Principles of Economics

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Overview

Introduction Nature & Scope of Economics The Economic Perspective The Economics & The Management Disciplines Eco. For Effective Mgmt. (Basic Questions) Identify Goals & Constraints Understand incentives Understand Markets Use Marginal Analysis

SCOPE & METHOD OF ECONOMICS

Economics: A behavioral, or social science The study of how individuals & societies choose to use the scarce resources for optimization .. Why Economics: - Opportunity Cost - Respond to incentives To make decisions - Marginalism - Trading off - Efficient Markets - for voting/electing

- understand global affairs - understand society

Firms Consumers

Governments

Intl. Organizations

Buy Car Dinner in Restaurant Marry sweetheart admissions Produce & sell goods & services Buy inputs & factors of productions Levy taxes Income inequalities Policies Economic affairs

Greek word - one who manages a household . - house - household management

Introduction to Economics

PREMISE: Mans motivation SELF-SATISFACTION / VALUE CREATION Trade offs Costs - paid to get Rationale for margins Respond to incentives Gains from trade (win-win) Mkt. Economy for Eco. Activity Efficiency v. Equity Opportunity Costs Marginalism (Cost benefit analysis) Mkt . Power Mkt. Failures, inflation recession, Externalities & Govt. Role Standard of Living & Productivity Money,. Growth & Employment SOCIETY & SCARCE RESOURCES: How to manage these resources? A HOUSEHOLD, A FIRM, AN ECONOMY /GOVT. & DECISIONS Who will work? What to produce? How much to produce? For whom to Produce? What resources to use in production? At what price to be sold? THE GOAL OF ECONOMICS IS TO REDUCE TRANSACTION COST

Economics & Theory

Economics: science of making decisions in the presence of limited resources Microeconomics: deals with the decisions made by individuals & groups, the factors that affect these decisions, & how these decisions effect others". Macroeconomics: deals with economics decisions made at macro or aggregate level.

Managerial economics:
applies economics theory to business problems, i.e., how to direct given resources through economic analysis to make decisions in achieving the managerial goals efficiently.

Economics & Role of Manager

The use of economic analysis to make business

decisions involving the best use (optimizing allocation) of an organizations scarce resources

Economics
The social science that studies the problem of allocation of scares resources for optimization of production, distribution, consumption & minimization of cost of goods & services. Science which studies human behavior as a relationship between ends and scarce means which have alternative uses. Alternative uses of available resources involves the study of choices as they are affected by incentives and resources. Micro Economics Macro Economics -Positive Approach: (What is, what was or will be?) -Normative Approach: (What ought to be?)

Microeconomics
Deals with the economic behavior & problems of individual agents (firm, industry, consumer etc.) & their interactions with markets, given scarcity, govt. regulation for a given market, product & service & factors of production. The Theory: considers aggregates of qty. demand & qty. supply at each possible price per unit to describe the mkt. equilibrium on price & quantity or respond to market changes over time.

Broadly termed as demand-& -supply/ market forces analysis.

Market structures, such as perfect competition & monopoly, are examined for implications for behavior & economic efficiency. Assumptions: ceteris paribus-other things remains unchanged, i.e., partial-equilibrium analysis. General-equilibrium theory: allows for changes in different markets & aggregates across all markets, including their movements & interactions toward equilibrium.

Macroeconomics
Examines the economy as a whole to explain broad aggregates and their interactions and effects. Such aggregates include: - National income & output, - Unemployment rate, - Price inflation & - Sub-aggregates like total consumption & investment & their components. It also studies effects of Monetary, Fiscal & Trade policies Now Macro economics has integrated micro-based modeling of sectors, including rationality of players, efficient use of market information, & imperfect competition. Also considers factors affecting the long-term level & growth of national income within a country & across countries.

Managerial Economics

It applies economic theory to business problems: - How to use economic analysis to make decisions of achieving goal of profit maximization & cost minimization? -Extensive use of QT/QM like operations research, programming & statistical tools like regression analysis in the absence of certainty & perfect knowledge. - It unifies theme & attempt to optimize business decisions, including unit-cost minimization & profit maximization, given the firm's objectives & constraints imposed & supported by technology & market conditions. Reliance: Upgrading technology to achieve EoS Samsung, LG, Sony, BMW: Entry in India P&G and HUL : Consumer preferences & Segmentation

Nature & Scope of Economics

Economics: A behavioral, or social science
The study of how individuals & societies choose to use the scarce resources for optimization ..

Why Economics: To make decisions

- Opportunity Cost - Marginalism - Efficient Markets - Respond to incentives - Trading off - For electing - Understand global affairs - Understand society

Firms
- Buy Car

Consumers

Govts.

Intl. Organizations

Dinner in Restaurant Marry sweetheart Admissions Medicines & treatment etc. - Produce & sell goods & services Buy factors & inputs productions Inventory, Storage, Disposing etc. - Levy taxes Generating Employment Economic Justice Policies Interest rates, Growth, EXIM, Economic affairs etc.

How Is Economics Useful?

Evaluating Choice Alternatives

Identify ways to efficiently achieve goals. Specify pricing and production strategies. Provide production and marketing rules to help maximize net profits.

Making the Best Decision

Economics can be used to efficiently meet management objectives. Managerial economics can be used to understand logic of company, consumer, and government decisions.

Scarcity & Basic Choice Problem

Economics : Tool for Improving Mgmt. Decision Making

Theory of the Firm

Expected Value Maximization

Owner-managers maximize short-run profits. Primary goal is long-term expected value maximization.

Constraints and the Theory of the Firm

Resource constraints. Social constraints

Limitations of the Theory of the Firm

Alternative theory adds perspective. Competition forces efficiency. Hostile takeovers threaten inefficient managers.

The Corporation - a Legal Device

Profit Measurement

Accounting Profits
Total revenue (sales) minus cost of producing goods or services. Reported on the firms income statement.

Economic Profits

Total revenue minus total opportunity cost.

Variability of Business Profits

Business

profits vary widely.

Opportunity Cost

Accounting Costs
The explicit costs of the resources needed to produce produce goods or services. Reported on the firms income statement.

Opportunity Cost

The cost of the explicit and implicit resources that are foregone when a decision is made. Total revenue minus total opportunity cost.

Economic Profits

Why Do Profits Vary Among Firms?

Disequilibrium Profit Theories

Rapid growth in revenues. Rapid decline in costs.

Compensatory Profit Theories

Better, faster, or cheaper than the competition is profitable.

Role of Business in Society

Why

Firms Exist
is useful in satisfying consumer

Business

wants. Business contributes to social welfare

Social

Responsibility of Business

Serve

customers. Provide employment opportunities. Obey laws and regulations.

Value Maximization: a Complex Process

The Economic Perspective

How are resources allocated among competing uses? (land, labor, capital & knowledge)

in the society in the firm

How do individuals make decisions?

the role of incentives the incentive conflicts & opportunistic behavior

Economics & The Mgmt. Disciplines

Business schools are basically schools of applied economics
- James March

Marketing Finance Human resources Operations Accounting

Economics & Mgmt. Disciplines

Relationship to other business disciplines

Marketing: demand, price elasticity Finance: capital budgeting, breakeven

analysis, opportunity cost, value added

Management Science: linear programming,

regression analysis, forecasting Strategy: types of competition, structureconduct-performance analysis Managerial Accounting: relevant cost, breakeven analysis, incremental cost analysis, opportunity cost

Eco. For Effective Mgmt. (Basic Questions)

Questions

that managers must answer:

- supply & demand?
- government regulations? - future conditions? factors? etc.

What are economic conditions in particular market?

-

market structure?
technology? intl. dimensions?

-macroeconomic

Should our firm be in this business? - if so, at what level/size? - at what price level? - what output level? etc.

Eco. & Effective Mgmt. (Basic Questions)

How to gain & maintain competitive advantage ? - cost-leader? - product differentiation? - market niche? - outsourcing, alliances, mergers? - international perspective? etc. What are the risks involved? Risk- uncertainty or chance, different from expectations - shifts in demand/supply conditions? - technological changes? - the effect of competition? - changing interest rates & inflation rates? - exchange rates fluctuations? - socio-political risk s? etc.

Identify Goals & Constraints

Sound decision making involves having welldefined goals.

Leads to making the right decisions.

In striking to achieve a goal, we often face constraints.

Constraints are an artifact of scarcity.

Understanding Firms Incentives

Incentives play an important role within the firm. Incentives determine:

How resources are utilized? How hard individuals work?

Managers must understand the role incentives play in the organization. Constructing proper incentives will enhance productivity & profitability.

Market Interactions

Consumer-Producer Rivalry Consumers attempt to locate low prices, while producers attempt to charge high prices. Consumer-Consumer Rivalry Scarcity of goods reduces the consumers bargaining power as they compete for the right to those goods. Producer-Producer Rivalry Scarcity of consumers causes producers to compete with one another for the right to service customers. The Role of Government Disciplines the market process.

Firm Valuation and Profit Maximization

The value of a firm equals the present value of current and future profits (cash flows). A common assumption among economist is that it is the firms goal to maximization profits.

This means the present value of current and future profits, so the firm is maximizing its value.

Marginal (Incremental) Analysis

Control Variable Examples: - Output - Product Quality - R&D etc.

- Price - Advertising

Basic Managerial Question: How much of the control variable should be used to maximize net benefits?

Net Benefits

Net Benefits = Total Benefits - Total Costs Profits = Revenue - Costs

Marginal Benefit (MB)

Change

in total benefits arising from a change in the control variable.

Slope

(calculus derivative) of the total benefit curve.

Marginal Cost (MC)

Change in total costs arising from a change in the control variable, Q. Slope (calculus derivative) of the total cost curve

Marginal Principle
To maximize net benefits, the managerial control variable should be increased up to the point where MB = MC. MB > MC means the last unit of the control variable increased benefits more than it increased costs. MB < MC means the last unit of the control variable increased costs more than it increased benefits.

The Geometry of Optimization: Total Benefit and Cost

Total Benefits & Total Costs Slope =MB Costs Benefits

B
C Slope = MC

Q*

The Geometry of Optimization: Net Benefits

Net Benefits

Maximum net benefits

Slope = MNB

Q*

The Gap Between Theory & Practice & The role of Managerial Economics

Gap exists between theory & practice in all walks of life Economic world is extremely complex because of interdependency of various factors on each other & economic theories are simplistic ceteris paribus assumption itself is more unrealistic.

Managerial economics bridges the gap between economic theory & business practice using economic logic & analysis of tools by
a) identifying the problems/objectives b) collecting the relevant facts & related info. c) processing & analyzing the facts & info. d) drawing the relevant conclusions e) determining & evaluating the alternative means f) taking a decision that is viable & feasible for optimizing goals.

Conclusion
Economics: A discipline about application of economic theory
& methods to managerial decision making & practices by enriching the analytical skills through developing the logical structuring of problems & providing adequate solutions.

Business: Transactions between 2 or more parties.

Decision Making: Steps: Identifying of strategies, evaluation of
strategies & determining of criteria for choosing strategies. Core elements of economic theory: The theory of firm, consumer & demand theory, production & cost theory, price theory & competition theory etc.,

Economics: a discipline that proceeds by making assumptions

in order to build simple models & as the situations being analyzed become more complex, more sophisticated & advanced methods of analysis become necessary to relax these assumptions.

Thanks !

Assignment

Explain the origin, nature, scope and significance of Economics. What is Managerial Economics? What are the techniques or methods used in managerial economics? How does the study of Managerial Economics help in decision making?