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Managerial EconomicsExecutive MBA Program
Session 1: Introduction toBusiness Economics
InstructorSandeep [email protected]
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Before we proceed..
Have you ever thought
why are these
companies sosuccessful?
One reason is:Management made right
decision at right time
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Business Success and Managerial
Economics- Imp. Of Decision
Making Increasingcomplexity of
business world
National andinternal production
of goods and
services Rapid change and
innovation in
technology
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Decis ion making is no t an easy task !!
Societys Resources are needed to makedecisions but they are Scarce (limited):
Management of societys resources is important
Includes management of Land, labour and
Capital (Factors of Production) Economics is the study of how society
manages its scarce resources: Allocation
of Resources
From where does the decision making
begin?
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Has this ever happened to you. . .? Who would iron? Who would take the kids to
the school? Who would watch which programin TV?
The word economy comes from a Greek word
for one who manages a household.
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Societys decision making? Not much
different How many doctors to hire? How many engineers?
Whose son will become a pilot? Whos daughter will be a model?
How much to earn? How much to save?
How much to produce to earn maximum profit?
Where should we locate out factory?
Super model
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How people makedecisions?
Fundamentalprinciples ofEconomics
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Principle #1: People Face Tradeoffs.
There is no such thing as a free lunch!
Money is a scare resource:The more burger you buy, the less money
you have in your pocket
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PPF Example
Producing one computer requires 100 hours
labor.
Producing one ton of wheat requires 10 hours
labor.
5,0000
4,000100
2,500250
1,000400
50,0000
40,00010,000
25,00025,000
10,00040,000
0500050,000
E
D
C
B
A
WheatComputersWheatComputers
ProductionEmployment of
labor hours
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Pointon
graph
ProductionCom-
putersWheat
A 500 0
B 400 1,000
C 250 2,500
D 100 4,000
E 0 5,0000
1,000
2,000
3,000
4,000
5,000
6,000
0 100 200 300 400 500 600
Computers
Wheat
(tons)
A
B
C
D
E
PPF Example
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ACTIVE LEARNING 1:
Answers
Point F:100 computers,
3000 tons wheat
Point Frequires
40,000 hoursof labor.
Possible but
not efficient:
could get moreof either good
w/o sacrificing
any of the other.
0
1,000
2,000
3,000
4,000
5,000
6,000
0 100 200 300 400 500 600
Computers
Wheat(tons)
F
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ACTIVE LEARNING 1:
Points on the PPF
B. Next, find the point that represents(300 computers, 3500 tons of wheat), label it G.
Would it be possible for the economy to produce
this combination of the two goods?
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ACTIVE LEARNING 1:
Answers
0
1,000
2,000
3,000
4,000
5,000
6,000
0 100 200 300 400 500 600
Computers
Wheat(tons)
Point G:300 computers,
3500 tons wheat
Point Grequires
65,000 hours
of labor.
Not possible
because
economy
only has
50,000 hours.
G
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All decisions involve tradeoffs.Some realistic examples:
Going to a party the night before your
midterm leaves less time for studying. Having more money to buy stuff
requires working longer hours, which
leaves less time for leisure. Society faces an important tradeoff:
eff ic iency vs . equ ity
Principle #1: People Face Tradeoffs
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Finding Opportunity CostWhat is the
opportunity cost of
producing 1
computer?
0
1,000
2,000
3,000
4,000
5,000
6,000
0 100 200 300 400 500 600
Computers
Wheat
(tons)
To produce 500
computers, 5000tons of wheat has
to be given up.
So, the opportunitycost of a computer
is 10 tons of
wheat.
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Finding Opportunity Cost using PPF Slope
Assume, you want
to produce 100computer.
What is the
opportunity cost of
producing 1computer?
Note: Slope is the
ratio of change in Y-
axis to X-axis.0
1,000
2,000
3,000
4,000
5,000
6,000
0 100 200 300 400 500 600
Computers
Wheat
(tons)1000
100slope = =10
Ans:
10 tons of wheat.
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ACTIVE LEARNING 2:
PPF and Opportunity Cost
20
In which country is the opportunity cost of cloth lower?
0
100
200
300
400
500
600
0 100 200 300 400
Cloth
Wine
0
100
200
300
400
500
600
0 100 200 300 400
Cloth
Wine
FRANCE ENGLAND
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ACTIVE LEARNING 2:
Answers
21
England, because its PPF is not as steep as Frances.
0
100
200
300
400
500
600
0 100 200 300 400
Cloth
Wine
0
100
200
300
400
500
600
0 100 200 300 400
Cloth
Wine
FRANCE ENGLAND
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Numerical problem related to Opportunity
Costs (Q.N. 4)
Pat takes 4 hours to brew a gallon of root beer and 2
hours to make a pizza. Kris takes 6 hours to brew a
gallon of root beer and 4 hours to make a pizza.
a. What is each roommates opportunity cost of making
a pizza?
b. If Pat and Kris trade foods with each other, who will
trade away pizza in exchange for root beer?
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Solution to Numerical ProblemPizza Root Beer
Pat 2 hours 4 hours
Chris
4 hours
6 hours
a) What is each roommates opportunity cost of making a
pizza?
Pat takes 4 hours to make 1 root beer and 2 hours to
make 1 pizza.
If Pat spends 2 hours, which he spends to make 1 Pizza
in making root beer, he makes 1/2 root beer.
So, Pat's Opportunity Cost is 1/2 root beer.
Similarly, Chris's Opportunity Cost is 2/3 root beer.
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b) If Pat and Kris trade foods with each other, who will
trade away pizza in exchange for root beer?
Solution to Numerical Problem
Pat will trade away pizza in exchange for the root beer
that Chris will make.
Pizza Root Beer
Pat
2 hours
4 hours
Chris 4 hours 6 hours
Note:Solve remaining problems from No. 1 to 7
from handout.
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The Shape of the PPF
The PPF could be a straight line, or bow-
shaped
Depends on what happens to opportunity cost
as economy shifts resources from one
industry
to the other.
If opp. cost remains constant,
PPF is a straight line.
(In the previous example, opp. cost of acomputer was always 10 tons of wheat.)
If opp. cost of a good rises as the economy
produces more of the good, PPF is bow-
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A
Why the PPF Might Be Bow-Shaped
At point A,most workers are
producing beer,
even those that
are better suitedto building
mountain bikes.
So, do not have
togive up much
beer to get more
bikes.
Mountain
Bikes
Beer
At A, opp. cost ofmtn bikes is low.
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B
Why the PPF Might Be Bow-Shaped
At B, most workersare producing bikes.
The few left in beer
are the best
brewers.
Producing more
bikes would require
shifting some of the
best brewers away
from beerproduction,
would cause a big
drop in beer output.
Mountain
Bikes
Beer
At B, opp. costof mtn bikes
is high.
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Many decisions are not all or nothing,
but involve Marginal changesincremental
adjustments to an existing plan.
Eg. Marginal cost, marginal revenue, etc.
A firm considers whether to increase output,
comparing the cost of the needed labor and
materials to the extra revenue.
Which subject Should I do my Ph.D in?
Should I eat like a pig or dont eat at all?
Principle #3: Rational People Think at the
Margin: Marginal analysis
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incentive: something that induces a person
to act, i.e. the prospect of a reward or
punishment.
In response to higher gas prices,sales of hybrid cars (e.g.,Toyota Prius) rise.
In response to higher cigarette taxes,
teen smoking falls.
Principle #4: People Respond to Incentives
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Rather than being self-sufficient, people can
specialize in producing one good or service
and exchange it for other goods. Countries also benefit from trade &
specialization:
get a better price abroad for goods they produce
buy other goods more cheaply from abroad than
could be produced at home
Principle #5: Trade Can Make Everyone
Better Off
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A marketis a group of buyers and sellers.(They need not be in a single location.)
Organize economic activity means
determining
what goods to produce
how to produce them
how much of each to produce
who gets them
Principle #6: Markets Are Usually A Good
Way to Organize Economic Activity
Famous insight by Adam Smith in The Wealth of Nations
(1776): Each of these households and firms acts as if led
by an invis ib le hand to promote general economic well-
being.
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Important roles for govt: enforce property rights(with police, courts) and promote efficiency
People are less inclined to work, produce, invest,
or purchase if large risk of their property beingstolen.
A restaurant wont serve meals if customers
do not pay before they leave.
Promote efficiency in case of market failure
Condition when the market fails to allocate
societys resources efficiently.
Causes: Market power and externality
Principle #7: Governments Can
Sometimes Improve Market Outcomes
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Positive and Normative Analysis:
The Economist as a Scientist and as a
Policy Advisor As scientists, economists make
positive statements,
which attempt to describe the world as it is.
As policy advisors, economists make
normative statements,
which attempt to prescribe how the world should
be.
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ACTIVE LEARNING 3:
Answers
c. A tax cut is needed to stimulate the economy.Normative, another value judgment.
d. An increase in the price of gasoline will cause an
increase in consumer demand for video rentals.
Positive, describes a relationship.
Note that a statement need not be true to be
positive.
M i l E i
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Managerial EconomicsEconomics:
Microeconomics and MacroeconomicsManagerial Economics:
Part of Microeconomics that deals with tools
and techniques of decision making formanagers
Applications of techniques
Risk analysis Production analysis
Pricing analysis
Capital budgeting
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Scope of Managerial
Economics Theory of demand Theory of production
Theory of exchange or price theory
Theory of profit
Theory of capital and investment
Environmental issues
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as s o orpora e ec s on
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as s o orpora e ec s onmaking
Find occasions for
making decisions
Identify possible
course of action
Evaluate benefits and
costs
Choose a course
For other benefits and details on Managerial Economics, pls.
refer to the reading materials.
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Thank you