Managerial Economics

Basic Economic Concepts

What is Economics?
Economics is the study of scarcity and choice

Scarcity means that there is a finite amount of a good or service (Basically they are limited). Because
something is limited, we need to make decisions regarding how we use and allocate our resources.

So studying economics helps use to better make decisions regarding how to deal with the condition of
scarcity.

Before we begin, there are few more definitions we should learn. In addition to scarcity you should
know that:

Goods are tangible items, or products, such as Pop Tarts, automobiles and I Phones.

Services are intangible items such as a haircut, mowing a lawn, and a dentist visit.

Also, you should know the difference between scarcity and shortage. Shortage is a short term
condition of a limited amount of a resource. For example, if there is a frost in Florida and the
orange crop is destroyed, the supply of oranges will be limited, but only for that growing season.

One of the most important aspects of choice in Economics is the idea that every choice has trade-off-
what didn’t you choose. This is related to the concept of opportunity cost.

Opportunity Cost is your second choice-what you give up when you make a decision. For
example, if you choose to go to college, you give up the salary you could have earned if you go
directly into the work force. The salary you would give-up is the opportunity cost of going to
college. Remember that Economics is the study of scarcity and choice. The concept of
opportunity cost is an important element in economic choices.

The Factors of Production

In order to better understand how we make decisions regarding scarcity and choice, it is important to
understand how goods and services are produced. This is where the concept of the factors of
production comes in:

The Factors of Production are classifications of what goes into the making of a good or
service. They include:

*Land or Natural Resources which are products used in the production of goods and
services, come from the earth. Examples could include lumber or oil.

Natural resources can be characterized as either:

Renewable resources are resources that can be replenished, such as trees that can be
replanted.
 Nonrenewable resources are resources that cannot be replaced such as coal.

*Labor or Human Resources is the work that goes into the production of a good or service.
When looking at this factor, we usually look at the number or workers and the workers’ skills.

*Capital is the term used for the items that are used to create a good or service. Examples of this
may include the building where a good is produced, or the tools utilized to create a good or
provide a service.

*Entrepreneurship is the putting together of land labor and capital to create a good or provide a
service. This is basically the ideas that go into the process of creating a good or providing a
service.

Basic Economic Questions

Societies need to determine how to put all of the factors of production together to best deal with the
issue of scarcity. To do this they need to address these Basic Economic Questions:

What goods and services should be produced? What goods and services does the
society need? What goods and should the society produce? Should the society specialize
in particular products and trade for others?

How should goods and services be produced? How should the factors of production
be combined? What resources should be used? How should we utilize our labor and
capital?

Who should receive the goods and services? How should goods and services be
distributed? Should everyone receive them? If not how does society decide who gets
particular goods and services and who might not?
 How Do You Study Economics?
Now that we have covered the basics of Economics, we can now discuss how students of economics
study economic topics:

First you should understand how the discipline is organized: In general, Economics is separated into two
areas:

Microeconomics: Which basically analyzes individual business situations or sectors of

the economy. For this course the topics we will study will include Supply and Demand,
Elasticity (the degree to which prices impact behavior), and Market Structures (the level
of competition in a particular industry).

Macroeconomics: Which analyzes the broad aspects of a country’s economy. In this

area we will study GDP, unemployment, inflation and the government’s tools to deal
with economic circumstances. Also, included in this topic will be topics pertaining
international trade.

One important thing to know about Economics is the fact that opinions are intertwined with facts,
and economists are influenced by their political leanings. Because of this, it is very important to
separate factual statements from statements containing opinions. Statements of fact (Positive
Statements) would be statements such as “the unemployment rate has decreased by 1%”.
Statements including opinion (Normative Statements) are usually prescriptive. An
example of this would be “The government should decrease taxes to improve the economy”.
Understanding the differences between these types of statements will help you to better
analyze economic positions.

So how do economists analyze the economy?

sb constant .ek ko First it is important to understand that Economics is a Social Science. Because of this
change krte hain there can be many variables that can impact a particular outcome. So economists need to
utilize the concept of Ceteris Paribus, which means all else being equal. What this
means is that economic analysis minimizes the number of variables considered. The
reason for this is that limiting variables helps to provide a simplified model to explain
certain economic circumstances.

Here are a couple of models to show you how this works.

The first model is the Production Possibilities Curve or the PPC.

The Production Possibilities Curve can demonstrate the idea that decisions have trade-offs and
opportunity costs. The PPC is a graphic representation of an economic trade-off which can
demonstrate the opportunity cost of a decision.
 Below is a PPC:

Good A

A
125
B
100

200 250 Good B

This model simplifies the choices in an economy. This economy can choose between 2 goods. Good A
and Good B. The curved line represents the maximum amount of production that can be achieved
considering all possible combinations of Good A and Good B. At point A the country can produce 125
units of good A, and 200 units of good B. If the country then chooses to produce 250 units of good B
(point B), the country must give up 25 units of good A: moving from 125 units to 100 units. So the
opportunity cost of producing 50 more units of good B (200-250) is 25 units of good A. Hopefully this
shows you how a simplified model can demonstrate the concept of opportunity cost.

The PPC can also demonstrate the level of efficiency an economy is operating at. Here is another PPC:

Good A

Good B
Remember the curved line represents the maximum production of all possible combinations of good A
and good B. Point B (on the line) is a location that is efficient: meaning that all the factors of production
in an economy are being fully utilized. Point A is inefficient: meaning that the factors of production are
not being fully utilized. Point A also represents a recession because the country is producing less than it is
capable of. In addition, Point A represents an economic situation with less than full- employment.
Point C is unobtainable given the current factors of production because it is beyond the maximum
amount of production of both goods A and B.

So there is our first model, the PPC. It simplified an economy by only looking at two goods, but this
simplification allows for a clear analysis of opportunity cost. It also provides a graphic representation of
both efficient and inefficient allocation of resources, and unobtainable production given the current factors
of production.

Our next model is The Circular Flow Diagram

The Circular Flow Diagram is a simplified model that demonstrates how money and goods
and services move through the economy.

Goods and Services

Consumer Spending

Individuals Businesses

Wages

Labor

This diagram represents the economic interaction between individuals and businesses. The top of the
diagram represents the Market for Goods and Services. In this market, individuals spend their money
(consumer spending) and in return they receive goods and services. The bottom of the diagram represents
the Factor Market. In this market, individuals provide labor (a factor of production). In return,
individuals receive payment (wages). The model also demonstrates the flow of money. The blue
inner circle shows how money flows from consumers to businesses and from businesses back to
individuals in return for their productive services. The red outer circle shows how goods and services
flow through the economy. Individuals provide services (labor) to the businesses and businesses
provide goods and services to individuals.

This simplified model of the economy will be important to understanding economic interactions and
later the course will help students in their understanding of how Gross Domestic Product (GDP) is
calculated.