What Business Leaders Should Know About The Economy

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

Much of economics instruction runs from theory to public policy implications of that theory. So macroeconomics rolls into fiscal and monetary policy to stabilize the economy. Microeconomics rolls into discussions of rent control, minimum wage and antitrust policy. The focus on policy is odd given that few students will become policy makers, but many will work for businesses or for non-profits that have to cope with fluctuating revenues and costs.

There’s a rich body of knowledge that can aid in business decisions. On the macroeconomics side, some sectors are more sensitive to business cycles (commodities, for example) and others are less sensitive (health care). Some industries rebound earlier after a recession (housing) and some later (business equipment). Business leaders would do well to study past cycles in their industries, looking at degree of cyclicality and timing of sales increases and declines.

The microeconomic theory of supply and demand is well understood by most experienced business people, but elasticities are crucial in practical situations. Take, for example, the increase in oil prices. Supply does not seem to be responding to higher prices as the blackboard sketches show. But most economics courses punt on the issue of how long it takes for supply and demand to come into equilibrium. It turns out that oil demand can rise rapidly when incomes and industrial production grow. Increases in oil supply, however, take many years of exploration, drilling and pipeline building. In the meantime, prices shoot up, only to come down after the new supply comes on line.

Economics teaches the importance of decision-making at the margins. 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 on one additional diamond compared to one additional gallon of water. Similarly, business decisions should not devolve to a simplistic question such as print advertising or online advertising. Instead, good marketing analysts compare the value of an additional dollar of print advertising to the value an additional dollar of online advertising.

Scarcity underlies the entire subject of economics. Management gurus lecture at conferences about the many things that business leaders should add to their to-do lists. But an executive’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 bit 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 only a start. The business manager must be able to apply basic principles immediately and intuitively. The advanced courses are valuable in reinforcing the basic principles.

Many economics professors are rightfully proud of their profession’s favorable impact on economic policy at times 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 enterprises subject to market forces (such as non-profits and local governments). Applying economics to these issues will help them in their careers, and also help the overall economy through more effective use of resources.