Introduction to Business Economics

Session I and 2

What is Economics
Economics is a science which deals with the unlimited wants and limited resources. Making choices in the face of scarcity. If things were not limited, there would not have been subject like economics Limited resources imply scarcity and unlimited wants lead to the problem of choice. Scarcity implies that, at any given point of time, an individual, organisation or a country can not have everything in any quantity that is desired. So the problem of economics is to make a choice efficiently so that use of resources is minimised and the satisfaction is maximised.

Contd
Economic system allocates scarce resources across the competing uses, combining and processing these resources to produce goods and services. It determines what to produce, how much to produce. It arranges for distribution of goods., provides for future growth.

Contd
Allocation problems, scarcity, choice Proper combination how much for each category Distribution who should get? Growth different engines of growth

Production Possibility Curve

At any given point of time, the resources available to an economy size of working population, land, building, machinery are all given. So if more resources are used for one sector, less will be available for the other sectors. So a combination of goods and services has to be decided for an economy.

Production Possibility curve

Production Possibility Frontier

It is based on the famous gun-butter paradox Concepts of scarcity, choice and efficiency can be well understood with the help of PPF In PPF, guns represent military goods and butter represents civilian goods. PPF slopes downwards which reflects scarcity of resources. To get more guns, society has to sacrifice butter PPF is concave to the origin indicating the increasing relative cost of transferring resources from one sector to another.

Production Possibility Frontier

With given resources, country can produce either more of butter or of guns.(B or C) Pt. A indicates inefficiency Pt. E is unattainable with the given resources Movement from ppf0 to ppf1 indicates expansion of resources

Application of PPC
Central problems of economy what, how, for whom During 2002-03 India produced 23.2 million tonnes of potato. This was partly influenced by how much land is used to raise a particular crop, which is a consequence of govt. policy and individuals choice What method to be used is also a problem of choice. Electricity can be produced with hydro, coal or nuclear power. Agriculture can be done by labour intensive or capital intensive method. Who earns how much is also a choice problem for the economy. Computer engineers earn more than the historians, teachers in US earn more than the teachers in India. This is an issue related to the distribution of wealth and income in the economy.

Economic Analysis
Comparative Statics
begin with an initial equilibrium position - the starting point change something identify the new equilibrium, e.g.: in neo-classical model of the firm
When demand increases? When costs rise? When a fixed cost increases?

This is the main purpose of the model -what it was designed to do

Normative prescriptions
it will cost me $30 per unit to supply something which will give me $20 per unit in revenue- should I do it? I must pay $20 billion to set up in my industry. Should I charge higher prices to get that money back?

Positive and Normative are linked by if? IF the aim of the firm is to maximise profit what will it do/what should it do?

Basic economic systems

In market economy, 3 fundamental problems are solved by market. The forces of demand and supply determine what, how much and for whom to produce In centrally planned economic system, these problems are solved by the state or government.

Approaches to the study of Economics

Micro economics refers to the analysis of scarcity and choices problem faced by single economic unit such as firm, producer, industry. It assumes the things to be constant other than the part of a system under study. Macro economics deals with the behaviour of aggregates such as Gross Domestic Product, employment and inflation rate. It focuses on the form and functioning of the economy as an aggregate system

Distinction between micro and macro economics

Microeconomics Deals with choices of individuals Aggregates arising out of individual choices are considered Eg. total demand for oranges Relative prices play imp role response of consumers & producers to change in relative prices is considered Macroeconomics Deals with economic aggregates Aggregate of heterogeneous goods is considered Gross National Product Aggregate prices are important like price level which combines prices of heterogeneous goods

Subject matter
Microeconomics product pricing theory of demand factor pricing theory of distribution economic welfare
Macroeconomics unemployment inflation poverty depression underdevelopment

Why should a manager study micro-economics?

To get a technical help in making optimal and rational economic decisions Profit decisions of a firm can be evaluated through economic theory Profits are functionally related to sales and revenue which in turn depend on demand Demand decisions are followed by production and supply. Price-supply decisions depend on the market structure Thus, various types of economic decisions taken by a manager can be evaluated through microeconomic analysis.

Contd..
Both the markets work on the basis of pricing system. So the Price theory is important subject matter of MiE. Role of Govt.- govt affects circular flow by purchasing and producing the goods for public consumption (education, defence, etc). Through taxes it can redistribute the income. Also consumption of some of the goods can be influenced thru commodity tax.

How to solve basic economic problems?

For the academic economist: to understand, to make predictions about firms behavior The positive approach to theory: What is? For the businessperson: to assist decision-making, to provide decision-rules which can be applied The normative approach to theory: What should be? These purposes are different, they can lead to misunderstanding, and economists are not always honest about the limitations of their approach for practical purposes.

What are these Limitations?

If the aim is prediction, unrealistic assumptions are acceptable and may be needed;
for instance, the firm may be assumed to behave as if its managers had perfect knowledge of its environment

If the aim is to produce decision-rules which can be applied by practising managers, unrealistic assumptions will produce decision-rules which are not operational
for instance, set output and price by MC=MR

How Can Managerial Economics Assist Decision-Making?

1. Adopt a general perspective, not a sample of one

2. Simple models provide stepping stone to more complexity and realism

3. Thinking logically has value itself and can expose sloppy thinking

Role of a Managerial Economist in India

Forecasting for demand and supply. Production planning at macro and micro levels. Capacity planning and product-mix determination. Economics of various productions lines. Economic feasibility of new production lines/processes and projects. Assistance in preparation of overall development plans. Preparation of periodical economic reports bearing on various matters such as the companys product-lines, future growth opportunities, market pricing situation, Preparing briefs, speeches, articles and papers for top management for various Chambers, Committees, Seminars, Conferences, etc. Keeping management informed on various national and international developments on economic/industrial matters.

Exercise I
Classify the following as topics of micro or macro A firms decision about how much income to save Effect of govt. regulation on auto emission Impact of higher national savings on economic growth Firms policy of hiring and firing workers National policy on Minimum wages Globalization for raising economic growth rate