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Global Economics for Managers MBA 505. Stephen E. Margolis. Economics. It’s not about the money. Economics Defined. The study of: Responses of humans to unlimited wants and limited resources . Scarcity Elaborations: Exchange (James Buchanan) Optimization and coordination. - PowerPoint PPT Presentation
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MBA 505 Economics for Managers1
Global Economics for Managers
MBA 505
Stephen E. Margolis
MBA 505 Economics for Managers2
Economics
It’s not about the money
MBA 505 Economics for Managers3
Economics DefinedThe study of:• Responses of humans to unlimited
wants and limited resources.• ScarcityElaborations:• Exchange (James Buchanan)• Optimization and coordination
So, what are we?
• Greedy materialists?
MBA 505 Economics for Managers
So, what are we?
• Greedy materialists?
Or
• Noble visionaries?
MBA 505 Economics for Managers
Our concern is with anything that people value.
• Yes, it’s all the stuff we buy: food, shelter, clothing, entertainment, education, medical care, automobiles, travel, jewelry, art, gadgets and so on.
• It is also everything else we value. Security, health, clean air and water, leisure, privacy, …children…
MBA 505 Economics for Managers
But isn’t scarcity temporary?
• No• We will live in scarcity – in the economists
sense of it, so long as we can imagine things we would like to have….more food, better food, better health, safer cars, cleaner air, faster travel, more free time.
• So again, is it greed? Imagination?
MBA 505 Economics for Managers
Adam Smith on self interest:
He advocates generosity in The Theory of Moral Sentiments, but in The Wealth of Nations famously offers this:
“It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest”
MBA 505 Economics for Managers
MBA 505 Economics for Managers9
What Makes Economics Different?
• Scarcity: The inevitability of choice.
Cost is the value of what is given up— Opportunity Cost
• Rationality: People pursue their own interests as they know it.
• Competition• Individualism:
As a methodologyAs an ethical foundation
MBA 505 Economics for Managers10
• Definition (done)• Course operation• Approach to economics• Law of demand• Supply and demand• Prices• Costs• Comparative Advantage
Today’s Lecture
MBA 505 Economics for Managers11
Course Operation
• Syllabus• Groups• Evaluation• Moodle• Paper
About this course
• Economics for business• Primarily microeconomics, but with some
coverage of macroeconomics and the principles of trade
• Introductory—intermediate level• Economics of business decisions• Applied as opposed to theoretical• It can be a first course in economics.
MBA 505 Economics for Managers
MBA 505 Economics for Managers13
P
Q
DMR
MCPm
(Don’t copy this down)
MBA 505 Economics for Managers14
P
Q
DMR
MCPm
5675
45655012389
(This either)
Objectives
• Understand how markets work• Understand the economic logic in business
decisions.
In other contexts this is expressed as organization and optimization, respectively.
MBA 505 Economics for Managers
MBA 505 Economics for Managers16
Normative and Positive Economics
• Positive• Normative
• Prescriptive
MBA 505 Economics for Managers17
Normative and Positive Economics
• Positive: What is• Normative: What’s good
• Prescriptive: What to do (See Normative)
Managers Are Teachers
Stephen E. Margolis
MBA 505 Economics for Managers19
Mathematics
Algebra 1?
y = mx + b
p = a - bq
This will become familiar
P
MBA 505 Economics for Managers
Q/t
a
a/b
P = a - bQ
This will become familiar
P
MBA 505 Economics for Managers
Q/t
a
a/b
P = a - bQ
-b is the slope, a is the vertical intercept
More math
I will use some calculus. It will always be optional.
Some things are easier and more persuasive that way.
MBA 505 Economics for Managers
Back to Economics
Demand, Supply, and EquilibriumA very quick overview.
The fundamental structure of economics
Incentives matter. We pick the lowhanging fruit
first.
MBA 505 Economics for Managers
The fundamental structure of economics
Incentives matter. We pick the lowhanging fruit
first.
Law of demand The law of diminishing marginal
product Supply behavior
MBA 505 Economics for Managers
MBA 505 Economics for Managers26
The Law of DemandIf the price of some good goes up, all other things equal, the quantity of the good that is consumed will fall.
Incentives Matter
What would the alternative be?
Suppose
Green Peppers
Regular Price: $.99 per pound
Today Only: $1.49
MBA 505 Economics for Managers
MBA 505 Economics for Managers28
Demand as a Diagram
Q/tA flow
Price
0
MBA 505 Economics for Managers29
Demand as a Diagram(My coffee consumption)
Q/tA flow
Price
0
3.00
2.00
1.00
* *
*
1 2 3
MBA 505 Economics for Managers30
Demand as a DiagramHillsborough St. Shops
Q/tA flow
Price
0
3.00
2.00
1.00
* *
*
1,000 2,500 5000
MBA 505 Economics for Managers31
It’s not (just) about the money
• Extensions to the law of demand– Seatbelts– Meetings– Emily’s Band-Aids – Insulin
– Shaving
MBA 505 Economics for Managers32
SupplyP
Q/t
S
MBA 505 Economics for Managers33
S and DP
Q/t
S
D
Qo
Po
MBA 505 Economics for Managers34
Price AdjustmentP
Q/t
D
Po
MBA 505 Economics for Managers35
More price AdjustmentP
Q/t
D
Po
MBA 505 Economics for Managers36
S and DP
Q/t
S
D
Qo
Po
S’
P’
MBA 505 Economics for Managers37
S and DP
Q/t
S
D
Qo
PoS’
P1
Q1
MBA 505 Economics for Managers38
S and DP
Q/t
S
D
Qo
PoD1
Q1
MBA 505 Economics for Managers39
S and D (one more time)P
Q/t
S
D
Q0
Po
Q1
D’P1
MBA 505 Economics for Managers40
About Prices
MBA 505 Economics for Managers41
About Prices• Chapter 2 material.• What matters is relative price.
– How many restaurant meals per month do I give up to make payments on an Cayman S.
– How many loaves of bread do I give up to get a bottle of wine?
– How many hours of leisure do I give up to get a 60” HDTV
Suppose every price doubles
• You wage is a price, that doubles too. • So do all your stocks. • And your bonds too. (Although that one is
more of a fantasy) What Happens?
MBA 505 Economics for Managers
MBA 505 Economics for Managers43
2008 2013
Movie 6.00 9.00Ticket
1 lb.Coffee 10.00 12.00
MBA 505 Economics for Managers44
What Is Pure Inflation?
A balanced increase in the prices of all goods, services and non money- denominated assets.
MBA 505 Economics for Managers45
Does that ever happen?
MBA 505 Economics for Managers46
Does that ever happen?
Well actually, No.
MBA 505 Economics for Managers47
What about the overall price level?
Suppose some prices went up 20%and some prices went up 50%, andyou wanted to know what happenedto the price level?
Laspeyres Index
The cost of the old bundle at the new prices The cost of the old bundle at the old prices
MBA 505 Economics for Managers
X 100
MBA 505 Economics for Managers49
A price index
100
10,0,
10,,
N
iii
N
iiti
qP
qPL
MBA 505 Economics for Managers50
Even StevenVegetarians, just make believe for a minute.
Suppose the price of beef goes up dramatically, but no other price changes. Suppose further that the cost of the bundle that you consume goes up exactly 5%. And finally, suppose you get a raise of exactly 5%, just to keep things even. Are things even?
Opportunity Cost Again
• Again, it is the concept of cost in economics.
• If taking an action does not impose any forgone opportunity, it has no cost.
• The empty factory floor
MBA 505 Economics for Managers
MBA 505 Economics for Managers52
Exchange and Production“The division of labour is limited by the extent of the market” Adam Smith
Specialization is a fundamental issue in economics, a fundamental characteristic of modern life
MBA 505 Economics for Managers53
Comparative Advantage
Paul
Steve
Motor Paint
45
30
30
40
MBA 505 Economics for Managers54
Comparative Advantage
Paul
Steve
Motor Paint
50
30
30
40 70
80
MBA 505 Economics for Managers55
Specialization
Paul
Steve
Motor Paint
50
30
30
40 70
80
Steve does both motors and finishes in 60hours, Paul does both paint jobs; 60 hours.
MBA 505 Economics for Managers56
Costs Motor Paint
Paul 40 30 70
Steve 30 50 80
If Paul paints both cars he takes 60 hoursIf Steve reworks both motors, he alsotakes 60 hours.
MBA 505 Economics for Managers57
Costs Motor Paint
Paul 40 30 70
Steve 30 50 80Steve’s cost of a motor is 3/5 of a paint job.Paul’s cost of a motor is 4/3 of a paint job.Steve is the low cost provider of motor work
MBA 505 Economics for Managers58
Costs Motor Paint
Paul 40 30 70
Steve 30 50 80
Steve’s cost of a paint job is 5/3 of a motor overhaul. Paul’s cost of a paint job is 3/4 of a motor overhaul.
Paul is the low cost provider of painting.
MBA 505 Economics for Managers59
Now, Suppose Steve is worse at both activities.
Motor Paint
Paul 40 30 70
Steve 45 75 120
CAN THEY TRADE?
MBA 505 Economics for Managers60
Steve’s comparative advantage?
Motor Paint
Paul 40 30 70
Steve 45 75 120
Steve does both motors, finishes in 90 hours. Paul does both paint jobs, finishes in 60. Notice that Steve’s opportunitycosts haven’t changed.
MBA 505 Economics for Managers61
LessonYour can be better at everything and still be the high cost provider, in termsof opportunity cost, of something.
You can be worse at everything and still be the low cost provider, in termsof opportunity cost, in something.
You may have an absolute advantage in no activity and still have a comparative advantage in something.
MBA 505 Economics for Managers62
Consumer Theory
• Foundations of demand• Illustrates choice under uncertainty• A tool for conceptualizing certain problems• Used in business fields
– Finance– Marketing
MBA 505 Economics for Managers63
What we assume about preferences.
• More is preferred to less• Consumers are willing to substitute• If A is preferred to B, and P is preferred to
C, then A is preferred to C• The more x you have and the less y, the
more x you would be willing to give up to get additional units of y.
Introducing…
The donut seller from hell
MBA 505 Economics for Managers
So, you’re driving to work….
In need of coffee. You pull into the parking lot of an odd shop marked only by the sign:
DONUTSThere is also something slightly odd about the man
behind the counter.There is a display case that might once have
displayed prices.
MBA 505 Economics for Managers
You order your coffee and then you ask,
“How much is a donut?”
MBA 505 Economics for Managers
A march down the demand curve
MBA 505 Economics for Managers
.80
.70
.60
.50
.40
.30
A march down the demand curve
So the donut seller says, $.80. and then, if you want a
second, $.70. And if you want a
third…
MBA 505 Economics for Managers
.80
.70
.60
.50
.40
.30
A march down the demand curve
.80 + .70 + .60 + .50 + .40 + .30 = $3.30
And yet, to sell six donuts with simple
pricing, you would have to charge how much per donut?
And revenue would be what?
MBA 505 Economics for Managers
.80
.70
.60
.50
.40
.30
Donuts
$
A march down the demand curve
.80 + .70 + .60 + .50 + .40 + .30 = $3.30
Conventional pricing would require a
price of $.30 to get the buyer to purchase six donuts, yielding revenue
of 6*.30 = 1.80
MBA 505 Economics for Managers
.80
.70
.60
.50
.40
.30
Donuts
$
OK, swell, what’s the point?
• Diminishing marginal valuation
• The step function that we see is also the individual’s demand curve.
• So, downward sloping demand originates in diminishing marginal evaluation
MBA 505 Economics for Managers
We will see the donut seller again
• Consumer surplus
• Price discrimination
MBA 505 Economics for Managers
The Science of Success.Why this book?
• The theme of this course is, what ideas that are accepted principles in economics are readily carried into business management?
• And related, to that, how does economics help us to better understand accepted business principles?
Market Based Management
• Views the firm as a miniature societies.
• Uses the principles that permit societies to prosper.
• These principles include the principles of markets.
MBA 505 Economics for Managers
Examples of applied economics
• Opportunity cost (p. 33, 109)
• Marginal analysis (p. 107)
• Comparative advantage (p. 35-6 and elsewhere)
MBA 505 Economics for Managers
And still more
Comparative advantage:Unless two people (nations) are exact multiples of each
other in terms of productivity, they will each have a comparative advantage, even if one is absolutely better in each activity.
The more productive party will benefit from practicing the activity in which it has the greatest advantage. The less productive party will benefit from practicing the activity in which it is least disadvantaged.
77
Elasticity
How we characterize demand and supply functions.
Here we will deal with price elasticityof demand.
78
Dreaded Elasticity
MBA 505 79
Scared as a Child?
21
21
21
21
PPPPQQQQ
80
Hear Elasticity…
Think
Responsiveness
81
Q
P
DPP’
Q Q’
Elastic
Q
P
PInelastic
P’
Q Q’
82
Q
P
DPP’
Q Q’
Elastic
Q
P
PInelastic
P’
Q Q’
Responsive
Not so responsive
83
Is it just slope?
Suppose price goes up $1 and the numberof units sold goes down 100,000 units.
Responsive or not?
84
We need to know not just the changein quantity and the change in price, but also the price and quantity. We get
PQ
PP
%%
100
100
85
PP
Rearranging:
QP
PQ
PP
Or, letting P and Q get small:
qp
dpdQ
86
Examples
• Your sales force reports that if they were to cut price by 10%, units sold would increase by 14%. What is the elasticity of demand?
• You are given a study that says that the elasticity of demand for one of your products is –2.5. A price increase of 4% will do what to units sold?
87
A simple numerical exampleQ=4000-.5P
What is the price elasticity of demand when P is 1500?
88
A simple numerical exampleQ=4000-.5P
What is the price elasticity of demand when P is 1500?
QP
dPdQ
89
Q=4000-.5P
What is the price elasticity of demand when P is 1500?
325015005.
23.
23.
QP
dPdQ
90
For example, if you raise price, what happens to revenue?
Does revenue always go up?
Now consider the relationship between price changes and revenue.
91
For example, if you raise price, what happens to revenue?
Does revenue always go up?
If you said no, you’re correct. If demand is very responsive, then the decrease in quantity will more than offset the increase in price.
92
Elasticity informs us about the effect of price changes on revenues. For this purpose, its more convenient to talk about the absolute values of elasticity. IF:
. ,1
Then the proportionate change in quantity is greater than the proportionate change in price. Revenues will increase when price decreases.
NC State MBA Program Fall 200293
On the other hand, IF:
.
Then the proportionate change in quantity is less than the proportionate change in price. Revenues will decrease when price decreases.
1
NC State MBA Program Fall 200294
Q
P
D
P/Q is large
P/Q is small
Elasticity varies along a straight-line demand curve.
NC State MBA Program Fall 200295
Q
P
D
Here’s a useful mnemonic;
Elastic
Inelastic
1
The arrows point in the direction of increased revenues.
Revenues are maximized where 1