Teaching economics to non-economists

Anthony Plumridge University of the West of England, Bristol

First degree in economics, sociology and politics, second degree in architecture, planning and environmental studies

Early career in marketing and strategic management, ran three small businesses, entered academic life in 1989

A belief in the vocational value of the rigorous analytical skills of economics

Necessary to demonstrate the potency of economic analysis in a relevant context

Modules taught include• The Market Environment to Business Systems students• Construction Economics to Building Studies students• Economics of the Legal System to LlB students• Housing and Property Economics to Joint Honours

students• Environmental economics to Environmental Management

students• Economics of Tourism to Business and Tourism students• European Economics to European Languages students• Tourism in Local Economic Development to MA

Sustainable Tourism students

Outreach activities• Delivered ESF funded programme of business economics

training to 90 SMEs 1999 – 2001• Provided Professional Development training to

stockbrokers, solicitors and Trading Standards Officers

Teaching economics to non-economists

Teaching economics to non-economists - contexts

Various contexts exist in which economics is taught as a subsidiary subject, each posing particular difficulties:

• as a half degree combined with a wide range of other half degrees (42 at UWE) as part of a joint honours programme - e.g. economics and media studies (some 200 students take economics as a half degree at UWE).

problem: the two half degrees are taught in isolation, interdisciplinary material is ignored, students often not grouped according to discipline combination and can feel isolated.

Teaching economics to non-economists - contexts

• as core component of a degree in another discipline

problem: a “critical mass” of basic economic theory needs to be included and a number of key threshold concepts fully understood; resource constraints mean there may be insufficient time to explore relevant contexts, applications or interdisciplinary material

Teaching economics to non-economists - contexts

• as an option on a degree in another discipline

problem: as above with added complication that often the module is offered to students on a number of disparate degree courses

Teaching economics to non-economists

THE LEAST DESIRABLE RESOURCE-DRIVEN SOLUTION:

Teach the same introductory economics module irrespective of the context or other disciplines studied.

WAYS OFIMPROVING ON THIS:

Administrative solution• Allocate students to seminar/tutorial groups according to

other discipline studied: appropriate contexts and interdisciplinary material can then be covered.

Teaching economics to non-economists

Assessment solution

• Use mini-project style assignments allowing students to choose appropriate interdisciplinary topics.

Resource economising solutions

• Support teaching of basic principles with self-directed learning material such as interactive software.

Welcome to "PROFITS AND COSTS"

an interactive introduction to the cost structure of a typical business

organisation

To move around the programme, click on the sheet tabs at the bottom of the page.Some cells have hidden notes: look for a red marker in the top right hand corner of the cell.

To read these select the cell with your cursor and then select Note on the Insert menu.Before selecting the Sheet 1 tab to move to the next screen, select Full Screen on the View menu.

THE PROFIT AND LOSS ACCOUNT OF A SMALL MANUFACTURERPERIOD YEAR 1SALES £000 (Revenue) 1000OUTPUT (000units) 100

COST OF SALES (Variable costs)Labour 140Materials 220Distribution 40TOTAL VARIABLE COSTS (TVC) 400GROSS PROFIT (Revenue - TVC) 600

EXPENSES (Fixed Costs)Administrative Salaries 80Directors' Fees 90Communications 20Information Technology 30Premises 90Advertising 50Travel/Entertaining 40Insurance 15Professional Fees 15Depreciation 100Tax 18TOTAL FIXED COSTS (TFC) 548TOTAL COSTS (TVC+TFC)) 948NET PROFIT (Gross Profit - TFC) 52

PRICE £ 10.0

OUTPUT is the quantity of the product produced. SALES (also called REVENUE) is the value of output sold. In this example, all output produced in the year is sold and SALES = OUTPUT X PRICE. This would not be so if some output was not sold but held as stock

COST OF SALES comprise what are known as the VARIABLE or DIRECT costs. These are costs which vary directly with Output. If production ceased, no variable costs would be incurred - Labour could be layed off, materials and components would not be used and there would be no product to distribute

GROSS PROFIT is calculated by subtracting the Variable Costs from Revenue. In this case GROSS PROFIT is 60% of Revenue. This is the GROSS PROFIT MARGIN.

EXPENSES comprise what are also known as the FIXED or INDIRECT costs. Expenses are also known as OVERHEADS. These are costs which do not vary directly with output. They are fixed in the SHORT TERM and only change when the SIZE or SCALE of the business changes in the LONG TERM.

NET PROFIT is calculated by subtracting Fixed Costs from Gross Profit. In this case NET PROFIT is 5.2% of Revenue. This is the NET PROFIT MARGIN.

NOW TRY CHANGING OUTPUT AND PRICE AND SEE WHAT HAPPENS TO REVENUE, COSTS AND PROFIT

PERIOD YEAR 1SALES £000 (Revenue) 1000OUTPUT (000units) 100

COST OF SALES (Variable costs)Labour 140Materials 220Distribution 40TOTAL VARIABLE COSTS (TVC) 400GROSS PROFIT (Revenue - TVC) 600

EXPENSES (Fixed Costs)Administrative Salaries 80Directors Fees 90Communications 20Information Technology 30Premises 90Advertising 50Travel/Entertaining 40Insurance 15Professional Fees 15Depreciation 100Tax 18TOTAL FIXED COSTS (TFC) 548TOTAL COSTS (TVC+TFC)) 948NET PROFIT (Gross Profit - TFC) 52

This simple Profit and Loss Account shows the Revenue, Costs and Profits accumulating over a year's trading.

It is more revealing to look at how this picture might build up over time. What follows is the progress of the same business over two years or eight quarters (eight three month periods):

* The business is established with a management and administrative team in the first quarter. There is no production yet.

* Then production starts up and sales build up over the following months and the business moves into profit.

* But then costs begin to rise as it becomes harder and harder to keep up with booming sales.

* The period of time considered is known as the short run

To see an extended picture of this go to Sheet 3(Note: the colur of the lines in the chart corresponds to the colours in the table)

PERIOD YEAR Q0 Q1 Q2 Q3 Q4 Q5 Q6 Q7SALES £000 (Revenue) 1000 0 100 200 300 400 500 580 600OUTPUT (000units) 100 0 10 20 30 40 50 58 60COST OF SALES Labour 140 0 21 28 32 60 105 252 308Materials 220 0 21 44 66 88 187 264 440Distribution 40 0 4 8 12 16 24 24 24TOTAL VARIABLE COSTS 400 0 46 80 110 164 316 540 772GROSS PROFIT 600 0 54 120 191 237 184 40 -172

EXPENSES Administrative Salaries 80 20 20 20 20 20 20 20 20Directors Fees 90 23 23 23 23 23 23 23 23Communications 20 5 5 5 5 5 5 5 5Information Technology 30 8 8 8 8 8 8 8 8Premises 90 23 23 23 23 23 23 23 23Advertising 50 13 13 13 13 13 13 13 13Travel/Entertaining 40 10 10 10 10 10 10 10 10Insurance 15 4 4 4 4 4 4 4 4Professional Fees 15 4 4 4 4 4 4 4 4Depreciation 100 25 25 25 25 25 25 25 25Tax 18 5 5 5 5 5 5 5 5TOTAL FIXED COSTS 548 137 137 137 137 137 137 137 137TOTAL COSTS 948 137 183 217 247 301 453 677 909NET PROFIT 52 -137 -83 -17 54 100 47 -97 -309 PRICE £ 10.0

TOTAL COSTS AND REVENUE

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TOTAL COSTS, REVENUE AND PROFIT OFA GROWING BUSINESS IN THE SHORT RUN

SEE THE EFFECT OF CHANGING THE PRICE BY CLICKING ON IT AND TYPING IN A NEW FIGURE

Total Costs and Revenue on the previous sheet give a usefull picture of the business, but a more telling picture emerges if we consider Average Costs and Price. Average Costs are obtained by dividing Total Cost by Output. Price is the same as Revenue divided by Output and is sometimes called Average Revenue.Sheet 5 shows a table and chart of Average Costs and price.

PERIOD Q1 Q2 Q3 Q4 Q5 Q6 Q7AVERAGE REVENUE (Price) 10.0 10.0 10.0 10.0 10.0 10.0 10.0

UNIT COST OF SALES Labour 2.1 1.4 1.1 1.5 2.1 4.4 5.1Materials 2.1 2.2 2.2 2.2 3.7 4.6 7.3Distribution 0.4 0.4 0.4 0.4 0.5 0.4 0.4AVERAGE VARIABLE COSTS 4.6 4.0 3.7 4.1 6.3 9.4 12.9UNIT GROSS PROFIT 5.4 6.0 6.4 5.9 3.7 0.6 -2.9

UNIT EXPENSES Administrative Salaries 2.0 1.0 0.7 0.5 0.4 0.3 0.3Directors Fees 2.3 1.1 0.8 0.6 0.5 0.4 0.4Communications 0.5 0.3 0.2 0.1 0.1 0.1 0.1Information Technology 0.8 0.4 0.3 0.2 0.2 0.1 0.1Premises 2.3 1.1 0.8 0.6 0.5 0.4 0.4Advertising 1.3 0.6 0.4 0.3 0.3 0.2 0.2Travel/Entertaining 1.0 0.5 0.3 0.3 0.2 0.2 0.2Insurance 0.4 0.2 0.1 0.1 0.1 0.1 0.1Professional Fees 0.4 0.2 0.1 0.1 0.1 0.1 0.1Depreciation 2.5 1.3 0.8 0.6 0.5 0.4 0.4Tax 0.5 0.2 0.2 0.1 0.1 0.1 0.1AVERAGE FIXED COSTS 13.7 6.9 4.6 3.4 2.7 2.4 2.3AVERAGE TOTAL COSTS 18.3 10.9 8.2 7.5 9.1 11.8 15.2UNIT NET PROFIT -8.3 -0.9 1.8 2.5 0.9 -1.8 -5.2

AVERAGE COSTS

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AVERAGE COSTS AND PRICE IN A GROWING BUSINESS IN THE SHORT RUN

UPPER AND LOWER BREAK EVEN POINTS

Try changing price in cell B7

Looked at either from the Total Cost and Revenue perspective or from Average Cost and Price, the business is in trouble: the demand for the product is beyond capacity. The business needs to increase the SCALE of operations by increasing the CAPITAL (factory space, machinery and equipment). This can be achieved only after the time needed to extend premises and install new machinery. This is known as the long run . Once the expansion is achieved the business is in a new short run time period until sufficient time has elapsed to allow a further increase in scale.

The necessary increase in scale will also require some increase in the size of the management team and the number of administrative staff. Fixed costs will thus rise. This can only be achieved in the long run. In most cases this increase in size will allow ECONOMIES OF SCALE to be achieved, resulting in a reduction in average total cost.

The next sheet shows how the business increases scale during year 2 so that in year 3 it can increase output. This is shown on the next sheet: year 1 is included for comparison purposes and year 3 shows the first full year of the new larger operation. Q0 is the transitional period during which production is transfered to the new factory.

PERIOD YR 1 YR 3 Q0 Q1 Q2 Q3 Q4 Q5 Q6 Q7SALES £000 (Revenue) 1000 3000 0 300 600 900 1200 1500 1725 1800OUTPUT (000units) 100 400 0 40 80 120 160 200 230 240COST OF SALES Labour 140 400 0 60 80 100 120 180 320 800Materials 220 750 0 75 150 225 300 375 525 675Distribution 40 125 0 13 25 38 50 63 225 250TOTAL VARIABLE COSTS 400 1275 0 148 255 363 470 618 1070 1725GROSS PROFIT 600 1725 0 153 345 538 730 883 655 75(Revenue - Variable Cost)EXPENSES Administrative Salaries 80 120 30 30 30 30 30 30 30 30Directors Fees 90 135 34 34 34 34 34 34 34 34Communications 20 30 8 8 8 8 8 8 8 8Information Technology 30 45 11 11 11 11 11 11 11 11Premises 90 180 45 45 45 45 45 45 45 45Advertising 50 150 38 38 38 38 38 38 38 38Travel/Entertaining 40 60 15 15 15 15 15 15 15 15Insurance 15 23 6 6 6 6 6 6 6 6Professional Fees 15 23 6 6 6 6 6 6 6 6Depreciation 100 200 50 50 50 50 50 50 50 50Tax 18 50 13 13 13 13 13 13 13 13TOTAL FIXED COSTS 548 1015 254 254 254 254 254 254 254 254TOTAL COSTS 948 2290 254 401 509 616 724 871 1324 1979NET PROFIT 52 710 -254 -101 91 284 476 629 401 -179

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NOTE THE POSITION OF THE NEW BREAK

EVEN POINTS

There is a Total Cost and Revenue graph shown below: Scroll down to view.

TOTAL COSTS AND REVENUE IN A LARGER GROWING BUSINESS IN THE SHORT RUN

In the chart below, the two scales of operation are compared on one average cost graph. Economies of Scale drive down the costs of the larger business.

As scale changes the period shown is the long run

AVERAGE TOTAL COST

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Larger scalePrice = £7.50

PERIOD Q1 Q2 Q3 Q4 Q5 Q6 Q7PRICE ( = Marginal Revenue) £ 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0OUTPUT (000units) 10.0 20.0 30.0 40.0 50.0 58.0 60.0TOTAL VARIABLE COSTS £000 46.0 80.0 110.0 164.0 316.0 540.0 772.0MARGINAL COST £ 3.4AVERAGE TOTAL COSTS £ 18.3 10.9 8.2 7.5 9.1 11.8 15.2

Profits are maximised where Marginal Cost equals Marginal Revenue. Here is an explanation of Marginal Cost:

This data is taken from Sheets 3 and 5

Marginal Cost (MC) is the extra cost of producing one more unit: to calculate MC from the data below take the increase in TVC and divide by the increase in output

The value in this cell is the increase in TVC (80 - 46 or 34) divided by the increase in output (10).The answer is put in between the columns as Marginal Cost is related to the change in output between Q1 and Q2You will get the same result if you work out MC using the change in Total Cost rather than Total Variable Cost

Now work out the Marginal Cost for Q2 to Q7.Check your results on the next sheet - this includes a graph of Marginal Cost