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  1. 1. Introduction Economic Analysis MS 102
  2. 2. Learning Objectives      To introduce key economic concepts like scarcity, rationality, equilibrium, time perspective and opportunity cost. To explain the basic difference between microeconomics and macroeconomics. To help the reader analyze how decisions are made about what, how and for whom to produce. To define managerial economics and demonstrate its importance in managerial decision making. To discuss the scope of managerial economics and its relationship with various other disciplines and functional areas.
  3. 3. Definition and Scope of Economics    Economics: Greek word oikos (house) and nomos (custom or law). Discusses how a society tries to solve the human problems of unlimited wants and scarce resources. Scientific study of the choices made by individuals and societies with regard to the alternative uses of scarce resources employed to satisfy wants.
  4. 4. Economics: Science or Art?          Theoretical aspect and an applied science in its practical aspects Not an exact science An “art” as well A systematic body of knowledge Unlike science, it lays down precepts or specific solutions for specific problems A social science Deals with the society as a whole and human behaviour in particular Studies the production, distribution, and consumption of goods and services A science in its methodology, and art in its application
  5. 5. Basic Assumptions  Ceteris Paribus Latin phrase  “With other things (being) the same” or “all other things being equal”. Rationality  Consumers maximize utility subject to given money income.  Producers maximize profit (or minimize cost) subject to given resources.  
  6. 6. Types of Economic Analysis   Micro and Macro Microeconomics (“micro” meaning small): study of the behaviour of small economic units    Focus on basic theories of supply and demand in individual markets Macroeconomics (“macro” meaning large): study of aggregates.   An individual consumer, a seller (or a producer, or a firm), or a product. Industry as a unit, and not the firm. Focus on aggregate demand and aggregate supply, national income, national capital formation, employment, inflation, etc.
  7. 7. Positive and Normative  Positive economics     Establishes a relationship between cause and effect. Analyzes problems on the basis of facts. It is “what is” in economic matters. Normative economics  Concerned with questions involving value judgments. Incorporates value judgments about what the economy should be like.  It is “what ought to be” in economic matters. 
  8. 8.   Short Run  Time period not enough for consumers and producers to adjust completely to any new situation  Some input (usually labour) is fixed and others (usually capital, etc.) are variable  Any time period less than a year Long Run  Time period long enough for consumers and producers to adjust to any new situation  “Planning horizon”  Decisions to adjust capacity, to introduce a larger plant or continue with the existing one, to change product lines  5 to 6 years, or even as high as 20 years
  9. 9.   Partial Equilibrium Analysis  Studies the internal outcome of any policy action in a single market only.  Examines effects only in the market(s) which is directly affected, and not on other markets. General Equilibrium Theory  Seeks to explain economic phenomena in an economy as a whole.  State in which all the industries in an economy are in equilibrium.
  10. 10. Kinds of Economic Decisions   Macroeconomic Issues  Are resources fully employed?  Is the economy growing? Microeconomic Issues  What to produce?  How to produce?  For whom to produce?  Are resources used economically?
  11. 11. Managerial Economics    Application of economic theory and the tools of analysis of decision science to examine how an organization can achieve its objectives most effectively. A means to an end to managers in any business, in terms of finding the most efficient way of allocating scarce organizational resources and reaching stated objectives. Applies economic theory and methods to business and administrative decision making.
  12. 12. Micro as well as Macro  Applied microeconomics  demand analysis, cost and production analysis, pricing and output decisions  Macroeconomic  national income, inflation and stages of recession and expansion Normative Bias  Prescriptive  States what firms should do in order to reach certain objectives  Decides on whether or not the probable outcome of a managerial decision is desirable
  13. 13. Decisions Resulting in Partial Equilibrium  Helps a firm in decision making  Decisions taken by any firm would relate to the equilibrium of that particular firm  Deals with partial equilibrium analysis
  14. 14. Economic Principles Relevant to Managerial Decisions Concept of Scarcity    Unlimited human wants Limited human capacity to satisfy such wants Best possible use of resources to get:   maximum satisfaction (from the point of view of consumers) or maximum output (from the point of view of producers or firms) Concept of Opportunity Cost   Rational choices in all aspects of business, since resources are scarce and wants are unlimited Opportunity cost is the benefit forgone from the alternative that is not selected.
  15. 15. Production Possibilities Curve     Shows the different combinations of the quantities of two goods that can be produced (or consumed) in an economy at any point of time  Subject to limited availability of resources Depicts the trade off between any two items produced (or consumed). Represents the opportunity cost concept Measures opportunity cost  Indicates the opportunity cost of increasing one item's production (or consumption) in terms of the units of the other forgone  Slope of the curve in absolute terms
  16. 16. PPC for the Society Food Infeasible Area P FP Q FQ Productively Inefficient Area O CP CQ Clothing
  17. 17.        Two goods, food and clothing, are used here to explain the PPC of the economy. Point P shows that FP of food and CP of clothing can be produced when production is run efficiently. So can FQ of food and CQ of clothing at point Q. All points on the PPC (like P and Q) are points of maximum productive efficiency. All points inside the frontier are feasible but productively inefficient. All points to the right of (or above) the curve are technically impossible (or cannot be sustained for long). A move from P to Q indicates an increase in the units of clothing produced. It also implies a decrease in the units of food produced. This decrease in the units of food is the opportunity cost of producing more clothing.
  18. 18. Assumptions    The economy is operating at full employment. Factors of production are fixed in supply; they can however be reallocated among different uses. Technology remains the same.
  19. 19. Concept of Margin or Increment      Marginality: a unit increase in cost or revenue or utility. Marginal Cost (or Revenue or Utility) is the change in Total Cost (or Total Revenue or Total Utility) due to a unit change in output. MCn= TCn-TCn-1, where n is the number of units of output Change in Total Cost dTC Marginal Cost = Change in Total Output = dQ Incremental: applied when the changes are in bulk.
  20. 20.  Discounting Principle     A rupee in hand today is worth more than a rupee received tomorrow. Time value of money Outflow and inflow of money and resources at different points of time 1 PVF = (1 + ) n r where PVF= Present Value of Fund, n = period (year, etc.) and r= rate of discount