Why do managers need the knowledge of economics in business?

Managers need to have a basic understanding of economics to understand the concept of value, for example, product value or service value. Value has a special meaning in economics since nothing has intrinsic value. It is only valuable if it is scarce or has a market value, meaning many people want it.

As far back as 1871, Carl Menger recognized that economic value is given by each person in a society. For example, in contemporary society people value coffee and Starbucks has high reputation for coffee, so it has a high value. However in another society where people do not value coffee, Starbucks would not even exist.  The value for various materials in society such as products, land, and labor used to create consumer goods do not actually increase. They increase only in response to their future value by customers. The famous economist, Menger, highlighted this.

In short, economics in a consumer society such as in the U.S., are based upon value which is essentially subjective. However there are objective ways of measuring the consumer market. Through bidding, consumer values are defined.  Bids for specific products or services define what members of that society think is important. This trickles down to the consumer in the form of prices. What society thinks is most important costs the most. Think of education, a college degree etc. Entertainment--video game players etc.

The manager needs to be informed by these basic principles of economics to "play the market" sort of speaking. He or she needs to understand how critical a role public perception plays in increasing the "subjective" value of a product or service in the minds of consumers. The more the consumer believes they need the product or service, the higher the price they will be willing to pay for it.

In addition, if consumers believe an item to be "in limited supply" they will buy it. For example, a study was done in supermarkets that showed that when the manager writes on the sale sign "limit two per customer", that the customers purchased those items faster. This suggests that the customers think the item is in great demand and that there exists a limited amount. They believe that scarcity affects them personally , in fact, when it does not. The fear imposed by the idea of scarcity depends on whether you really want or need the item, in the first place. If ringworm were scarce no one would know about it; but if some consumer good that everyone considers important became scarce, such as gasoline, the prices would be sky high and evryone would be talking about it as the number one energy problem.

It is critical for a manager to know basic economic theory and how it applies to offering products and services to the public in a market economy, in order for a business to be managed successfully.