1. PAPER C Fundamentals of Business Economics. Acorn chapters. 1. Introduction to economics. 2 The price mechanism. 3. Elasticity of demand and supply. FUNDAMENTALS OF BUSINESS ECONOMICS. Published by: Kaplan Publishing UK. Unit 2 The Business Centre, Molly Millars Lane,. Wokingham, Berkshire. We are grateful to the CIMA for permission to reproduce past examination questions. The answers to CIMA Exams have been prepared by Kaplan Publishing.
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Business economic meets these needs of the business firm. This is illustrated in the As regards the scope of business economics, no uniformity of views exists among it can be used to explain Demand Theory or fundamental theorem of. This Study Text has been written around the Fundamentals of Business Economics syllabus. • • • It is comprehensive. It covers the syllabus content. No more, no. To Understand the fundamentals of Business Economics. • To Know whether Economics is a Science or an Art. • To Study the Basic Economic terminologies.
And you get it from the words. Micro -- the prefix refers to very small things. Macro refers to the larger, to the bigger picture. And so, micro-economics is essentially how actors..
And you hear the words scarce resources a lot when people talk about economics. And a scarce resource is one you don't have an infinite amount of.
For example, love might not be a scarce resource. You might have an infinite amount of love. But a resource that would be scarce is something like food, or water, or money, or time, or labor. These are all scarce resources. And so microeconomics is how do people decide where to put those scarce resource, how do they decide where to deploy them. And how does that.. Macro-economics is the study of what happens at the aggregate to an economy. So, 'aggregate', what happens in aggregate to an economy, from the millions of individual actors.
Aggregate economy. We now have millions of actors. And often focuses on policy-related questions. SO, do you raise or lower taxes. Or, what's going to happen when you raise or lower taxes.
Do you regulate or de-regulate? How does that affect the overall productivity when you do this. So, it's policy, top-down.. And in both macro- and micro-economics, there is especially in the modern sense of it, there is an attempt to make them rigorous, to make them mathematical. So, in either case you could start with some of the ideas, some of the philosophical ideas, so of the logical ideas, to say someone like Adam Smith might have.
So, you have these basic ideas about how people think, how people make decisions. So, philosophy, 'philosophy' of people, of decision-making, in the case of micro-economics -- 'decision-making' And then you make some assumptions about it. Or you simplify it.. And you really are simplifying. You say "oh, all people are rational", "all people are gonna act in their own self-interest, or all people are going to maximize their gain", which isn't true -- human beings are motivated by a whole bunch of things.
Competition leads to efficiency among firms and enables prices to be low. Competition can be categorized into perfect and monopolistic competition. Price elasticity can be termed as a measure of the response that demand has to a change in price. What is International Economics? International economics looks at how the financial dealings among different countries affect consumers and governing financial institutions. Some basic concepts here include balance of trade and balance of payments, economic development, barriers to trade, exchange rates, benefits of trade and foreign currency markets and trade.
The exports of a country minus its imports would be balance of trade. Balance of payments BOP is used by counties to monitor all international monetary transactions. BOP is divided into current account, capital account and financial account. Stakeholders can be divided into internal. They can therefore be fundamental to corporate governance.
Mendelow classified stakeholders on a matrix whose axes are power or influence the stakeholder can exert and degree of interest the stakeholder has in the organisation's activities.
Minimal effort is expended on segment A. They may accept low rates of pay because they feel that their work is important to society. Coalitions of stakeholder groups are likely to have more influence than single stakeholders or small uniform groups. An example would be a major customer.
An example might be a contractor's labour force. They should. While often passive. They are fundamental to operations and are able to disrupt them if they wish to. Stakeholders in segment C must be treated with care.
Stakeholders in segment B do not have great ability to influence strategy. Community representatives and charities might fall into segment B. A charity is a good example. Such bodies do not have an over-riding responsibility to promote the interests of the owners: The concept of the behavioural coalition is particularly relevant here.
Key stakeholders may participate in decisionmaking. Groups of stakeholders with a common interest coalitions will have more influence than a single stakeholder.
It is important that they are not disappointed or aggrieved. There will be a class of beneficiaries whose requirements are the reason the organisation exists. Large institutional shareholders might fall into segment C.
They should therefore be kept informed. In general. The charity will hope the donors will continue to provide funds in the future. Hunt identifies five different initial management responses to the handling of conflict.
Torrington and Hall say that 'to some extent conflict can be handled by ignoring it. Strategies cannot be aimed simply at profitability. The disadvantage of this is that it creates all the lingering resentment and hostility of 'win-lose' situations. Integration and collaboration: This may lead to a better overall solution than simply splitting the difference. There were three significant corporate governance reports in the United Kingdom during the s.
The Cadbury and Hampel reports covered general corporate governance issues. Though mostly discussed in relation to large quoted companies. Emphasis must be put on the task. The recommendations of these three reports were merged into a Combined Code in One party suppresses its own interest and accommodates the other in order to preserve working relationships despite minor conflicts.
Many non-profit organisations will demand a particularly high standard of conduct in ethical terms. As Hunt remarks. Management style and practices. Managers must take the potential for such conflict into account when setting policy and be prepared to deal with it if it arises in a form that affects the organisation.
Arthur Andersen's audit work was investigated in connection with allegations that Andersen had ignored high-risk accounting issues.
Sometimes the failure to carry out proper oversight is due to a lack of information being provided. Another important control is lack of adequate technical knowledge in key roles.
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Leeson was able to do this because he was in charge of both dealing and settlement. The behaviour of Nick Leeson. These high profile cases have highlighted the need for guidance to tackle the various risks and problems that can arise in organisations' systems of governance.
A rapid turnover of staff involved in accounting or control may suggest inadequate resourcing. Often corporate collapses are followed by criticisms of external auditors. One possible symptom of this is the payment of remuneration packages that do not appear to be warranted by results.
CIMA BA1 Fundamentals of Business Economics
The presence of non-executive directors on the board is felt to be an important safeguard against domination by a single individual. Sometimes the single individual may even bypass the board to action his own interests. An increasing number of high profile corporate scandals and collapses at the start of the s.
These have dealt primarily with companies. Their recommendations also included requirements for regular meetings of the board of directors.
Proper corporate governance reduces such risks by aligning directors' interests with the company's strategic objectives. Non-executive directors have no financial interests in the company of which they are directors.
Giving out misleading information was a major issue in the UK's Equitable Life scandal where the company gave contradictory information to savers. This can have wide-ranging benefits.
In order to promote openness and transparency. The organisation may also be closed down as a result of serious regulatory breaches. The board should determine the remuneration of non-executive directors 22 2: A remuneration committee.
This means there should be a strong and independent body of non-executive directors with a recognised senior member other than the chairman. Higgs also recommended that a description of how the Board operates should be included in a company's Annual Report. Remuneration Companies should establish a formal and clear procedure for developing policy on executive remuneration and for fixing the remuneration package of individual directors. The board Every director should use independent judgement when making decisions.
There should be an appropriate balance between executive and non-executive directors. Directors should not be involved in setting their own remuneration. Every director should receive appropriate training. Nominations committee There are should be a nominations committee to oversee appointments to the board. Chairman and Chief Executive There are two leading management roles. Higgs recommended that at least half the members of a Board. Combination of the roles of chairman and chief executive should be justified publicly.
A clear division of responsibilities should exist so that there is a balance of power. Ownership of shares represents ownership of equity in the company concerned: Any ownership interest is generally known as equity. The companies are expected to maximise the wealth of their shareholders by generating profit from trading operations. Funds are raised for the business activity by dividing up the ownership of the company into equal parts called shares that are then sold to investors for cash.
The audit committee should review the audit. The market value of a quoted company's shares bears no relation to their nominal value. The company uses the money it receives from issuing shares. In particular the committee should keep matters under review if the auditors supply significant non-audit services. Preference shares are a special class of shares that you will learn more about later in your accounting studies.
A shareholder is someone who owns shares in a company. downloading and selling prices for each share are quoted by the exchange's dealers. This is by contrast with bonds.
Profits can then be paid to the shareholders as dividends. For now. The number of shares held by a shareholder represents his proportional ownership of the profits.
Audit committees and auditors There should be formal and clear arrangements with the company's auditors. It does this by trading at a profit. We discussed the objectives of companies earlier in this chapter. Companies should have an audit committee consisting of non-executive directors.
If a company's shares are traded on a stock market. We will work on the basis that the main financial objective of a company is to maximise the wealth of its shareholders. The shares are ordinary shares if they have no additional rights attached to them such as priority rights to receive payments from the company. Outside the UK it is not uncommon for a company's shares to have no nominal value.
The ordinary shares of UK companies have a nominal value. Investors will only provide funds if they believe that the prospective returns are adequate. Shares in quoted companies are usually bought and sold via an official stock exchange market.
This is an important principle that you will return to later in your CIMA studies. If you wish to borrow money to download a car. Two very important considerations when deciding whether to download shares in a company are its current share price and its prospects for the future. Investors will ask themselves whether they can reasonably expect to receive a proper return on their investment.
As already mentioned. An increase in risk will tend to push the share price down. It is far less obvious and possibly difficult to establish and measure in the case of a private company. Good profit performance will tend to push the price up.
Shareholders are assumed to have a firm idea of the return they require from their investments: If a large number of shareholders decide to dispose of their shares. A high degree of risk means that returns are likely to accrue at irregular intervals and that they are likely to be variable in amount.
The market price of a firm's shares is thus subject to a number of influences connected with the investment's likely effect on shareholder wealth. These influences on share price themselves result from the interplay of a large number of factors. The senior managers of a quoted company are under pressure to maintain and. This will be generally true whether they are taking up an initial issue of shares or downloading existing shares on a stock exchange. A further important consideration in deciding just what would be a proper return is the risk associated with the investment.
A similar principle applies when companies raise funds by issuing shares: External factors include wider developments such as economic recession and demographic change. Shareholders are assumed to monitor the performance of the companies they invest in and are likely to sell their shares in companies that underperform in order to invest in companies that seem to be performing more satisfactorily.
Short-term measures include ROCE.
Unfortunately both profit and capital employed are accounting concepts and can be defined in a number of different ways. ROCE is calculated as profit divided by capital employed: Shareholders need some objective measures of company performance so that they can make informed investment decisions.
As result. In this context. We would hope that a company's ROCE would be higher than the minimum level its shareholders have decided is acceptable to them as a return on their investment. In the simplest terms. The amount of profit is not in itself an adequate measure: Clearly if the company makes a loss. ROCE can also be defined as return on net assets. The principle employed here is that ROCE is of interest to all parties with a claim on the company's profits. A very high return might well indicate a rather speculative and therefore risky investment.
Calculating capital in this way leads to an alternative name for ROCE: ROCE does this for us. The greater the margin of safety between this required return and ROCE. Capital employed is defined as total assets less current liabilities. These measures can be divided into those suitable for the shorter term and those suitable for the longer term.
This sum should be equal to equity plus the nominal value of any outstanding loans. The total number of shares in the authorised share capital is not relevant here. We cannot really comment on the size of Snoxall plc's ROCE unless we know something about what is normal for its industry. Assessment focus point In the simple example above. Note that a company is likely to have far more shares authorised than issued. ROCE is a more general measure of the overall productivity of capital.
EPS is usually calculated as the profit available to equity shareholders divided by the number of equity shares in issue. Interest payable ROCE for 20X9 would be calculated as: Calculate earnings per share in 20X9. This is usually because they anticipate that their return will improve substantially in the future. Key term Cost of capital is the minimum acceptable return on an investment.
The earnings yield addresses this shortcoming by comparing the earnings per share with the market price of the share. It is widely accepted that the current price of a quoted company's shares reflects the future income to which shareholders are entitled to. We assume that a constant dividend will be paid each year into the indefinite future. This dividend valuation model shows the 28 2: When considering whether or not to download shares in a company. For the past.
There are two ways to measure this a The first is to base future income on expected future dividends.
One aspect of this will be the dividend income the investors will receive in the future as a result of holding shares in the company. The second concept which is more complex and will be covered in section 5.
Here we are only concerned with equity capital and thus with the rather simpler concept of the cost of equity. This represents the equity shareholders' requirements for the performance of their investments. We can expect that they will also give us a reasonable idea of how the company is doing in the current accounting period. What is the expected rate of return from the ordinary shares? Rational investors will only download a share if its cost is less than A more realistic assumption is that dividends.
Ex dividend or 'ex div' means that the downloadr of shares is not entitled to receive the next dividend payment. Formulae Cost of equity share capital. To calculate this future value. If we assume that dividends are constant throughout the life of the company then the share price is expressed by the formula shown below: In this case.
In order to make rational decisions about where to invest their money. The formula to calculate the discounted value of a cash inflow to be received at a future date is: The appropriate discount rate to use will depend on the specific circumstances of a calculation.
The discount rate will have an inverse relationship to the future value of the income stream. That is. Some companies do not pay dividends: When a discount rate has been applied to a stream of future earnings. In other words. The discount rate or discount factor is calculated as: Once again. They can do this by discounting future income streams to convert them to their net present value. The future earnings are discounted by applying a discount rate to them.
There are several such models. Key term The free cash flow to the firm FCFF is the after tax cash generated by the business and available for distribution to the equity holders and debt holders of the company. The present value of the earnings is then obtained by adding together all the discounted cash flows. It is calculated in its simplest form from the Profit before interest and tax PBIT by adding back non-cash items such as depreciation and subtracting taxes and capital expenditure.
Year 1 1. The present value of the earnings that an investment project is expected to generate can be compared to the cost of the investment to see the overall net present value NPV of the project. If the NPV is positive the project should be regarded as cash generating and allowed to proceed.
Key term The free cash flow to equity FCFE represents the potential income that could be distributed to the equity holders of a company. Dividing this figure by 2. The dynamics of the relationship are simple. Assessment focus point Your syllabus requires you to be able to carry out both types of valuation calculation illustrated above. What should the company's current market value and ordinary share price be?
Changes in the immediate future will have a larger effect than those in the more distant future. An increase in the cost of equity will reduce the current market value and vice versa.
In both the dividend valuation and free cash flow models. The earnings figures for the next three years are given below. If we know what the equity shareholders' required rate of return is. Current market value is. Existing investors. The rate of return required by investors is a feature of the present but is determined by investors' assessments of both current and expected future factors such as risk and the returns likely to be available elsewhere. The company's directors have stated that the company effectively ceased its participation in these activities at the end of the end of the last accounting period.
Required Explain the effect this change is likely to have on the market value of the company's shares. As a result of the relationship outlined above. Answer The profit forecast has increased by one fifth. Question Changing the cost of equity Flo plc has for many years been involved in dangerous and speculative activities involving prospecting for radioactive ores in politically unstable parts of the world.
P0 In practical terms. Tekel plc's shares will become more attractive to investors with capital to invest and demand for them will increase. Required Explain the effect this is likely to have on the market value of the company's shares. The higher the discount rate is. Answer The effect of this change in business focus is a significant reduction in the riskiness of Flo plc's activities overall.
This should have the effect of reducing the cost of equity. Demand will increase. Since the forecast cash flows are unchanged. In practical market terms. Increased demand will drive the price up to a point at which the current investors are prepared to sell. Flo plc has become a much more attractive investment. The dividend valuation model discounts expected future dividends to relate the cost of equity to market share price. The stakeholder view holds that there are many groups in society with an interest in the organisation's activities.
Although it is convenient for economists to assume that profit maximisation is the central objective of firms. A number of reports have been produced in various countries aiming to address the risk and problems posed by poor corporate governance. The valuations based on discounting forecast free cash flows also relate the cost of equity to market share price.
Shareholders need objective measures of company performance if they are to make sensible investment decisions. Organisations are not autonomous. An increase in forecast dividends or free cash flows will lead to an increase in current market price. Where the management of a business is separated from its ownership by the employment of professional managers.
Quick quiz 1 Who proposed a model of business based on the objective of maximising sales? Which one of the following is not a stakeholder for a mutual organisation? What is the formula for earnings per share? Megalith plc has authorised share capital of What will happen to this value if Megalith plc's cost of equity rises? A B C D It will rise It will fall It will remain the same It is impossible to say 8 What is the name of the process through which future income streams are given a present value?
The company has An increase in the discount rate used for a present value calculation will inevitably produce a fall in the present value computed.
The cost of equity is the discount rate for this calculation. If you thought the answer was C By definition. Answers to quick quiz 1 2 3 D Baumol The stakeholders of an organisation are people or organisations who have a legitimate interest in the strategy and behaviour of that organisation.
The aggregate amount of goods supplied by every individual firm adds up to the market supply. By studying an individual firm we are looking at the 'building blocks' of market supply. We contrast the concept of opportunity cost which we introduced in Chapter 1. Theory of costs Introduction In this chapter we will be looking at the costs of production for an individual firm. Topic list 1 Costs of production 2 Average co sts.
The long run is a period sufficiently long to allow full flexibility in all the factors of production used. Key term The short run is a time period in which the amount of at least one factor of production land. This may seem odd to an accountant. In order to understand how firms go about seeking profit. Production is carried out by firms using the factors of production which must be paid or rewarded for their use.
Whether a firm can maintain these profits in the long run will depend on the nature of the industry it is operating in.
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In the longer run. It is widely accepted that this will enable us to give a useful explanation of the way firms behave. Key terms Profit is equal to total revenue minus total cost of any level of output. Total costs can be divided into fixed and variable elements.
These elements have different effects on total cost as output is increased. The basic condition for profitability is very simple: Decisions must therefore be taken for the short run within the restriction of having some resources in fixed supply. We will start by considering the costs incurred by a firm that makes and sells goods.
Any profit earned in excess of this normal profit is known as supernormal. The cost of production is the cost of the factors used.
CIMA Business Economics study text.pdf
We will return to this point later in this Study Text when we look at the differences between perfect competition and monopoly. Total cost is the cost of all the resources needed to produce a given level of output.
Decisions in the long run are therefore subject to fewer restrictions about resource availability. Inputs are variable at the decision of management. Which one s of them. This is because TFC is the same amount regardless of the volume of output. Average cost AC. AFC must get smaller. A decision to change the quantity of an input variable which is fixed in the short run will involve a change in the scale of production.
There could also be constraints around technology which could limit the productivity of other factors of production. Variable costs are costs which change according to the level of output. Average variable costs per unit AVC — total variable costs divided by the number of units — will also change as output volume increases. Theory of costs Question Costs To test your understanding of these concepts. The key determinant of a time period being 'short' is that at least one factor of production is fixed.
Average cost for a given level of output is the total cost divided by the total quantity produced. All inputs are variable in the long run. Average cost is made up of an average fixed cost per unit plus an average variable cost per unit.
Total cost comprises total fixed cost TFC and total variable cost TVC Fixed costs are costs which do not change when levels of production change. Inputs which are treated as fixed in the short run are likely to include capital items. Note that in economics the 'short run' is not a time period which can be measured in days or months.
This is the extra cost incremental cost of producing one more unit of output. Suppose a firm has made units of output. Make sure you know what each of the curves is. An example might help.
Thus fixed capital and variable labour can be combined to produce different levels of output. The costs might be as follows. Figure 1 shows how the various elements of cost vary as output changes. The firm may combine with this capital different amounts of labour.
Here is an illustration of the relationship between the different definitions of the firm's costs. The figures used are hypothetical. There is a 'cross-over' point. In this example. Total cost.
Marginal cost. MC is higher than AC. Total costs of production carry on rising as more and more units are produced. Total fixed costs per period are a given amount. A further feature of cost accounting is that costs can be divided into fixed costs and variable costs.
Normal profit is the opportunity cost of entrepreneurship. It too starts by falling. AC and MC compared. AC changes as output increases. It starts by falling. At lowest levels of output. The opportunity cost of entrepreneurship is the amount of profit that an entrepreneur could earn elsewhere and so must be forgone to undertake the current project.
The MC of each extra unit of output also changes with each unit produced.
If he could earn more by undertaking a different enterprise. MC is less than AC. Average cost is the cost per unit of output. Average cost. In this situation. As we have already mentioned. Note the following points on this set of figures. At highest levels of output. The position of the business in economic terms would be as follows. Relevant future costs are the opportunity costs of the input resources to be used.
Question Accounting profit and economic profit Wilbur Proffit set up his business one year ago.
Accounting profits consist of sales revenue minus the explicit costs of the business. It would pay the trader to put his buildings and capital to the alternative use. Past or 'sunk' costs are not relevant to our decisions now. He has no non-current assets other than the building from which he trades. In the short run. Economists do not take this approach. In that time. In accounting terms. Implicit costs are benefits forgone by not using the factors of production in their next most profitable way opportunity costs.
Explicit costs are those which are clearly stated and recorded. It is a well established principle in accounting and economics that relevant costs for decision-making purposes are future costs incurred as a consequence of the decision.
This follows similar logic. When the average cost curve is falling. If the cost of making one extra unit of output exceeds the average cost of making all the previous units. If the cost of making an extra unit is less than the average cost of making all the previous units.Short of time: In other words, it sets your objectives for study. You may want to modify the sequence a little as has been suggested above to adapt it to your personal style.
BPP Learning Media Ltd You can, of course, sell your books, in the form in which you have bought them once you have finished with them. And often focuses on policy-related questions.
It is widely accepted that the current price of a quoted company's shares reflects the future income to which shareholders are entitled to. BPP Learning Media's Learning to Learn Accountancy book helps you to identify what intelligences you show more strongly and then details how you can tailor your study process to your preferences.
The aggregate amount of goods supplied by every individual firm adds up to the market supply.