forces (such as non-profit organizations and local governments). Applying economics to these issues will help them in their careers and will also help the economy as a whole through more efficient use of resources.

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