Module 1 - Introduction to Managerial Economics

8/8/2019 Module 1 - Introduction to Managerial Economics

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Managerial Economics

Module-1

Topic of discussion:Introduction to Economics

Aim of the Module:The aim of these lessons is to provide students with backgroundinformation on the nature and conceptual evolution of economics and theeconomic problem.

Learning Objectives:

At the end of the lessons, students should understand the following:

The fundamental nature of economics - unlimited wants and scarceresources and the need to make choices

The three questions related to the economic problem and itsimplications for an economy

A definition of opportunity cost o Production possibility frontiers and their relevance to the concept

of opportunity cost

Prepared by

Makim UddinAdjunct Faculty, International Islamic University Chittagong

Dhaka Campus


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INTRODUCTION

Economics may appear to be the study of complicated tables and charts, statistics andnumbers, but, more specifically, it is the study of what constitutes rational human behaviorin the endeavor to fulfill needs and wants.

As an individual, for example, you face the problem of having only limited resources withwhich to fulfill your wants and needs, as a result, you must make certain choices with yourmoney. You'll probably spend part of your money on rent, electricity and food. Then youmight use the rest to go to the movies and/or buy a new pair of jeans. Economistsare interested in the choices you make, and inquire into why, for instance, you might chooseto spend your money on a new DVD player instead of replacing your old TV. They would wantto know whether you would still buy a carton of cigarettes if prices increased by $2 per pack.The underlying essence of economics is trying to understand how both individuals and nationsbehave in response to certain material constraints.

We can say, therefore, that economics, often referred to as the "dismal science", is a study ofcertain aspects of society. Adam Smith (1723 - 1790), the "father of modern economics" andauthor of the famous book "An Inquiry into the Nature and Causes of the Wealth of Nations",

spawned the discipline of economics by trying to understand why some nations prosperedwhile others lagged behind in poverty. Others after him also explored how a nation'sallocation of resources affects its wealth.

To study these things, economics makes the assumption that human beings will aim to fulfilltheir self-interests. It also assumes that individuals are rational in their efforts to fulfill theirunlimited wants and needs. Economics, therefore, is a social science, which examines peoplebehaving according to their self-interests. The definition set out at the turn of the twentiethcentury by Alfred Marshall, author of "The Principles Of Economics" (1890), reflects thecomplexity underlying economics: "Thus it is on one side the study of wealth; and on theother, and more important side, a part of the study of man."

HISTORY OF ECONOMICS

The first writings on the subject of economics occurred in early Greek times as Plato, in TheRepublic, and Aristotle wrote on the topic. Later such Romans as Cicero and Virgil also wroteabout economics.

In medieval times the system of feudalism dominated. With feudalism, there was a strictclass system consisting of nobles, clergy and the peasants. In the system, the king ownedalmost all the land and under him were a series of nobles that had land holdings of varioussizes. On these landholdings were series of manors. These were akin to large farming tracts inwhich the peasants or serfs worked the land in exchange for protection by the nobles.

Later the system of mercantilism predominated. It was an economic system of the major

trading nations during the 16th, 17th, and 18th cent., based on the idea that national wealthand power were best served by increasing exports and collecting precious metals in return.Manufacturing and commerce became more important in this system.

In the mid eighteenth century, the Industrial Revolution ushered in an era in which machinesrather than tools were used in the factory system. More workers were employed in factoriesin urban areas rather than on farms. The Industrial Revolution was fueled by great gains intechnology and invention. This also made farms more efficient, although fewer people wereworking the farms. During this time the idea of "laissez faire" became popular. This means


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that economies work best without lots of rules and regulations from the government. Thisphilosophy of economics is a strong factor in capitalism, which favors private ownership.

In the nineteenth century, there was reaction to the "laissez-faire" thinking of the eighteenthcentury due to the writings of Thomas Malthus. He felt that population would always advancefaster than the science and technology needed to support such population growth. DavidRicardo later stated that wages tend to settle at a poor or subsistence level for mostworkers. John Stuart Mill provided the backdrop for socialism with his theories that supportedfarm cooperatives and labor unions, less competition. These theories were brought to a highpoint by Karl Marx who attacked the capitalistic, "laissez-faire" theories of competition andinstead favored socialisms, marked more government control and state rather than privateownership of property.

Another important idea at this time was the change in how items are valued. While formerlyand item's value stayed the same according to what the item was, now worth of an item isdetermined by how many people want the item and how great the supply of the item was.This was the beginning of the laws of supply and demand.

In the first half of the twentieth century, John Maynard Keynes wrote about business cycles -

when the economy is doing well and when it is in a slump. His theories led to governmentsseeking to put more controls on the economy to prevent wide swings.

After World War II, emphasis was placed on the analysis of economic growth anddevelopment using more sophisticated technological tools.

In recent years, economic theory has been broadly separated into two major fields:macroeconomics, which studies entire economic systems; and microeconomics, whichobserves the workings of the market on an individual or group within an economic system. Inthe later twentieth century such ideas as supply side economics which states that a healthyeconomy is very necessary for the health of the nation and Milton Friedman's ideas that themoney supply is the most important influence on the economy.

In the twenty-first century, the rapid changes and growth in technology have spawned theterm "Information Age" in which knowledge and information have become importantcommodities.


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WHAT IS ECONOMICS?

Economics is the science that deals with the production, distribution, and consumption ofgoods and services and with the theory and management of economies or economic systems.

CLASSICAL AND NEO CLASSICAL ECONOMICS

Classical economics

Classical economics refers to work done by a group of economists in the eighteenth andnineteenth centuries. They developed theories about the way markets and market economieswork. The study was primarily concerned with the dynamics of economic growth. It stressedeconomic freedom and promoted ideas such as laissez-faire and free competition.

Famous economists of this school of thought included Adam Smith, David Ricardo, ThomasMalthus and John Stuart Mill.

Neo classical economics

An approach to economics that relates supply and demand to an individual's rationality andhis or her ability to maximize utility or profit. Neoclassical economics also increased the useof mathematical equations in the study of various aspects of the economy. This approach wasdeveloped in the late-nineteenth century, based on books by William Stanley Jevons, CarlMenger and Leon Walras.

Since its inception, neoclassical economics has grown to become the primary take onmodern-day economics. Although it is now the most widely taught form of economics, thisschool of thought still has its detractors. Most criticism points out that neoclassicaleconomics makes many unfounded and unrealistic assumptions that do not represent real

situations. For example, the assumption that all parties will behave rationally overlooks thefact that human nature is vulnerable to other forces, which cause people to make irrationalchoices. Therefore, many critics believe that this approach cannot be used to describe actualeconomies.

Neoclassical economics is also sometimes blamed for inequalities in global debt and traderelations because the theory holds that such matters as labor rights will improve naturally, asa result of economic conditions.

IMPORTANCE OF STUDYING ECONOMICS

Economics is an insightful study of how people behave and organizations operate underconstraints of resources. It provides powerful tools to understand and analyze many aspectsof our lives and help us to be an informed, perceptive decision-maker. Decision-making is anintegral part of business or governmental organizations. The economics department atGeorgia State University offers a modern curriculum to prepare you for future endeavors andto meet unforeseen challenges successfully. There are many good reasons to studyeconomics:


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(1) To be a knowledgeable worker, consumer, investor, and citizen: Economics traininghelps develop methodical ways of thinking and problem solving which can be used in our livesas effective members of the workforce, responsible and knowledgeable citizens, informedconsumers, savers, and investors, and perceptive participants in the global economy.

(2) To acquire a set of important skills for career-building: A key element for getting a joband succeeding in a career is your set of desirable skills. Economics training offersindividuals a terrific set of marketable skills. They include written communication andpresentation skills, quantitative communication skills, and analytical problem-solving skills.Learning to communicate your ideas in writing and presentation to a broad range ofaudiences is a key component of our economic curriculum. Economics majors are alsotrained to understand numerical data and recognize their importance, use a variety of dataanalysis and computing tools, and communicate quantitative information to others.Moreover, there is no better major to acquire analytical problem-solving skills thaneconomics. Economic principles can be applied to identify the core elements of manyproblems confronting business and government and to formulate effective decisions to tacklethose problems.

(3) To seek employment that interests you: Finding employment that interests you can be

crucial for a successful and fulfilling career. Studying economics is exciting and fun, and itopens a wide variety of career opportunities for individuals. Economics graduates have goneon to rewarding professional careers in industry, trade, banking and finance, law, consulting,government, research, and education. The career flexibility is coupled with the fact thateconomists often receive high salaries.

(4) To gain a solid foundation for other advanced fields of study: Because of vigorous andcomprehensive training, economics majors are sought by not only employers but alsograduate schools. Graduate study in law, business, politics, or public policy commonlydemands logical thinking abilities and strong investigative and quantitative skills. Indeed,economics is one of the most highly respected academic disciplines

(5) Flexible: With the major changes that have taken place in the world of work, the rapid

changes in technology and globalization, it is not uncommon for individuals to make severalcareer changes during their lives. Today's hot specialized degree has often becometomorrow's target for downsizing. Companies that were relatively unchallenged in thedomestic market have suffered as a result of global competition. As a result, experts incareer development recommend that one seriously consider a flexible degree such aseconomics.

(6) Rewarding: Majors in economicsreceive average starting salaries that are in the upperrange of salary offers made to majors with other business degrees and significantly abovemost majors in other areas of the liberal arts.

(7) Challenging: Economics is a discipline in which you learn a unique way of thinking. Thisunique way of thinking is a primary reason that economics is also a flexible degree. Economic

concepts have been applied to a number of different areas that would, at first, seem totallyunrelated to economics. However, the concepts of economics are critical to finding solutionsto problems in a wide variety of areas.

(8) Rich in Skills(a) Analytical/Critical Thinking Skills - There is no better major for learninganalytical problem solving than economics. You have learned how to take a problem,and break it down into its separate elements (ceteris paribus). You have learned thateconomics has a core set of tools that can be applied in a wide variety of settings (the


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same tools apply to both consumer and firm behavior, for example). All of business isproblem solving, and this is the expertise you have learned from the logical constructsin economics.

(b) Quantitative Skills (Mathematical and Statistical Techniques) - This means theability to understand numbers and their importance, and the ability to communicatequantitative information to others. All the graphs in economics represent quantitativeconcepts, and as an economics major you will certainly have no fear of graphs.Further, many classes use explicit numerical problem solving. You also have theopportunity to explicitly learn a wide range of statistical and computing tools, inStatistics, and Econometrics. You have the opportunity to explicitly learn a broadrange of mathematical tools in Mathematical Economics, Game Theory, ExperimentalEconomics and a wide variety of other courses.

(c) Communication Skills (Written and Oral) - This means communicating with avariety of audiences in a variety of formats. In economics, you will learn tocommunicate your ideas in writing- through essay exams, papers, and homework. Inaddition, the small class sizes in the upper level classes allows you the opportunity tospeak in class. All of these tools improve your interpersonal communication skills.

Some classes also present the opportunity to work with other students explicitly.

MICROECONOMICS AND MICROECONOMICS

What DoesMicroeconomics Mean?

The branch of economics that analyzes the market behavior of individual consumers and firmsin an attempt to understand the decision-making process of firms and households. It isconcerned with the interaction between individual buyers and sellers and the factors thatinfluence the choices made by buyers and sellers. In particular, microeconomics focuseson patterns of supply and demand and the determination of price and output in individual

markets (e.g. coffee industry).

What DoesMacroeconomics Mean?

The branch of economics that studies the behavior of the aggregate economy.Macroeconomics examines economy-wide phenomena such as changes in unemployment,national income, rate of growth, gross domestic product, inflation and price levels.

WHAT'S THE DIFFERENCE BETWEEN MACROECONOMICS AND MICROECONOMICS?What are the differences between Microeconomics versus Macroeconomics?

The subject is broadly divided into two main branches: microeconomics, which deals withindividual agents, such as households and businesses, and macroeconomics, whichconsiders the economy as a whole, in which case it considers aggregate supply and demandfor money, capital and commodities. Aspects receiving particular attention in economics areresource allocation, production, distribution, trade, and competition. Economics may in principlebe (and increasingly is) applied to any problem that involves choice under scarcity ordetermining economic value.


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Mainstream economics focuses on how prices reflect supply and demand, and uses equationsto create economic models in order to predict the consequences of decisions or events, and tomeasure realchanges in production. Models can also analyze the behavior of whole societies.

1. Microeconomics deals the allocation of resources, production of commodities,determinations of price, etc, are affected by the independent decisions of the consumers,producers and other economic agents.

Macroeconomics deals with aggregate variables facing an economy. Gross NationalProduct (GDP), aggregate employment level, the general price level, the growth rate of theeconomy, etc.

2. Macroeconomics shows how the equilibrium levels of income and consumption of theeconomy are determined.

Whereas Microeconomics determines the utility maximizing levels of commodities of aconsumer.

3. Microeconomics discusses the determination of relative prices of the commodities and

services.

Macroeconomics discusses the determination of general price level in the economy.

4. Microeconomics assumes prices of other commodities and services to remain fixed when itexplains the determination of price of one commodity.

Macroeconomics assumes that the relative prices have already been determined when itexplains the determination of the general price level.

5. Values of Macroeconomic variable are not equal to sums of values of microeconomicvariables. The two types of variables are quite distinct. Consider, for example, the case oftransfer payments to a person, who wins a lottery award of forty lake taka. There is no

doubt that the income of the person has increased, but national income has not increaseddue to the increment in personal income. In other words, national income does not reflectthe increment in personal income in this case.

The bottom line is that microeconomics takes a bottoms-up approach to analyzing the economywhile macroeconomics takes a top-down approach. Regardless, both micro- andmacroeconomics provide fundamental tools for any finance professional and should be studiedtogether in order to fully understand how companies operate and earn revenues and thus, howan entire economy is managed and sustained.


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MANAGERIAL ECONOMICS

Managerial economics (sometimes referred to as business economics), is a branch ofeconomics that applies microeconomic analysis to decision methods of businesses or othermanagement units. As such, it bridges economic theory and economics in practice. It drawsheavily from quantitative techniques such as regression analysis and correlation, Lagrangiancalculus (linear). If there is a unifying theme that runs through most of managerial economicsit is the attempt to optimize business decisions given the firm's objectives and givenconstraints imposed by scarcity, for example through the use of operations research andprogramming.

Almost any business decision can be analyzed with managerial economics techniques, but it ismost commonly applied to:

Risk analysis - various models are used to quantify risk and asymmetric informationand to employ them in decision rules to manage risk.

Production analysis - microeconomic techniques are used to analyze productionefficiency, optimum factor allocation, costs, economies of scale and to estimate the

firm's cost function.

Pricing analysis - microeconomic techniques are used to analyze various pricingdecisions including transfer pricing, joint product pricing, price discrimination, priceelasticity estimations, and choosing the optimum pricing method.

Capital budgeting - Investment theory is used to examine a firm's capital purchasingdecisions.

At universities, the subject is taught primarily to advanced undergrads. It is approached as anintegration subject. That is, it integrates many concepts from a wide variety of prerequisitecourses. In many countries it is possible to read for a degree in Business Economics whichoften covers managerial economics, financial economics, game theory, business forecasting

and industrial economics.


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SCARCITY

Scarcity is the problem of infinite human needs and wants, in a world of finite resources.Society has insufficient productive resources to fulfill those wants and needs. Alternatively,scarcity implies that not all of society's goals can be pursued at the same time; trade-offs aremade of one good against others. In an influential 1932 essay, Lionel Robbins definedeconomics as "the science which studies human behaviour as a relationship between ends andscarce means which have alternative uses."

Goods (including services) that are scarce are called economic goods (or simply 'goods' iftheir scarcity is presumed). Other goods are called free goods if they are desired but in suchabundance that they are not scarce, such as air and seawater. Too much of something freelyavailable can informally be referred to as a 'bad', but then its absence can classified as agood, thus, a mown lawn, clean air, etc.

For example, fruits such as strawberries are scarce on occasion because they grow only atcertain times of the year. When the supply of strawberries is lower, they are scarce, or notalways available. If enough people want strawberries when none are available, then thedemand increases. And this demand is high not because the price is low but because the

supply is low.

POSITIVE AND NORMATIVE ECONOMICS

Both macro- and micro-economics involve facts, theories, and policies. Each containselements ofpositive economics and normative economics.

Positive economics deals with what the economy is actually like. Such factually basedanalysis is critical to good policy analysis. All sciences and fields of learning try to be positiveand deal with facts and models based on facts. Try to be positive i.e. scientific in yourstatements, especially when writing essays and in the exam room!

In contrast, normative economics involves value judgments about what the economy shouldbe like or what particular policy actions should be recommended to get it to be that way. Itunderlies expressions of support for particular economic policies.

Positive Statements

Positive statements are objective statements dealing with matters of fact or they questionabout how things actually are. Positive statements are made without obvious value-judgments and emotions. They may suggest an economic relationship that can be tested byrecourse to the available evidence.

Positive economics can be described as what is, what was, and what probably will be

economics. Statements are based on economic theory rather than raw emotion. Often thesestatements will be expressed in the form of a hypothesis that can be analysed andevaluated.

Examples:

A rise in interest rates will cause a rise in the exchange rate and an increase in thedemand for imported products

Lower taxes may stimulate an increase in the active labour supply


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A national minimum wage is likely to cause a contraction in the demand for low-skilled labour

The UK economy now has lower unemployment than Germany The American stock market has boomed in recent years A rise in consumer incomes will lead to a rise in the demand for new cars A fall in the exchange rate will lead to an increase in exports overseas

If the government raises the tax on beer, this will lead to a fall in profits of thebrewers A reduction in income tax will improve the incentives of the unemployed to search for

work A rise in average temperatures will increase the demand for chicken The level of poverty in the UK has increased because of the fast growth of executive

pay

Normative Statements

Normative statements are subjective - based on opinion only - often without a basis in factor theory. They are value-laden, emotional statements that focus on "what ought to be". It is

important to be able to distinguish between these types of statements - particularly whenheated arguments and debates are taking place. Most economists tend to adopt a positiveapproach.

Examples: The decision to grant independence for the Bank of England is unwise and should be

reversed A national minimum wage is totally undesirable as it does not help the poor and

causes higher unemployment and inflation The national minimum wage should be increased to 6 as a method of reducing

poverty Protectionism is the only proper way to improve the living standards of workers whose

jobs are threatened by cheap imports The level of duty on petrol is too unfair and unfairly penalizes motorists Drivers of 4x4 vehicles should pay higher road tax and a higher congestion charge if

they drive into London The government should increase the national minimum wage to 6 per hour in order

to reduce relative poverty. The retirement age should be raised to 75 to combat the effects of our ageing

population

The government ought to provide financial subsidies to companies manufacturing anddeveloping wind farm technology


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PRODUCTION POSSIBILITY FRONTIER (PPF)

Under the field of macroeconomics, the production possibility frontier (PPF) represents thepoint at which an economy is most efficiently producing its goods and services and,therefore, allocating its resources in the best way possible. If the economy is not producingthe quantities indicated by the PPF, resources are being managed inefficiently and theproduction of society will dwindle. The production possibility frontier shows there are limitsto production, so an economy, to achieve efficiency, must decide what combination of goodsand services can be produced.

Let's turn to the chart below. Imagine an economy that can produce only Computer and Gun.According to the PPF, points A, B and C - all appearing on the curve - represent the mostefficient use of resources by the economy. Point X represents an inefficient use of resources,while point Y represents the goals that the economy cannot attain with its present levels ofresources.

As we can see, in order for this economy to produce more Computer, it must give up someof the resources it uses to produce Gun (point A). If the economy starts producing more Gun(represented by points B and C), it would have to divert resources from making Computerand, consequently, it will produce less Computer than it is producing at point A. As the chartshows, by moving production from point A to B, the economy must decrease Computerproduction by a small amount in comparison to the increase in Gun output. However, if theeconomy moves from point B to C, Computer output will be significantly reduced while theincrease in Gun will be quite small. Keep in mind that A, B, and C all represent the mostefficient allocation of resources for the economy; the nation must decide how to achieve thePPF and which combination to use. If more Computer is in demand, the cost of increasing itsoutput is proportional to the cost of decreasing Gun production.

Point X means that the country's resources are not being used efficiently or, morespecifically, that the country is not producing enough Gun or Computer given the potential ofits resources. Point Y, as we mentioned above, represents an output level that is currentlyunreachable by this economy. However, if there was a change in technology whiles the levelof land, labor and capital remained the same, the time required to pick Gun and grapeswould be reduced. Output would increase, and the PPF would be pushed outwards. A newcurve, on which Y would appear, would represent the new efficient allocation of resources.


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When the PPF shifts outwards, we know there is growth in an economy. Alternatively, whenthe PPF shifts inwards it indicates that the economy is shrinking as a result of a decline in itsmost efficient allocation of resources and optimal production capability. A shrinking economy

could be a result of a decrease in supplies or a deficiency in technology.

An economy can be producing on the PPF curve only in theory. In reality, economiesconstantly struggle to reach an optimal production capacity. And because scarcity forces aneconomy to forgo one choice for another, the slope of the PPF will always be negative; ifproduction of product A increases then production of product B will have to decreaseaccordingly.

Opportunity Cost

Opportunity cost or economic opportunity loss is the value of the next best alternativeforgone as the result of making a decision. Opportunity cost analysis is an important part of a

company's decision-making processes but is not treated as an actual cost in any financialstatement. The next best thing that a person can engage in is referred to as the opportunitycost of doing the best thing and ignoring the next best thing to be done.

Opportunity cost is a key concept in economics because it implies the choice betweendesirable, yet mutually exclusive results. It is a calculating factor used in mixed marketswhich favour social change in favour of purely individualistic economics. It has beendescribed as expressing "the basic relationship between scarcity and choice." The notion ofopportunity cost plays a crucial part in ensuring that scarce resources are used efficiently.Thus, opportunity costs are not restricted to monetary or financial costs: the real cost ofoutput forgone, lost time, swag, pleasure or any other benefit that provides utility shouldalso be considered opportunity costs.

This is important to the PPF because a country will decide how to best allocate its resourcesaccording to its opportunity cost. Therefore, the previous Computer/Gun example shows thatif the country chooses to produce more Computer than Gun, the opportunity cost isequivalent to the cost of giving up the required Gun production.


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BASIC PROBLEMS OF ECONOMIC ORGANIZATION AND THEIR SOLUTIONS

The fundamental economic problem in any society is to provide a set of rules for allocatingresources and/or consumption among individuals who can't satisfy their wants, given limitedresources. The rules that each economic system provides function within a framework offormal institutions (e.g., laws) and informal institutions (e.g., customs).

In every nation, no matter what the form of government, what the type of economic system,who controls the government, or how rich or poor the country is, three basic economicquestions must be answered. All 3 problems are more clearly explained using a ppf/ppc:

1) What to produce:

This problem is what should the economy produce in order to satisfy consumer wants (as seenby demand curves) as best as possible using the limited resources available. If a countryproduces goods in a way that maximizes consumer satisfaction then the economy isallocatively efficient.

2) How to produce:

This problem is how to combine production inputs to produce the goods decided in problem 1as most efficiently as possible. An economy achieves productive efficiency if it producesgoods using the least resources possible. A productively efficient economy is represented byan economy that is able to produce a combination of goods on the actual curve of the PPF.

3) For whom to produce:

Should the economy produce goods targeted towards those who have high incomes or thosewho have low incomes. What sort of demographic group should the goods in the economythat are produced be targeted towards? If the economy is addresses this problem then it hasreached pareto efficiency or pareto optimality.

How to solve them in different economic system?

Countries have scarce resources. The economic systems of countries are designed to allocatethose resources, through a production system, to provide output for their citizens. Thefundamental questions that these systems answer are:

What and how much will be produced? How will it be produced? For whom will it be produced?

If all three problems are addressed at any one time then the economy has achieved staticefficiency. If the economy achieves static efficiency over a period of time then it isdynamically efficient.

All these problems are focused around the problem of unlimited wants and limited resources.Where resources are the factors of production (such as labor, capital, technology, land)which are used to produce the products that satisfy the wants.

In practice, all economies are actually mixed economies, incorporating some facets of bothmarket and command economies. The relative importance of the particular economic systemin the country is the determinant of the type of economic system that it is generallyconsidered to be.


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ECONOMIC SYSTEM

There are four main types of economic system:

a) Traditional or Subsistence Economiesb) Command Economiesc) Mixed Economiesd) Market Economies

Traditional or Subsistence Economies

A traditional economy is an economic system in which resources are allocated by inheritance,and which has a strong social network and is based on indigenous technology and methods.Although this type of economy has been converted to mixed, command, or markettechnologies in many societies that were once traditionally driven; over 400 million peopleacross the globe still practice this methodology, as researched by the World Bank.

Characteristics:

A subsistence economy is one where: There is little specialisation and trade within the economy and with other countries The productivity of workers tends to be low leading to low incomes and a poor

standard of living People tend to live in family groups, and grow most of their own food, make their own

houses, gather their own fuel and provide their own leisure activities i.e. to a greatextent they are self-sufficient

Few goods and services are marketed and command a price or value - there is littlesurplus production to export

Traditional economies are found in rural, non-developed countries Technology is not used in traditional economies Men and women are given different economic roles and tasks Usually social behavior based on custom Individuals dont make decisions on what they want, determined by elders

Some parts of Asia, Africa, South America and the Middle East have traditional economies

Advantages Everyone knows their role Little uncertainty of what and how to produce, for whom is usually themselves

Disadvantages Discourages new ideas/technology

Punishes people that break rules Lower standard of living


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Command Economies

A command economy is one where all key economic decisions are made by the government(or state). The government decides:

What to produce, How it is to be produced and

How it is to be allocated to consumers.

This involves a great deal of economy planning by the state. The price mechanism has noactive role in a pure command economy since market prices are rarely used. By stateplanning, goods and services can be produced to satisfy the needs of all the citizens of acountry, not just those who have the money to pay for goods. Over the last decade, manyformer planned economies have attempted to bring market forces into their economy.

Characteristics:

The government or other central authority makes decisions and determines howresources will be used

There is little individual freedom

There is no competition Businesses are not run to create a profit Consumers have few chooses in the market place Factories are concerned with quotas Shortages are common because of poorly run factories and farms The government dictates the job in which you work The government sets the prices of goods and services

Examples of command economies: Cuba, North Korea and the People's Republic of China

Advantages:

Maximize consumers' welfare and demands Mostly affordable for the consumers Maximizes the continues utilization of resources. Distributes wealth equally among all people so there are no inequalities. Some education, health care, public services available at little or no cost

Disadvantages:

No competition to motivate the workers Labor only try to maintain the standards Achieve the government's target but did not improving them

Lack innovation. Can not detect consumer preferences accurately. Overstaffing problems, poor product quality, lack of efficiency. Sacrifice for the good of the state and benefit for future generations No incentive to work hardjust enough to fill quota Little flexibilitydiscourages change


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Mixed Economies

A mixed economy is a mixture of a pure free-enterprise market economy and a commandeconomy. There is a private sector and a public sector in the economy. Both these sectorsexist and function for achieving national objectives and make the economic system of thecountry. In fact the mixed economy is the happy combination of private enterprise withgovernment enterprise on the one side there is freedom of enterprise, private ownership andprofit earning. On the other side there is government guidance and control so as to stop evileconomic, pressures. In order to remove the effects of the capitalistic economy, mixedeconomy has been introduced. It prevails in most of the countries of the world.

Characteristics:

Government and individuals share the decision making process Government guides and regulates production of goods and services offered Individuals own means of production Protects consumers and workers from unfair policies Most effective economy for providing goods and services

The United States and most Western European countries are mixed economies

Advantages

The mixed economy is helpful in increasing national production in the country. Both public and private sectors work hard to bring about more production. The problems created by free enterprise and too much public control are solved

through mixed economy. It provides freedom of enterprise ownership and profit earning as well as social

welfare and political freedom. All the national recourses are utilized under mixed economy.

Disadvantages

Mixed economy is half way house. It is not helpful in achieving optimal use of national resources. The mixed economy suffers from the drawbacks of both the capitalism and the

socialism. Mixed economy seldom achieved progress. It suffers from continues backwardness.

Under mixed economy wastage of different types occurs in the economy.


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Market EconomiesA market economy is one where economic decisions are made through the free marketmechanism. The forces of market demand and supply, without any government intervention,determine how resources are allocated. This is known as the working of the price mechanism.

Characteristics:

Resources are owned and controlled by individuals Economic decisions are made by individuals competing to earn profits Individual freedom is considered very important Economic decisions are made by the basic principles of supply and demand Profit is the motive for increasing work rather than quotas Also called capitalist economies There are many economic freedoms There is competition among businesses Competition determines price which increase the quality of the product People and firms act in their own best interests Allow buyers/sellers to come together to exchange goods & services

Ex: US, Japan, Germany

Advantages

Over time can adjust to change Individual freedom Little government interference Decentralized decision making Variety of goods/services High consumer satisfaction

Disadvantages

Doesnt provide for basic needs of ALL members Doesnt provide enough services people highly value

o Ex: education, health care High degree of uncertainty for workers & businesses Can fail if 3 conditions are not met

o Reasonably competitive marketso Resources able to move from one activity to anothero Consumer access to information to make wise choiceso Government helps to ensure these


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International Trade, Comparative Advantage and Absolute Advantage

International Trade

The economic system of exchanging good and services, conducted between individualsand businesses in multiple countries.

Comparative Advantage

In economics, the law of comparative advantage refers to the ability of a party (anindividual, a firm, or a country) to produce a particular good or service at a lower marginalcost and opportunity cost than another party. It is the ability to produce a product mostefficiently given all the other products that could be produced. [1][2] It can be contrasted withabsolute advantage which refers to the ability of a party to produce a particular good at alower absolute cost than another.

Comparative advantage explains how trade can create value for both parties even when one

can produce all goods with fewer resources than the other. The net benefits of such anoutcome are called gains from trade.

Absolute Advantage

In economics, absolute advantage refers to the ability of a party (an individual, firm, orcountry) to produce more of a good or service than competitors, using the same amount ofresources. If a party has an absolute advantage when using the same input as another party,it can produce a greater output.[7][8] Since absolute advantage is determined by a simplecomparison of labor productivities, it is possible for a party to have no absolute advantage inanything.[9] It can be contrasted with the concept of comparative advantage which refers tothe ability to produce a particular good at a lower opportunity cost.

Module 1 - Introduction to Managerial Economics

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Transcript of Module 1 - Introduction to Managerial Economics