Introduction

Principles of
Economics

Faculty of Business and Economics, The IIPM, New Delhi

 Fundamentals of Economics

“The Age of Chivalry is gone;

that of sophisters,
economists, and calculators
has succeeded. ”
---Edmund Burke

Faculty of Business and Economics (FBE), The IIPM, New Delhi

 HOW PEOPLE MAKE DECISIONS?

Study of economics starts with 4

principles of individual decision
making:
 People face tradeoffs
 The cost of something is what
you give up to get it.
 Rational people think at the
margin.
 People respond to incentives.

Faculty of Business and Economics (FBE), The IIPM, New Delhi

 # 1: People Face Tradeoffs
“There is no such thing as a free
lunch”
 To get something we like we usually
have to give up something we don’t
like.
 A student and her time:
 Studying vs. napping.
 Society’s tradeoffs:
 Guns vs. Butter
 Clean environment and higher GDP

Faculty of Business and Economics (FBE), The IIPM, New Delhi

 … People Face Tradeoffs
 Society’s tradeoffs (cont’d):
 Efficiency vs. Equity
 Efficiency: Society getting the
most it can from its scarce
resources.
 Equity: Distributing economic
prosperity fairly among the
members of society.

Faculty of Business and Economics (FBE), The IIPM, New Delhi

 # 2: The Cost of Something is
what You Give Up
 Making decisions requires
comparing the costs and benefits
of alternative courses of
actions.
 To go to university or not to go?
 Opportunity cost: Whatever must
be given up to obtain some item.

Faculty of Business and Economics (FBE), The IIPM, New Delhi

 # 3: Rational People Think at
the Margin

 Marginal changes: Small

incremental adjustments to
marginal changes.
 Individuals and firms can make
better decisions by thinking at
the margin.
 By comparing the marginal
benefits (MB) with the
associated marginal costs (MC)
of a decision.
Faculty of Business and Economics (FBE), The IIPM, New Delhi
 # 4: People Respond to
Incentive
• Marginal changes in costs or
benefits motivate people to
respond.
– When the price of apples rise………
…
• The decision to choose one
alternative over another occurs
when that alternative’s marginal
benefits exceed its marginal
costs!

Faculty of Business and Economics (FBE), The IIPM, New Delhi

 Principles of Economics
• Consider leisure, often defined as
“time which one can spend as one
pleases”. Leisure brings out personal
eccentricities. Suppose that, after
satisfying all your obligations, you
have 3 hours a day of free time and
can devote it to gardening, laying
bricks, or writing history. What is
the best way to allocate your time?
Lets’ ignore the possibility that time
spent on some of these activities
might be an investment that will
enhance your earning power in the
future. Rather, assume that these are
all pure consumption or utility-
yielding pursuits.

Faculty of Business and Economics (FBE), The IIPM, New Delhi

 Principles of Economics
• Consider yourself the
marketing President of a Units Asia N.A E.U.
multi-market seller like TCS
which sells software
services in various foreign 1 10 9 8
markets. The marginal
revenues, marked in US $
billion (through sale of 2 9 8 7
software) of TCS are
mentioned in the format. 3 8 7 6
• Work out the revenue
maximizing 4 7 6 5
combination/allocation/behav
iour, wherein TCS plans to
have presence in all these 5 6 5 4
markets and is guided by
that assumption that 6 5 4 3
‘marginal revenue is a
monotonically decreasing
function of selling.’ 7 4 3 2

Faculty of Business and Economics (FBE), The IIPM, New Delhi

 Equi-Marginalism (Relative Activity
Level Principle)
• Multi-market Seller (MR1 = MR2 =
MR3 = MR4 = MRN)
• Multi-plant monopolist (MC1 = MC2
= MC3 = MC4 = MCN)
• Multi-factor employer (MP1 = MP2 =
MP3 = MP4 = MPN)
• Multi-product firm (Mπ1 = Mπ2 =
Mπ3 = Mπ4 = MπN)
• Multi-commodity consumer (MU1 =
MU2 = MU3 = MU4 = MUN)

Faculty of Business and Economics (FBE), The IIPM, New Delhi

 Principles of Economics
Tom Cruise's savings consist of
$10,000 in a savings account that
yields 2% a year interest and
another $10,000 in a money market
fund that pays interest of 5% a
year. Tom Cruise has just received
a gift of $10,000 from his mother.
His bank pays 4% interest on
savings accounts with a minimum
deposit of $20,000.The money market
fund pays 5% interest on
investments up to $100,000.

Faculty of Business and Economics (FBE), The IIPM, New Delhi

 Principles of Economics
• Calculate the average interest rate (= dollar
amount of interest divided by amount of
investment) from the savings account if Tom
Cruise deposits the additional $10,000 in the
savings account and qualifies for the higher
interest rate.
• Calculate the average interest rate if Tom Cruise
deposits the additional $10,000 in the money
market fund.
• Calculate the marginal interest rate (= increase
in dollar amount of interest divided by
additional investment) from the savings account
if Tom Cruise deposits the additional $10,000 in
the savings account.
• Calculate the marginal interest rate if Tom
Cruise deposits the additional $10,000 in the
money market fund.
• From the viewpoint of maximizing his total
interest income, where should Tom Cruise deposit
the additional money?

Faculty of Business and Economics (FBE), The IIPM, New Delhi

 Boundaries of Firm
• General Motors divested Delphi
Automotive Systems, which
manufactures auto components,
systems and modules
• Daimler Chrysler took over the
import and wholesale distribution
of Benz cars in Asia Pacific
• ISP AOL merged with Time Warner,
a producer of films and music,
and provider of cable television
services

Faculty of Business and Economics (FBE), The IIPM, New Delhi

 Organizational Boundaries
• There are two sets of
boundaries
• Vertical Boundaries:
delineate activities closer
to or further from the end
user
• Horizontal Boundaries:
define the scale and scope
of an firm’s operations
Faculty of Business and Economics (FBE), The IIPM, New Delhi
 Summary
• When individuals make decisions,
they face tradeoffs among
alternative goals.
• The cost of any action is measured
in terms of foregone
opportunities.
• Rational people make decisions by
comparing marginal costs and
marginal benefits.
• People change their behavior in
response to the incentives they
face.
Faculty of Business and Economics (FBE), The IIPM, New Delhi