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.
Microeconomics and Macroeconomics
• Microeconomics is the study and analysis of the
behavior of individual segments of the economy:
individual consumers, workers, and owners of
resources, individual firms, industries and markets for
goods and services.
• As a necessary means for addressing the behavior of
rational individuals (both consumers and producers),
microeconomics develops a number of foundation
concepts and optimization techniques that explain the
everyday business decisions managers must routinely
make in running a business.
• These decisions involve such things as
choosing the profit maximizing production
level, deciding how much of the various
productive inputs to purchase in order to
produce the chosen output level at lowest
cost, choosing how much to spend on
advertising, allocating production between
two or more manufacturing plants located in
different places and setting the profit-
maximizing prices for the goods the firm sells.
• On the other hand, macroeconomic is the
study of the whole economy. The subject
matter of macroeconomics are national
income, unemployment and inflation etc.
• Managerial economics is one of the most
important and useful courses in your curriculum
of studies.
• It will provide you with a foundation for studying
other courses in finance, marketing, operation
research and managerial accounting.
• 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.
• Management is the discipline of organizing and
allocating a firm’s scarce resources to achieve its
desired objectives.
• These two definitions clearly point to the
relationship between economics and managerial
decision making.
• In fact, we can combine these two terms and
define managerial economics as the use of
economic analysis to make business decisions
involving the best use of an organization’s scarce
resources.
 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.