Introduction to Economic Analysis Presented by Professor Sanchita Som

Introduction to Economics The Science of Economics is made for the benefit and development of the world.  - Kautilya Chanakya

The Economic Problem Unlimited Wants Scarce Resources – Land, Labour, Capital, ….. Resource Use Choices

Economic Problems The problem of choice making arising out of limited means and unlimited wants is called economic problem. Why do economic problems arise? Unlimited wants Different priorities Limited means Means having alternative uses. Multiplicity of want

Types of Resources Land: naturally occurring resources whose supply is inherently fixed (i.e., does not respond to changes in price) Labor: the physical work that is needed to make the products or provide the services. Capital: the machines that are used to produce the products. Entrepreneurial Talent: the bright ideas that people contribute to making or improving the goods and services.

Economic Problems

The Economic Problem What goods and services should an economy produce? – should the emphasis be on agriculture, manufacturing or services, should it be on sport and leisure or housing? How should goods and services be produced? – labour intensive, land intensive, capital intensive? Efficiency? Who should get the goods and services produced? – even distribution? more for the rich? for those who work hard?

What is Economics? Oikonomous – ‘one who manage household’ Economics is the study of how societies use scarce resources to produce valuable commodities and distribute them among different people.

Objectives To understand the subject matter & the essence of Economics and Managerial Decision-Making Managerial Economics : It refers to the application of economic theory & the tools of analysis of decision science to examine how an organisations can achieve its aims or objectives most efficiently. It studies the economic aspects of managerial decision making

Managers’ Objectives Maximizing the value of the firm (Through profit maximization) Alternative objectives: =>Market share maximization =>Growth Maximization =>Maximizing their own benefits

Economic Conditions Market Conditions Factor Prices Managerial Problems Managerial Decision Company’s Performance Market Conditions

Why do we study Economics? You are the manager of your own business firm. For taking any decision for your firm what variables should you consider?

Why do we study Economics? To Learn a Way of Thinking To Understand the Society To Understand Global Affairs To Be An Informed Voter

To Learn a Way of Thinking Opportunity Cost Marginalism Sunk Cost Efficient Market

Opportunity Cost Definition – the cost expressed in terms of the next best alternative sacrificed When a particular alternative is chosen from a set of alternatives it implies sacrificing the other alternatives The cost of the forgone alternatives is the opportunity cost of the decision Helps us view the true cost of decision making Implies valuing different choices Example : Firm purchases a new piece of equipment for Rs.10,0000 to generate more profit, this amount could have been deposited in an interest- earning account.

Marginalism It should not be confused with average. Definition : The process of analysing the additional or incremental costs or benefits arising from a choice or decision It should not be confused with average. Example : Marginal labour unit  Marginal output of labour , Marginal revenue  Additional unit sold

Sunk Cost Definition : Costs that can not be avoided, regardless of what is done in the future, because they have already been incurred Example : For an airplane that is about to take off with empty seats,the marginal costs of an extra passenger is zero, but giving a big discount for few seats will be profitable

Efficient Market Definition : A market in which profit opportunities are eliminated almost instantaneously

Why do we study Economics? Economic knowledge serves us in managing our personal lives, in understanding society and in improving the world around us. The ways that economics can help us individually will be as different as are our personal lives.

Why do we study Economics? Learning about stock market may help people manage their own finances. Better awareness of the determinants of cost and revenue will produce better business decisions. The doctor, the investor and the farmer all need to know about profit from their businesses.

Scope of Economics: Micro Economics The study of how households and firm make decisions and how they interact in specific markets Examples: impact of foreign competition on the Indian automobile industry

Scope of Economics: Macro Economics The study of economy-wide phenomena Examples: the effect of borrowing by the Indian government, When politicians talk about “the economy” being in recession they are talking about Macroeconomics.

Ex : The Govt. should raise the minimum wage Methods of Economics Positive Economics Purely descriptive statements or scientific predictions; “If A, then B,” a statement of what is (attempts to describe the world as it is ) Ex : Minimum wage law cause unemployment Normative Economics Analysis involving value judgments; relates to whether things are good or bad, a statement of what ought to be (attempts to prescribe how the world should be) Ex : The Govt. should raise the minimum wage

Descriptive Economics and Economics Theory The compilation of data that describe phenomena and facts Ex : Economic survey of India publish many data related to economics Economic Theory A statement or set of related statements about cause and effect ,action and reaction Ex : The Law of Demand ,Law of Supply

Theories and Models A model is a formal statement of a theory, usually a mathematical statement of a presumed relationship between two or more values Variable is a measure that can change from time to time or from observation to observation Ceteris Paribus / all else equal : A device used to analyse the relationship between two variables while the values of other variables are held unchanged

Pitfalls in Economic Reasoning In all areas of economics, old and new, certain pitfalls lie in the path of the serious economist. Falling to keep “others Things Equal” The Post Hoc Fallacy Fallacy of Composition

others Things Equal several forces interacting at the same. Most of economic problems involve several forces interacting at the same. E.g.: the number of cars bought in a given year is determined by the price of cars, consumer incomes, gasoline prices etc. How can we isolate the impact on car sales of a single variable such as the price of gasoline.

The Post Hoc Fallacy A common mistake in studies of cause-and-effect relationships is the Post Hoc Fallacy. E.g.: Dr. Optimist’s observation is that after the Govt. has cut tax rates, the Govt.s total tax revenues began to rise. Dr.Optimist then claims “Aha, if we lower the tax rates, we will rise revenues and reduce the budget deficit.”

The Post Hoc Fallacy Dr.Optimist fallacy was to assume that the tax cut was responsible for the increase in Govt.s revenues; overlooked was the fact that the growing economy was raising people’s income and might have increased tax revenues even more had taxes not been cut.

The Fallacy of Composition The erroneous belief that what is true for a part is necessarily true for the whole Example : Increasing saving is obviously good for an individual, since it provides for retirement or a "rainy day," but if everyone saves more, it may cause a recession by reducing consumer demand.

Economic Policy Efficiency : An efficient economy is one that produces what people want at the least possible cost Equity : It is a concept or idea of fairness in Economics Economic Growth : A sustainable rise in per Capita Income overtime Stability : A condition in which national output is growing steadily , with low inflation and full employment of resources

The Circular-Flow Diagram Spending Revenue Market for Goods and Services Goods & Services sold Goods & Services bought Firms Households Wages, rent, interest and profit Income Labor, land, and capital Inputs for production Market for Factors of Production 7

COMBINATION CLOTH STEEL A 18 B 1 17 C 2 15 D 3 12 E 4 7 F 5 (METER) (TON) A 18 B 1 17 C 2 15 D 3 12 E 4 7 F 5

OPPORTUNITY COST OF CLOTHS (TONS OF STEEL) COMBINATION CLOTH (METER) STEEL (TON) OPPORTUNITY COST OF CLOTHS (TONS OF STEEL) A 18 B 1 17 C 2 15 D 3 12 E 4 7 5 F

PRODUCTION POSSIBILITY FRONTIER A graph that shows all the combination of goods and services that can be produced if all of society's resources are used efficiently - P.P.F. Slope = Marginal rate of Transformation Law of Increasing Opportunity Cost

Alternative Economic System

General Equilibrium A General equilibrium is defined as a situation in which all markets and all decision making units are simultaneously in equilibrium and each market is interrelated.

Theories of International Trade Absolute Advantage : A producer has an absolute advantage over another in the production of a good or services if it can produce the same amount of output with less input relative to other countries. Comparative Advantage : A producer has a comparative advantage over another in the production of a good or services if it can produce that product at a lower opportunity cost

Theory of Absolute Advantage Country Commodity A B Country 1 80 100 Country 2 120 90

Theory of Comparative Advantage Country Commodity A B Country 1 80 90 Country 2 120 100

`Laissez-Faire Economics An economy in which individual people and firms pursue their own self interests without any central direction or regulation

1. Case and Fair, Principles of Economics, 8e, Pearson Education Reference 1.   Case and Fair, Principles of Economics, 8e, Pearson Education   2. N. Gregory Mankiw, Principles of Economics, 4e,Thomson 3.       Lipsey and Chrystal, Economics, 10e (2003), Oxford University Press 4.       Brue and McConnell, Essentials of Economics, 2007, Tata McGraw Hill 5.Dominik Salvatore, Managerial Economics in a Global Economy, 4e, Thomson South-Western

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