Unit 1


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Unit 1

  5. 5. Economics Is The Art Of Making The Most Of Life - GB SHAW
  6. 6. WHAT IS ECONOMICS?• Scarcity – a basic human dilemma – Limited resources vs. unlimited wants – The human condition requires making choices• Definitions of Economics – Mankiw’s definition • …is the study of how society manages its scarce resources – Hedrick’s definition • …is how society chooses to allocate its scarce resources among competing demands to improve human welfare – Alternative definitions • … what economists do. • … is the study of choice.
  7. 7. DEFINITIONS – BY VARIOUS GURUS• The term economics comes from the Greek word oikos (house) nomos (custom or law)• Adam smith – father of economics – He saw economic as “ an enquiry into an nature and causes of the wealth of nations”• Alfred marshall – Economic s is the study of mankind in the everyday business of life• Lionel robins – Economics is the science which studies human behavior as a relation ship between ends and scarce means which have alternative uses
  8. 8. Debate – Whether Economics Is A Science Or An Art?
  9. 9. BASIC ASSUMPTIONS• Economic theories are based on certain assumptions.• The assumptions are nothing but tools in the hands of economists to convert complications to their own advantages and simplicity.• The basic assumptions are – Ceteris paribus – Latin word(things being equal/ constant) – Rationality(compare the cost and benefits of a decision before going a head) • Firms aims at maximize profit and minimize cost • Consumer aims at maximizing utility and minimizing sacrifice
  10. 10. TYPES OF ECONOMIC ANALYSIS• Micro and macro.• Positive and normative.• Short run and long run.• Partial and general equilibrium.
  11. 11. MICRO AND MACROECONOMICS• MICRO ECONOMICS – It looks at the smaller picture of the economy. – It is the study of behavior of smaller economic units such as that an individual consumer, producer/seller or a product. – It focuses on the basic theory of supply and demand in individual markets.(Example- automobiles, FMCG, Telecommunication etc) – It deals with the how individual businesses decide how much to produce and what price to sell it and how individual consumer decide how much to buy. – It analysis the market behavior of individual consumers and firm and their decision making.
  12. 12. ….CONTD• MACRO ECONOMICS – It is the branch of economics that deals with the study of aggregates. – Study the industry as a unit and not the firm. – It talks about aggregate demand and aggregate supply – It talks about national income, GDP,GNP, inflation, employment etc.• Micro and macro economics complement each other
  13. 13. POSITIVE AND NORMATIVE• POSITIVE STATEMENT – This are factual by nature, whose truth or falsehood can be verified by empirical study or logic.• NORMATIVE STATEMENTS – It involve some degree of value judgment and cannot be verified by empirical study or logic
  14. 14. ILLUSTARTION- FOR POSITIVE AND NORMATIVE ECONOMICS• The distribution of income in India is unequal.• The distribution of income in India should be equal.
  15. 15. ..contd• POSITIVE ECONOMICS – It establishes relationship between cause and effect. – It analysis problems on the basis of facts. – It describe the probable effect of cause bit it would not provide any guidelines/instruction to avoid those causes.• NORMATIVE ECONOMICS – It concerned with the questions involving value judgment. – It incorporates the value judgments about what the economy should be like.
  16. 16. SHORT RUN AND LONG RUN• Marshall gave the contribution of different period time in market analysis.• He defined the periods in market as a market period.• Short run(less than a year) – It is a time period not enough for consumers and producers to adjust completely to any new situation. – In production decisions short run is a period when it may not be possible to change all the inputs. – In this some input are fixed others are variable. – Manager has to select different levels of variable input to combine with the fixed input in order to optimize the level of production
  17. 17. …CONTD• LONG RUN – It is a time period long enough for consumers and producers to adjust to any situation. – All inputs can be varied. – Managerial economist deals with decisions whether to expand capacity , change product lines etc. – Time period – 5-6 years/ even as high as 20 years
  18. 18. PARTIAL AND GENERAL EQULIBRIUM• EQUILIBRIUM – It is a state of balance that occur in a model.• Partial equilibrium analysis – It studies the internal outcome of any policy action in a single market only. – The effects are examined only in the markets which is directly affected not on other markets. – We refer to partial equilibrium analysis when a single firm or a single consumer is in equilibrium others firms in industry may not be in equilibrium.
  19. 19. ….CONTD• General equilibrium analysis – It is the branch of economics that seeks to explain economic phenomena like production, consumption and prices in a economy as whole. – It tries to give an understanding of the whole economy by looking at the macro perspective.
  20. 20. KINDS OF ECONOMIC DECISION• Fundamental Questions of Economics - Scarcity requires all societies to answer the following questions: – What is to be produced?(consumer goods/capital goods) – How is to be produced? (efficiency) – For whom will it be produced? • Market economy • Command economy – Are resources used economically? – Are resources fully employed? – Is the economic growing WHFM Questions
  21. 21. MANAGERIAL ECONOMICS-MEANING“Managerial economics is a means to an endto managers in any business in terms offinding the most efficient way of allocatingscarce organizational resources and reachingstated objectives.”
  22. 22. DEFINITION- MANAGERIAL ECONOMICS• BY SALVATORE – Managerial economics refers to the application of economic theory and the tools of analysis of decision science to examine how an organization can achieve its objectives most effectively.• BY DOUGLAS – Managerial economics is the application of economic principles and methodologies to the decision making process with in the firm or organization.
  23. 23. MANAGERIAL ECONOMICS- MICRO VS MACRO• Managerial economics is applied micro economics to a significant extent though it draws extensively from macroeconomics theory. – Example : it draws demand analysis, cost and production analysis, pricing and output decision from micro economics. Where it also derives market intelligence knowledge from GDP,GNP, INFLATION etc.
  24. 24. MANAGERIAL ECONOMICS- NORMATIVE BIAS• Managerial economics has a normative bias stating what firms should do. In order to reach certain objectives.• Economic issues confronting managers would often involve value judgments.• In managerial situations one has to take decisions which will affect organizations future therefore managers cannot be simply content with being factual
  25. 25. MANAGERIAL ECONOMICS – PARTIAL EQUILIBRIUM• Managerial economics deals with partial equilibrium analysis with focus on equilibrium of a firm or an industry, not the economy.• Decision making of managers would relate to the equilibrium of particular firm.
  26. 26. ECONOMIC PRINCIPLES TO MANAGERIAL DECISIONS• The key economic concepts and principles that constitute the broad framework of managerial economics are – Concept of scarcity – Concept of opportunity cost – PPF – production possibilities curves – Concept of margin or increment – Discounting principle• According to the above economic principles the decision are taken by managers in their operating environment.
  27. 27. Concept of scarcity• The starting point of any economic analysis is the existence of human wants(unlimited). DEMAND FOR RESOURCES RESOURCES• All desirable things(resources) are short in supply compare to our needs(demand).The decision should made to optimally utilize them.
  28. 28. …contd• So the economic problems lies in making the best possible use of resources.• In order to get maximum satisfaction (consumer point of view) or maximum output (producers point of view)
  29. 29. Concept of opportunity cost• The managerial economist has to make rational choices in all aspects of business because of scarce resources and unlimited wants.• Opportunity cost is the benefit from alternative that is not selected. A B C D E F
  30. 30. Production Possibility Frontiers- PPF/PPC/TRANSFORMATION CURVE• Show the different combinations of goods and services that can be produced with a given amount of resources.• It also depicts the trade off between any two items produced /consumed.• This curve measures the opportunity cost by indicating the opportunity cost of increasing one items production /consumption in terms of units of other.(slope of the curve)• PPC highlights the significance of scarcity of resources and need to use them judiciously
  31. 31. ..CONTD• The concept of PPC used in both micro and macro economics.• PPC for individual firm/consumer-micro• PPC for entire society – macro.
  32. 32. Production Possibility Frontiers- individual X axis- clothing y axis- food A M Fp N P Fq Q Cp Cq B
  33. 33. Assumptions and explanation• What ever is earned by individual is spent.• At point P on AB shows – At given income individual can buy Fp units of food and Cp units of clothing.• If the individual wants to have any more clothing at same level of income they needs to sacrifice some units of food.• That bring individual to point Q• Fq < Fp and Cq>Cp• M – not attainable it represents combination of commodities beyond income.• N- not desirable combination of commodity that would not maximally utilize the individuals income.
  34. 34. Production Possibility Frontiers-society If the country is at point A on the PPF It can produce the combination of Yo Capital Goods capital goods and Xo consumer goods Ym If it devotes all resources to capitalIf it reallocates its Aresources (moving Yo goods it couldround the PPF produce a maximumfrom A to B) it can of Ym.produce moreconsumer goods If it devotes all itsbut only at the resources to Y1 Bexpense of fewer consumer goods itcapital goods. The could produce aopportunity cost of maximum of Xmproducing an extraXo – X1 consumergoods is Yo – Y1capital goods. Xo X1 Xm Consumer Goods
  35. 35. Production Possibility Frontiers- society Production Capital Goods inside the PPF – e.g. point B means the C Y1 country is not A using all its . Yo resourcesIt can only produce at Bpoints outside the PPFif it finds a way ofexpanding itsresources or improvesthe productivity ofthose resources italready has. This willpush the PPF furtheroutwards. Xo X1 Consumer Goods
  36. 36. …contd• Assumptions – Factors of production are fixed in supply – Technology remains same• No ‘ideal’ point on the curve• Any point inside the curve – suggests resources are not being utilised efficiently• Any point outside the curve – not attainable with the current level of resources• Useful to demonstrate economic growth and opportunity cost
  37. 37. CONCEPT OF MARGIN AND INCREMENT• Marginal analysis is one of the cornerstones of economic theory.• The concept of marginality deals with a unit increase in cost or revenue or utility.• Marginal cost – It is the change in total cost /total revenue/total utility due to unit change in output. – Marginal cost/marginal revenue/marginal utility is the total cost /total revenue/total utility of the last unit of output.
  38. 38. ….contd• Marginal cost express in – MCn =TCn-TCn-1………. Where n is the number of units of output – Marginal cost= change in total cost/change in total output(dtc / dq ) How ever in reality variables may not be subject to such unit change as explained above. So for practical purpose we use incremental concept rather than marginal concept
  39. 39. • Incremental concept is applied usually when the changes are not necessarily in terms of a single unit but in bulk.• In such additional revenue earned as “incremental revenue”• Example = increase in sales – Due to promotional activities
  40. 40. DISCOUNTING PRINCIPLE• Discounting refers to the time value of money.• The in hand today is more value than a rupee received tomorrow.• The value of money depreciates with time.• PVF=1/(1+r)nPVF= present value of fundn=periodr=rate of discount.
  42. 42. RELATION OF MANAGERIAL ECONOMICS WITH DECISION SCIENCES • Decision sciences provide the tools and techniques of analysis used in managerial economics. • The theory of managerial economics largely utilizes the tools of mathematics and econometrics. • Important aspects of decision sciences that are used in managerial economics include numeric and algebraic analysis , optimization , statically estimation , forecasting and game theory.
  43. 43. • Economic theory • Managerial • Quantitative • Theory of firm economics analysis • Price theory • All your • GNP GDP analysis • Solution to managerial decision making
  44. 44. HOW DIFFERENT ECONOMICIES SLOVE THEIR ECONOMIC PROBLEMS?• Economies are classified into three broad categories according to their mode of production , exchange , distribution and the role which government plays in economic activity. – Capitalist economy. – Socialist economy. – Mixed economy.
  45. 45. CAPITALIST ECONOMY• An economy is called capitalist or a free market economy if it has a following characteristics. – The right of private property – Freedom of enterprise – Freedom to choice by the consumer(consumer sovereignty) – Profit motive – Competition – Inequalities in income.
  46. 46. How capitalist economics solve their problems• This economy has no central planning authority to decide what , how , and for whom to produce. – Deciding what to produce – Deciding how to produce – Deciding for whom to produce – Deciding about consumption , saving and investment.
  47. 47. THEORY OF FIRM• FIRM – Firm is an entity that draws various types of factors of production in different amounts from the economy and converts them into desirable output through a process with the help of suitable technology. – There are five factors of production namely land , labor , capital , enterprise and organization.
  48. 48. Form of ownership Private Public Joint sector sector sector Individual collective company corporation departmentproprietorship partnership cooperative
  49. 49. OBJECTIVES OF FIRM• Profit maximization• Baumols theory of sales revenue maximization.• Marris hypothesis of maximization of growth rate.• williamson’s model of managerial utility function• Behavioral theories……
  50. 50. How Do Economists Study Human Behavior?• Economics as a Science – The scientific method • Observation→Theory→Data→Testing – Rational Behavior • Weighing benefits and costs and maximizing total net benefits • Marginal vs. Total Thinking – Economic Theory and Models • Simplification by assumption • Ceteris Paribus – Holding other factors constant • Prediction vs. realism – Microeconomic versus Macroeconomics
  51. 51. – Bias towards use of natural rather than controlled experiments– The specialized language of economics (e.g. “He has lots of money.”) • Money – medium of exchange • Wealth – accumulated financial and non-financial assets • Income – the purchasing power earned during a given period
  52. 52. Why do Economists Study Human Behavior?• Scientists versus policy makers• Positive Economics – Descriptive - what the world is like. – Objective- value judgments need not be made – Positive statements can theoretically be tested by appealing to the facts• Normative Economics – Prescriptive - what the world ought to be like – Subjective – value judgments must be made – Normative statements cannot be tested appealing to facts.
  53. 53. Categories of Basic Principles of Economics• How do people make decisions?• How do people interact?• How does the economy work overall?
  54. 54. How Do People Make Decisions?• Principle #1 - People face tradeoffs – Time allocation – an example of tradeoffs – Efficiency versus equity – Production Possibilities Frontier
  55. 55. • Principle #2 - The cost of something is what you have to give up to get it – Opportunity costs are independent of monetary units
  56. 56. • Principle #3 - Rational people think at the margin – Rational or irrational decision-making – Marginal benefits and costs versus total benefits and costs – Weighing marginal costs and benefits leads to maximizing net benefits (total welfare) – The boxes example
  57. 57. .• Principle #4 –People respond to incentives – Reactions to changes in marginal benefits and costs – Increases (decreases) in marginal benefits mean more (less) of an activity – Increases (decreases) in marginal costs mean less (more) of an activity
  58. 58. How Do People Interact?• Principle #5 - Trade can make everybody better off
  59. 59. • Principle #6 - Markets are usually a good way of organizing economic activity – the “failure” of centrally planned economies and the movement towards markets for the WHFM questions
  60. 60. Markets– Principles 1-5 combine with markets to turn the pursuit of self-interest into promoting the interests of society– creativity and productivity are stimulated by the pursuit of self-interest into improving resource allocations– in some cases markets fail to allocate resources effectively so,
  61. 61. • Principle #7 Governments can sometimes improve interaction that occurs in markets – there are circumstances when market signals fail to allocate resources efficiently or equitably – Public Goods, Externalities and Income Distribution – Some goods or services that people desire will not be produced by markets. – Some goods or services will either be underproduced (vaccines) or overproduced (pollution) because markets fails to register certain benefits or costs.
  62. 62. – markets may also fail to provide an equitable or fair distribution of resources– government intervention with its ability to coerce (the opposite of voluntary) can regulate, tax and subsidize to change market outcomes– efficiency and equity: the pie analogy– if government intervention always the proper solution?
  63. 63. How Does the Economy Work as a Whole?• Principle # 8 – A country’s standard of living depends upon its ability to produce goods and services – Materialism – more toys mean more welfare – wealth: a necessary or sufficient condition for happiness (are rich people happier, children with lots of toys)
  64. 64. • Principle #9 – The general level of prices rises when the government prints and distributes too much money