As observed in
many past posts, economics has close linkages with real life. As practising
managers or entrepreneurs economics helps in undertaking structured analysis
and decision making. There are pointers towards increasing returns of decision
making using structured tools like economics. Therefore, economics to a business
practitioner would be indispensable. It is not that economics offers something
new or novel. Many economic theories have been practiced consciously or sub-consciously
over centuries by businessmen and others. What economists have done from Adam Smith
onwards is to theorize the empirical observations. The empirical observations
when aggregated would point to certain patterns which emerge as theory. For long,
there were no distinction between macro or micro economics, something came into
existence through the thoughts of John Maynard Keynes and his successors. Macroeconomics
evolved in a different fashion in contrast to microeconomics. The former
sounded glamorous yet behind the glamour face lay a rough journey.
Macroeconomics needed lot of data, analysis, intuition etc. unlike microeconomics
which rested on few assumptions and premises. Therefore, good macroeconomists
are usually rare to find though many claim to be macroeconomists.
To a business
setting, macroeconomics seemed something distant that its micro counterpart
which would be intuitive. Microeconomics dealing with individual interactions
would appeal to firm decision making, whereas macro sounded as distant
abstract. Yet macroeconomics has a critical application to business
practitioners. Incidentally, while microeconomics resting of few principles
works on understanding behaviour through the prism of these principles,
macroeconomics rests on the premise of the aggregate of these interactions yet
the outcomes would be very different from the mere sum of the aggregates. The sum
of the parts put together is more than the whole when it comes to linking to
microeconomic actions to macroeconomic outcomes. Therefore it would be prudent
to have a glance at how macroeconomics would help in decision making at the
level of the firm.
Microeconomics
rests on product differentiation, understanding of cost structures, demand
patterns and the linkages between input and output. These factors are usually
internal to the firm and thus within the control of the firm. Yet factoring in
macroeconomics in decision making would entail understanding those factors
which are external to the firm. The factors that usually are macroeconomic in nature
are not in the control of the firm and thus extrinsic to decision making. While
being extrinsic, these factors critically influence the patterns of firm
decision making and consequently the profits of the firm. These factors will be
discussed in the subsequent paragraphs.
Firms expect a stability
in demand. The unpredictability of demand would send the firm’s production plan
and demand forecasting awry. To borrow from the financial statements, the
instability in demand patterns would affect the sales. It is not just the
volatility in sales but corresponding spill-over in production too. In absence
of reliable forecasts for sales or volatility in sales, the firm might end up
producing more resulting in unplanned inventory thus higher carrying costs or
stock-outs in case of production being lower than the demand. Thus the demand
would impact on the sales and the production expense and raw material expenses
among many others in the accounting statement. The spill-overs will affect the
raw material producing firms thus creating an aggregate impact that perhaps is
much worse than that of at an individual level.
Firms desire predictability in prices.
Frequent price changes impose menu costs thus affecting the firm sales. Since
buyers would desire stability in prices, firms would have to maintain stability
in the prices of the final goods and services. At the firm’s end frequent changes
in raw material prices or prices of labour or prices of land or other factors
of production would impose constraint on production costs thus impacting the
cost of sales in the financial statements. These would impose an impact on firm’s
gross profit that gets spilled over the firm’s bottom line. The firms when
imposed on price stability on the consumer side would have to face serious cuts
on margins when faced with price unpredictability on the supply side. Therefore,
firms have to keep a close watch on the price movements. The inflationary or
deflationary pressures both take a toll on firm’s profit projections. Thus to a
firm, understanding inflationary figures and their decomposition would
obviously become important.
The firms also
have to face an external influence of interest rates. Firms need financing both
on working capital and on capital budgeting. The firms therefore will have to
finance these requirements through short term and long term borrowings. The interest
rate fluctuations will thus affect the firm’s outflows. The firms have to plan
for their outflows and thus the unpredictability will add to their woes. The firm’s
interest payments being unpredictable will have an impact on Profit before tax
(PBT). Further higher interest rates will impact firm’s investment plans. Interest
rates and investment are inversely related. Higher deposit rates might impact
firm sales since the consumers might defer consumption and prefer higher
savings.
Firms also face
impact of taxes. The indirect taxes add to the pressures on the raw materials
and the supply side. They also add to pressures on the production and sales. While
incidence is on customers, the firm’s position will depend on the price
elasticity of the good under question. At times the firms might not pass on
these indirect taxes to the customers thus absorbing themselves at the cost of decline
in their margins. Direct taxes impact firm’s profit after taxes thus their
bottom line.
Both taxes and
interest rates are outside the purview of the firm. The interest rates are
under the control of the Central Bank, the Reserve Bank of India in the
domestic context. The tax rates are under the subject matter of the government.
Thus the decision making of the Central Bank and the government would impact
the fortunes of the firms either way. In addition, the exchange rates is the
subject matter of market dynamics and thus again outside the purview of the
firm. Exchange rates will not have an impact if purely a domestic firm both
from supply and demand side. However, in a globalised world, there are import
of raw materials or technology or export of finished goods thus bringing in the
exchange rate component. Therefore volatility in exchange rates will hinder the
fortunes of the firm.
Thus as one observes,
the firms do face possible sources of uncertainty outside of their control. These
factors are macroeconomic in nature thus the firm decision making becomes a
subject matter of macroeconomic influences as much as microeconomic influences.
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