Getting to know Economics - A primer for students from science background

1. Basics of Managerial
Economics
A study of Choice

2. What is Economics?
 Essence best captured by Lionel Robbins in 1932 as “the science
which studies human behaviour as a relationship between ends
and scarce means which have alternative uses."
 It is all about allocating scarce resources between competing
demands.
 How individuals and societies use limited resources to satisfy
unlimited wants.

3. Is Economics a Science?
 YES ,..because it uses scientific methods to explain and study social
behaviour.
 Economics sets up hypotheses-- a reasonable proposition about the
workings of the world which may or may not be true.
 Then uses Data to validate or verify hypotheses. Statistical methods
are used to analyse the data.
 Ceteris Paribus Assumption:In order to test an hypothesis we need
to keep constant other factors that may affect it. Other things are
called ceteris paribus factors.

4. Why is Economics a science?
 Many economic theories are abstractly
represented with graphs. A picture or graph
can be less confusing than words.
 Equations. Graphs are two-dimensional
pictures of mathematical equations.
 Equations can represent relationships
between three or more things, like:
 Y = 3 + 2X - 4Z

6. Fundamental Economic
Problem:

7. What are resources?

8. Resource payments
Economic Resource Resource payment
land rent
labor wages
capital interest
entrepreneurial ability profit

9. The Problem
Wants and needs are relative - my
burning want might be very different
from the wants of someone like the
boy in the image above. Resources
are not evenly distributed

10. Fundamental Principles
 Choice --- arises because all resources have alternative
uses and thus an opportunity cost. Limited resources
,their alternative use and infinite human wants give rise
to economic problem.

11. Why is Scarcity so
important?
 Scarcity dictates that we must answer the three basic
questions of allocation which are:
 Q1 ) What goods and services will be produced with
society's resources?
 -capital goods
 -consumer goods
 -public goods

12. Q2) How will society's resources be used to
produce the goods and services?
- land intensive
- labour intensive
-capital intensive
Q 3) For whom? Who receives the goods
and services produced with society's
resources?
- Income distribution

13. How to decide or make a choice as to
what use the resource can be put to
use ?
 Economists use a tool called:
 Opportunity Cost – the quantity of other goods that
must be sacrificed to obtain another unit of a good.
Monetizing opportunity costs is clearly valuable, because
it gives a means of comparison. This cost does not
involve actual payment.
The opportunity cost of any alternative is defined as the
cost of not selecting the "next-best" alternative.

16. Food for thought
 Did Bill Gates and Tiger Woods consider
opportunity costs while making their career
decisions?
 They are the world’s most famous college
drop-outs.
 Opportunity cost of what?

17. Concepts in Decision
Making
 Explicit versus Implicit cost:
 Total economic cost= sum of implicit and explicit cost.
 Accounting Profit versus Economic Profit of a business unit:

 Managerial Economics concerns with Economic Profits:

18. Explicit Vs Implicit costs
Opportunity
Cost of an
additional year
in PG education
Explicit Cost Implicit Cost
Tuition fees Rs 200000 Foregone Salary Rs 200000
Books Rs 20000
Entertainment Rs 20000
Total Rs 240000 Rs 200000
Total opportunity
Cost
Total Explicit cost
+ Total Implicit
Cost = Rs 440000

19. Accounting Vs Economic
Profit:
Ratna’s Food Delivery :
Revenue Rs 200000
Explicit Cost -Rs 60000
Depreciation -Rs 5000
Tax -Rs 4200
Accounting Profit Rs 130800
Implicit Cost
Interest loss @ 9% p.a. - Rs 18000
Salary foregone - Rs 300000
Economic Profit - Rs 187200

20. Where does resources
allocation take place?
 Through Markets. Market is where
individual choices interact. So, Economics
studies markets.
 The medium of interaction is very often
the Price.

22. Concepts of economics in
Decision Making
 2. Marginal Analysis:
 Most Economic decisions are “either-or” decisions or “how
much” decisions.
 Either –Or Decisions:
 buy a car or not
 Run your own business or work for someone else
 How much decisions :
 How many miles do you go before an oil change in your
car?
 How many workers to hire in your company?

23. Marginal Analysis:
 Marginal analysis is used to analyse “how much”
decisions.
 Involves comparing the benefit of doing a little more of
an activity (marginal benefit) to the cost of doing a little
bit more of that same activity ( marginal cost).
 Marginal Benefit vs Marginal Cost.
 All economic decisions happen at the margin.

24. Net benefit: Note this
 Individuals are not expected to maximize
benefit; nor are they expected to minimize
costs.
 Individuals are assumed to attempt to
maximize the level of net benefit (total
benefit minus total cost) from any activity in
which they are engaged.

25. Marginal analysis
 MB > MC  expand the activity
 MB < MC  contract the activity
 optimal level of activity: MB = MC (Net
benefit is maximized at this point)

26. Example:
 Patty delivers pizza using her own car, and she is paid
according to how many pizzas she delivers. The
accompanying table shows Patty’s total benefit and total
cost when she works a specific number of hours.
Calculate the optimal number of hours Patty should
work.
Quantity of
hours worked
Total Benefit
( RS)
Total Cost ( Rs)
0 0 0
1 30 10
2 55 21
3 75 34
4 90 50
5 100 70

27. Two types of Economic analyses:
Normative and Positive Economics
 Positive economics has an obvious Cause – Benefit Analysis. A hike
in the prices of luxury items will cause a definite drop in demand.
Positive Economics is backed by theory. Its is a statement of fact.
 Normative economics offers prescriptions based on value judgements :
eg, a tax should be imposed on cigarettes to discourage smoking. Should
property tax be imposed to build a local park?

28. Two Main Branches :Micro
and Macro Economics
 Microeconomics studies how individuals, firms and households
make decisions to allocate limited resources , typically in markets
where goods or services are being bought and sold.
 Macroeconomics gives us a birds’ eye view of the functioning of the
whole economy specially National Income, Output, Unemployment,
Inflation , Monetary and Fiscal policy.

29. Managerial Economics
 Is the link between microeconomic theory and business practice.

 Applies economics tools and techniques to business and
administrative decision making.
 Essentially a study of competitive markets, market power and
imperfect markets.

30. Scope of Managerial economics: what will we
study?
 Demand analysis and forecasting:
Demand analysis helps in analyzing the various types of demand
which enables the manager to arrive at reasonable estimates of
demand for product of his company. Managers not only assess
current demand but also assess future demand.
 Production function:
Conversion of inputs into outputs . With limited resources managers
have to make the alternative uses of this limited resource.
 Cost analysis:
Cost analysis is helpful in understanding the cost of a particular
product. It takes into account all the costs incurred while
producing a particular product.

31. Scope of Managerial
Economics
 Pricing system: Here pricing refers to the pricing of a
product .
 Macro Economics : understanding how the wheels of
the economy work.

32.  1) Describe some of the opportunity costs when you decide to do the
following:
 A) attend university instead of taking a job.
 B) watch a movie instead of studying for an exam
 C) Ride the bus instead of driving a car
Review Questions:

33. Review Questions:
 2) Indicate whether each of the following is a topic of
microeconomics or macroeconomics:
 The impact of higher oil prices on the production of steel
 The increased demand in the last 15 years for exotic dietary
supplements
 The surge in aggregate economic activity that hit much of Asia late
in the early 2000s
 The sharp increases in the price of gold in India between 2003 and
2013.
 The impact of preservation of wilderness areas on the logging
industry and on the price of lumber

34. Review Questions :
 Karma and Don run a furniture-refinishing business from their
home. Which of the following represent an explicit cost of
the business and which represent an implicit cost?
 a. Supplies such as paint stripper, varnish, polish, sandpaper, and so
on
 b. Basement space that has been converted into a workroom
 c. Wages paid to a part-time helper
 d. A van that they inherited and use only for transporting furniture
 e. The job at a larger furniture restorer that Karma gave up in order

35. Applying opportunity cost:
CASE 1
 A leading charity is working
in a country that has been
hit by a severe earthquake.
It knows that there are a
wide range of competing
needs of the population in
the area: food; clothing;
shelter; medicine;
counselling; education;
clearing up, and
reconstruction of houses
and amenities

36. Applying Opportunity Cost
 It only has a limited amount of funds, far
less than would be required to satisfy all
these requirements. It has to make some
tough choices but tries to rationalise those
choices by placing a value on the
importance in terms of the benefits to the
widest number of people from the
allocation of its scarce resources (in other
words, spending its money).

37. The Decision
 It decides to focus on the erection of tents
and provision of medicine as its main
priorities. The monetary cost of this
decision might be Rs 15 million but the
opportunity cost would be expressed as
the food that is not being provided for the
displaced population, or the clothing,
reconstruction and clearance that would
have to be sacrificed.