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8/4/2019 MM Session 1
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1
MICROECONOMICS FOR
MANAGERSYEAR 2011-12 TERM 1
RAHUL NILAKANTAN
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Rules of the game
Please be on time
No mobile phone or laptop usage
Class participation welcomed
2
Say your name before you say anything else
Quantity / quality trade-off
Read before coming to classWe will not cover all the material from the book
ALL the material from the book can be tested
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Why Economics? Economics provides the intellectual foundations of
many management subjectsMarketing RUM, hedonic utility models
Strategy game theory / industrial organization
3
OB & HR contract theory, information economics Finance asset pricing, auction theory
International Business international trade & finance
Understanding Economics concepts and toolsenhances managerial decision making
See SUV example in your book pg.14
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This course Textbook
Pindyck and Rubinfeld Evaluation
Mid-term exam 35%
4
n -term exam Surprise quizzes 20%
Class participation 10%
Makeup policy
Only if you were on leave with approval of PGP chair
Instructor will decide the nature of the makeup
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Session plan
Preliminaries
Basic economic concepts 1
Consumer behavior 2, 3
5
Demand and supply analysis 4, 5
Elasticity of demand and supply 6
Impact of taxes and subsidies 7
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Session plan
Producers
Theory of production 8
Theory of cost 9, 10
6
Profit maximization and competitive supply 11
Monopoly and market power 12, 13
Pricing with market power 14
Monopolistic competition and oligopoly 15, 16
Game theory and competitive strategy 17
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Principles of EconomicsCourtesy Tilman Slembeck (Univ. of St. Gallen)
Scarcity
Situation where needs exceed means Goods are not freely available to take Does scarce mean the same thing as rare?
Rationality
8
Individual acts as ifbalancing costs against benefits toarrive at action that maximizes personal advantage Goal oriented behavior
Compare costs and benefits of alternatives
Preferences People can assign utilities to all options and choose the
option that maximizes net utility
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Operationalizing notion of rationality
Three managers are discussing a possible increase
in TV production. A: we should examine the effect of the increase on
productivity (TV output per worker)
9
B: we should examine the effect of the increase onaverage cost of TVs
C: we should examine whether the extra revenue
exceeds the extra costs Who is on the right track and why?
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Principles of Economics Restrictions
Choice set is constrained e.g. budget constraint, non-negative profit constraint, etc.
Opportunity cost Cost of next best foregone alternative
10
What is the opportunity cost of coming here for PGDM? The Economic Principle Application of rationality to situations of scarcity Maximize profit given input availability and prices
Minimize costs for a given level of output Maximize utility for given income
Minimize expenditure for given utility
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Principles of Economics Efficiency
In production (Economic Principle) or in distribution(Pareto criterion)
Marginal analysis
11
Analyze decisions in terms of marginal benefits andmarginal costs
Equilibrium
Situation where no one has an incentive to change hisbehavior
Stable outcome after interactions have taken place
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Marginal analysis example 1 Average vs. marginal analysis
Cost of adding one more passenger to an existingflight is Rs.100 (cost of drinks and snacks)
Average cost of a passenger per flight is Rs.2,000
12
(Rs.1,00,000 per flight, 50 passenger capacity) At the boarding gate, there are still some seats to be
filled. A passenger shows up and is willing to pay only
Rs.200 for the ticket. Should he be allowed to fly? Short term analysis
Long term analysis
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Marginal analysis example 2 Sunk costs
You have invested Rs.10 crore in a housing project inMumbai
Real estate crash occurs expected sales revenue from
13
selling completed project Rs.5 crore Project has no value if not completed
If completing the project costs Rs.2 crore, should you
complete the project or abandon it?What is the most you should pay to complete the
project?
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Sunk costs continued DRDO has spent Rs.125 crores on RnD and product
development for Arjun MBT Insists that the army should order at least 500 tanks so
that money spent so far does not go to waste
14
Army argues that Arjun tank is approachingobsolescence, so huge costs of adoption outweigh
the expected future benefits
Who is using the Economic way of thinking?
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Positive vs. normative issues Positive
Cause and effect analysis Normative
What ought to be (value judgment)
15
Statement 1: LPG rationing is a poor social policybecause it interferes with the workings of thecompetitive market system
Statement 2: LPG rationing is a policy under whichmore people are made worse off than are madebetter off
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Real vs. nominal prices Inflation
Situation in which overall price level is rising Makes inter-temporal comparison of prices difficult
Nominal price
17
rice una juste or in ation
Real price
Price adjusted for inflation
Consumer price index (CPI)
Measure of the aggregate price level
Can thus be used to measure inflation rate
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Consumer Price Index CPI CPI is a measure of overall cost of goods and
services bought by a typical consumer Comes in different flavors: IW, UNME, AL/RL
Uses retail rices
18
Covers goods and services
Lower fuel, higher food weights
CPI calculated by Labor Bureau of Ministry of
Labor & Employment
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Table 1.1 The Real Price of Eggs and of a College Education
1970 1980 1990 2000 2007
Consumer Price Index 38.8 82.4 130.7 172.2 205.8
Nominal Prices
Grade A Large Eggs $0.61 $0.84 $1.01 $0.91 $1.64
Real vs. nominal prices19
38.8$1.01 $0.30
130.7= =
, , , , ,
Real Prices ($1970)
Grade A Large Eggs $0.61 $0.40 $0.30 $0.21 $0.31
College Education $2,530 $2,313 $3,568 $4,548 $5,196
1970
1980
Real price of eggs in 1980 nominal price in 1980CPI
CPI=
1970
1990
Real price of eggs in 1990 nominal price in 1990CPI
CPI=
38.8$0.84 $0.40
82.4= =
The real price of eggs in 1970 dollars is calculated as follows:
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The Real Price of Eggs and of a College Education (continued)
1970 1980 1990 2000 2007
Consumer Price Index 38.8 82.4 130.7 172.2 205.8
Nominal Prices
Grade A Large Eggs $0.61 $0.84 $1.01 $0.91 $1.64
Real vs. nominal prices20
, , , , ,
Real Prices ($1980)
Grade A Large Eggs $2.05 $1.33 $1.01 $0.69 $1.04
College Education $2,530 $2,313 $3,568 $4,548 $5,196
real price in 2007 real price in 1970Percentage change in real price
real price in 1970
=
The percentage change in real price is calculated as follows:
1.04 2.050.49
2.05
= =
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Practice question 1 Why did real price of eggs fall?
Why did real price of college degrees rise?
21
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Practice question 2 Suppose INR rises against USD i.e. fewer INR to buy
1 USD Why does this simultaneously
22
consumers? Decrease the real price of US cars for Indian
consumers?
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Practice answer 3 Nominal price of STDs fell from Rs.5 per minute in 1996 to
Rs.3 per minute in 1999, a 40% decrease
CPI increased by 20% over this period
What happened to real price of STDs?
24
Let 1996 CPI be 100 and 1999 CPI be 120 i.e. 20% increase
Real price of STDs as expressed in 1996 rupees
1996 real price = 1996 nominal price = Rs.5 per minute
1999 real price = (CPI 1996 / CPI 1999)*1999 nominal price Rs. (100 / 120) * 3 = Rs. 2.50 per minute
Real price fell from Rs. 5 per minute to Rs.2.50 per minute i.e. a 50%decline