Lecture 1 Business Economics

8/2/2019 Lecture 1 Business Economics

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Definition

It is the Social Science concerned with the

efficient use of scarce resources to achieve

the maximum satisfaction of economic wants.

Lets focus on key phrases in this definition

Social Science, Scarce Resources,Maximum Satisfaction and Economic

Wants


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Scarce Resources

The resources are scarce and therefore thegoods and services produced using theseresources are also scarce. There is no such

thing as free lunch, some body pays for it Since we use scarce resources therefore they

must be used in most productive manner i:eBest use. Every single use means it foregoesanother possible use Opportunity Cost ofnot going for 2nd best option


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Utility An economic term referring to the total

satisfaction received from consuming a goodor service in a rational manner

It is an abstract concept rather than concrete

Utility is hard to measure but it can bedetermined indirectly with consumer behavior

Utility increases with wealth but at a

decreasing rate. Marginal utility is the additional satisfaction

derived from each extra unit of consumption


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Rational Behavior

It means same person may make differentchoices under different circumstances

Choices will vary greatly among individuals

and also change as costs and benefits change Rational self interest is different from selfish

behavior.

Choices reflect the pursuit of self interest andare rational but they are based on differingpreferences and circumstances


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Economic Wants

Wants are different from Needs which are

necessary for survival like food shelter

Want is something which a person likes to

have needs have high priority wants have low

Some foods are needs but some may be wants

as well as needs

Ice cream is want but milk is need


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Marginalism

Economics involves lot of marginal analysis like

marginal utility marginal cost marginal benefits

For instance a gain of additional utility by

consumption of one more drink is corresponded

with additional cost

Some times we consume too much of a good

which means its marginal costs outweigh

marginal benefits so we are sacrificing goodswhich are more valuable at the margins-the

place where we consider very last unit of each.

And hence the concept of marginalization


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Economic Methodology

Observation of raw facts or data collection

Formulation of a hypothesis

Testing of Hypothesis

Acceptance, rejection or modification of it

Continued testing of hypothesis. If favorablehypothesis evolves into theory and a well

tested and widely accepted theory leads tolaw. The process of deriving theories andprinciples is called theoretical economics


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Theories

Facts

Policy Economics

Theoretical Economics

Figure 1.1

The relationship

between facts,

Theories, and

Policies in

Economics.


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Some Terminologies

Generalizations: Economic theories, laws andprinciples are generalizations relating toeconomy and its behavior. They are imprecise

because economic facts are diverse and notwo individuals and institutions act in thesame way. These principles are expressed astendencies of typical consumer, worker or

business firm. Although some consumers orfirms may not be following these trends yet onaverage overall economy follows these trends.


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Some Terminologies

Ceteris Paribus or Other things being equal

assumption means that other variables except

those under consideration are held constant

for a particular analysis.

Abstractions: economic theories or principles

are abstractions or simplifications that omit

irrelevant facts. This is simplifying the mattersand avoids cluttering.


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Policy Economics

It recognizes that theories and data can be

used to formulate polices. Economic theories

provide basis for economic policy.

The typical steps in creation of economic

policy are

Stating the goal

Determine policy option

Implement and evaluate the selected policy


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ECONOMIC POLICY

STATE THE GOAL

POLICY OPTIONS

IMPLEMENT &

EVALUATE


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Economic Goals

May be economic growth, economic efficiency, full

employment, equitable distribution of income and

balance of trade etc

These goals may be complementary, mutuallyexclusive or even conflict with each other. Full

employment may reduce poverty and income

inequalities but higher taxation may discourageentrepreneurs and may therefore have trade offs.

When goals conflict societies prioritize objectives.


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Macroeconomics

Macroeconomics examines the economy or itsbasic subdivisions as a whole such asgovernment, business sectors or households.

So households are considered as if lumpedtogether.

It deals with economic measures such as totalincome, total output, total employment,aggregate expenditures and general level ofprices in analyzing various economic problems.


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Microeconomics

It looks at specific economic units or very

small segment of the economy Microscopic

Here we talk of an individual industry firm or

household

Eg: Price of specific products, no of workers

employed in a firm, income and production

processes of a firm etc


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Normative v/s Positive approach

In Microeconomics positive rather than

normative models are used which means how

things are rather than how they should be.

An example of positive statement may be

income inequality has increased during the

past decade while a normative statement

may be the government should tax the richto decrease income inequality


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Normative v/s Positive approach

Positive Economics focuses on facts and causeand effect relationship

Positive economics avoids value judgment and

aims at conducting scientific analysis Policy Economics, on the other hand, involves

normative economics which incorporates

value judgment: How economy should be andwhat policies should be adopted to achievethat goal. It talks of desirability


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Principles of Macroeconomics

Principle 1: people face tradeoffs. To get one

thing we give up another.

Principle 2: cost of something is what u give up

to get it: or Opportunity cost

Principle 3: Rational people think at the margin,

they compare costs and benefits at the margins

Principle 4: People respond to incentives: they

change their decisions when marginal benfits

exceed marginal costs


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Principle 5: Trade can make every one better off.Competition results in gains from trade as people

specialize

Principle 6: Markets are a good way to organizeeconomic activity. Adam Smiths invisible hand

Principle 7: Governments can, sometimes,

improve market outcomes. When market fail to

allocate resources efficiently, governments can

intervene to promote efficiency and equity. Pls

note here externality and market power


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Principle 8: the standard of living depends on acountrys production. It can be measured in

terms of personal incomes or market value of a

nations production

Principle 9: prices rise when the governments

print too much money. Large quantity of money

decreases value of the currency

Society faces a short run tradeoff between

inflation and unemployment. When prices go up

unemployment goes down: only in short run !!!


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Pitfalls to Sound Reasoning

Biases: some people have biases like most ofus have about foreign debt etc

Loaded Terminologies: Like high profits are

termed as Obscene, low prices as exploitative,government is bunch of mindless bureaucratsand government regulations as socialists.

Misperception of definitions like investment isconstrued as purchase of bonds instead ofpurchase of capital assets like plant andmachinery


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Fallacy of composition which means what iscorrect for an individual is not true for whole.Example: A bumper crop is good for an

individual farmer but not for all of them asprices will go down.

Causation Fallacy: Post hoc and correlation v/scausation. Post hoc occurs because event Aprecedes event B which make people to believethat B was caused by A. In other words afterthis therefore because of this fallacy


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Correlation v/s Causation: Correlation between2 events means that they are associated insome systematic way. For instance if X and Y

also then it doesnt necessarily mean that Yhas increased because X increased. It could becoincidental or dependant on a 3rd factor.

Economic Example, income and highereducation

Proverbial Example Old Womans Cock


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Graphs

Its the time to look at graphs.

In a graph we have 2 axis, X and Y. Have u ever

thought which variable should be taken on X

and which variable u take on Y?


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Graphs

Its the time to look at graphs.

In a graph we have 2 axis, X and Y. Have u ever

thought which variable should be taken on X and

which variable u take on Y?

Independent variable on X and Dependent on Y

To draw a line we need two points of X variable

which have their corresponding Y Values


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Graphs

Now lets think about the slope of the line

What is the Slope: Its Rise over Run

What is the equation of the line:


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Graphs

What is the Slope: Its Rise over Run

What is the equation of the line: Y=mX+C


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Graphs

Income per week Consumption per week

$ 0 $ 50

100 100

200 150

300 200

400 250

So Which variable should we take on X-Axis and which

variable should we take on Y. Income is independent

variable so goes on X and Consumption is dependant

variable and hence goes on Y.


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Graphs

So what is the slope of the line and equationof this line

Begin by taking 2 points say 100, 100 and 50, 0

Rise over Run means distance between 2vertical points and 2 horizontal points

So 100-50

100-0

So the slope of this line is 0.5

Positive Slope means when X increases Y alsoincreases

= 50/100 or 0.5


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Graphs

Now what is the line equation As I mentioned it is Y=mX+C where m=slope and

C is a constant. So lets find out the equation for

this line

To do this we need only one point of X and Y

So lets take 200, 150 (x, y)

Now 150 = 0.5 * 200 + C

Or 150 = 100 + C or

C = 150 100 or C = 50 (See graph even when

X=0 the person still spends 50 and it is constant


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CONSUMPTION

(C)

0 100 200 300 400

INCOME (Y)

$400

300

200

100

a

b

c

d

e

C = 50 + .5Y

CONSUMPTION


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Graphs

Relationship between ticket price & attendanceTicket Price (in $) Attendance (in thousands)

50 0

40 4

30 8

20 12

10 16

0 20

Now lets take Attendance on X Axis and Ticket Price

on Y Axis. What is Slope and Equation of the line


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0 4 8 12 16 20ATTENDANCE IN THOUSANDS (Q)

$50

40

30

20

10

a

b

c

f

e

d

TICKETPRICE(P)

P=50-2.5Q


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The Economizing Problem

Two fundamental problems

Societys economic wants i:e economic wants

of its citizens and institutions are unlimited

and insatiable

Economic resources- the means of producing

goods and services- are scarce or limited


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Unlimited Wants Consumers use goods to get utility.

Utilities vary widely from necessities to

luxuries- food shelter clothing to racing cars and

yachts.

Services also provide utility such as 5 star

services and security etc.

Institutions are not much different in this

regard. Pvt institutions want factories to work

efficiently while Government institutions strive

to provide services like high ways law & Order

etc


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PROPERTY RESOURCES

LAND

CAPITAL

HUMAN RESOURCESLABOR

SCARCE RESOURCES

ECONOMIC RESOURCES


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PROPERTY RESOURCES

LAND

CAPITAL

HUMAN RESOURCESLABOR

ENTREPRENEURIAL ABILITY

SCARCE RESOURCES

ECONOMIC RESOURCES

Also known

as theInputFactors ofProduction


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Scarce Resources

Economic resources include Land, Labor,Capital and Entrepreneurship.

Entrepreneurial ability is also a scarce

resource because as he takes risk, combinesresources and takes strategic decisions toproduce goods and services to make profits.

These 4 resources land, labor, capital andentrepreneurial ability are called factors ofproduction


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ENTREPRENEURIAL ABILITY

Takes The Initiative

Makes StrategicBusiness Decisions

InnovatorThe Risk Bearer


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Employment and Efficiency

Since economics focuses on best use of scarceresources therefore it aims at ensuring bestefficiency.

This presupposes 2 aspects, full employmentand full production.

Full employment means those who can belegally employed like no child labor.

Full production means all resources are bestutilized to provide maximum satisfaction orout put. If not so then they are under utilized.


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Allocative Efficiency

Allocative efficiency is least cost production of a

particular mix of goods most wanted by society.

This means apportionment of limited resources

in such a way that society obtains the mix which

it wants the most. At this point Price = MC

The point of maximum allocative efficiency is

achieved in perfect competition at the pointwhere MR=MC and MC=AR=P


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Productive Efficiency

Productive efficiency or technical efficiency

occurs when the economy produces a mix of

goods at the lowest possible cost given other

goods. Its called Production Possibility Frontier.This is attained when firms produce at the

bottom of their Average Cost Curves. Perfectly

competitive firms also achieve this in the longrun as they produce at P=MC and this happens

to be tangent to the lowest point of AC curve


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Production Possibilities Model

4 simplifying assumptions

1. Full employment and productive efficiency,100% utilization of resources at least cost

2. Fixed Resources: Factors of production are infixed supply though can be reallocated.

3. Fixed Technology: in the short run the

methods of production cant be changed.4. Two goods: As discussed earlier the society

produces 2 goods or services only


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Production Possibilities Model

Type of Product A B C D E

Pizzas (in hundred thousands) 0 1 2 3 4

Robots (in thousands) 10 9 7 4 0

In the above table Pizzas are depicted as consumer goods while

robots are presented as capital investment. So by picking A

society chooses to forego current consumption and concentrateson capital goods which are futuristic. Less now more later


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PIZZA 0 1 2 3 4(in hundred thousands)

ROBOTS 10 9 7 4 0

(in thousands)

in table form

graphical form

Robo

ts

(thousands)

Pizzas (hundred thousands)

PRODUCTION POSSIBILITIES


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ROBOTS 10 9 7 4 0

(in thousands)

in table form

graphical form

Robo

ts

(thousands)



O C O OSS S


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ROBOTS 10 9 7 4 0

(in thousands)

in table form

graphical form

Robo

ts

(thous

ands)





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ROBOTS 10 9 7 4 0

(in thousands)

in table form

graphical form

Robots

(thous

ands)





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ROBOTS 10 9 7 4 0

(in thousands)

in table form

graphical form

Robots

(thous

ands)





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ROBOTS 10 9 7 4 0

(in thousands)

in table form

graphical form

Robots

(thous

ands)





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At any point in time,a full-employment, full-

production economy must

sacrifice some of productXto

obtain more of productY.


Limited Resources

means a limitedoutput...


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Q

Robots

(thousands)

14

13

12

11

10

9

8

7

65

4

3

2

1

1 2 3 4 5 6 7 8

A B

C

D

E

W

Attainable

but

Inefficient

Unattainable

Attainable& Efficient




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Q

Q

Rob

ots(thous

ands)


14131211109

87654

321

1 2 3 4 5 6 7 8

A B

C

D

E

W

Attainable

butInefficient

Unattainable

Attainable& Efficient


Notes...

The amount of other

products that must beforgone or sacrificed toobtain 1 unit of a specific

product is called the

opportunity costof thatgood.

LAW OF INCREASINGOPPORTUNITY COSTS


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Law of Increasing Opportunity Cost

The opportunity cost, the value of foregone

production, increases as the quantity of a good

produced increases .

It is explained as the slope of productionpossibilities curve. It analyzes the alternative

combination of the two goods.

It generates a distinctive convex shape, flat atthe top and steep at the bottom.


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Economic Rationale: LIOC

The sacrifice of one good increases (Robots) as we

produce more of other good (Pizza).

This is because economic resources are not

completely adaptable to alternate uses. Forinstance land may be suitable for agriculture and

not for mining. Similarly technology may be labor

intensive and not capital intensive. This lack of perfect flexibility or interchangeability

is the cause of Increasing Opportunity Cost


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Economic Rationale contd

As we saw earlier economic activity likeproduction or consumption should continuetill marginal benefits exceed marginal costs.

The optimal point of production therefore iswhere MC=MB

See the graph and tell me why. To sum up

Resources are being efficiently allocated toany product when marginal benefits andmarginal costs of it are equal or MB=MC



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P

QMargin

alBenefit

&Cost

Quantity of Pizzas

$15

10

5

1 2 3


MC

MB

Allocative Efficiency: MB=MC

MB=MC


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Production Possibility Curve: recap

1. Scarcity of resources is implied by the area ofunattainable combinations of output-lying onthe right of the curve

2. Choice among outputs is reflected by the varietyof attainable combinations along the curve

3. Opportunity cost is illustrated by the downwardslope of the curve and

4. The law of increasing opportunity cost is impliedby the concavity of the curve.

Q


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Q

Q

Robots(thousands)


14

13

12

11

10

9

8

7

6

54

3

2

1

1 2 3 4 5 6 7 8

U

Unemployment &Underemployment

Shown by PointU

More of either or

both is possible


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Economic GrowthQ

Q

Robots(thousa

nds)


14

13

12

11

10

9

87

6

5

4

32

1

1 2 3 4 5 6 7 8

A

B

C

D

E



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Applications... Unemployment and

Productive Inefficiency Tradeoffs and Opportunity

Costs

Shifts in the ProductionPossibilities Curves



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Economic Systems

Market systems or Capitalism or Commandsystem or Communism.

In Capitalism individual buyers and sellersinteract resulting in competition.

In pure capitalism Laissez Faire approach isdominant which means let it be means nogovernment interference or control

A planned economy relies exclusively on thecentral plan given by the government, eventhough there are few private productions andmarkets

ECONOMIC SYSTEMS


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ECONOMIC SYSTEMS

THE MARKET SYSTEMPure CapitalismLaissez-faire

THE COMMAND SYSTEM

SocialismCommunism

CIRCULAR FLOW MODEL


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BUSINESSES HOUSEHOLDS

RESOURCEMARKET

RESOURCES INPUTS

PRODUCTMARKET

CIRCULAR FLOW MODEL

CIRCULAR FLOW MODEL


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RESOURCEMARKET

RESOURCES INPUTS

$ COSTS $ INCOMES

GOODS &SERVICES GOODS &SERVICES

PRODUCTMARKET

CIRCULAR FLOW MODEL

CIRCULAR FLOW MODEL


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RESOURCEMARKET

RESOURCES INPUTS

$ COSTS $ INCOMES

PRODUCTMARKET


CIRCULAR FLOW MODEL

CIRCULAR FLOW MODEL


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RESOURCEMARKET

RESOURCES INPUTS

$ COSTS $ INCOMES

PRODUCTMARKET


CIRCULAR FLOW MODEL

Documents

Lecture 1 Business Economics