What is Economics?

Economics studies how individuals and

societies seek to satisfy needs and wants
through incentives, choices, and allocation
of scarce resources.
Technolo
gy Land
Oil & fuel

Doctor
s
 Defining Economics
 Resources
– Things used to produce other things to satisfy
people’s wants

 Wants
– What people would buy if their incomes were
unlimited
 Defining Economics
 With limited income (resources),
people must make choices to satisfy their
wants.
 We never have enough of everything,
including time, to satisfy our every desire.
 Defining Economics
 Individuals, businesses, and nations face
alternatives, and choices must be made.
 Economics studies how these choices are
made.
 Definition of Economics
Adam Smith (1776)
defined what was then called
political economy as
"an inquiry into the nature and causes of the
wealth of nations“
 Definition of Economics
Alfred Marshall
“Economics is a study of man in the ordinary
business of life. It enquires how he gets his
income and how he uses it. Thus, it is on the
one side, the study of wealth and on the
other and more important side, a part of the
study of man.”
 Definition of Economics
Robbins
Economics is a science which studies
human behaviour as a relationship between
ends and scarce means which have
alternative uses.
 Focus of Economy
 The economic problem –
“ the problem of having needs and unlimited wants, but
limited resources “
– that underlies the definition of economics
 The types of reasoning and investigative methods that
economists use
 The production choices an entire economy faces
 The three basic economic questions and how various
economic systems answer them
 Factors of Production
 Economic Resources
– Natural Resources – raw materials found in nature that are used
to produce goods
– Human Resources – people’s knowledge, efforts, and skills
used in their work
– Capital Resources – used to produce goods and services
(buildings, materials, and equipment)
– Entrepreneurial Resources - recognize the need for new goods
or service
 Scarcity – shortage of resources
Situation in which the amount of something available
is insufficient to satisfy the desire for it
 The economic problem
Basic economic questions
– What to produce?
– How to produce?
– For whom to produce?

11
 Scarcity and Economics
 Problems studied in economics: the scarcity
of resources—and the choices it forces us to
make
– Households – have limited income to allocate
among goods and services
– Firms – production is limited by costs of
production
– Government agencies – the budget is limited,
so goals must be carefully chosen
 Scarcity and Economics
 Economists study the decisions made by
households, firms, and governments to

– Explain how our economic system operates

– Forecast the future of our economy,
– Suggest ways to make that future even better
 Microeconomics
 Micro comes from the Greek word mikros,
meaning “small”
 Studies the behavior of individual
households, firms, and governments
– Choices they make
– Interaction in specific markets
 Focuses on individual parts of an economy
Macroeconomics vs. Microeconomics
 Microeconomics focuses on how decisions are made
by individuals and firms and the consequences of those
decisions.
Ex.: How much it would cost for a university or
college to offer a new course ─ the cost of the
instructor’s salary, the classroom facilities, the class
materials, and so on.
Having determined the cost, the school can then
decide whether or not to offer the course by weighing
the costs and benefits.
 Macroeconomics
 Macro comes from the Greek word makros,
meaning “large”
 Studies the behavior of the overall economy
 Focuses on big picture and ignores fine
details
Macroeconomics vs. Microeconomics
 Macroeconomics examines the aggregate
behavior of the economy (i.e. how the actions of all
the individuals and firms in the economy interact to
produce a particular level of economic performance
as a whole).
Ex.: Overall level of prices in the economy
(how high or how low they are relative to prices
last year) rather than the price of a particular
good or service.
 Macroeconomics vs. Microeconomics

MICROECONOMIC MACROECONOMIC
QUESTION QUESTION
Go to business school or How many people are
take a job? employed in the economy
as a whole?
What determines the What determines the
salary offered by Citibank overall salary levels paid
to Mr X management to workers in a given
trainees? year?
Macroeconomics vs. Microeconomics
MICROECONOMIC QUESTION MACROECONOMIC
QUESTION
What determines the cost to a What determines the overall level
university or college of offering a of prices in the economy as a
new course? whole?
What government policies should What government policies should
be adopted to make it easier for be adopted to promote full
low-income students to attend employment and growth in the
college? economy as a whole?
What determines whether Citibank What determines the overall trade
opens a new office in Shanghai? in goods, services and financial
assets between the US and the rest
of the world?
 Four Principal Ways that Macroeconomics
Differs from Microeconomics:

1.In macroeconomics, the behavior of the whole

macro economy is, indeed, greater than the
sum of individual actions and market outcomes.
2.Macroeconomics is widely viewed as providing
a rationale for continual government
intervention to manage short-term fluctuations
and adverse events in the economy.
 monetary policy
 fiscal policy
3.Macroeconomics is the study of long-run
growth: What factors lead to a higher long-
run growth rate? And are there government
policies capable of increasing the long-run
growth rate?
4.The theory and policy implementation focus
on economic aggregates -- economic
measures that summarize data across many
different markets for goods, services,
workers, and assets.
 Positive and Normative
Economics
 Positive economics: how the economy works
– Can be true or false
– Can be tested by looking at the facts
 Normative economics: what should be
– Value judgments, identify problems, and prescribe
solutions
– Cannot be proved or disproved by the facts alone
 Nature of Managerial
Economics

 Essentially microeconomic in nature

 Pragmatic in nature
 Belongs to normative economics
 Problem solving in nature
 Scope of Managerial
Economics
 Demand Estimation, Elasticity & Forecasting
 Production function & cost analysis
 Pricing & output determination in different market
structures
 Profit planning & management
 Capital budgeting & management
 Break –even analysis
 Linear programming
Basic Assumptions
 Ceteris Paribus
 Latin phrase
 “With other things (being) the same” or
“all other things being equal”.
 Rationality
 Consumers maximize utility subject to
given money income.
 Producers maximize profit subject to given resources
or minimize cost subject to target return.
 Types of Economic Analysis
 Micro and Macro
 Microeconomics (“micro” meaning small): study
of the behaviour of small economic units
 
An individual consumer, a seller/ a
producer/ a firm, or a product.
 
Focus on basic theories of supply and demand
in individual markets
 Macroeconomics (“macro” meaning large):
study of aggregates.
 Industry as a unit, and not the firm.
 Focus on aggregate demand and aggregate
supply, national income, employment, inflation,
etc.
 Types of Economic Analysis

 Positive and Normative

Positive economics: “what is” in economic matters
 Establishes a cause and effect between
relationship variables.
 Analyzes problems on the basis of facts.
 Normative economics: “what ought to be” in
economic matters.
Concerned with questions involving value judgments.


 Incorporates value judgments about what the

economy
should be like.
 Types of Economic Analysis
contd..
 Short Run and Long Run
Short run: Time period not enough for consumers and
producers to adjust completely to any new situation.
 Some inputs are fixed and others are variable

 Long run: Time period long enough for consumers and

producers to adjust to any new situation.
 All inputs are variable

 Decisions to adjust capacity, to introduce a larger

plant or continue with the existing one, to change

product lines.
 Types of Economic
Analysis

 Partial and General Equilibrium
 Partial equilibrium analysis: Related to micro analysis
 Studies the outcome of any
policy action in a single market only.
 Equilibrium of one firm or few
firms and not necessarily the industry
or economy.
 General equilibrium: explains economic
phenomena in an economy as a whole.
 State in which all the industries in an economy
are in equilibrium.
 State of full employment
 Economic Principles
Relevant to Managerial
Decisions

30
 Economic Principles

Opportunity Cost
Marginal Principle and Decision Rule
Incremental Principle and Decision Rule
Contribution Analysis
The Equi-Marginal Principle
Time perspective in Business decision 31
1. The Opportunity Cost
• The cost involved in any decision
consists of the sacrifices of
alternatives required by that decision.

• The opportunity cost of a choice is the

value of the alternative forgone.

• Expresses basic relationship between

‘scarcity’ and ‘choice’
 Expected Revenues from
Investment Options

Option 1

Option 2
Option 3

220 M
18 M
16 M

Expansio New Buying Shares

n Production in
Unit another firm
 Expected Revenues from
Investment Options

To achieve
option 1, Option
Option
2 becomes the
1
OPPORTUNITY
Option 2 COST
Option 3

20
M 18
M 16
M

Expansio New Buying Shares

n Production in another
Unit firm
 The difference between
actual earning and its
opportunity cost is called
economic gain/profit

16
M

Expansio New Buying Shares

n Production in another
Unit firm
Parameters
• Opportunity costs are not restricted to
monetary or financial costs

• Other aspects such as pleasure, time lost

and output forgone are considered too

• For example, Appointing a new manager

in the business
Appointing a new Manager
Option A Option B
• Promotion of an internal • Appointing a new
employee to a managerial employee with the
position with experience required qualification
but without qualification

• the opportunity cost for • The opportunity cost for

promoting an internal recruiting a new
employee to a managerial employee is the
post is the lack of experience and
required qualification commitment of the
present internal
employee towards the
business
 2. Marginal
Principle
• Widely used term in Economics

• The term ‘Marginal’ refers to the change

in total quantity or value due to one-unit
change in its determinant

• This could be an increasing or a

decreasing change
Elements of Marginal Principle
• Total Cost of Production (TCn)
• Total Revenue (TRn)
• Marginal Cost (MC)
• Marginal Revenue (MR)
• Total Cost for producing an additional
unit of the commodity (TCn-1)
• Total Revenue by selling an additional
unit of the commodity (TRn-1)
• Total Cost of Production (TCn)
- The total cost of production of a
commodity depends on the number of
units produced. example, if 300 units are
produced at Rs.20 each then the Total
Cost amounts to Rs.6000

• Total Revenue (TRn)

- The total revenue of the firm depends on
the total number of units it sells.
example, 300 units sold at Rs.35 each
amounts to a Total Revenue of Rs.10,500
• Marginal Cost (MC)
- The marginal cost is the change in the
total cost as a result in producing an
additional unit. example, Total cost of
producing 300 units is Rs.6000 and the
total cost of producing an additional
unit is 6020.
[ MC = TCn – TCn-1 ]
MC = 6020 – 6000
MC = 20
• Marginal Revenue
- The Marginal revenue is the revenue
collected due to a sale of an additional
unit.
Example, Total Revenue earned by selling
350 units is Rs.10,500 and the Total
revenue earned by selling and additional
unit is 10,535
[ MR = TRn – TRn-1 ]
MR = 10535 – 10500
MR = 35
2. The concept of ‘Marginal’ value, when
used in cost analysis, reduces the
value of MC to the change in variable
cost only. Therefore, marginal
analysis can only be applied to a
situation in which only the variable
cost changes
3. Incremental Principle
• Incremental principle is the opposite of marginal
principle

• Incremental principle is applied to business

decision that involves bulk production and
constant change in total cost and the total
revenue

• Data is easily available

• Combination of fixed and variable cost

Elements of Incremental Principle
• Incremental Cost

- The total change in cost is called the

incremental cost

- Incremental cost can be defined as the

cost that arises due to a business
decision
Incremental Cost

Current Production Cost 100 M

Incremental Cost

New Production Cost 115 M

Incremental Cost

100 M 15 M

15 Million is the Incremental

cost
Elements of Incremental Principle
• Incremental Revenue

- When a business decision is successfully

implemented, it results in a significant
increase in the total revenue

- This increase in the revenue is termed as

incremental revenue
Incremental Revenue

Current Revenue 130 M

Incremental Revenue

Revenue after successful implementation

of Incremental cost - 150 M
Incremental Revenue

130 M 20 M

20 Million is the
Incremental revenue
Incremental Reasoning

• Conclusions based on incremental

concept (Incremental Cost +
Incremental Revenue) in business
decision is termed as Incremental
reasoning

• Incremental Reasoning is used in

accepting or rejecting a business
proposition
Incremental Reasoning for
setting up a new plant
Incremental Reasoning
Incremental Incremental Excess Incremental
Revenue Cost revenue

20 M 15 M 5M

5 million/15 million = 33.33 % gross profit on

investment

According to the incremental reasoning the firm should

immediately accept the proposition
4. Contribution Analysis

• The analysis of a business decision

between Incremental Revenue and
Incremental Cost

• Generally applied to analyze the

contribution made by overheads costs
and revenue
It is a useful technique for taking
business decision on:

•Whether or not to accept a project ?

•Whether or not to introduce a new
product ?
•Whether or not to accept a new
order ?
•Whether or not to add an additional
plant ?
•Whether to make or buy ?
 Costs taken into consideration
for Contribution Analysis
• Incremental Costs
i. Present Explicit Costs
a.Explicit variable costs
. Direct labour cost
. Direct material cost
. Direct variable overheads

b.Fixed Costs
. New additional equipment
. New additional personnel
ii. Opportunity Cost

iii.Future Incremental
Costs
. Depreciation
. Reserves
. Advertising
 Revenues taken into
consideration for Contribution
Analysis
Incremental Revenues

i.Present Explicit Revenue

ii.Possible Opportunity
Revenue

iii.Possible future revenue

5. The Equi-Marginal Principle
• Allocation of available resources
amongst the alternative activities

• An input should be so allocated that

the value added by the last unit is the
same in all cases

• Goal of maximizing profits

Consumer point of view
Every commodity will have different utility
for different consumer.

The consumer will want to purchase both

commodities and will want to reap highest
possible marginal utility

This is possible when the consumer

complies his purchase of commodities in a
way that gives maximum value
Example
Units Marginal utility of Marginal Utility
Apples of Oranges
1 10 8
2 8 6
3 6 4
4 4 2
5 2 0
6 0 -2
7 -2 -4
8 -4 -6
Business point of view
• When a business intends to start a new
project and get and faces problems of
resource allocation between its
alternatives

• Equi-Marginal principle helps in

deciding how much resources to
allocate in which project by studying
the marginal utility of each project.
Units of Marginal
expenditure Productivity
(Rs. 10 Million) Project A Project B Project
C
1st 50 40 35

45 30 30
2n
d
35 20 20
20 10 15
3rd
10 0 12
4th

5th
6. Time Perspective
• All business decision are taken within a
certain time limit

• Time perspective
i. Short run
ii.Long run

• Determination of time perspective is of

great significance specially where
projects are involved
• Short Run
A decision to buy explosive
materials for manufacturing
crackers involves short run
demand prospect

• Long Run
Spending on labor welfare.
i. Will result in expense initially
ii.Will increase productivity in
long run
Production Possibilities Curve
Shows the different combinations of the quantities of two
 goods that can be produced (or consumed) in an
economy at any point of time.
Depicts the trade off between any two items produced
 (or consumed).
Highlights the concepts of scarcity and opportunity cost

 Indicates the opportunity cost of increasing one item's
production (or consumption) in terms of the units of the other
forgone
 Slope of the curve in absolute terms
Assumptions

 The economy is operating at full employment.
 Factors of production are fixed in supply; they can however
be reallocated among different uses.
 Technology remains the same.
Production Possibilities Curve
Contd…

Food

Technically
P Infeasible Area
FP

FQ Q

Productively
Inefficient Area

O
CP Clothing

CQ
 Production Possibilities Curve
Contd…

 All points on the PPC (like P and Q) are points of

maximum productive efficiency.
 In the figure, OFp of food and OCp of clothing can be
produced at Point P and OFQ of food and OCQ respectively
at point Q, when production is run efficiently.
 All points inside the frontier are feasible but productively
inefficient.
 All points to the right of (or above) the curve are
technically impossible (or cannot be sustained for long).
 A move from P to Q indicates an increase in the units of
clothing produced and vice versa.
 It also implies a decrease in the units of food produced.
This decrease in the units of food is the opportunity cost
of producing more clothing.
 Thank
You…….