EMBA Sem I Managerial Economics Session1-Introduction to Business Economics

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    Managerial EconomicsExecutive MBA Program

    Session 1: Introduction toBusiness Economics

    InstructorSandeep [email protected]

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    Before we proceed..

    Have you ever thought

    why are these

    companies sosuccessful?

    One reason is:Management made right

    decision at right time

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    Business Success and Managerial

    Economics- Imp. Of Decision

    Making Increasingcomplexity of

    business world

    National andinternal production

    of goods and

    services Rapid change and

    innovation in

    technology

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    Decis ion making is no t an easy task !!

    Societys Resources are needed to makedecisions but they are Scarce (limited):

    Management of societys resources is important

    Includes management of Land, labour and

    Capital (Factors of Production) Economics is the study of how society

    manages its scarce resources: Allocation

    of Resources

    From where does the decision making

    begin?

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    Has this ever happened to you. . .? Who would iron? Who would take the kids to

    the school? Who would watch which programin TV?

    The word economy comes from a Greek word

    for one who manages a household.

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    Societys decision making? Not much

    different How many doctors to hire? How many engineers?

    Whose son will become a pilot? Whos daughter will be a model?

    How much to earn? How much to save?

    How much to produce to earn maximum profit?

    Where should we locate out factory?

    Super model

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    How people makedecisions?

    Fundamentalprinciples ofEconomics

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    Principle #1: People Face Tradeoffs.

    There is no such thing as a free lunch!

    Money is a scare resource:The more burger you buy, the less money

    you have in your pocket

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    PPF Example

    Producing one computer requires 100 hours

    labor.

    Producing one ton of wheat requires 10 hours

    labor.

    5,0000

    4,000100

    2,500250

    1,000400

    50,0000

    40,00010,000

    25,00025,000

    10,00040,000

    0500050,000

    E

    D

    C

    B

    A

    WheatComputersWheatComputers

    ProductionEmployment of

    labor hours

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    Pointon

    graph

    ProductionCom-

    putersWheat

    A 500 0

    B 400 1,000

    C 250 2,500

    D 100 4,000

    E 0 5,0000

    1,000

    2,000

    3,000

    4,000

    5,000

    6,000

    0 100 200 300 400 500 600

    Computers

    Wheat

    (tons)

    A

    B

    C

    D

    E

    PPF Example

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    ACTIVE LEARNING 1:

    Answers

    Point F:100 computers,

    3000 tons wheat

    Point Frequires

    40,000 hoursof labor.

    Possible but

    not efficient:

    could get moreof either good

    w/o sacrificing

    any of the other.

    0

    1,000

    2,000

    3,000

    4,000

    5,000

    6,000

    0 100 200 300 400 500 600

    Computers

    Wheat(tons)

    F

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    ACTIVE LEARNING 1:

    Points on the PPF

    B. Next, find the point that represents(300 computers, 3500 tons of wheat), label it G.

    Would it be possible for the economy to produce

    this combination of the two goods?

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    ACTIVE LEARNING 1:

    Answers

    0

    1,000

    2,000

    3,000

    4,000

    5,000

    6,000

    0 100 200 300 400 500 600

    Computers

    Wheat(tons)

    Point G:300 computers,

    3500 tons wheat

    Point Grequires

    65,000 hours

    of labor.

    Not possible

    because

    economy

    only has

    50,000 hours.

    G

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    All decisions involve tradeoffs.Some realistic examples:

    Going to a party the night before your

    midterm leaves less time for studying. Having more money to buy stuff

    requires working longer hours, which

    leaves less time for leisure. Society faces an important tradeoff:

    eff ic iency vs . equ ity

    Principle #1: People Face Tradeoffs

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    Finding Opportunity CostWhat is the

    opportunity cost of

    producing 1

    computer?

    0

    1,000

    2,000

    3,000

    4,000

    5,000

    6,000

    0 100 200 300 400 500 600

    Computers

    Wheat

    (tons)

    To produce 500

    computers, 5000tons of wheat has

    to be given up.

    So, the opportunitycost of a computer

    is 10 tons of

    wheat.

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    Finding Opportunity Cost using PPF Slope

    Assume, you want

    to produce 100computer.

    What is the

    opportunity cost of

    producing 1computer?

    Note: Slope is the

    ratio of change in Y-

    axis to X-axis.0

    1,000

    2,000

    3,000

    4,000

    5,000

    6,000

    0 100 200 300 400 500 600

    Computers

    Wheat

    (tons)1000

    100slope = =10

    Ans:

    10 tons of wheat.

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    ACTIVE LEARNING 2:

    PPF and Opportunity Cost

    20

    In which country is the opportunity cost of cloth lower?

    0

    100

    200

    300

    400

    500

    600

    0 100 200 300 400

    Cloth

    Wine

    0

    100

    200

    300

    400

    500

    600

    0 100 200 300 400

    Cloth

    Wine

    FRANCE ENGLAND

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    ACTIVE LEARNING 2:

    Answers

    21

    England, because its PPF is not as steep as Frances.

    0

    100

    200

    300

    400

    500

    600

    0 100 200 300 400

    Cloth

    Wine

    0

    100

    200

    300

    400

    500

    600

    0 100 200 300 400

    Cloth

    Wine

    FRANCE ENGLAND

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    Numerical problem related to Opportunity

    Costs (Q.N. 4)

    Pat takes 4 hours to brew a gallon of root beer and 2

    hours to make a pizza. Kris takes 6 hours to brew a

    gallon of root beer and 4 hours to make a pizza.

    a. What is each roommates opportunity cost of making

    a pizza?

    b. If Pat and Kris trade foods with each other, who will

    trade away pizza in exchange for root beer?

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    Solution to Numerical ProblemPizza Root Beer

    Pat 2 hours 4 hours

    Chris

    4 hours

    6 hours

    a) What is each roommates opportunity cost of making a

    pizza?

    Pat takes 4 hours to make 1 root beer and 2 hours to

    make 1 pizza.

    If Pat spends 2 hours, which he spends to make 1 Pizza

    in making root beer, he makes 1/2 root beer.

    So, Pat's Opportunity Cost is 1/2 root beer.

    Similarly, Chris's Opportunity Cost is 2/3 root beer.

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    b) If Pat and Kris trade foods with each other, who will

    trade away pizza in exchange for root beer?

    Solution to Numerical Problem

    Pat will trade away pizza in exchange for the root beer

    that Chris will make.

    Pizza Root Beer

    Pat

    2 hours

    4 hours

    Chris 4 hours 6 hours

    Note:Solve remaining problems from No. 1 to 7

    from handout.

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    The Shape of the PPF

    The PPF could be a straight line, or bow-

    shaped

    Depends on what happens to opportunity cost

    as economy shifts resources from one

    industry

    to the other.

    If opp. cost remains constant,

    PPF is a straight line.

    (In the previous example, opp. cost of acomputer was always 10 tons of wheat.)

    If opp. cost of a good rises as the economy

    produces more of the good, PPF is bow-

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    A

    Why the PPF Might Be Bow-Shaped

    At point A,most workers are

    producing beer,

    even those that

    are better suitedto building

    mountain bikes.

    So, do not have

    togive up much

    beer to get more

    bikes.

    Mountain

    Bikes

    Beer

    At A, opp. cost ofmtn bikes is low.

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    B

    Why the PPF Might Be Bow-Shaped

    At B, most workersare producing bikes.

    The few left in beer

    are the best

    brewers.

    Producing more

    bikes would require

    shifting some of the

    best brewers away

    from beerproduction,

    would cause a big

    drop in beer output.

    Mountain

    Bikes

    Beer

    At B, opp. costof mtn bikes

    is high.

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    Many decisions are not all or nothing,

    but involve Marginal changesincremental

    adjustments to an existing plan.

    Eg. Marginal cost, marginal revenue, etc.

    A firm considers whether to increase output,

    comparing the cost of the needed labor and

    materials to the extra revenue.

    Which subject Should I do my Ph.D in?

    Should I eat like a pig or dont eat at all?

    Principle #3: Rational People Think at the

    Margin: Marginal analysis

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    incentive: something that induces a person

    to act, i.e. the prospect of a reward or

    punishment.

    In response to higher gas prices,sales of hybrid cars (e.g.,Toyota Prius) rise.

    In response to higher cigarette taxes,

    teen smoking falls.

    Principle #4: People Respond to Incentives

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    Rather than being self-sufficient, people can

    specialize in producing one good or service

    and exchange it for other goods. Countries also benefit from trade &

    specialization:

    get a better price abroad for goods they produce

    buy other goods more cheaply from abroad than

    could be produced at home

    Principle #5: Trade Can Make Everyone

    Better Off

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    A marketis a group of buyers and sellers.(They need not be in a single location.)

    Organize economic activity means

    determining

    what goods to produce

    how to produce them

    how much of each to produce

    who gets them

    Principle #6: Markets Are Usually A Good

    Way to Organize Economic Activity

    Famous insight by Adam Smith in The Wealth of Nations

    (1776): Each of these households and firms acts as if led

    by an invis ib le hand to promote general economic well-

    being.

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    Important roles for govt: enforce property rights(with police, courts) and promote efficiency

    People are less inclined to work, produce, invest,

    or purchase if large risk of their property beingstolen.

    A restaurant wont serve meals if customers

    do not pay before they leave.

    Promote efficiency in case of market failure

    Condition when the market fails to allocate

    societys resources efficiently.

    Causes: Market power and externality

    Principle #7: Governments Can

    Sometimes Improve Market Outcomes

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    Positive and Normative Analysis:

    The Economist as a Scientist and as a

    Policy Advisor As scientists, economists make

    positive statements,

    which attempt to describe the world as it is.

    As policy advisors, economists make

    normative statements,

    which attempt to prescribe how the world should

    be.

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    ACTIVE LEARNING 3:

    Answers

    c. A tax cut is needed to stimulate the economy.Normative, another value judgment.

    d. An increase in the price of gasoline will cause an

    increase in consumer demand for video rentals.

    Positive, describes a relationship.

    Note that a statement need not be true to be

    positive.

    M i l E i

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    Managerial EconomicsEconomics:

    Microeconomics and MacroeconomicsManagerial Economics:

    Part of Microeconomics that deals with tools

    and techniques of decision making formanagers

    Applications of techniques

    Risk analysis Production analysis

    Pricing analysis

    Capital budgeting

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    Scope of Managerial

    Economics Theory of demand Theory of production

    Theory of exchange or price theory

    Theory of profit

    Theory of capital and investment

    Environmental issues

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    as s o orpora e ec s on

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    as s o orpora e ec s onmaking

    Find occasions for

    making decisions

    Identify possible

    course of action

    Evaluate benefits and

    costs

    Choose a course

    For other benefits and details on Managerial Economics, pls.

    refer to the reading materials.

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    Thank you