SUBJECT: MANAGERIAL ECONOMICS

MODULE 1 : BASIC CONCEPTS AND PRINCIPLES

OBJECTIVES:

1. Introduce key economics and assumptions of economics

2. Know the basic difference bet. Microeconomics and macroeconomics
3. Analyze how decisions are made about what, how and for whom to produce.
4. Discuss the scope of managerial economics and its relationship with various other disciplines and
functional areas

SESSION 1

Economics is defined as the social science that deals with the production, distribution, and consumption
of goods and services. Evolved in the 19th century, the economic studies have become one of the most
significant studies of modern days. From a small shop to a country, Economics plays a crucial role in the
efficient running of both. No business can flourish without applying the principles of economics. The study
of economics is extensive and varied. The nature and scope of economics depend upon the interaction of
economic agents and how economies work. Let’s analyze the nature and scope of economics deeply.

Nature of Economics:
The nature of economics deals with the question that whether economics falls into the category of science
or arts. Various economists have given their arguments in favour of science while others have their
reservations for arts.

Economics as a Science

To consider anything as a science, first, we should know what science is all about? Science deals with
systematic studies that signify the cause and effect relationship. In science, facts and figures are collected
and are analyzed systematically to arrive at any certain conclusion. For these attributes, economics can
be considered as a science. However, economics is treated as a social science because of the following
features:

▪ It involves a systematic collection of facts and figures.

▪ Like in science, it is based on the formulation of theories and laws.

▪ It deals with the cause and effect relationship.

These points validate that the nature of economics is correlated with science. Just as in science, various
economic theories are also based on logical reasoning.

Economics as an Art

It is said that “knowledge is science, action is art.” Economic theories are used to solve various economic
problems in society. Thus, it can be inferred that besides being a social science, economics is also an art.

Activity ___

Make your own definition of economics based on your understanding

Basic Assumptions:
Economic assumptions are assumptions that a company makes about the general market environment.
Specifically, the environment it plans to operate in during the period of its financial plan. Companies make
economic assumptions regarding the upcoming state of the economy, i.e., the marketplace. Businesses
try to predict what the business environment will be like and how it will affect their ability to generate
profits.

Economists also make economic assumptions when they build economic models. Sometimes they make
economic assumptions regarding levels of competition or marketing. They may also make assumptions
about substitute goods.

Many economic models assume that the players in the marketplace have perfect information regarding
their choices. Others may even assume that we can measure subjective human values quantitatively.

In this context, the word ‘marketplace‘ refers to ‘market‘ in its abstract sense.

Without economic assumptions, economists would not be able to produce quantitative economic models
with meaningful conclusions.

Economic Assumptions

Company executives, economists, and statisticians frequently make economic assumptions.

Economic assumptions – two definitions

Below are two definitions of the term; one from a company’s and the other from an economist’s point of
view:
Company’s viewpoint

This definition, from BusinessEnglish.com, explains economic assumptions from a company’s viewpoint:

“The set of assumptions that a firm will make about the upcoming economic situation.”

Economist’s viewpoint

This definition, which Mike Moffatt writes in ThoughtCo.com, explains the meaning of the term from an
economist’s viewpoint:

“A basic assumption of economics begins with the combination of unlimited wants and limited resources.”

“All of economics, including microeconomics and macroeconomics, comes back to this basic assumption
that we have limited resources to satisfy our preferences and unlimited wants.”

Economic assumptions
Scarcity

Scarcity or paucity refers to limitation. Raw materials, components, goods, and other supplies are limited.
However, we exist in an environment with unlimited human wants.

This is one of economics’ fundamental problems, i.e., having limitless human wants in a market where
resources that are not limitless.

Trade-off

If our wants are limitless but scarcity exists, we cannot satisfy all our wants. Therefore, we must make
choices. When we chose one thing, we are subsequently trading it for something else. In other words,
every choice has a cost, i.e., a trade-off. When we chose something, we also wonder what we will have to
give up. We call this determining what the opportunity cost is.

In other words, first, we ask ourselves: “If I choose this, what will I have to give up?” Then, we can
determine whether we are better off with our choice.

Self-interest

Our goal is to make a choice that maximizes our satisfaction. In other words, we all act in our own self-
interest

Rational Behavior

Rational behavior refers to a decision-making process that is based on making choices that result in the
optimal level of benefit or utility for an individual. The assumption of rational behavior implies that people
would rather take actions that benefit them versus actions that are neutral or harm them. Most classical
economic theories are based on the assumption that all individuals taking part in an activity are behaving
rationally.

Ceteris Paribus

Ceteris paribus, literally "holding other things constant," is a Latin phrase that is commonly translated into
English as "all else being equal." A dominant assumption in mainstream economic thinking, it acts as a
shorthand indication of the effect of one economic variable on another, provided all other variables
remain the same.

Costs and benefits

We all make decisions by comparing the cost and benefits of things. Whenever we make a choice, we
compare the choice’s marginal costs against its marginal benefits. In other words, we perform a cost-
benefit analysis or benefit-cost analysis. This analysis is a type of economic analysis.

Scope of Economics:
Economists use different economic theories to solve various economic problems in society. Its
applicability is very vast. From a small organization to a multinational firm, economic laws come into play.
The scope of economics can be understood under two subheads: Microeconomics and Macroeconomics.
Let’s discuss these in detail:

Microeconomics

Microeconomics examines individual economic activity, industries, and their interaction. It has the
following characteristics:
▪ Elasticity: It determines the ratio of change in the proportion of one variable to another variable. For
example- the income elasticity of demand, the price elasticity of demand, the price elasticity of supply,
etc.
▪ Theory of Production: It involves an efficient conversion of input into output. For example- packaging,
shipping, storing, and manufacturing.
▪ Cost of Production: With the help of this theory, the object price is evaluated by the price of resources.
▪ Monopoly: Under this theory, the dominance of a single entity is studied in a particular field.
▪ Oligopoly: It corresponds to the dominance of small entities in a market.

Macroeconomics

It is the study of an economy as a whole. It explains broad aggregates and their interactions “top down.”
Macroeconomics has the following characteristics:

▪ Growth: It studies the factors which explain economic growth such as the increase in output per
capita of a country over a long period of time.
▪ Business Cycle: This theory emerged after the Great Depression of the 1930s. It advocates the
involvement of the central bank and the government to formulate monetary and fiscal policies to
monitor the output over the business cycle.
▪ Unemployment: It is measured by the unemployment rate. It is caused by various factors like rising
in wages, a shortfall in vacancies, and more.
▪ Inflation and Deflation: Inflation corresponds to an increase in the price of a commodity, while
deflation corresponds to a decrease in the price of a commodity. These indicators are valuable to
evaluate the status of the economy of a country.

Positive And Normative Economics:

Positive Economics
Positive economics is a stream of economics that focuses on the description, quantification, and
explanation of economic developments, expectations, and associated phenomena. It relies on objective
data analysis, relevant facts, and associated figures. It attempts to establish any cause-and-effect
relationships or behavioral associations which can help ascertain and test the development of economics
theories.

Positive economics is objective and fact-based where the statements are precise, descriptive, and clearly
measurable. These statements can be measured against tangible evidence or historical instances. There
are no instances of approval-disapproval in positive economics.

Here's an example of a positive economic statement: "Government-provided healthcare increases public

expenditures." This statement is fact-based and has no value judgment attached to it. Its validity can be
proven (or disproven) by studying healthcare spending where governments provide healthcare.

Normative Economics
Normative economics focuses on the ideological, opinion-oriented, prescriptive, value judgments, and
"what should be" statements aimed toward economic development, investment projects, and scenarios.
Its goal is to summarize people's desirability (or the lack thereof) to various economic developments,
situations, and programs by asking or quoting what should happen or what ought to be.

Normative economics is subjective and value-based, originating from personal perspectives, feelings, or
opinions involved in the decision-making process. Normative economics statements are rigid and
prescriptive in nature. Thy often sound political or authoritarian, which is why this economic branch is
also called "what should be" or "what ought to be" economics.

An example of a normative economic statement is: "The government should provide basic healthcare to
all citizens." As you can deduce from this statement, it is value-based, rooted in personal perspective, and
satisfies the requirement of what "should" be.
Basic Economic Problem

• The fundamental economic problem is the issue of scarcity and how best to produce and distribute
these scare resources.
• Scarcity means there is a finite supply of goods and raw materials.
• Finite resources mean they are limited and can run out.
• Unlimited wants mean that there is no end to the quantity of goods and services people would like
to consume.
• Because of unlimited wants – People would like to consume more than it is possible to produce
(scarcity)

Therefore because of scarcity, economics is concerned with:

• What to produce?
• How to produce?
• For whom?