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Principles of Economics
SUPPLY DEMAND
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Overview
Introduction Nature & Scope of Economics
The Economic Perspective
The Economics & The Management Disciplines Eco. For Effective Mgmt. (Basic Questions)
Identify Goals & Constraints
Understand incentives Understand Markets
Use Marginal Analysis
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SCOPE & METHOD OF ECONOMICS
Economics: A behavioral, or social science
The study of how individuals & societies choose to use the scarceresources for optimization ..
Why Economics: To make decisions
- Opportunity Cost - Marginalism - Efficient Markets
- Respond to incentives - Trading off - for voting/electing
- understand global affairs - understand society
Firms Consumers Governments Intl. Organizations
Buy Car Dinner in Restaurant Marry sweetheart admissions
Produce & sell goods & services Buy inputs & factors of productions
Levy taxes Income inequalities Policies Economic affairs
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Introduction to Economics
PREMISE: Mans motivation SELF-SATISFACTION / VALUE CREATIONTrade offs Costs - paid to get Rationale for margins
Respond to incentives Gains from trade (win-win)
Mkt. Economy for Eco. Activity Efficiency v. Equity
Opportunity Costs Marginalism (Cost benefit analysis) Mkt . Power
Mkt. Failures, inflation recession, Externalities & Govt. Role
Standard of Living & Productivity Money,. Growth & Employment
THE GOAL OF ECONOMICS IS TO REDUCE TRANSACTION COST
Greek word - one who manages a household .
- house - household management
A HOUSEHOLD, A FIRM, AN ECONOMY /GOVT. & DECISIONSWho will work? What to produce? How much to produce?
For whom to Produce? What resources to use in production?
At what price to be sold?
SOCIETY & SCARCE RESOURCES: How to manage these resources?
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Economics & Theory
Economics:
science of making decisions in the presence of limited resources
Microeconomics:
deals with the decisionsmade by individuals & groups, the factorsthat affect these decisions, & how these decisions effect others".
Managerial economics:
applies economics theory to business problems, i.e., how to direct
given resources through economic analysis to make decisions in
achieving the managerial goals efficiently.
Macroeconomics:
deals with economics decisions made at macro or aggregate level.
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Economics &
Role of Manager
The use of economic analysis to make business
decisions involving the best use(optimizing allocation) of an organizationsscarce resources
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EconomicsThe social science that studies the problem of
allocation of scares resources for optimizationof production, distribution, consumption &
minimization of cost of goods & services.
Science which studies human behavior
as a relationship between ends and scarce
means which have alternative uses.
Alternative uses of available resources involves the study of
choices as they are affected by incentives and resources.Micro Economics Macro Economics
-Positive Approach: (What is, what was or will be?)
-Normative Approach: (What ought to be?)
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Microeconomics
Assumptions:ceteris paribus-other things remains unchanged, i.e.,
partial-equilibrium analysis.
General-equilibrium theory: allows for changes in different markets
& aggregates across all markets, including theirmovements & interactions toward equilibrium.
Deals with the economic behavior & problems of individual agents
(firm, industry, consumer etc.) & their interactions with markets,
given scarcity, govt. regulation for a given market, product & service& factors of production.
The Theory: considers aggregates of qty. demand & qty. supply at
each possible price per unit to describe the mkt. equilibrium
on price & quantity or respond to market changes over time.Broadly termed as demand-& -supply/ market forces analysis.
Market structures, such as perfect competition & monopoly, are
examined for implications for behavior & economic efficiency.
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Also considers factors affecting the long-term level & growth ofnational income within a country & across countries.
MacroeconomicsExamines the economy as a whole to explain broad aggregates and
their interactions and effects.
Such aggregates include:
- National income & output,
- Unemployment rate,
- Price inflation &
- Sub-aggregates like total consumption & investment & theircomponents.
Now Macro economics has integrated micro-based modeling of
sectors, including rationality of players, efficient use of market
information, & imperfect competition.
It also studies effects of Monetary, Fiscal & Trade policies
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Managerial Economics It applies economic theory to business problems:
- How to use economic analysis to make decisions of achievinggoal of profit maximization & cost minimization?
-Extensive use of QT/QM like operations research,
programming & statistical tools like regression analysis in the
absence of certainty & perfect knowledge.
- It unifies theme & attempt to optimize business decisions,
including unit-cost minimization & profit maximization, given
the firm's objectives & constraints imposed & supported bytechnology & market conditions.
Reliance:Upgrading technology to achieve EoS
Samsung, LG, Sony, BMW: Entry in India
P&G and HUL: Consumer preferences & Segmentation
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Nature & Scope of Economics
Why Economics:To make decisions- Opportunity Cost - Marginalism - Efficient Markets
- Respond to incentives - Trading off - For electing- Understand global affairs - Understand society
Firms Consumers Govts. Intl. Organizations
- Buy Car Dinner in Restaurant Marry sweetheartAdmissions Medicines & treatment etc.
- Produce & sell goods & services Buy factors & inputs productions
Inventory, Storage, Disposing etc.
- Levy taxes Generating Employment Economic Justice Policies
Interest rates, Growth, EXIM, Economic affairs etc.
Economics: A behavioral, or social science
The study of how individuals & societies choose to use the scarceresources for optimization ..
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How Is Economics Useful?
Evaluating Choice Alternatives Identify ways to efficiently achieve goals.
Specify pricing and production strategies.
Provide production and marketing rules to
help maximize net profits.
Making the Best Decision Economics can be used to efficiently meet
management objectives. Managerial economics can be used to
understand logic of company, consumer, andgovernment decisions.
S i & B i
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Scarcity & Basic
Choice Problem
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Economics : Tool for Improving Mgmt. Decision Making
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Theory of the Firm
Expected Value Maximization Owner-managers maximize short-run profits.
Primary goal is long-term expected value maximization.
Constraints and the Theory of the Firm Resource constraints. Social constraints
Limitations of the Theory of the Firm Alternative theory adds perspective.
Competition forces efficiency.
Hostile takeovers threaten inefficient managers.
Th C i
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The Corporation
- a Legal Device
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Profit Measurement
Variability of Business Profits
Business profits vary widely.
Accounting ProfitsTotal revenue (sales) minus cost of producing
goods or services.
Reported on the firms income statement.
Economic Profits
Total revenue minus total opportunity cost.
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Opportunity Cost
Accounting CostsThe explicit costs of the resources needed to produce
produce goods or services.
Reported on the firms income statement. Opportunity Cost
The cost of the explicit andimplicit resources that are
foregone when a decision is made.
Economic Profits
Total revenue minus total opportunity cost.
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Why Do Profits
Vary Among Firms?
Disequilibrium Profit Theories Rapid growth in revenues.
Rapid decline in costs.
Compensatory Profit Theories
Better, faster, or cheaper than the competition is
profitable.
R l f B i
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Role of Business
in Society
Why Firms ExistBusiness is useful in satisfying consumerwants.
Business contributes to social welfare
Social Responsibility of Business
Serve customers.Provide employment opportunities.
Obey laws and regulations.
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Value Maximization: a Complex Process
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Economics & The Mgmt. Disciplines
Marketing
Finance
Human resources Operations
Accounting
Business schools are basically
schools of applied economics- James March
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Economics & Mgmt. Disciplines Relationship to other business disciplines
Marketing:demand, price elasticityFinance:capital budgeting, breakeven
analysis, opportunity cost, value added
Management Science:linear programming,regression analysis, forecasting
Strategy:types of competition, structure-
conduct-performance analysisManagerial Accounting:relevant cost,
breakeven analysis, incremental cost analysis,
opportunity cost
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Questions that managers must answer:
Eco. For Effective Mgmt. (Basic Questions)
What are economic conditions in particular market?
- market structure? - supply & demand?
- technology? - government regulations?
- intl. dimensions? - future conditions?
-macroeconomic factors? etc.
Should our firm be in this business?
- if so, at what level/size? - at what price level?
- what output level? etc.
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Eco. & Effective Mgmt. (BasicQuestions)
How to gain & maintain competitive advantage ?
- cost-leader? - product differentiation?- market niche? - outsourcing, alliances, mergers?
- international perspective? etc.
What are the risks involved?
Risk- uncertainty or chance, different from expectations
- shifts in demand/supply conditions?
- technological changes?
- the effect of competition?
- changing interest rates & inflation rates?
- exchange rates fluctuations?
- socio-political risk s? etc.
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Identify Goals & Constraints
Sound decision making involves having well-
defined goals.
Leads to making the right decisions.
In striking to achieve a goal, we often face
constraints.
Constraints are an artifact of scarcity.
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Understanding Firms Incentives
Incentives play an important role within the firm.
Incentives determine:
How resources are utilized?
How hard individuals work?
Managers must understand the role incentives
play in the organization.
Constructing proper incentives will enhance
productivity & profitability.
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Market Interactions Consumer-Producer Rivalry
Consumers attempt to locate low prices, whileproducers attempt to charge high prices.
Consumer-Consumer Rivalry
Scarcity of goods reduces the consumers bargainingpower as they compete for the right to those goods.
Producer-Producer Rivalry
Scarcity of consumers causes producers to compete
with one another for the right to service customers. The Role of Government
Disciplines the market process.
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Firm Valuation and Profit
Maximization
The value of a firm equals the present value of current
and future profits (cash flows).
A common assumption among economist is that it is the
firms goal to maximization profits.
This means the present value of current and future profits, so
the firm is maximizing its value.
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Control Variable Examples:
- Output - Price
- Product Quality - Advertising
- R&D etc.
Basic Managerial Question:
How much of the control variable should be used tomaximize net benefits?
Marginal (Incremental) Analysis
N t B fit
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Net Benefits Net Benefits = Total Benefits - Total Costs
Profits = Revenue - Costs
Marginal Benefit (MB)Change in total benefits arising from a change in the
control variable.
Slope (calculus derivative) of the total benefit curve.
Marginal Cost (MC) Change in total costs arising from a change in the
control variable, Q.
Slope (calculus derivative) of the total cost curve
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The Geometry of Optimization:
Total Benefit and Cost
Q
Total Benefits& Total Costs
Benefits
Costs
Q*
B
CSlope = MC
Slope =MB
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The Geometry of Optimization:
Net Benefits
Q
Net Benefits
Maximum net benefits
Q*
Slope =MNB
The Gap Between Theory & Practice &
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The Gap Between Theory & Practice &
The role of Managerial Economics Gap exists between theory & practice in all walks of life
Economic world is extremely complex because of interdependency
of various factors on each other & economic theories are simplistic
ceteris paribus assumption itself is more unrealistic.
Managerial economics bridges the gap betweeneconomic theory & business practice using economic
logic & analysis of tools by
a) identifying the problems/objectives
b) collecting the relevant facts & related info.c) processing & analyzing the facts & info.
d) drawing the relevant conclusions
e) determining & evaluating the alternative means
f) taking a decision that is viable & feasible for optimizing goals.
C l i
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ConclusionEconomics: A discipline about application of economic theory
& methods to managerial decision making & practices byenriching the analytical skills through developing the logical
structuring of problems & providing adequate solutions.
Business:Transactions between 2 or more parties.
Decision Making: Steps: Identifying of strategies, evaluation ofstrategies & determining of criteria for choosing strategies.
Core elements of economic theory: The theory of firm, consumer
& demand theory, production & cost theory, price theory &
competition theory etc.,
Economics: a discipline that proceeds by making assumptionsin order to build simple models & as the situations being analyzed
become more complex, more sophisticated & advanced methods
of analysis become necessary to relax these assumptions.
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Assignment
Explain the origin, nature, scope and
significance of Economics.
What is Managerial Economics? What are the
techniques or methods used in managerial
economics?
How does the study of Managerial Economics
help in decision making?