An important issue which concerns business economics is to show the relationship between business firms and society.

What role does business firms play in a society? Do they behave in a socially responsible manner, that is, do they serve social interest or merely maximise their private profits at the expense of social welfare.

These are the issues of business economics which we now analyse. Business economics clarifies the role business firms play in a society and also suggests ways of improving the benefits which firms provide to the society.

1. Role of Business Economics:

The vital role which business firms play in increasing social welfare is quite clear. It is due to the working of business firms that a high rate of economic growth has been achieved in the United States and other western countries.


Benefits of this economic growth have been widely shared. The high rate of economic growth has resulted in improving social well-being and removing poverty. To put in the words of Adam Smith, the father of economics, business firms have greatly increased the ‘wealth of nations’ (that is, the volume of output of goods and services) in the capitalist world.

The social benefits conferred by business firms on the communities are despite the fact that businesses work to maximise their profits or maximise the value of their firms. In their bid to maximise profits, business firms organise the work of production by engaging and combining the various productive resources and bringing about coordination between them. The suppliers of capital, labour, raw materials and other resources receive rewards from the firms for their contribution to the production of goods and services.

These business firms generate income and employment for labour, the owners of capital, land and other resources. This has greatly benefited them and contributed to their well-being. Besides, consumers too have gained from increasing quantity of goods and services produced by business firms for their consumption.

Apart from the gain to the resource owners and consumers, business firms contribute a good deal of revenue to the government. Taxes on profits (i.e. income of business firms), excise duties on their production, sales tax on the goods produced by them and other such taxes yield a lot of public revenue which are used by the Government to expand the services provided by it and to increase public investment for economic growth.


All the above mentioned contributions of business firms to economic growth and social well-being depend on the efficiency with which they use national resources and allocate them among products and services, A fundamental question that has been often raised is how business firms, which in their productive activities are guided by maximisation of private profits, work to increase social welfare.

The answer to this question was provided by Adam Smith, the author of now well-known classic ‘Wealth of Nations’. Advocating for a free market system he clarifies the role of business in promoting social well-being despite the fact that it pursues the goal of profit maximisation.

Adam Smith argues that it is the profit-driven market system (also called price mechanism) that drives business firms to promise welfare though they work for private’s gain. It is worth quoting him. “Every individual endeveavours to employ his capital so that its produce may be of greatest value. He generally neither intends to promote the public interest, nor knows how much he is promoting it.

He intends only his own security, only his own gain. And he is in this led by an invisible hand to promote an end which was no part of his intention. By pursuing his own interest, he frequently promotes that of society more effectively than when he realty intends to promote it.

2. Social Responsibility of Business:


Now, an important questions is whether successful business-firms always behave in a socially responsible way, that is, promote social well-being without harming it in any way, the answer is ‘no’. Some argues that businesses exist by public consent to serve the needs of society.

Therefore, they survive only because they promote social welfare. However, this is not correct. Various problems are faced by society because of socially undesirable ways business firms perform their activities.

Further, they impose certain social costs on the society for which they do not pay. However, society has taken steps to regulate and control them so as to induce or force them to serve social interest and minimise the harms done by them. We mention below the socially undesirable problems which the workings of profit-driven business firms have created and how society has tried to regulate their activities to ensure that they work in public interest.

First problem that has been often faced is the emergence of monopolies in free market economies for the production of some important products or services. For example, economies of large-scale production and distribution are such that only one electricity producing and distributing company, only one company providing telephone service can efficiently serve a city.

Such monopolistic firms are likely to exploit the consumers by charging higher prices and making excessive profits. It is in such cases that government on behalf of the society has intervened to directly regulate them. The Government has fixed fair prices for such commodities or services which are based on cost plus fair return on investment made by business firms.

The second problem posed by free private business is the emergence of oligopoly (that is, a few producers of a product competing with each other). In certain industries economies of scale are so large or barriers to entry into the industry are so strong that only a few firms serve a given market. If there exists competition among these few firms, no problem arises. But they formally or tacitly collude with each other and form a cartel, they pose a threat to social interest.

Such collusion among the few firms eliminates or substantially reduces competition. Such collusion among the firms or formation of a cartel leads to higher monopoly price being charged and restriction of output. Such collusion or formation of a cartel has been sought to be controlled by the society through enacting laws such as antitrust law in the US and Monopolistic and Restrictive Trade Practices Act in India. These acts are designed to prevent collusion among firms and creation of monopolies through mergers. By promoting competition these laws work for social betterment of the people and ensure social responsibility of business.

A further socially undesirable activity of free private business has been the exploitation of workers due to unequal bargaining power of the employers and workers. In India in private business enterprises, especially owned and managed by small-scale business firms, workers are paid very low wages because they are not well-organized and also because huge unemployment prevails in the Indian economy. Employers even do not make arrangements for their housing which have resulted in slums in the cities.

Further, child labour and women are employed in private enterprises at very low wages while a lot of work is obtained from them. This has necessitated the regulation of business by the Government which have fixed minimum wages that must be paid to workers. The employment of child labour has been banned. Law regarding ‘equal pay for equal work’ are being enforced under which women are to be paid equal wages as men.


But a very serious problem that arises in a business activity is that it imposes heavy social costs on the economy. It is now common knowledge that productive activities of business firms have created an acute problem of environment pollution. They dump their toxic wastes into the air and water. The pollution creates lung ailments, asthma and other health hazards for the people.

These are called social costs by the economists because while the firms impose these costs on the society, they do not pay for them. Often they do not provide safeguards so that undue smoke and other poisonous gases are not emitted by them. Bhopal gas tragedy is a shining example of how private business firms neglect their social responsibility by not providing adequate safeguards for leakage and emission of poisonous gases.

Now, a considerable attention is being paid by the society to internalize these social costs, that is, private business firms are forced to pay for these social costs. Safety standards are being laid down for emission limits on manufacturing processes and products that pollute the environment. Provision for heavy fines has been made who do not provide adequate safeguards. Firms that do not meet these safety standards are even closed down.

It may be noted that all the above measures, namely regulation of monopolies, antitrust laws, labour laws and anti-pollution policies are examples of actions that society has taken to modify the profit-maximising behaviour of business firms so that they perform their task of producing and distributing goods and service in a socially responsible way. These social constraints have an important bearing on the business activities of firms and hence on managerial decision making.

3. Social Responsibility and Value Maximisation Model of the Firm:


With the above constraints imposed by the society on the working of business enterprises, does the value or profit maximisation model of the firm remain adequate when issues of social responsibility are included in it. Answer to this question is in affirmative. These are two ways in which the economic model of the firm retains its utility, validity arid importance despite the social efforts to modify behaviour of business firms.

One way is in so far as the social efforts are confined to inducements in the form of suitable fiscal and monetary measures such as taxes, subsidies, concessional rates of interest, these measures can be easily incorporated in the value-maximisation model of the firm. The second type of social measures such as licensing laws, anti-pollution measures, labour laws etc. can be considered as constraints of the model of the firms and managers have to take into account these constraints in decision making.

Thus, with the constraints imposed on the business firms so that they should operate in socially responsible manner makes the decision-making model as one of constrained maximization’ of the value of the firm. This makes the process of decision making as” constrained decision making” by managers. Thus, in this sense the economic model of the firm still retains its usefulness despite measures adopted to ensure social responsibility of business firms.