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8/13/2019 Economic Principles and Management Decision Making
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Lecture 3
Economic Principles and
Management Decision Making
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Session Outline
Defining Economics Why is Economics important?
Classifying Economic Systems
Economic Tools to Make Strategic Business
Decisions
Fundamental Concepts of Managerial
Economics
How the Principles of Economics Affect
Decision Making
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What is Economics about?
The study of economics is aboutmuch more than money
Economics provides insight notonly into financial matters, but the
world at large Economics is a powerful tool for
understanding how human beingsbehave
Economics helps peopleunderstand individual, businessand government decisions.
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Definition
Economics is the social science that examines theways in which individuals and entire societies
allocate scarce resources to meet their needs and
wants.
Resources are by nature limited. People do not havethe time, money or materials to do or acquire all of
the things they need and want.
This means individuals, families, companies and
entire nations have to prioritize their needs and
wants, deploying their available resources
accordingly.
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Lord Lionel Robbins
Definition
Economics is a social science which
studies human behaviour as a relationship
between ends and scarce means that
have alternative uses
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Why is Economics
important?
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Benefits
People make economic decisions daily.
Studying economics prepares you to be amore knowledgeable and informedparticipant in the modern economy.
A basic understanding of economics canmake you a smarter consumer, worker andinvestor
This understanding allows the projection of
future economic conditions based oncurrent indications.
News and Current Events
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Other Considerations
Life Decisions Household budgeting etc.
Informed citizens
A knowledge of economics helps a person
become a more knowledgeable participant in thepolitical process.
Nation Building
In building a nation, a national identity must becreated to unify the citizens.
Divide and Rule
Symbols
Cohesion
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Misconceptions
Economics is not solely about money. Thediscipline concerns itself with scarcity andallocation of resources, which haveapplications beyond monetary concerns.
However, economic theory is not foolproofbecause it is a social science based on theinterplay between culture and money.
Economic effects change as culturalcustoms change.
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Resource allocation
Type of resources
Labour (wage)
Land (rent)
Capital (interest)
Entrepreneur (profit)
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Different Ideologies
Social reformism & intervention
Laissez-faire economics
Marxist political economy
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Classifying Economic Systems
Completely Planned SystemAll resources controlled by government
Completely Free (Capitalist) system
All resources controlled by private
sector
Mixed Market SystemResources controlled by both private
and public sectors in varying degrees
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Totally
planned
Economy
N.
Korea
CubaPoland France
UK
USA
Early 1980s
China Hong
Kong
Totally
Free-
market
Economy
Classifying Economic Systems
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Totally
planned
econom
y
N. Korea
N. Korea
Cuba
China
Poland
Poland France
France UK
UKUSA
USA
Early 1980s
Early 2000s
China Hong
Kong
CubaChina
(Hong
Kong)
Totally
Free-
market
economy
Classifying Economic Systems
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Economic Tools to Make
Strategic Business Decisions
Econometric Tools
Economic indicators
Economic Graphs
Shift-share Model
Location Quotient
Economic Base
Technique
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Fundamental Concepts of
Managerial Economics
Microeconomic
Principles
Scarcity, choice andopportunity cost
Production possibility
frontier
Marginal Analysis
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Microeconomics
What to Produce and where
How to Produce
How to Finance the Production
Who will get what is produced -
Distribution
Achieving the three Es Efficiency, Effectiveness and
Equity
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Scarcity and choice
Human wants, e.g. housing, clothing food,transport
Relatively unlimited wants-insatiable
Limited resources, e.g. land & finance Scarcity and need to choose
Choosing among alternatives
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Choice
Rationalise choices Making judgements about relative worth
of alternative resources
Scale of preference Utility-satisfaction from good or resource
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Opportunity cost
Opportunity costs Sacrifice of alternative use
Sacrifice of next best
Real cost measure
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Production possibility curve
Illustrates economic concepts (e.g.scarcity, choice, OC)
Factor combination
Attainable and unattainable output Sacrificing present for future consumption
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Production Possibilities Curve
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Marginal Analysis
Total utility (TU) Marginal utility (MU)
Diminishing Marginal Utility
TU & MU from consuming water
No of Glasses TU MU
1 30 30
2 43 13
3 50 74 54 4
5 54 0
6 49 -5
Figure 1.1: Marginal Utility
-10
-5
0
5
10
15
20
25
30
35
1 2 3 4 5 6
No of Glasses of wa ter
Utils
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Optimal Allocation of Resources
Deciding on conversion of a dual carriageway to
motorway: How many miles should be converted?
1
mile
2
miles
3
miles
4
miles
5
miles
6
miles
Total benefit
(m)
5 8 11 15 16 16.5
Total cost(m)
3 4.5 6 8 10 12
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Weighing Marginal Benefits
& Marginal Costs
1 mile 2 miles 3 miles 4 miles 5 miles 6 miles
Total benefit m 5 8 11 15 16 16.5
Total cost (m) 3 4.5 6 8 10 12
Marginal benefit (m) 3 3 4 1 0.5Marginal cost (m) 1.5 1.5 2 2 2
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How the Principles of Economics Affect
Decision Making Trade-off
Choosing entails trading off a target against anotherand is a fundamental issue of the decision-making
process.
Marginal Benefits and Costs
Adjustments to the existing status quo. e.g. changingjobs for higher wages
Response to Incentives
Indices of elasticity show changes in people's
behaviour as a response to certain incentives.
Opportunity Cost
The decision-making process requires comparing the
costs and benefits of alternative courses of action
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How the Principles of Economics Affect
Decision Making
Making Capital Investments Using the Laws of
Supply and Demand
Assessing a Companys Investment Potential
Using Price Elasticity
Determine Whether to Enter a New Market
Using Marginal Analysis
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Seminar Questions
How to Make a Decision at the Margin inEconomics
Calculating marginal utility