Economics Rajesh Panda Associate Professor, SIBM, Pune. [email protected]...

Economics

Rajesh PandaAssociate Professor, SIBM, Pune.

[email protected]@gmail.com

Various facets

• Microeconomics• Macroeconomics• Managerial Economics

Key Concepts• Growth• Development• GDP• GNP• Inflation and deflation• Import and export• Exchange value and PPP• Capitalism and communism• Planning vs. execution• Political economy• Economics for managers• Changing Global Economic scenario

Economics definitions• Adam Smith

– Economics enquires into the factors that determine wealth of the country

• Marshall– Economics is the study of mankind in the ordinary business of

life• Robbins

– Economics is the science of scarcity – Economics is the science which studies human behavior as a

relationship between ends and scarce means which have alternate uses

– Unlimited wants, scarce means, Alternative use of means

Economics

……..is the study of how scarce resources of a society are used to produce important commodities and distribute them among different people.

Subject matter

• Economics studies the management of society’s scarce resources. • Management of resources is the central theme of economics because resources are scarce. Hence economics is also called the science of scarcity.

Why is Economics important?

• To ensure proper allocation of scarce resources.• To ensure cost minimisation.• Improving one’s ability to understand business fluctuations and transactions with clarity.

Scarcity

• Scarcity is unavailability of a resource or a good in abundance. • On account of limited resources society is unable to produce all the goods and services it wants to.

Economic study

Economics

Macro Econom

ics

Micro Economics

Micro Economics

• Micro economics deals with minute aspects of the economy. • It deals with each economic

unit on individual level. • It deals with how individuals

and firms make decisions under different situations and how do they interact.

Macro Economics

• ………….studies economy as a whole • It is a study of various economic variables in general. • It studies economy wide phenomena such as nation’s income, recession, economic growth, inflation, output etc.

Statements in Economics…….

•We get to see two types of statements in economic theory. • They are:

•Positive statements and•Normative statements

Positive statements……..

• These statements are also referred to as Positive and Normative economics.• Positive economics explains things, economic problems and variables as they are. • Positive economics explains, ‘what is…’

Normative Economics……..

• Normative economics explains how economic variables should be.

• Normative economics explains ‘what should be…..’

Subject matter of Micro Economics

• Micro economics deals with demand . supply and equilibrium in a market. • The forces of demand and supply are at the centre of micro economic theory.• These forces determine price fluctuations relating to any product.

Micro economic efficiency

• Efficiency in production• Efficiency of distribution• Allocative efficiency

Subject matter of Macro Economics

• Macro economics deals with issues that are aggregate in nature.• They include: National income – Employment-

Inflation etc..

• It also studies the relationships between different aggregates.

Microeconomics

• Product pricing– Theory of Demand– Theory of production cost

• Factor pricing– Wages– Rents– Interest– Profit

• Economic welfare

Macroeconomics

• Income and employment– Consumption function– Investment

• General price level and inflation• Economic Growth• Distribution( relative shares of wages and

profits)

Central Problems of an Economy

• What to Produce• How to produce• For Whom to produce• What provision be made for economic growth

Central problems are solved:

• Market/price Mechanism• Economic Planning

Production Possibility Curve

• Represents alternate production possibities facing an economy

Production Possibility

Cloth (000 m) Wheat (000 Qt)

A 0 15

B 1 14

C 2 12

D 3 9

E 4 5

F 5 0

Production Possibilities FrontierC

ars

Computers


ars

1000

3000Computers


ars

1000

3000

700

Computers


ars

1000

3000

700

2000Computers


ars

1000

3000

700

2000

A

EfficientResource Use

Computers

Principles of Economics Illustrated by the Production Possibilities Frontier . . .

• Efficiency• Tradeoffs• Opportunity Cost• Economic Growth


ars

1000

3000

700

2000Computers


ars

1000

3000

700

2000

Tradeoffs

Computers


ars

1000

3000Computers


ars

1000

3000

Growth

Computers

Capitalism

• Right to private property• Freedom of entreprise• Freedom of choice by customers• Profit Motive• Competition• Price system• Inequalities of income

Critical evaluation of capitalism

• Free market doesn’t ensure maximum social satisfaction at minimum social cost

• Consumer sovereignty may not be valid• Economic instability and unemployment• Doesn’t ensure rapid growth in developing

countries• Concentration of wealth and income

Capitalism Vs Communism

Microeconomics

• Product pricing– Theory of Demand– Theory of production cost

• Factor pricing– Wages– Rents– Interest– Profit

• Economic welfare

Theory of Demand

• Law of Demand: states the functional relationship between price and quantity demanded

• Why does the curve slope downward?– Income effect– Substitution effect

• Exceptions– Veblin Effect– Giffin goods

Determinants of Demand• Taste and preference of consumers• Income of people• Changes in prices of the related Goods

– Complementary goods– Substitutes

• The number of consumers in the market• Changes in propensity to consume

– Consumption led growth– Savings led growth

• Consumer expectation with regard to future price• Income distribution

– Marginal propensity to consume for the rich is much lesser than the poor

• Contraction and extraction in demand• Increase and decrease in demand

Demand function

• Demand function• Supply function• Equilibrium

Demand function• Qd= f ( P, I, p, T, A)• Considering price as the only independent

variable– Qd= f ( P )

• Detremine Market demand function– Qa= 40- 2P– Qb= 34- .5p– Qc= 24.5-.3P

• Demand function and supply function

• A market consists of three consumers whose individual demand functions are as follows.1. P= 35-.5 Qa2. P= 50- .25Qb3. P= 40- 2 QcFind out the market demand function. If the supply

function is given by Qs= 40 +.5P, determine the equilibrium quantity and price

So what should managers do?

• Market share to wallet share

Demand : Marshall’s cardinal utility

– Utilities are measurable and quantifiable

• Law of DMU– The additional benefit a person derives from a

given increase of his stock of a thing diminishes with every increase in the stock that he already has

Draw the graphs for Total utility and Marginal Utility

Cups of coffee consumed/day

Total utility Marginal utility

1 12 12

2 22 10

3 30 8

4 36 6

5 40 4

6 41 1

7 39 -2

8 34 -5

• Principles of equi-marginal utility– Consumer will distribute his money income

between the goods in such a way that the utility derived from the last rupee spent on each good is equal

– Marginal utility of money expenditure= marginal utility of the product/price

Marginal utility of product X and YUnits Mux (marginal utility of

product X)Muy (marginal utility of product Y)

1 20 24

2 18 21

3 16 18

4 14 15

5 12 9

6 10 3

Price of Good X 2

Price of Good Y 3

Marginal utility of money expenditure

Units MUx/Px MUy/Py

1 10 8

2 9 7

3 8 6

4 7 5

5 6 3

6 5 1

Consumer equilibrium is established when the consumer buys 6 units of Ggod X and 4 units of Good Y.

Find out the optimal combination of goods for a customer:

– Price of X= 5– Price of Y=2– Total income= 22

Units consumed MUx MUy

1 30 20

2 25 18

3 20 16

4 15 14

5 10 12

6 5 10

7 1 8

Indifference curve analysis of demand

• Utility cant be measured, but can be compared

• Ordinal analysis of demand is the indifference curve which represents all those combinations of goods which give the same satisfaction to the consumer

Indifference curveIncome-1 Income-2

Good X Good Y Good X Good Y

1 12 2 14

2 8 3 10

3 5 4 7

4 3 5 5

5 2 6 4

Budget line

– Shows all those combinations of two goods which the consumer can buy by spending his money income on the two goods at their given prices

– Change in budget line vs. shift in budget line– Consumer’s equilibrium– Income consumption curve• ICC is the locus of equilibrium points at various levels of

consumer’s income• ICC for luxury goods and inferior goods

Elasticity of Demand

• e=(%change in quantity demanded)/ (% change in price )– Elastic demand– Inelastic demand– Unitary elastic demand

• Difference in elasticity may be because of possibility of substitution

Problems

1. If the price of a commodity falls from $10 to $9 per unit, the quantity demanded increases from100 units to 120 units. Find out the price elasticity of demand

2. A consumer purchases 80 units of a commodity when its price is $1 and purchases only 48 units when its price is $2. What is the price elasticity of demand for this commodity? (Arc elasticity of demand)

Total expenditure method• Total revenue method/total outlay method• Elasticity is computed from the total change in expenditure.• This method can only say whether elasticity is more than

one, less than one or equal to one.Price per unit Quantity

demandedTotal expenditure

Price elasticity

5 30 150 >1

4.75 40 190 >1

4.5 50 225 >1

4.25 60 255 >1

4 75 300 >1

3.75 80 300 =1

3.5 84 294 <1

3.25 87 282.75 <1

Determinants of elasticity

• Availability of substitutes• Proportion of consumer’s income spent on

the commodity• Number of uses of the commodity• Complementarity between goods• Time of elasticity

Importance of price elasticity of demand

• Pricing decisions by business Firms• Uses in economic policies regarding price

regulation• Explanation of paradox of plenty• Use in international trade• Importance in fiscal policy

Cross elasticity of demand

• Degree of responsiveness of demand for one good to the change in price of another good

• (%change in the quantity demanded of X)/(%change in price of Y)

• Positive for substitute goods• Negative for complementary goods

Problem

• If the price of coffee rises from Rs 45 to Rs. 50 per hundred gram, as a result of this consumer’s demand for tea increases from 60 gram per day to 70 gram per day. Find out the cross elasticity of tea for coffee.

Income elasticity of demand

• Percentage change in purchases of a good/ percentage change in income

• a consumer’s daily income increases from $50 to $ 60, and so his purchase of good X increases from 25 units per month to 30 per month. Calculate the income elasticity of good X

• Income elasticity for inferior goods and luxury goods

Consumer surplus

• Difference between the price that a consumer is willing to pay and the price one actually pays for a product

• Excess of price that a customer would be willing to pay rather than go without a thing over that which he actually pays is the economic measure of consumer’s surplus.

Marginal utility and consumer surplus

No of units MU ($) Price($) Marginal benefit

1 20 12 8

2 18 12 6

3 16 12 4

4 14 12 2

5 12 12 0

6 10 12 -2

Consumer surplus 20

Marshall’s measure of consumer surplus-graphical representationDiamond and water paradox

Theory of production

• Factors of production: Land, Labour, capital, entrepreneur• Production function• Law of variable function• Law of return to scale• Isoquant• Isocost• LCC• Theory of cost• BEP analysis• Theory of firms• Concept of revenue

Production Function

• The relationship between input and output of a firm is called as production function– The law of variable proportion– Laws of return to scale

• Theory of firm: what level of output to be produced to maximize the profit

• Theory of production supports the theory of firm

Production Function

• Production function states the maximum quantity of output that can be produced with any given quantities of various inputs

• Q= f(L, K, M)• L, K, M stand for labour, capital and raw material• Short run production function : Law of variable

proportion• Long run production Function: forms laws of

return to scale

Short run Production Function

• Law of variable proportion• Law of diminishing return• Varying one input while we keep all other

variables fixed

Concepts of productInput (units( Total product

(quintals)Marginal product Average product

1 80 80 60

2 170 90 85

3 270 100 90

4 368 98 92

5 430 62 86

6 480 50 80

7 504 24 72

8 504 0 63

9 495 -9 55

10 480 -15 48

• Total product: total amount of output produced by a given amount of factor

• Average product: total product/ no. of units of factors employed– AP= Q/L

• Marginal Product: output at the margin– Addition to the total output by the employment of

an extra unit of a factor– MP = Change in Q/ Change in L

Law of variable proportion• Stage-1: Increasing returns

– TP increases– AP increases, and maximum where stage 1 ends– MP increases and then declines– MP is the highest at the point of inflection

• Stage-2: diminishing returns– TP increases– AP and MP decline– TP is the highest when it ends– MP is zero when stage 2 ends

• Stage 3: negative returns– TP and AP decline– MP is negative

ProblemNumber of variable input

Total output (TP) Marginal product of the variable input (MP)

Average product of the variable input (AP)

3 - 18 30

4 - 20 -

5 130 - -

6 - 5 -

7 - - 19.5

8 136 - -

Isoquant• also called as equal product curve• Two factors are considered asvariables in the production process• Isoquant represents all those factor combinations capable of producing

same amount of output

Factor combinations

FDactor-1 Factor -2

A 1 12

B 2 8

C 3 5

D 4 3

E 5 2

Isocost line

• Represents various combinations of two factors that the farm can buy with a given outlay.

• Helps in determining what combinations of factors the firm will choose for production

Return to scale

• All factors or inputs in a production process are variable– Constant returns to scale– Increasing returns to scale– Decreasing returns to scale

Cost of production and cost curves

• Accounting cost• Economic cost

• Economic cost= Accounting costs + implicit cost

• Economic profit = total revenue- economic costs

• Short run and long run• Short run costs– Fixed and variable

• Total cost (TC)= TFC + TVC• Average Total cost= TC/Q• AFC= TFC/Q• AVC= TVC/Q• Marginal cost= change in TC/ Change in Q

• Exercise----------------------

Units of output

T6otal fixed cost

Total variable cost

Total cost Average fixed cost

Average variable cost

Average total cost

0 50 0 50

1 50 20 70

2 50 35 85

3 50 60 110

4 50 100 150

5 50 145 195

6 50 190 240

7 50 237 287

8 50 284 334

Graphical representation

Problem Output TC TFC TVC AFC AC

0 50

1 70

2 100

3 120

4 135

5 150

6 160

7 165

Marginal costOutput Total cost Marginal cost

0 100 -

1 125 25

2 145 20

3 160 15

4 180 20

5 206 26

6 136 30

7 273 37

Problem Quantity TFC TVC TC AFC AVC AC MC

1 30 10 40 30 10 - -

2 30 18 - 15 - 24 -

3 - 24 54 - 8 18 6

4 30 32 - 7.5 - 15.5 -

5 - 42 72 6 - 14.4 10

Concepts of revenue

• Total revenue• Average revenue• Marginal revenue• Production function: decision when MC= MR

Summary

• Micro Vs. Macro• Demand and supply• Cardinal and ordinal utility• Production function• Cost concepts• Revenue concepts

Economics Rajesh Panda Associate Professor, SIBM, Pune. [email protected]...

Documents

Transcript of Economics Rajesh Panda Associate Professor, SIBM, Pune. [email protected]...