LECTURE ONE

Definition of Economics

• Economics is the social science that studies the production, distribution and consumption of goods and services in a world of scarce resources.

• Economics is the study of the behavior of human beings in producing, distributing and consuming material goods and services in a world of scarce resources.

• Economics is the study of how choices are made regarding the use of scarce resources in the production, consumption and distribution of goods and services.

• In all these definitions, the key term is scarce resources.• A resource is scarce when there is not enough resource

available to satisfy various wants of a society.• Because the needs and wants of the population exceed

the ability of the resources to satisfy various wants, scarcity exists.

• Scarcity forces the country to choose the amount of resources that it wants to allocate between various goods and services.

• In doing so, people must consider the concept of opportunity cost.

• This type of cost can be defined as the amount or subjective value that must be sacrificed in choosing one activity over the next best alternative.

• Because of the scarcity of resources, the more that the country allocates to one good, say good A, the less it will have to produce the other good, say good B and vice versa.

• Thus the OC of additional units of A are the units of B that the country must forgo in the resource allocation process.

• The concept of OC is crucial to understanding individual choice because in the end all costs are OC.

• That is every choice you make means forging some other alternative.

• Suppose you want to do both a job and an MBA. But you have only one option, either job or MBA.

• Suppose you decide to do an MBA.• The OC of doing an MBA is the amount of

salary forgone while doing an MBA.

Economics and Decision Making

• In the presence of a limited supply relative to demand, countries must decide how to allocate their scarce resources.

• This decision is central to the study of economics. • Essentially allocation decision can be viewed as

comprising three separate choices:• What goods and services should be produced?• How should these goods and services be produced?• For whom these goods and services be produced?

• The first question involves the product decision. Should the country with scarce resources produce guns?

• Should it produce butter or bread? If so, how much bread and butter and how many guns?

• This applies to countless other goods and services the country is capable of producing.

• The second question involves the decision regarding the allocation of a country’s resources in the production of a particular good or service.

• Suppose a country decides to produce a certain amount of butter.

• What amounts of land, labour, capital and entrepreneurial efforts should be devoted to this end?

• The third question involves the decision that must be made about the distribution of a country’s output of goods and services among its member of its population.

• All countries must deal with these basic questions because all have scarce resources. Scarcity is a more serious problem in some countries than others, but all have needs and wants that cannot be completely met by their existing resources.

• There are essentially three ways a country can answer the questions of what, how and for whom.

• These ways, referred to as processes are as follows:• Market process: The use of supply, demand and

material incentives to answer the questions of what, how and for whom.

• Command process: The use of a government or central authority to answer the three questions.

• Traditional process: The use of customs and traditions to answer the three questions.

• Countries including BD generally employ a combination of these three processes to allocate their scarce resources.

• The market process is predominant in the US and therefore it has a market economy, although command process plays an important role.

• In USA, the production and consumption are the result of decentralized decisions of many firms and individuals.

• There is no central authority telling people what to produce or where to ship it.

• Each individual producer makes what he or she thinks will be profitable;

• Each consumer buys what he or she chooses.• In USA, the command process does not necessarily

mean that a government literally orders the production of certain amounts of guns, butter or other goods and services;

• Rather a government may use the material incentives of the market process to allocate resources in certain way, a process often referred to as indirect command.

• For example, the government can control the allocation of resources in a more direct way through various laws governing the actions of both consumers and producers.

• For example, the government controls manufacturing and distribution of certain goods and services through such agencies as the US Food and Drug Administration.

• The command economy is alternative to market economy in which there is a central authority making decisions about production and consumption.

• In SU, command economies have been tried between 1917 and 1991, but they did not work very well.

• Producers in SU found themselves unable to produce because they did not have crucial raw materials or they succeeded in producing but then found nobody wanted their products.

• In such an economy, consumers were often unable to find necessary items.

• Command economies are famous for long lines at shop as sometimes found in BD when consumers stand in long lines in front of BDR shops for some items fixed by the government.

• The traditional process is mostly prevalent in countries whose economies are still developing as India and BD.

• Examples of traditional process are found in eating habits and hiring practices based on familial relationships.

• One example of how traditional process influences the allocation of scarce resources is the religious restriction on certain foods like beef and pork.

The Economics of a Business

• The economics of a business: By this term we mean the key factors that affect the ability of a firm to earn an acceptable rate of return on its owner’s investment.

• The key factors are customers, competition and technology.

• The impact of changing economics on well established companies can be better understood and appreciated within the framework of Four Stage Model of Change.

• Stage I Stage II Stage III Stage IV• Cost plus Cost mana Rev Mana Rev plus• -gement -gement

• Stage I can be called good old days for companies such as IBM, Kodak, Sears etc whose dominance of the market allowed them to achieve higher profit margins by simply marking up their costs to provide them with a suitable level of profits.

• Then changes in technology, competition and customers put pressures on profit margins as well as market shares and forced them into Stage II where the company must engage in cost-cutting, restructuring, reengineering and downsizing in response to changes in three key factors.

• The example of companies like IBM, Kodak, Sears etc. showed that these companies sought to enter Stage III when they realized that continual focus on cost limited their ability to increase profits.

• In Stage III, their main focus was “top line growth” which they tried to achieve by reducing workforce or by becoming more efficient.

• In this process they also diverted their attention to diversification of products, improving as well as expanding the markets and modernizing the image of their products.

• Although these companies may have reaffirmed their ability to grow their top line, many critics like Wall Street analysts questioned their ability to grow in a profitable manner.

• Thus stage IV becomes a necessary part of a company’s full recovery from the impact of changing economics.

Explicit Cost vs Implicit Cost

• An explicit is a cost that requires an outlay of money.

• For example tuition cost for doing an MBA.• Implicit cost is measured by the value of the

benefits forgone.• For example the salary that have to give up for

doing an MBA.

• Accounting profit is defined as revenue minus explicit cost minus depreciation.

• Economic profit is defined as revenue minus-explicit cost minus depreciation minus implicit cost.

• Microeconomics is the study of economy by parts.

• Macroeconomics is the study of the economy as whole.

• Microeconomics is concerned with the study of individual consumers and producers in specific markets and macroeconomics deals with aggregate economy.

• Topics in microeconomics include supply and demand in individual markets, the pricing of specific outputs and inputs, production and cost structures for individual goods and services and the distribution of income and output in the population.

• Topics in macroeconomics include analysis of gross domestic product, unemployment, inflation, fiscal and monetary policy etc.