Dr. Amarendu NandyAssistant Professor

Indian Institute of Management Ranchiamarendu@iimranchi.ac.in

Lecture 1

IIM Ranchi PGDM 2014-16

(Ladies and) Gentlemen, you are now about to embark on a course of studies

which will occupy you for two years. Together, they form a noble adventure. But

I would like to remind you of an important point. Nothing that you will learn in

the course of your studies will be of slightest possible use to you in after life,

save only this, that if you work hard and intelligently you should be able to

detect when a man is talking rot, and that, in my view, is the main, if not the

sole, purpose of education.

~ Alexander Smith, Scottish poet

the most important decisions you will make (in life) are whom you

marry, whom you are friends with, what you love, what you despise and

how to control your impulses. Employers dont care for marks as much

as whether you are creative, curious, persistent, bold, and can work in

teams.

~ Manish Sabharwal, Chairman, Teamlease ServicesThe Economic Times, June 30, 2013

Ph.D. National University of Singapore (NUS) LeeKuan Yew School of Public Policy (LKYSPP)

Research Interests: Issues in International, Internal, Return Migration Developmental aspects of Remittances Socio-economic Impact of Demographic Changes Economics of Social Security India's Business Environment

Previous teaching experience Goa Institute ofManagement; National University of Singapore

Joined IIM Ranchi on June 20, 2011. Currently also theChairperson , PGDM & Area Chairperson - Economics

Lifes Guiding Philosophy: The true meaning of life is toplant trees, under whose shade you do not expect to sit ~Nelson Henderson

Passionate about: Food; Music; Photography

Happily married! One son (3 years 6 months)

Hometown: Durgapur, West Bengal

Web profile: http://www.iimranchi.ac.in/profile.php?i=1

Social network profiles: http://in.linkedin.com/pub/amarendu-

nandy/36/bb4/1b3 https://www.facebook.com/amarendu.nandy

Office: Level 3, Suchana BhawanConsulting Hours: Flexible (Prior email appointment preferable) E-mail: amarendu@iimranchi.ac.inPhone: (0651) 2280083 Ext. 120

Textbook

Baye, Michael R. and Jeffrey T. Prince (2014), ManagerialEconomics and Business Strategy (Indian edition), Eighthedition, New Delhi: McGraw Hill.

Recommended Alternate Textbook:

Pindyck, Robert S., Daniel L. Rubinfeld and Prem L.Mehta (2009), Microeconomics, Seventh Edition, NewDelhi: Pearson Prentice Hall.

Bernheim, B.D., M.D. Whinston, and A. Sen, (2009),Microeconomics, Special Indian Edition, New Delhi: TataMcGraw-Hill.

Other ReadingsJournal articles, news stories/analyses from financialdailies (both national and international), and variousReports, most of which shall be shared online via theCourse Management System (CMS) Canvas(https://canvas.instructure.com). Some may bedistributed in class.

You are also urged to read the following two bookswritten for the layman if you want to get a feel forhow economic principles can help to reallyunderstand important aspects of the businessworld and also government policy.

Harford, Tim (2006), The Undercover Economist, London: Little Brown. This book covers much of the ground we do in this course

(and more) but motivates concepts through excellentlychosen real world examples. The style is very engaging, soyou don't realize you are learning economics till after youhave learnt it! Follow his website at:http://timharford.com/ or follow him on Twitter:@TimHarford

Levitt, Steven D. and Stephen J. Dubner (2006), Freakonomics, New York: Harper Collins. The subtitle of the book A rogue economist explores the

hidden side if everything is apt. Reading this well written and easy to read book will help you understand how economic reasoning can help you analyze and understand many supposedly non-economic problems. Follow their blog at: http://www.freakonomics.com/blog/ or follow on Twitter: @freakonomics

Resources related to the course is available on the Course Management System (CMS) athttps://canvas.instructure.com. Please bookmark this page for a quick access to the course.

You need to compulsorily register for the course, as lecture slides and notes, timetable,additional reading resources, course announcements, online discussion board,assignments, submissions, etc. shall be shared/conducted via the CMS. Please note thatparticipation in CMS shall be a graded component. Upload a picture for your profile, andwrite something about yourself. No registrations will be allowed after July 5, 2014.

Deadlines for submission for Group Project Work need to be adhered to, failing which, youwill not be graded in that component. No requests for consideration will be entertained.

You may start a discussion in CMS on any topic which is of relevance for this course. Alldiscussion threads/posts need to be on aspects related to the course. I shall reserve theright to remove any post which I may deem inappropriate/irrelevant. Make sure that evenwhile you debate/discuss a point refuting your colleagues point(s), do so respectfully.

Also make extensive use of our digital resources:http://www.iimranchi.ac.in/?page_id=195

Class room lectures In class active learning exercises and discussions Social learning through Course Management System - Canvas In-class/online exposure to relevant academic research and case studies/mini-

cases Reading assignments sourced from scholastic journals, news stories from

financial dailies, blogs, and various reports; and Group project work

Academic HonestyCheating or plagiarism is breach of academic honesty, and may result in F grade in the course. It is a

fraudulent act to sign the attendance sheet if you do not intend to stay for the whole class segment.

Class EtiquetteYou are advised to maintain an environment of mutual respect to foster learning and encourage debate.Please be respectful towards everyone in the classroom. This includes, at a minimum: arriving to class ontime; not interrupting me or your colleagues; raising your hand to make a point and waiting for your turnto speak; and turning off your cell phones before class.

Laptop UseLaptop computer use is not permitted in my classroom. Occasionally there may be learning-by-doingbenefits to certain exercises and lectures presented in class. In those instances a laptop computer will beallowed for your use in the classroom.

GradingAlthough I shall try my best to be objective, there may be some subjectivity in grading. A student who maybe on the border between two grades and has exhibited effort and improvement could be pushed up tothe higher grade. A student who has been habitually late, rude, and obnoxious shall remain where he/sheis on the grading scale. I shall reserve the right to change the seating, deduct grade points, or drop anystudent who persists in acting in a puerile manner.

Component Weightage Evaluation Type Comments1 Class Quiz (announced or

unannounced)10 Individual | Closed

BookMCQs. Two out of three quizzes. The third quiz is optional. Students may decide if they wish it to replace the earlier quiz - first or second (with lower marks) after seeing the third quiz paper.

2 Mid-term Examination 25 Individual | Closed Book

Mix of MCQs and Analytical/Numerical Questions

3 Group Project Work 20 Group Work Groups of no more than 6 students. Topics need to be approved by me. Deadlines shall be sacrosanct.

4 End Term Examination 30 Individual | Open Book No MCQs. Problem/Case-based questions. Open book, notes, photocopies. No laptop.

5 Class Participation 15 Individual Quality of class and online participation shall be important.

to learn a way of thinking

to understand society (E.g. - IndustrialRevolution)

to understand global affairs/currentaffairs better The events of September 11, 2001, dealt a blow

to the tourism industry and left airlines in deepfinancial trouble; Global financial andeconomic crisis of 2008-09 emanating from theU.S. led to worldwide impact on individuals andbusinesses.

to be an informed voter When we participate in the political process,

we are voting on issues that require a basicunderstanding of economics.

In a business school, the test of good (theory) is always that of its practicality or usefulness. Many of the tools that shall be a part of your practical training will be based on economic theory. For example, in finance you will learn all about the efficient market hypothesis

which is an amazingly important tool for investment analysis that really makes senseonly if you understand the law of demand and supply or market rationality.

Economics is to business school what boot camp is to the Marine Corps! Just as in boot camp, you may endure sleepless nights of seemingly pointless

activity, all with the goal of toughening you for the grim years of combat that lieahead.

Economics shall help you examine the world in a very particular way. And thisapproach can be useful to non-economists.

Why give grades? - Grades are expensive andcomplicated. Large amounts of resources aredevoted to the giving and getting. An economicanalysis is often begun by asking why resourcesare used in a particular way.

This question is way to broad and so the nextstep will be to break it down into smallerquestions.

An economic approach to the puzzle begins byasking why do professors supply them and why do students demand them.

Why do professors supply grades? Pecuniary Rewards: By offering tests and promising grades, the class becomes more valuable to the student

(why?) and so the student is willing to pay (participate) more. Non-Pecuniary Rewards (Utility): Most Profs enjoy their subject, think its important and want their students to

learn (or at least stay awake during part of the lecture). Grades motivate the student to learn (or not to fallasleep!).

Why do students demand grades? They Dont! Employers and grad schools are the real users of grades, and so the demand for grades is actually a

derived demand - the students demand for grades is actually derived from the employers demand (in much thesame way that Maruti Suzukis demand for steel is really derived from the demand for cars).

Why do employers and grad schools demand grades? Grades are an absolute measure of knowledge (consistent with the HUMAN CAPITAL theory of education). Grades are a relative measure of knowledge (consistent with the SIGNALING/SORTING theory of education).

The theory we have described has two important characteristics: It is logically consistent, and more important Give explanations that can, at least in principle, be refuted.

What is the use of this theory? Theories can be a good guide to policy. There are two basic grading policies: You can be graded on an absolute scale (e.g.,everybody who scores a 90

or better gets an A), or on a relative scale (the top 20% of the class gets an A) If I believe that students work harder when in competition against an absolute scale and that employers are

interested in the absolute level of achievement, Id use an absolute scale. If I believe students work harder whenin competition against each other and that employers are interested in relative rankings, Id use a relative scale.

Corporate Decision Making: Fords Sport Utility Vehicle

The design and efficient production of Fords

SUVs involves not only some impressive

engineering, but a lot of economics as well.

Ford has to think carefully about how thepublic would react to the design and

performance of its new products.

Ford had to be concerned with the cost ofmanufacturing these cars.

Ford had to think about its relationship to thegovernment and the effects of regulatory

policies.

Public Policy Design: Automobile Emission Standards for the

Twenty-First Century

The design of a program like the Pollution Control Act

involves a good deal of economics.

First, the government must evaluate the monetaryimpact of the program on consumers.

The government must determine how new standardswill affect the cost of producing cars.

Finally, the government must ask why the problemsrelated to air pollution are not solved by our market-

oriented economy.

Questions that managers must answer:

What are the economic conditions in a particular market?

Market Structure? Supply and Demand Conditions? Technology? Government Regulations? International Dimensions? Future Conditions? Macroeconomic Factors?

Should our firm be in this business?

If so, what price and output levels achieve our goals?

Questions that managers must answer:

How can we maintain a competitive advantage over our competitors?

Cost-leader? Product Differentiation? Market Niche? Outsourcing, alliances, mergers,

acquisitions? International Dimensions?

Questions that managers must answer: What are the risks involved?

Risk is the chance or possibility that actual future outcomes will differ from those expected today.

Types of risk Changes in demand and supply conditions Technological changes and the effect of competition Changes in interest rates and inflation rates Exchange rates for companies engaged in international trade Political risk for companies with foreign operations

Economics is the study of the choices consumers, businessmanagers, and government officials make to attain their goals,given their scarce resources/subject to their constraints.

Need to make choices arises due to scarcity as factors of production arefinite. Scarcity exists when there is not enough of something(product/service/resource) to satisfy everyones wants, at a zero price.

Goods, services, and productive resources that are scarce have apositive price (economic goods). Commodities that have a zero pricebecause they are relatively unlimited in supply are called free goods.

The concept of scarcity is summarized in the economic admonitionthat there aint no such thing as a free lunch (TANSTAAFL). All goodsand services have an opportunity cost. Even the resources used toproduce a free lunch could have been used to produce somethingelse.

Human Nature and Reality

People have unlimited wants.

People have limited resources to acquire the things they want.

As a result, they must make choices.

Choices involve pursuing some things while forgoing others.

The choices we make depend on the incentives we face. An incentive is a reward that

encourages an action or a penalty that discourages an action.

Factors of production are classified into one of four broad categories

Land - includes all natural resources (crude oil, water, air, minerals, etc.) Labour encompasses both quantity and quality of human resources Capital - term refers to final goods produced for use in further production

(fishing nets; blast furnaces, etc.) Entrepreneurship - organize resources for new or better products; agent

of innovation and change.

Role of entrepreneurs in economic progress is a key issue in themarket versus government debate. The Austrian economist JosephSchumpeter argued that free markets unleash the animal spirits ofentrepreneurs, propelling innovation, technology, and growth.Government regulation tends to stifle those very animal spirits.

Depending on the nature of scarcity and the kind of choices it forces on us, threecore issues must be resolved:

WHAT to produce with our limited resources? HOW to produce the goods and services that we select? FOR WHOM goods and services are produced, i.e. who should get them?

Important: Who should answer these questions?

Should market participants decide how much water to supply? Who gets it? Or, shouldgovernment intervene to assure adequate water supply?

Should individuals take care of health and retirement? Or, should government providesafety net of health and pensions?

Should the government regulate airfare? Or, should airlines set prices? Should interest rates be set by private banks? Or, should government control interest

rates? Should Microsoft decide what features get included in a computers OS, or should the

government make that decision?

Microeconomics The branch of economics that

examines the functioning of theeconomy at the level of individualconsumers, workers, firms, goods, andmarkets.

looks at the individual unit - thehousehold, the firm, the industry. Itsees and examines the trees.

Macroeconomics

The branch of economics that examines the economic behavior of aggregates - income, employment, output, and so on - on a national scale.

looks at the whole, the aggregate. It sees and analyses the forest.

Examples of Microeconomic and Macroeconomic Concerns

DIVISION OF

ECONOMICS PRODUCTION PRICES INCOME EMPLOYMENT

Microeconomics Production/output in

individual industries and

businesses

How much steel

How much office space

How many cars

Price of

individual

goods and

services

Price of medical

care

Price of

gasoline

Food prices

Apartment

rents

Distribution of

income and

wealth

Wages in the auto

industry

Minimum wage

Executive salaries

Poverty

Employment by

individual businesses

and industries

Jobs in the steel

industry

Number of employees

in a firm

Number of

accountants

Macroeconomics National production/output

Total industrial output

Gross domestic product

Growth of output

Aggregate price

level

Consumer prices

Producer prices

Rate of inflation

National income

Total wages and

salaries

Total corporate

profits

Employment and

unemployment in the

economy

Total number of jobs

Unemployment rate

Managerial economicsapplies microeconomictheory to business problems How to use economic

analysis to make decisionsto achieve firms primarygoal of maximizing the valueof the firm/ profitmaximization, and do somost efficiently

Mathematical Economics Expresses and analyzes

economic models using thetools of mathematics.

Econometrics Employs statistical methods

to estimate and testeconomic models usingempirical data.

Positive economic analysis: addressesfactual questions, typically abouteconomic choices or market outcomes. Itdescribes what exists and how it works.

What did happen? What will happen?What would happen?

Historical fact-finding

Forecasting

Cause-and-effect analysis of actionsand their consequences

Stick to objective facts and avoid valuejudgments

Normative economic analysis:

addresses questions that involve

value judgments concerning the

allocation of resources

What ought to happen?

What should happen?

Makes ethical judgments value

judgments.

COMPARING POSITIVE AND NORMATIVE QUESTIONS

Positive Questions Normative Questions

If the government increases the minimum wage, how many workers will lose their

jobs?

Should the government increase the minimum wage?

If two office-supply firms merge, will the price of office supplies increase?

Should the government block the merger of two office-supply firms?

How does a college education affect a persons productivity and earnings?

Should the government subsidize a college education?

How do consumers respond to a cut in income taxes?

Should the government cut taxes to stimulate the economy?

If a nation restricts shoe imports, who benefits and who bears the cost?

Should the government restrict imports?

To develop a model, economists generally follow these steps:

1. Observe and identify phenomenon to be explained.

2. Formulate an explanation: An economic theory.

3. Develop a model to formalise the theory.

4. Decide on the assumptions to use in developing the model.

5. Formulate a testable hypothesis.

6. Collect and analyze real-world economic data to test the hypothesis.

7. Revise the model if it fails to explain well the economic data.

8. Retain the revised model to help answer similar economic questions in the future.

Model: Models are simplified and analytical depictions of reality. The point of the modelis to sharpen intuition - learn what is important and why; and give us testablepredictions.

Ockhams razor : The principle that irrelevant detail should be cut away. Do not multiply entities: Simple is better.

Maps are useful abstract representations of reality.

ceteris paribus, or all else equal: A device used to analyze the relationship

between two variables while the values of other variables are held

unchanged.

Using the device of ceteris paribus is one part of the process of abstraction - sothat changes due to the factor being studied may be examined independently of

those other factors. In formulating economic theory, the concept helps us simplify

reality to focus on the relationships that interest us.

All Else Equal: Ceteris Paribus

Expressing Models in Words, Graphs, and Equations

The most common method of expressing the quantitative relationship between two

variables is graphing that relationship on a two-dimensional plane.

Cautions and Pitfalls

post hoc, ergo propter hoc Literally, after this (in time), therefore because of this. Acommon error made in thinking about causation: If Event A happens before Event B, it is

not necessarily true that A caused B.

fallacy of composition The erroneous belief that what is true for a part is necessarily

true for the whole.

association is not causation The mistaken assumption that because two events occur

together, one must cause the other. Also given as correlation is not causation.

violation of ceteris paribus This occurs when one attempts to analyze the effect of one

thing while holding everything else constant, when in fact other things have changed.

The Mechanisms of Choice

O Adam Smith, in his classic work, TheWealth of the Nations (1776) said theinvisible hand determines what getsproduced, how, and for whom. He urgedthe government to leave it alone (laissezfaire).

O WHAT: Producers are driven by profitpotential

O HOW: To maximize profit, producers seeklowest-cost method

O FOR WHOM: Market distributes good to thehighest bidder (willing and able to pay forthe product)

O The invisible hand is now called marketmechanism. The essential feature ofmarket mechanism is the price signal.

The Invisible Hand of a Market Economy

The Mechanisms of Choice

O Karl Marx, in the Communist Manifesto(1848) and Das Kapital (1867) laid thefoundation for a communist state in whichthe government would be the master ofeconomic outcomes.

O Marx criticized Adam Smiths laissez-fairepolicy, and emphasized how free marketstend to concentrate wealth and power inthe hands of the few (the capitalists), atthe expense of many (the proletariat).

O Marx argued that the government not onlyhad to intervene but had to own all themeans of production in order to savageinequalities.

Government Intervention and Command Economies

The Mechanisms of Choice

O John Maynard Keynes conceded that themarket was pretty efficient in organizingproduction. However, individual producers andworkers had no control over the broadereconomy.

O A completely unregulated market might veeroff in one direction and then another asproducers all could rush to increase output atthe same time; or throttle back production atthe same time in a herd-like manner.

O The government, Keynes reasoned, could actlike a pressure gauge, letting off excess steamor building it up as the economy needed.

O In Keyness view, government should play anactive but not all-inclusive role in managingthe economy.

Government Intervention and Command Economies

Web Link

To read more about famous economists

and their thoughts, you are encouraged

to visit the website of the Federal

Reserve Bank of San Francisco at

www.frbsf.org/education and click on

Great Economists and Their Times

under Publications.

Categorizing nations by the extent of markets vs. government reliance

Source: GlobeScan 2010 poll for Program on International Policy Attitudes, University of Maryland

Web Link

Also take a look at the

Index of Economic

Freedom, published by the

Heritage Foundation at

www.heritage.org

Mixed economies: Most

nations uses a combination

of market signals and

government directives to

select economic outcomes.

Market Failure: An

imperfection in the market

mechanism that prevents

optimal outcomes.

Government failure:

Government intervention

that fails to improve

economic outcomes.

Recommended Reading

Life After Capitalism by

Robert Skidelsky in Project

Syndicate (Jan 20, 2011):

http://www.project-

syndicate.org/commentary

/life-after-capitalism

Three Important Economic Ideas

1. People are rational

O Rational individuals weigh the benefits and costs of each action, and they choose anaction only if the benefits outweigh the costs.

O Does not imply everyone always makes the best decision. Economists assume thatconsumers and firms use all available information as they act to achieve their goals.

O The operating assumption of behavioural economics is that cognitive biases oftenprevent people from making rational decisions, despite their best efforts.

O In one study where people were offered a choice of a fancy Lindt truffle for 15 cents and aHersheys kiss for a penny, a large majority (73%) chose the truffle. But when offered the samechocolates for one penny less each - the truffle for 14 cents and the kiss for nothing - only 31% ofparticipants selected it. The word free, we discovered, is an immensely strong lure, one thatcan even turn us away from a better deal and toward the free one.

Source: Ariely, Dan (2009), The End of Rational Economics, Harvard Business Review, July.Those interested, may want to read Dans Predictably Irrational: The Hidden Forces That ShapeOur Decisions (HarperCollins, 2008). Also read: The Behavioural Economics of Thanksgiving!

Class ExerciseO Price of a cup of coffee increases at

your favorite coffee shopO Scenario A: From Rs. 72 to Rs.

79.20. Would you still buy that one cup of coffee?

O Scenario B: From Rs. 63 to Rs. 69.30. Would you still buy that one cup of coffee?

O Scenario C: From Rs. 74 to Rs. 81.4. Would you still buy that one cup of coffee?

Three Important Economic Ideas

O A 2011 NBER study indicates how individual decision-making may deviate from rationality. TheNBER study (http://www.nber.org/papers/w17030) focuses on "the used car market and askswhether it is affected by consumers exhibiting a heuristic, or short cut, known as left-digit bias:the tendency to focus on the left-most digit of a number while partially ignoring other digits."

O Findings of the study:Using data that come from wholesale auctions encompassing more than 22 million used cartransactions, the authors document significant price drops at each 10,000-mile threshold from 10,000to 100,000 miles, ranging from about $150 to $200. For example, cars with odometer values between79,900 and 79,999 miles, on average, are sold for approximately $210 more than cars with odometervalues between 80,000 and 80,100 miles, but for only $10 less than cars with odometer readingsbetween 79,800 and 79,899.consumers.

O Any more examples?

Bounded Rationality is the idea that individual decision making is limited by personal information,

cognitive limitations, and time constraints.

The basic idea of economics is that people act in ways to maximize their self-interest. We do things

that will increase our utility, or happiness. It seems logical that we would make rational decisions in

order to accomplish that. Unfortunately, information asymmetry, cognitive biases and other factors

conspire to bound our rationality, and people often make choices that lead to outcomes that go

against their desires.

Benefits and CostsQ: You are waiting in line at checkout #12 at the grocery store when younotice that the line at checkout #1 is shorter and moving more quickly,but you decide to stay in the line you are in. How can you justify, using theconcepts of marginal cost and marginal benefit, your decision not toswitch lines?

Benefits and CostsQ: You are trying to decide which professor to take for Economics. (You don't wantto take it at all, but you have to.) Professor A is known to have great classes(fascinating lectures with lots of fun stuff thrown in), but she gives verychallenging exams. Professor B's classes are quite dull, but his exams are quiteeasy. What are the marginal costs and benefits of taking Economics fromProfessor A rather than from Professor B? Who would you pick?

Three Important Economic Ideas

2. People respond to economic incentives

O Human beings act from a variety of motives, including religious belief, envy, andcompassion. Economists emphasize that consumers and firms consistentlyrespond to economic incentives.

O Article from Wall Street Journal, October 8, 2002 [Link: FBI Presses Banks toBoost Security as Robberies Rise]

O FBI couldnt understand why banks were not taking steps to improve security in the faceof an increase in robberies. FBI officials suggest that banks place uninformed, armedguards outside their doors and install bullet-resistant plastic, known as bandit barrier infront of the teller windows. Consider this:

O Installing bullet-resistant plastic costs $10,000-$20,000O Well trained security guard receives $50,000 per year in salary and benefitsO The average loss in a bank robbery is only $1,200

O The economic incentive to banks is clear: it is less costly to put up with bank robberiesthan to take additional security measures.

Three Important Economic IdeasO How incentives/disincentives work:

O Incentives for drivers who avoid traffic jams (The New York Times, June 11,2012): Link

O Nudging using behavioural economics to improve the effectiveness ofgovernment policies (The Economist, March 24, 2012): Link

O A letter sent to non-payers of vehicle taxes was changed to use plainer English, alongthe line of pay your tax or lose your car. In some cases the letter was furtherpersonalised by including a photo of the car in question. The rewritten letter alonedoubled the number of people paying the tax; the rewrite with the photo tripled it.

PEDALING FOR TELEVISION TIME

Do people respond to incentives?

Children were put into two groups:

Control group: Obese children randomly assigned to a TV with a

stationary bike in front of the TV no pedaling required to watch TV.

Treatment group: Obese children randomly assigned to a TV with a

stationary bike in front of it pedaling is required to watch TV.

Outcome: The control group watched TV 21 hours on average and the treatment group

only 2 hours on average per week.

To illustrate the notion that people are rational and

respond to incentives, consider an experiment conducted

by researchers at St. Lukes Roosevelt Hospital in New

York City. The researchers addressed the following

question: If a child must pedal a stationary bicycle to run

a television set, will he watch less TV?

APPLYING THE CONCEPTS

FREAKONOMICS

According to Levitt, it is in the best interest of the realtor to convince sellers to take an

offer lower than they would receive if the property remained on the market.

Since the percentage of the sales price that real estate salespersons receive from selling

a house is a very small fraction, a $10,000 increase in sales price might net a real estate

professional another $150 commission for a tremendous amount of additional work.

It is in the real estate salespersons best interest to convince the seller to make the quick

sale and take the first reasonable offer.

Levitt points toward evidence that real estate professionals tend to leave their own

properties on the market longer and receive 2-3% more in sales price.

Economics is truly a social science that can be used to explain quite a bit of human behavior.

Economist Steven Levitt, one of the authors of the best selling book Freakonomics,

answers a host of questions typically not tackled by most economists. One of the questions

is related to realtors and agency relationships. In other words, do realtors really work for real

estate sellers? Does a real estate agent have an incentive to get you the highest price?

APPLYING THE CONCEPTS

Will Women Have More Babies if the Government Pays Them To?

More than 45 countries in

Europe and Asia have taken

steps to try to raise their

birthrates. These policies

suggest that people may

respond to economic incentives

even when making the very

personal decision of how many

children to have.

Source: Hubbard and OBrien (2010), Microeconomics, 3e.

The Rational-Actor Paradigm

O The rational-actor paradigm assumes that people act rationally, optimally, and self-interestedly. To change behavior, you have to change incentives.O Good incentives are created by rewarding good performance.

O A well-designed organization is one in which employee incentives are aligned withorganizational goals. By this we mean that employees have enough information tomake good decisions, and the incentive to do so.

O You can analyze any problem by asking three questions:(1) Who is making the bad decision?(2) Does the decision maker have enough information to make a good decision?; and(3) the incentive to do so?

O Answers to these questions will suggest solutions centered on(1) letting someone else make the decision, someone with better information or incentives;(2) giving the decision maker more information; or(3) changing the decision makers incentives.

Three Important Economic Ideas

3. Optimal decisions are made at the margin

O Some decisions are all or nothing! But most decisions in life involve doing a little more or a little less (marginal).

O Should you watch another hour of TV or spend that hour studying for the exam next day?

O Should Apple produce an additional 200,000 iPads?

O Optimal decision is to continue any activity up to the point where the marginal benefit equals the marginal cost, i.e. MB = MC.

Three Important Decision Pitfalls

O Economic analysis predicts likely behaviorO Three general cases of mistakes

1. Measuring costs and benefits as proportions instead of absolute amounts

2. Ignoring implicit costs3. Failure to think at the margin

Pitfall #1

O Measuring costs and benefits as proportions instead of absolute amount

O Would you walk to town to save $10 on a $25 item?

O Would you walk to town to save $10 on a $2,500 item?

Action

Marginal Costs

Marginal Benefits

Pitfall #2O Ignoring implicit costs

O Consider your alternatives

O The value of a Frequent Flyer coupon depends on its next best useO Expiration dateO Do you have time for

another trip?O Cost of the next best trip

Explicit Costs

Implicit Costs

Opportunity Cost

Pitfall #3

O Failure to think at the marginO Sunk costs cannot be

recovered

O Examples:O Eating at an all-you-

can-eat restaurantO Attend a second year

of law school

Marginal Benefits

Marginal Costs

There are gains from trade

Voluntary trades will be beneficial to bothparties, otherwise why would they havetraded?

Everyone will have a comparativeadvantage in some activity andconsequently there will be gains tospecializing in that activity and usingsurplus production to trade for othergoods or services.

Markets move toward equilibrium

Markets -- interaction between individuals free markets are where there is no coercion to trade or

interact

Coordination of the interaction of individuals is achieved through prices (trading rates).

Equilibrium -- where no individual has an reason to change their action

If individuals are free to trade then trading will continue until no one else wishes further trades

Resources should be used efficiently to achieve societys goals

Efficiency -- the inability to improve one persons well being without hurting someone else (Pareto Optimality)

If we are inefficient in our use of resources, we are wasting them.

Why would you want to deny someone additional welfare if it didnt hurt anyone elses welfare?

This is a normative statement. What about other goals for society such as fairness or equity in the distribution of societys wealth?

Market usually lead to efficiency

This statement is often taken to meanthat society (a collective decisionperhaps taken by government) should notinterfere with individual choice. Apositive statement leading to a normativeconclusion.

But markets can fail to achieve anefficient result-- for example, congestionon the highways.

ECONOMIC ANALYSIS AND MODERN PROBLEMS

Economic View of Traffic Congestion

To an economist, the diagnosis of the congestion problem is straightforward.

When you drive onto a busy highway during rush hour, your car takes up space

and decreases the distance between the vehicles on the highway. The normal

reaction to a shorter distance between moving cars is to slow down. So when you

enter the highway, you force other commuters to spend more time on the highway.

One possible solution to the congestion problem is to force people to pay for using

the road, just as they pay for gasoline and tyres.

The job for the economist is to compute the appropriate congestion tax and

predict the consequences of imposing the tax.

CONGESTION PROBLEM

What is the role of prices in allocating resources?

To illustrate the economic way of thinking, lets

consider again how an economist would approach

the problem of traffic congestion.

Use assumptions to simplify

Isolate variablesceteris paribus

Think at the margin

If the government imposes a congestion tax to reduce congestion during rush

hour, the question for the economist is: How high should the tax be?

Determine the cost imposed by the marginal driver:

Driver forces each of 900 commuters to spend 2 extra seconds on the

highway

Total travel time increases by 30 minutes

Value of time is Rs.100 per hour

Appropriate congestion tax is Rs. 50

APPLYING THE CONCEPTS

When markets are not efficient, government intervention can lead to improvement in social

welfare

Yet there isnt a guarantee that governments will improve upon the market outcome. Rather they hold out the possibility to improve upon the efficiency of the outcomes of individual choice.

Important to remember -- it is not that individuals make bad choices it is that market has failed to coordinate their decisions

Summary of Principles

1) Resources are scarce2) Every Choice has an Opportunity Cost3) Choices are made at the margin4) Individuals seek their self interest5) There are gains from trade6) Markets move toward equilibrium7) Resources should be used efficiently8) Markets usually lead to efficiency9) When markets dont achieve efficiency, government

intervention can improve social welfare

Type of Data Publishing Authority Frequency Time Lag Link

GDP; Index of Industrial

Production (IIP)

Central Statistics Office,

Ministry of Statistics and

Programme

Implementation (MOSPI)

Quarterly (GDP)

Monthly (IIP)

Two months (GDP)

1.5 months (IIP)

http://mospi.nic.in/Mospi

_New/site/home.aspx

Complete Economic and

Financial Data

Ministry of Finance Periodically http://finmin.nic.in/

Handbook of Statistics on

Indian Economy; Balance

of Payment (BOP);

External Commercial

Borrowings (ECBs)

Reserve Bank of India

(RBI)

Yearly, quarterly and

monthly respectively

http://www.rbi.org.in/ho

me.aspx

Export and Import Ministry of Commerce

and Industry

Monthly 1 month http://commerce.nic.in/tr

adestats/indiatrade.asp?i

d=1

Foreign Institutional

Investments (FIIs) in

Indian markets; Mutual

Funds Investments

Securities and Exchange

Board of India (SEBI)

Daily http://www.sebi.gov.in/In

dex.jsp?contentDisp=Dat

abase

Wholesale Price Index

(WPI)

Office of the Economic

Advisor (OEA), Ministry of

Commerce and Industry

Monthly 1 month http://eaindustry.nic.in/

Consumer Price Index -

Industrial Workers (CPI

IW)

Labour Bureau,

Government of India

Monthly 1 month http://labourbureau.nic.in

/indexes.htm

Money Supply; Foreign

Exchange Reserves;

Deposit and Credit

Growth of Scheduled

Commercial Banks;

Indices relating to Real

Effective Exchange Rate

(REER)/Nominal Effective

Exchange Rate (NEER)

Reserve Bank of India

(RBI)

Weekly; fortnightly http://rbi.org.in/scripts/S

tatistics.aspx

INTERNATIONAL

United Nations (UN): http://unstats.un.org/unsd/databases.htm [Cross-country data - COMTRADE; Census Knowledge Base; Demographic

Yearbook; Millennium Indicators Database; National Accounts; Services Trade; and Social Indicators among many others]

World Bank: http://data.worldbank.org/ [1200+ indicators spread across various databases including World Development Indicators

(WDI); Global Development Finance (GDF); Doing Business (DB); Global Economic Monitor (GEM); Education (EdStats); Gender

(GenderStats); Millennium Development Goals (MGDs); Country Policy and Institutional Assessment (CPIA); Actionable Government

Indicators (AGIs); Business Environment and Enterprise Performance Survey (BEEPS); International Comparison Programme (ICP);

Quarterly External Debt Statistics (QEDS); Remittance Prices; and Worldwide Governance Indicators (WGI) among others]

International Monetary Fund (IMF): http://www.imf.org/external/data.htm [Publishes a range of time series data on IMF lending, exchange

rates, and other economic and financial indicators including World Economic Outlook (WEO); International Financial Statistics (IFS);

Principal Global Indicators (PGI); Quarterly External Debt Statistics (QEDS); Balance of Payments Statistics (BOPS); Primary Commodity

Prices; Government Finance Statistics (GFS), etc.]

World Trade Organization (WTO): http://stat.wto.org/Home/WSDBHome.aspx?Language= [International trade statistics by trade, tariff, and

service profiles]

Organisation for Economic Co-operation and Development (OECD): http://stats.oecd.org/Index.aspx [Various economic and social

indicators across themes for member countries. Also, data on selected indicators for non-member countries are available.]

Eurostat: http://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home/ [European statistics under various categories.]

Asian Development Bank (ADB): http://www.adb.org/statistics/ [Compiles recent key economic, financial, and social indicators from

developing member countries and other international sources.]

United Nations Economic and Social Commission for Asia and the Pacific (UNESCAP): http://www.unescap.org/stat/data/index.asp

[Contains time series data for selected indicators covering a wide range of issues including demography, migration, education, health,

poverty, gender, employment, economy, government finance, employment, transport, and environment.]

International Labour Organization (ILO): http://laborsta.ilo.org/ [Data and metadata on 200 countries or territories on labour statistics]

NATIONAL

Economic Survey and Union Budget: http://indiabudget.nic.in/

National Sample Survey Organisation (NSSO): http://mospi.gov.in/nsso_4aug2008/web/nsso.htm [

Under MOSPI. Conducts nationwide sample surveys on various socio-economic issues in successive

rounds]

Centre for Monitoring Indian Economy (CMIE): http://www.cmie.com/ [Databases available on

macroeconomy (including international economic statistics); sectoral services; firm-level data services;

state analysis; and other customized solutions]

IndiaStat: http://www.indiastat.com/default.aspx [The site collects, collates and compiles socio-economic

information about India and its states]

CapitaLine: http://www.capitaline.com/new/index.asp [Market data and financial information on

securities, derivatives and commodities traded on Indian stock markets.]

EPW Research Foundation: http://www.epwrf.res.in/

Ecofin-Surge: http://www.ecofin-surge.co.in/ [Compilation of Indian data covering Macro-economic

variables like GDP, Government Finances, Industrial & Agricultural Production indices, Inflation, etc., and

Banking & Financial market indicators like Interest rates, Stock & Commodity market indices. Also

contains economic and financial historic time-series data on the global economy.]

International

Financial Times: http://www.ft.com/home/india

The Economist: http://www.economist.com/index.html

The Wall Street Journal: http://www.wsj.com

New York Times: http://www.nytimes.com/pages/business/index.html

Bloomberg BusinessWeek: http://www.businessweek.com/

National

The Economic Times: http://economictimes.indiatimes.com/

Business Standard: http://www.business-standard.com/

Livemint: http://www.livemint.com/

The Business Line: http://www.thehindubusinessline.com/businessline/

The Financial Express: http://www.financialexpress.com/

Gregory Mankiw: gregmankiw.blogspot.com

James Hamilton and Menzie Chinn: http://www.econbrowser.com/

Paul Krugman: http://krugman.blogs.nytimes.com/

Raghuram Rajan: http://blogs.chicagobooth.edu/faultlines

Nouriel Roubini: http://www.roubini.com/

Steven Levitt and Stephen J. Dubner: http://freakonomics.blogs.nytimes.com/

WSJ Blogs: http://blogs.wsj.com/economics/

McKinsey Global Institute: http://www.mckinsey.com/mgi/

Martin Wolf: http://blogs.ft.com/martin-wolf-exchange/

Mark Thoma: http://economistsview.typepad.com/

The World Bank: http://blogs.worldbank.org/governance/category/topics/macroeconomics-and-economic-growth

Tim Harford: http://blogs.ft.com/undercover/

The Economist: http://www.economist.com/blogs/freeexchange/

J. Bradford DeLong: http://delong.typepad.com/

Economic Policy Review at HBS: http://www.econblog.org/

New Economist: http://neweconomist.blogs.com/

Ajay Shah: http://ajayshahblog.blogspot.com/

Indian Economy Blog on Businessweek: http://bx.businessweek.com/indian-economy/blogs/

Google Public Data Explorer: http://www.google.co.in/publicdata/directory