lecture 1 business economics
TRANSCRIPT
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Definition
It is the Social Science concerned with the
efficient use of scarce resources to achieve
the maximum satisfaction of economic wants.
Lets focus on key phrases in this definition
Social Science, Scarce Resources,Maximum Satisfaction and Economic
Wants
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Scarce Resources
The resources are scarce and therefore thegoods and services produced using theseresources are also scarce. There is no such
thing as free lunch, some body pays for it Since we use scarce resources therefore they
must be used in most productive manner i:eBest use. Every single use means it foregoesanother possible use Opportunity Cost ofnot going for 2nd best option
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Utility An economic term referring to the total
satisfaction received from consuming a goodor service in a rational manner
It is an abstract concept rather than concrete
Utility is hard to measure but it can bedetermined indirectly with consumer behavior
Utility increases with wealth but at a
decreasing rate. Marginal utility is the additional satisfaction
derived from each extra unit of consumption
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Rational Behavior
It means same person may make differentchoices under different circumstances
Choices will vary greatly among individuals
and also change as costs and benefits change Rational self interest is different from selfish
behavior.
Choices reflect the pursuit of self interest andare rational but they are based on differingpreferences and circumstances
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Economic Wants
Wants are different from Needs which are
necessary for survival like food shelter
Want is something which a person likes to
have needs have high priority wants have low
Some foods are needs but some may be wants
as well as needs
Ice cream is want but milk is need
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Marginalism
Economics involves lot of marginal analysis like
marginal utility marginal cost marginal benefits
For instance a gain of additional utility by
consumption of one more drink is corresponded
with additional cost
Some times we consume too much of a good
which means its marginal costs outweigh
marginal benefits so we are sacrificing goodswhich are more valuable at the margins-the
place where we consider very last unit of each.
And hence the concept of marginalization
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Economic Methodology
Observation of raw facts or data collection
Formulation of a hypothesis
Testing of Hypothesis
Acceptance, rejection or modification of it
Continued testing of hypothesis. If favorablehypothesis evolves into theory and a well
tested and widely accepted theory leads tolaw. The process of deriving theories andprinciples is called theoretical economics
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Theories
Facts
Policy Economics
Theoretical Economics
Figure 1.1
The relationship
between facts,
Theories, and
Policies in
Economics.
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Some Terminologies
Generalizations: Economic theories, laws andprinciples are generalizations relating toeconomy and its behavior. They are imprecise
because economic facts are diverse and notwo individuals and institutions act in thesame way. These principles are expressed astendencies of typical consumer, worker or
business firm. Although some consumers orfirms may not be following these trends yet onaverage overall economy follows these trends.
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Some Terminologies
Ceteris Paribus or Other things being equal
assumption means that other variables except
those under consideration are held constant
for a particular analysis.
Abstractions: economic theories or principles
are abstractions or simplifications that omit
irrelevant facts. This is simplifying the mattersand avoids cluttering.
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Policy Economics
It recognizes that theories and data can be
used to formulate polices. Economic theories
provide basis for economic policy.
The typical steps in creation of economic
policy are
Stating the goal
Determine policy option
Implement and evaluate the selected policy
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ECONOMIC POLICY
STATE THE GOAL
POLICY OPTIONS
IMPLEMENT &
EVALUATE
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Economic Goals
May be economic growth, economic efficiency, full
employment, equitable distribution of income and
balance of trade etc
These goals may be complementary, mutuallyexclusive or even conflict with each other. Full
employment may reduce poverty and income
inequalities but higher taxation may discourageentrepreneurs and may therefore have trade offs.
When goals conflict societies prioritize objectives.
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Macroeconomics
Macroeconomics examines the economy or itsbasic subdivisions as a whole such asgovernment, business sectors or households.
So households are considered as if lumpedtogether.
It deals with economic measures such as totalincome, total output, total employment,aggregate expenditures and general level ofprices in analyzing various economic problems.
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Microeconomics
It looks at specific economic units or very
small segment of the economy Microscopic
Here we talk of an individual industry firm or
household
Eg: Price of specific products, no of workers
employed in a firm, income and production
processes of a firm etc
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Normative v/s Positive approach
In Microeconomics positive rather than
normative models are used which means how
things are rather than how they should be.
An example of positive statement may be
income inequality has increased during the
past decade while a normative statement
may be the government should tax the richto decrease income inequality
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Normative v/s Positive approach
Positive Economics focuses on facts and causeand effect relationship
Positive economics avoids value judgment and
aims at conducting scientific analysis Policy Economics, on the other hand, involves
normative economics which incorporates
value judgment: How economy should be andwhat policies should be adopted to achievethat goal. It talks of desirability
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Principles of Macroeconomics
Principle 1: people face tradeoffs. To get one
thing we give up another.
Principle 2: cost of something is what u give up
to get it: or Opportunity cost
Principle 3: Rational people think at the margin,
they compare costs and benefits at the margins
Principle 4: People respond to incentives: they
change their decisions when marginal benfits
exceed marginal costs
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Principles of Macroeconomics
Principle 5: Trade can make every one better off.Competition results in gains from trade as people
specialize
Principle 6: Markets are a good way to organizeeconomic activity. Adam Smiths invisible hand
Principle 7: Governments can, sometimes,
improve market outcomes. When market fail to
allocate resources efficiently, governments can
intervene to promote efficiency and equity. Pls
note here externality and market power
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Principles of Macroeconomics
Principle 8: the standard of living depends on acountrys production. It can be measured in
terms of personal incomes or market value of a
nations production
Principle 9: prices rise when the governments
print too much money. Large quantity of money
decreases value of the currency
Society faces a short run tradeoff between
inflation and unemployment. When prices go up
unemployment goes down: only in short run !!!
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Pitfalls to Sound Reasoning
Biases: some people have biases like most ofus have about foreign debt etc
Loaded Terminologies: Like high profits are
termed as Obscene, low prices as exploitative,government is bunch of mindless bureaucratsand government regulations as socialists.
Misperception of definitions like investment isconstrued as purchase of bonds instead ofpurchase of capital assets like plant andmachinery
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Pitfalls to Sound Reasoning
Fallacy of composition which means what iscorrect for an individual is not true for whole.Example: A bumper crop is good for an
individual farmer but not for all of them asprices will go down.
Causation Fallacy: Post hoc and correlation v/scausation. Post hoc occurs because event Aprecedes event B which make people to believethat B was caused by A. In other words afterthis therefore because of this fallacy
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Pitfalls to Sound Reasoning
Correlation v/s Causation: Correlation between2 events means that they are associated insome systematic way. For instance if X and Y
also then it doesnt necessarily mean that Yhas increased because X increased. It could becoincidental or dependant on a 3rd factor.
Economic Example, income and highereducation
Proverbial Example Old Womans Cock
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Graphs
Its the time to look at graphs.
In a graph we have 2 axis, X and Y. Have u ever
thought which variable should be taken on X
and which variable u take on Y?
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Graphs
Its the time to look at graphs.
In a graph we have 2 axis, X and Y. Have u ever
thought which variable should be taken on X and
which variable u take on Y?
Independent variable on X and Dependent on Y
To draw a line we need two points of X variable
which have their corresponding Y Values
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Graphs
Now lets think about the slope of the line
What is the Slope: Its Rise over Run
What is the equation of the line:
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Graphs
What is the Slope: Its Rise over Run
What is the equation of the line: Y=mX+C
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Graphs
Income per week Consumption per week
$ 0 $ 50
100 100
200 150
300 200
400 250
So Which variable should we take on X-Axis and which
variable should we take on Y. Income is independent
variable so goes on X and Consumption is dependant
variable and hence goes on Y.
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Graphs
So what is the slope of the line and equationof this line
Begin by taking 2 points say 100, 100 and 50, 0
Rise over Run means distance between 2vertical points and 2 horizontal points
So 100-50
100-0
So the slope of this line is 0.5
Positive Slope means when X increases Y alsoincreases
= 50/100 or 0.5
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Graphs
Now what is the line equation As I mentioned it is Y=mX+C where m=slope and
C is a constant. So lets find out the equation for
this line
To do this we need only one point of X and Y
So lets take 200, 150 (x, y)
Now 150 = 0.5 * 200 + C
Or 150 = 100 + C or
C = 150 100 or C = 50 (See graph even when
X=0 the person still spends 50 and it is constant
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CONSUMPTION
(C)
0 100 200 300 400
INCOME (Y)
$400
300
200
100
a
b
c
d
e
C = 50 + .5Y
CONSUMPTION
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Graphs
Relationship between ticket price & attendanceTicket Price (in $) Attendance (in thousands)
50 0
40 4
30 8
20 12
10 16
0 20
Now lets take Attendance on X Axis and Ticket Price
on Y Axis. What is Slope and Equation of the line
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0 4 8 12 16 20ATTENDANCE IN THOUSANDS (Q)
$50
40
30
20
10
a
b
c
f
e
d
TICKETPRICE(P)
P=50-2.5Q
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The Economizing Problem
Two fundamental problems
Societys economic wants i:e economic wants
of its citizens and institutions are unlimited
and insatiable
Economic resources- the means of producing
goods and services- are scarce or limited
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Unlimited Wants Consumers use goods to get utility.
Utilities vary widely from necessities to
luxuries- food shelter clothing to racing cars and
yachts.
Services also provide utility such as 5 star
services and security etc.
Institutions are not much different in this
regard. Pvt institutions want factories to work
efficiently while Government institutions strive
to provide services like high ways law & Order
etc
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PROPERTY RESOURCES
LAND
CAPITAL
HUMAN RESOURCESLABOR
SCARCE RESOURCES
ECONOMIC RESOURCES
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PROPERTY RESOURCES
LAND
CAPITAL
HUMAN RESOURCESLABOR
ENTREPRENEURIAL ABILITY
SCARCE RESOURCES
ECONOMIC RESOURCES
Also known
as theInputFactors ofProduction
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Scarce Resources
Economic resources include Land, Labor,Capital and Entrepreneurship.
Entrepreneurial ability is also a scarce
resource because as he takes risk, combinesresources and takes strategic decisions toproduce goods and services to make profits.
These 4 resources land, labor, capital andentrepreneurial ability are called factors ofproduction
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ENTREPRENEURIAL ABILITY
Takes The Initiative
Makes StrategicBusiness Decisions
InnovatorThe Risk Bearer
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Employment and Efficiency
Since economics focuses on best use of scarceresources therefore it aims at ensuring bestefficiency.
This presupposes 2 aspects, full employmentand full production.
Full employment means those who can belegally employed like no child labor.
Full production means all resources are bestutilized to provide maximum satisfaction orout put. If not so then they are under utilized.
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Allocative Efficiency
Allocative efficiency is least cost production of a
particular mix of goods most wanted by society.
This means apportionment of limited resources
in such a way that society obtains the mix which
it wants the most. At this point Price = MC
The point of maximum allocative efficiency is
achieved in perfect competition at the pointwhere MR=MC and MC=AR=P
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Productive Efficiency
Productive efficiency or technical efficiency
occurs when the economy produces a mix of
goods at the lowest possible cost given other
goods. Its called Production Possibility Frontier.This is attained when firms produce at the
bottom of their Average Cost Curves. Perfectly
competitive firms also achieve this in the longrun as they produce at P=MC and this happens
to be tangent to the lowest point of AC curve
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Production Possibilities Model
4 simplifying assumptions
1. Full employment and productive efficiency,100% utilization of resources at least cost
2. Fixed Resources: Factors of production are infixed supply though can be reallocated.
3. Fixed Technology: in the short run the
methods of production cant be changed.4. Two goods: As discussed earlier the society
produces 2 goods or services only
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Production Possibilities Model
Type of Product A B C D E
Pizzas (in hundred thousands) 0 1 2 3 4
Robots (in thousands) 10 9 7 4 0
In the above table Pizzas are depicted as consumer goods while
robots are presented as capital investment. So by picking A
society chooses to forego current consumption and concentrateson capital goods which are futuristic. Less now more later
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PIZZA 0 1 2 3 4(in hundred thousands)
ROBOTS 10 9 7 4 0
(in thousands)
in table form
graphical form
Robo
ts
(thousands)
Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES
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PIZZA 0 1 2 3 4(in hundred thousands)
ROBOTS 10 9 7 4 0
(in thousands)
in table form
graphical form
Robo
ts
(thousands)
Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES
O C O OSS S
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PIZZA 0 1 2 3 4(in hundred thousands)
ROBOTS 10 9 7 4 0
(in thousands)
in table form
graphical form
Robo
ts
(thous
ands)
Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES
PRODUCTION POSSIBILITIES
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PIZZA 0 1 2 3 4(in hundred thousands)
ROBOTS 10 9 7 4 0
(in thousands)
in table form
graphical form
Robots
(thous
ands)
Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES
PRODUCTION POSSIBILITIES
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PIZZA 0 1 2 3 4(in hundred thousands)
ROBOTS 10 9 7 4 0
(in thousands)
in table form
graphical form
Robots
(thous
ands)
Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES
PRODUCTION POSSIBILITIES
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PIZZA 0 1 2 3 4(in hundred thousands)
ROBOTS 10 9 7 4 0
(in thousands)
in table form
graphical form
Robots
(thous
ands)
Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES
PRODUCTION POSSIBILITIES
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At any point in time,a full-employment, full-
production economy must
sacrifice some of productXto
obtain more of productY.
PRODUCTION POSSIBILITIES
Limited Resources
means a limitedoutput...
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Q
Robots
(thousands)
14
13
12
11
10
9
8
7
65
4
3
2
1
1 2 3 4 5 6 7 8
A B
C
D
E
W
Attainable
but
Inefficient
Unattainable
Attainable& Efficient
Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES
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Q
Q
Rob
ots(thous
ands)
Pizzas (hundred thousands)
14131211109
87654
321
1 2 3 4 5 6 7 8
A B
C
D
E
W
Attainable
butInefficient
Unattainable
Attainable& Efficient
PRODUCTION POSSIBILITIES
Notes...
The amount of other
products that must beforgone or sacrificed toobtain 1 unit of a specific
product is called the
opportunity costof thatgood.
LAW OF INCREASINGOPPORTUNITY COSTS
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Law of Increasing Opportunity Cost
The opportunity cost, the value of foregone
production, increases as the quantity of a good
produced increases .
It is explained as the slope of productionpossibilities curve. It analyzes the alternative
combination of the two goods.
It generates a distinctive convex shape, flat atthe top and steep at the bottom.
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Economic Rationale: LIOC
The sacrifice of one good increases (Robots) as we
produce more of other good (Pizza).
This is because economic resources are not
completely adaptable to alternate uses. Forinstance land may be suitable for agriculture and
not for mining. Similarly technology may be labor
intensive and not capital intensive. This lack of perfect flexibility or interchangeability
is the cause of Increasing Opportunity Cost
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Economic Rationale contd
As we saw earlier economic activity likeproduction or consumption should continuetill marginal benefits exceed marginal costs.
The optimal point of production therefore iswhere MC=MB
See the graph and tell me why. To sum up
Resources are being efficiently allocated toany product when marginal benefits andmarginal costs of it are equal or MB=MC
PRODUCTION POSSIBILITIES
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P
QMargin
alBenefit
&Cost
Quantity of Pizzas
$15
10
5
1 2 3
PRODUCTION POSSIBILITIES
MC
MB
Allocative Efficiency: MB=MC
MB=MC
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Production Possibility Curve: recap
1. Scarcity of resources is implied by the area ofunattainable combinations of output-lying onthe right of the curve
2. Choice among outputs is reflected by the varietyof attainable combinations along the curve
3. Opportunity cost is illustrated by the downwardslope of the curve and
4. The law of increasing opportunity cost is impliedby the concavity of the curve.
Q
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Q
Q
Robots(thousands)
Pizzas (hundred thousands)
14
13
12
11
10
9
8
7
6
54
3
2
1
1 2 3 4 5 6 7 8
U
Unemployment &Underemployment
Shown by PointU
More of either or
both is possible
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Economic GrowthQ
Q
Robots(thousa
nds)
Pizzas (hundred thousands)
14
13
12
11
10
9
87
6
5
4
32
1
1 2 3 4 5 6 7 8
A
B
C
D
E
PRODUCTION POSSIBILITIES
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Applications... Unemployment and
Productive Inefficiency Tradeoffs and Opportunity
Costs
Shifts in the ProductionPossibilities Curves
PRODUCTION POSSIBILITIES
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Economic Systems
Market systems or Capitalism or Commandsystem or Communism.
In Capitalism individual buyers and sellersinteract resulting in competition.
In pure capitalism Laissez Faire approach isdominant which means let it be means nogovernment interference or control
A planned economy relies exclusively on thecentral plan given by the government, eventhough there are few private productions andmarkets
ECONOMIC SYSTEMS
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ECONOMIC SYSTEMS
THE MARKET SYSTEMPure CapitalismLaissez-faire
THE COMMAND SYSTEM
SocialismCommunism
CIRCULAR FLOW MODEL
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BUSINESSES HOUSEHOLDS
RESOURCEMARKET
RESOURCES INPUTS
PRODUCTMARKET
CIRCULAR FLOW MODEL
CIRCULAR FLOW MODEL
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BUSINESSES HOUSEHOLDS
RESOURCEMARKET
RESOURCES INPUTS
$ COSTS $ INCOMES
GOODS &SERVICES GOODS &SERVICES
PRODUCTMARKET
CIRCULAR FLOW MODEL
CIRCULAR FLOW MODEL
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BUSINESSES HOUSEHOLDS
RESOURCEMARKET
RESOURCES INPUTS
$ COSTS $ INCOMES
PRODUCTMARKET
GOODS &SERVICES GOODS &SERVICES
CIRCULAR FLOW MODEL
CIRCULAR FLOW MODEL
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BUSINESSES HOUSEHOLDS
RESOURCEMARKET
RESOURCES INPUTS
$ COSTS $ INCOMES
PRODUCTMARKET
GOODS &SERVICES GOODS &SERVICES
CIRCULAR FLOW MODEL