Managerial Economics CIA 3.

Siddhi Pawaskar
1820552
3 BBA E
 MANAGERIAL ECONOMICS CIA 3- COMPONENT 1.
The Impact Of The Great Depression (1929).

I. What is a Negative Externality?

A negative externality is a cost that is suffered by a third party as a consequence of an economic

transaction. In a transaction, the producer and consumer are the first and second parties, and third
parties include any individual, organization, property owner, or resource that is indirectly
affected. Externalities are also referred to as spillover effects, and a negative externality is also
referred to as an ‘external cost’.

An external cost, such as the cost of pollution from industrial production, makes the marginal
social cost (MSC) curve higher than the private marginal cost (MPC).

The socially efficient output is where MSC = MSB, at Q1, which is a lower output than the market
equilibrium output, at Q.

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 II. About The Great Depression of 1929.

A worldwide depression struck countries with market economies at the end of the 1920s. Although
the Great Depression was relatively mild in some countries, it was severe in others, particularly in
the United States, where, at its nadir in 1933, 25 percent of all workers and 37 percent of all
nonfarm workers were completely out of work. Some people starved; many others lost their farms
and homes.

The Great Depression that began at the end of the 1920s was a worldwide phenomenon. By 1928,
Germany, Brazil, and the economies of Southeast Asia were depressed. By early 1929, the
economies of Poland, Argentina, and Canada were contracting, and the U.S. economy followed in
the middle of 1929. As Temin, Eichengreen, and others have shown, the larger factor that tied
these countries together was the international gold standard.

(NOTE: The gold standard was a commitment by participating countries to fix the prices of their
domestic currencies in terms of a specified amount of gold.)

III. Impact Of The Great Depression.

We will focus on how the Great Depression affected the following areas:

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 Political Social
Economy
Impact Impact

Banking
Employment
Sector

1. ECONOMY.

Economy Deflation

Trade

During the first five years of the depression, the economy shrank 50%. In 1929, economic
output was $105 billion, as measured by gross domestic product. That's the equivalent of $1.057
trillion today

The economy began shrinking in August 1929. By the end of the year, 650 banks had failed.
In 1930, the economy shrank another 8.5%, according to the Bureau of Economic Analysis. GDP
fell 6.4% in 1931 and 12.9% in 1932. By 1933, the country had suffered at least four years
of economic contraction. It only produced $57 billion, half what it produced in 1929.

Part of the contraction was due to deflation. The Consumer Price Index fell 27% between
November 1929 to March 1933, according to the Bureau of Labor Statistics. Falling prices sent
many firms into bankruptcy. The BLS also reported that the unemployment rate peaked at 24.9%
in 1933.

New Deal spending boosted GDP growth by 10.8% in 1934. It grew another 8.9% in 1935, a
whopping 12.9% in 1936, and 5.1% in 1937. Unfortunately, the government cut back on New
Deal spending in 1938. The depression returned and the economy shrank 3.3%.

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 a. Stock Market.
The stock market lost 90% of its value between 1929 and 1932. It didn't recover for 25
years. People lost all confidence in Wall Street markets. Businesses, banks, and
individual investors were wiped out. Even people who hadn't invested lost money. Their
banks invested the money from their savings accounts.
b. Trade.
As countries' economies worsened, they erected trade barriers to protect local industries.
In 1930, Congress passed the Smoot-Hawley tariffs, hoping to protect U.S. jobs.
Other countries retaliated. That created trading blocs based on national alliances and
trade currencies. World trade plummeted 65% as measured in dollars and 25% in the total
number of units. By 1939, it was still below its level in 1929. Here's world trade for the
first five years of the Depression:
• 1929: $5.3 billion
• 1930: $4.9 billion
• 1931: $3.3 billion
• 1932: $2.1 billion
• 1933: $1.8 billion

2. POLITICAL.

The Depression affected politics by shaking confidence in unfettered capitalism. That type of
laissez-faire economics is what President Herbert Hoover advocated, and it had failed.

As a result, people voted for Franklin Roosevelt. His Keynesian economics promised that
government spending would end the Depression. The New Deal worked. In 1934, the economy
grew 10.8% and unemployment declined.

But FDR became concerned about adding to the $5 trillion U.S. debt. He cut back government
spending in 1938, and the Depression resumed. No one wants to make that mistake again.

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Politicians rely instead on deficit spending, tax cuts and other forms of expansionary fiscal policy.
That's created a dangerously high U.S. debt.

The Depression ended in 1939 as government spending ramped up for World War II. That's led to
the mistaken belief that military spending is good for the economy. But it doesn't even rank as one
of the four best real-world ways to create jobs.

3. SOCIAL

The Dust Bowl drought destroyed farming in the Midwest. It lasted 10 years, too long for most
farmers to hold out. To make things worse, prices for agricultural products dropped to their lowest
level since the Civil War. As farmers left in search of work, they became homeless.

Wages for those who still had jobs fell 42%. Average family incomes dropped 40% from $2,300
in 1929 to $1,500 in 1933. That's like having income fall from $32,181 to $20,988 in 2016 dollars.
As a result, the number of children sent to orphanages increased by 50%. Roughly 250,000 older
children left home to find work.

In 1933, Prohibition was repealed. That allowed the government to collect taxes on sales of now-
legal alcohol. FDR used the money to help pay for the New Deal.

The depression was so severe and lasted so long that many people thought it was the end of the
American Dream. Instead, it changed that dream to include a right to material benefits. The
American Dream as envisioned by the Founding Fathers guaranteed the right to pursue one's own
vision of happiness.

4. EMPLOYMENT.

n 1928, the final year of the Roaring Twenties, unemployment was 3.2%. That's less than the
natural rate of unemployment. By 1930, it had more than doubled to 8.7%. In 1931, it skyrocketed
to 15.9% in 1931 and, in 1932, to 23.6%. By 1933, unemployment was 24.9%. Almost 15 million
people were out of work. That's highest unemployment rate ever recorded in America.

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New Deal programs helped reduce unemployment to 21.7% in 1934, 20.1% in 1935, 16.9% in
1936 and 14.3% in 1937. But less robust government spending in 1938 sent unemployment back
up to 19%. It remained above 10% until 1941, according to a review of the unemployment rate by
year.

5. BANKING.

During the Depression, half of the nation's banks failed. In the first 10 months of 1930 alone, 744
failed. That was 1,000% more than the annual rate in the 1920s. By 1933, 4,000 banks had failed.
As a result, depositors lost $140 billion. People were stunned to find out that banks had used their
deposits to invest in the stock market. They rushed to take their money out before it was too late.
These “runs” forced even good banks out of business.

IV. What Caused The Great Depression?

According to Ben Bernanke, the past chairman of the Federal Reserve, the central bank helped
create the Depression. It used tight monetary policies when it should have done the opposite.
According to Bernanke, these were the Fed's five critical mistakes:

1. The Fed began raising the fed funds rate in the spring of 1928. It kept increasing it
through a recession that started in August 1929.
2. When the stock market crashed, investors turned to the currency markets. At that time,
the gold standard supported the value of the dollars held by the U.S. government.
Speculators began trading in their dollars for gold in September 1931. That created a run
on the dollar.
3. The Fed raised interest rates again to preserve the dollar's value. That further restricted
the availability of money for businesses. More bankruptcies followed.

1. The Fed did not increase the supply of money to combat deflation.
2. Investors withdrew all their deposits from banks. The failure of the banks created more
panic. The Fed ignored the banks' plight. This situation destroyed any of consumers’
remaining confidence in financial institutions. Most people withdrew their cash and put it
under their mattresses. That further decreased the money supply.

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The Fed did not put enough money in circulation to get the economy going again. Instead, the
Fed allowed the total supply of U.S. dollars to fall 30 percent. Later research has supported parts
of Bernanke's assessment.

V. What Ended the Great Depression?

In 1932, the country elected Franklin D. Roosevelt as president. He promised to create federal
government programs to end the Great Depression. Within 100 days, he signed the New
Deal into law, creating 42 new agencies. They were designed to create jobs, allow unionization,
and provide unemployment insurance. Many of these programs still exist. They help safeguard
the economy and prevent another depression.

(Note: New Deal is an economic policy Franklin D. Roosevelt launched to end the Great
Depression.)

(TIMELINE)

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 VI. Keynesian Economics and the Great Depression

Keynesian economics is sometimes referred to as "depression economics," as Keynes's General

Theory was written during a time of deep depression not only in his native land of the United
Kingdom but worldwide. The famous 1936 book was informed by directly observable economic
phenomena arising during the Great Depression, which could not be explained by classical
economic theory.

• Keynesian Economics focuses on using active government policy to manage aggregate

demand in order to address or prevent economic recessions.
• Keynes developed his theories in response to the Great Depression, and was highly
critical of classical economic arguments that natural economic forces and incentives
would be sufficient to help the economy recover.
• Activist fiscal and monetary policy are the primary tools recommended by Keynesian
Economists to fight Unemployment.

VII. Conclusion.

It is quite impossible to face a situation like the one in 1929. The Impact of The Great Depression
was enormous and not likely to happen again on a scale as large as that. Yet, we may face
recessions or stock market crashes that could compare to the Great Depression (Financial Crisis,
2008)

Six Reasons Why the Depression Could Reoccur

1. Stock market crashes can cause depressions by wiping out investors' life savings. If
people have borrowed money to invest, then they will be forced to sell all they have to
pay back the loans. Derivatives make any crash even worse through this leveraging.
Crashes also make it difficult for companies to raise the needed funds to grow. Finally,
a stock market crash can destroy the confidence required to get the economy going again.
2. Lower housing prices and resultant foreclosures totaled at least $1 trillion in losses to
banks, hedge funds, and other owners of subprime mortgages on the secondary market.

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 Banks continue to hoard cash even though housing prices have increased. They are still
digesting the losses from one million foreclosures.
3. Business credit is needed for businesses so they can continue to run on a daily basis.
Without credit, small businesses can't grow, stifling the 65 percent of all new jobs that
they provide.
4. Bank near-failures frightened depositors into taking out their cash. Although the Federal
Deposit Insurance Corporation insures these deposits, some became concerned that this
agency would also run out of money. Commercial banks depend on consumer deposits to
fund their day-to-day business, as well as make loans.
5. High oil prices could return once U.S. shale producers are forced out of business.
Millions of jobs were lost when oil prices plummeted. At the same time, many consumers
bought new cars and SUVs when gas prices were low. They will be pinched when prices
rise again.
6. Deflation is an even bigger threat. Low oil and gas prices have had a deflationary impact,
and so has a 25 percent increase in the U.S. dollar that depresses import prices. These
deflationary pressures seem like a boon to consumers, but they make it difficult for
businesses to raise wages. The result could be a downward spiral. That is similar to what
happened during the Great Depression.

Six Reasons Why the Depression Won't Reoccur

1. Stock price declines haven't exceeded 11 percent in one day or 30 percent in a year. The
kick-off to the Depression was the Stock Market Crash of 1929. By the stock market's
close on Black Tuesday, the Dow had fallen 25 percent in just four days.
2. Housing prices and foreclosures have recovered. Rental rates are relatively high, which
has brought investors back to the housing market. Now that confidence has been restored,
housing prices will continue to rise. The foreclosure pipeline, which once seemed
endless, has disappeared.
3. Business credit has been affected the most. The world's central banks have pumped in
much of the liquidity needed. In effect, they have replaced the financial system itself.
4. Monetary policy is expansionary, unlike the contractionary monetary policies that caused
the Great Depression. During the recession in the summer of 1929, the Fed decreased

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 the money supply by 30 percent. It raised the fed funds rate to defend the value of the
dollar. Without liquidity, banks collapsed, forcing people to remove all funds and stuff
them under the mattress, causing economic collapse. The FDIC helps prevent bank runs
by insuring deposits.
5. Economic output fell 4 percent from its high of $14.4 trillion in the 2nd quarter of 2008
to its low of $13.9 trillion a year later. It fell a whopping 25 percent during the
Depression. It has recovered to $18 trillion.
6. There is a big difference between a recession and a depression. Even if another Great
Recession does occur, it is unlikely to turn in a global depression.

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 MANAGERIAL ECONOMICS CIA 3- COMPONENT 2.

UTILITY ANALYSIS.

I. What is Utility?.

Goods are desired because of their ability to satisfy human wants. The property of a good that
enables it to satisfy human wants is called utility.

As individuals consume more of a good per time period, their total utility (TU) or satisfaction
increases, but their marginal utility diminishes.

Marginal utility (MU) is the extra utility received from consuming one additional unit of the good
per unit of time while holding constant the quantity consumed of all other commodities.

For example, one hamburger per day (or, more generally, one unit of good X per period of time)
gives the consumer a total utility (TU) of 10 utils, where a util is an arbitrary unit of utility. Total
utility increases with each additional hamburger consumed until the fifth one, which leaves total
utility unchanged.

This is the saturation point. Consuming the sixth hamburger then leads to a decline in total utility
because of storage or disposal problems. Marginal utility is positive but declines until the fifth
hamburger, for which it is zero, and becomes negative for the sixth hamburger.

TABLE 1.1:

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FIG 1.1. Total and Marginal Utility In the top panel, total utility (TU) increases by smaller and
smaller amounts (the shaded areas) and so the marginal utility (MU) in the bottom panel declines.
TU remains unchanged with the consumption of the fifth hamburger, and so MU is zero. After the
fifth hamburger per day, TU declines and MU is negative.

II. Law of Diminishing Marginal Utility.

The total and marginal utility curves are obtained by joining the midpoints of the bars measuring
TU and MU at each level of consumption. Note that the TU rises by smaller and smaller amounts
(the shaded areas) and so the MU declines. The consumer reaches saturation after consuming he

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fourth hamburger. Thus, TU remains unchanged with the consumption of the fifth hamburger and
MU is zero. After the fifth hamburger, TU declines and so MU is negative. The negative slope or
downward-to-the-right inclination of the MU curve reflects the law of diminishing marginal
utility.

Utility schedules reflect tastes of a particular individual; that is, they are unique to the individual
and reflect his or her own particular subjective preferences and perceptions. Different individuals
may have different tastes and different utility schedules. Utility schedules remain unchanged so
long as the individual’s tastes remain the same.

III. Ordinal and Cardinal Utility.

Cardinal utility means that an individual can attach specific values or numbers of utils from
consuming each quantity of a good or basket of goods. In Table 1.1 we saw that the individual
received 10 utils from consuming one hamburger. He received 16 utils, or 6 additional utils, from
consuming two hamburgers. The consumption of the third hamburger gave this individual 4 extra
utils, or two-thirds as many extra utils, as the second hamburger. Thus, Table 1.1 and Figure 1.1
reflect cardinal utility. They actually provide an index of satisfaction for the individual. In contrast,
ordinal utility only ranks the utility received from consuming various amounts of a good or baskets
of goods.

III A. Consumer’s Equilibrium (Marshall)

Regarding this Prof. Marshall has said that “The excess of price which he (consumer) would be
willing to pay rather than go without. The thing over that which he actually does pay, is the
economic measure of this surplus satisfaction. It may be called “Consumer’s Surplus”

In actual life, when we buy a commodity for consumption, we gain some utility by consuming it,
at the same time we lose some utility in terms of the price that we need to pay for it. In the
beginning, utility gained is usually higher than the utility lost.

This concept is used to explain the gap between total utility that a consumer gets from the
consumption of a certain commodity and the total money value which he actually pays for the
same.

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Prof. Marshall has discussed the concept of Consumer’s Surplus on the basis of the following
assumptions:

1. Marginal Utility of Money is Constant:

The marginal utility of money to the consumer remains constant. It is so when the money spent on
purchasing the commodity is only a small fraction of this total income.

2. No Close Substitutes Available:

The commodity in question has no close substitutes and if it does have any substitute, the same
may be regarded as an identical commodity and thus only one demand should may be prepared.

3. Utility can be Measured:

The utility is capable of cardinal measurement through the measuring rod of money. Moreover,
the utility obtainable from one good is absolutely independent of the utility from the other goods.
No goods affect the utility that can be derived from the other goods.

4. Tastes and Incomes are Same:

That all people are of identical tastes, fashions and their incomes also are the same.

TABLE 1.2:

The above table expresses the various amounts of utilities he derives from the consumption of
different units of bread. From the first bread alone he derives marginal utility of Rs. 10 but the
price which he pays is Rs. 2 and hence Rs. 8 is the Consumer’s Surplus.

FIG 1.2:

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In this diagram AB is a demand curve of a consumer OR is the market price. The price line is
parallel to X axis because of perfect competition. At point P the marginal curve AB intersect the
market price curve OR. Thus for OQ quantity the consumer derives utility as AOQP where as he
pays ROQP. Thus, triangular shaded area ARP is Consumer’s Surplus.

Ordinal utility specifies that consuming two hamburgers gives the individual more utility than
when consuming one hamburger, but it does not specify exactly how much additional utility the
second hamburger provides. Similarly, ordinal utility would say only that three hamburgers give
this individual more utility than two hamburgers, but not how many more utils.3

Ordinal utility is a much weaker notion than cardinal utility because it only requires that the
consumer be able to rank baskets of goods in the order of his or her preference.

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 IV. Indifference Curve.

An indifference curve shows the various combinations of two goods that give the consumer equal
utility or satisfaction. A higher indifference curve refers to a higher level of satisfaction, and a
lower indifference curve refers to less satisfaction.

Table 1.3:

(Fig 1.3: The individual is indifferent among combinations A, B, C, and F since they all lie on
indifference curve U1. U1 refers to a higher level of satisfaction than U0, but to a lower level than
U2.)

For example, Table 1.3 gives an indifference schedule showing the various combinations of
hamburgers (good X) and soft drinks (good Y) that give the consumer equal satisfaction. This
information is plotted as indifference curve U1 in the left panel of Figure 1.3 The right panel
repeats indifference curve U1 along with a higher indifference curve (U2) and a lower one (U0).

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Indifference curve U1 shows that one hamburger and ten soft drinks per unit of time (combination
A) give the consumer the same level of satisfaction as two hamburgers and six soft drinks
(combination B), four hamburgers and three soft drinks (combination C), or seven hamburgers and
one soft drink (combination F). On the other hand, combination R (four hamburgers and seven soft
drinks) has both more hamburgers and more soft drinks than combination B (see the right panel of
Figure 1.3), and so it refers to a higher level of satisfaction.

Thus, combination R and all the other combinations that give the same level of satisfaction as
combination R define higher indifference curve U2. Finally, all combinations on U0 give the same
satisfaction as combination T, and combination T refers to both fewer hamburgers and fewer soft
drinks than (and therefore is inferior to) combination B on U1. Although in Figure 1.3 we have
drawn only three indifference curves, there is an indifference curve going through each point in
the XY plane (i.e., referring to each possible combination of good X and good Y).

That is, between any two indifference curves, an additional curve can always be drawn. The entire
set of indifference curves is called an indifference map and reflects the entire set of tastes and
preferences of the consumer.

V. Features of Indifference Curve

1. Indifference curve slopes downwards from left to right: An indifference curve slopes
downwards from left to right, which means that in order to have more of bananas, the
consumer has to forego some mangoes. If the consumer does not forego some mangoes
with an increase in number of bananas, it will mean consumer having more of bananas with
same number of mangoes, taking her to a higher indifference curve. Thus, as long as the
consumer is on the same indifference curve, an increase in bananas must be compensated
by a fall in quantity of mangoes.

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 2. Higher indifference curve gives greater level of utility: As long as marginal utility of a
commodity is positive, an individual will always prefer more of that commodity, as more
of the commodity will increase the level of satisfaction.

3. Two indifference curves never intersect each other: Two indifference curves intersecting
each other will lead to conflicting results. To explain this, let us allow two indifference
curves to intersect each other as shown in the figure 1.3 As points A and B lie on the same
indifference curve IC1 , utilities derived from combination A and combination B will give
the same level of satisfaction. Similarly, as points A and C lie on the same indifference
curve IC2 , utility derived from combination A and from combination C will give the same
level of satisfaction.

VI. The Consumer’s Budget.

Let us consider a consumer who has only a fixed amount of money (income) to spend on two
goods. The prices of the goods are given in the market. The consumer cannot buy any and every
combination of the two goods that she may want to consume. The consumption bundles that are
available to the consumer depend on the prices of the two goods and the income of the consumer.
Given her fixed income and the prices of the two goods, the consumer can afford to buy only those
bundles which cost her less than or equal to her income.

VI A. Budget Set and Budget Line

Suppose the income of the consumer is M and the prices of bananas and mangoes are p1 and p2
respectively5 . If the consumer wants to buy x1 quantities of bananas, she will have to spend p1
x1 amount of money.

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Similarly, if the consumer wants to buy x2 quantities of mangoes, she will have to spend p2 x2
amount of money. Therefore, if the consumer wants to buy the bundle consisting of x1 quantities
of bananas and x2 quantities of mangoes, she will have to spend p1 x1 + p2 x2 amount of money.
She can buy this bundle only if she has at least p1 x1 + p2 x2 amount of money.

Given the prices of the goods and the income of a consumer, she can choose any bundle as long
as it costs less than or equal to the income she has. In other words, the consumer can buy any
bundle (x1 , x2 ) such that

p1 x1 + p2 x2 ≤ M

The inequality is called the consumer’s budget constraint.

The set of bundles available to the consumer is called the budget set. The budget set is thus the
collection of all bundles that the consumer can buy with her income at the prevailing market prices.

VII. Changes in Income and Prices and the Budget Line

A particular budget line refers to a specific level of the consumer’s income and specific prices of
the two goods. If the consumer’s income and/or the price of good X or good Y change, the budget
line will also change. When only the consumer’s income changes, the budget line will shift up if
income (I) rises and down if I falls, but the slope of the budget line remains unchanged.

Change in Income:

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If only the price of good X changes, the vertical or Y-intercept remains unchanged, and the budget
line rotates upward or counterclockwise if PX falls and downward or clockwise if PX rises.

Change in Price:

VIII. Consumer’s Equilibrium:

In economics, it is generally assumed that the consumer is a rational individual. A rational

individual clearly knows what is good or what is bad for her, and in any given situation, she always
tries to achieve the best for herself. From the bundles which are available to her, a rational
consumer always chooses the one which gives her maximum satisfaction

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The optimum point would be located on the budget line. A point below the budget line cannot be
the optimum. Compared to a point below the budget line, there is always some point on the budget
line which contains more of at least one of the goods and no less of the other, and is, therefore,
preferred by a consumer whose preferences are monotonic.

Points above the budget line are not available to the consumer. Therefore, the optimum (most
preferred) bundle of the consumer would be on the budget line.

In the Figure below, the budget line is tangent to the black colored indifference curve. The first
thing to note is that the indifference curve just touching the budget line is the highest possible
indifference curve given the consumer’s budget set.

Bundles on the indifference curves above this, like the grey one, are not affordable. Points on the
indifference curves below this, like the blue one, are certainly inferior to the points on the
indifference curve, just touching the budget line.

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 REFERENCES.

CIA 3 COMPONENT 1: Great Depression.

1. Amadeo, Kimberly. (2019, 05 August). Effects Of Great Depression.

https://www.thebalance.com/effects-of-the-great-depression-4049299

2. Amadeo, Kimberly. (2019, 05 August). The Great Depression, What Happened,

What Caused It, How It Ended.
https://www.thebalance.com/the-great-depression-of-1929-3306033

3. Amadeo, Kimberly. (2019, 25 July). Timeline of The Great Depression.

https://www.thebalance.com/great-depression-timeline-1929-1941-4048064

4. HILLSDALE COLLEGE ONLINE COURSES. (OCTOBER 19, 2015).

Keynesian Economics and the Great Depression. http://blog.hillsdale.edu/online-
courses/keynesian-economics-and-the-great-depression

CIA 3 COMPONENT 2: Utility Analysis.

1. Salvatore, Dominick. (2009, 21st May) Principles Of Microeconomics; Oxford University

Press, London.

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