Transcript Lecture 1: Introduction

Lecture 1
Introduction & Basics of Economics
Dr. Rajeev Dhawan
Director
Given to the
EMBA 8400 Class
March 19, 2010
Course Objective & Teaching Philosophy
Practical Course to Comprehend the
Economic Environment so that Managers
can make their Decisions
Philosophy is that Micro Sectors Add Up
to a Macro Environment
Optimal Blend of Economics and Real
World Experience/Common Sense
Train You to Critically Evaluate and
Interpret Business Press Writings
Course Layout
Week 1 – Basic Economic Concepts and
Microeconomics I
Week 2 – Microeconomics II and Basics
Macroeconomics I
Week 3 – Macroeconomics II
Grading Policy
TWO RULES:
– No Early or Makeup Exams
– All Exams are Open Book
20% Quiz #1 (30 minutes)
30% Quiz #2 (45 minutes)
50% Final Comprehensive
Exam (2 hours)
Macro Framework
Households: Consume & Work
Firms: Production & Investment
Government: Money Supply,
Taxes, Expenditures
Foreign Sector: Exports,
Imports & Exchange Rate
Introduction
The 10 Principles of Economics
What is Economics?
 Economics is the study of how we use our scarce
productive resources for consumption, now or in
future.
– Paul Samuelson
 Resources are scarce:
– Society has limited resources and therefore cannot
produce all the goods and services people wish to have
– Example: clean air & water
– Scarcity is not poverty
Basic Questions
What to produce in what quantity?
How to produce them?
When and where to produce?
For whom?
Who makes economic decisions and by
what process?
Basic Concepts
Opportunity Cost: Things are Scarce
– Next Best Alternative
Ex: Party on Friday night vs. study for exams
– Cost of Time
Ex: 1 hour wait time at the dentist
Basic Concepts
Marginal Concept: At the Margin
Shots of Wild Turk ey
Marginal
Shot
Satisfaction Satisfaction
1
50
20
2
70
10
3
80
5
4
85
1
5
86
0
6
86
Utility: Level of Satisfaction (here, drunkenness)
Basic Concepts
Sunk/Fixed Costs: Expenditures Made that
Cannot be Recovered
– Example:
You bought a computer laptop for $1500
A newer, upgraded model costs $1200
The dealer will accept a trade in + $400
What do you do?
Winnick’s Voyage to the Bottom of the Sea
WSJ; by Andy Kessler
 First Mover, FCC regulated + fixed costs
 Regulated utility
 Price protection
You can’t lose
 Traffic / use was of low economic value or
cashless
 Global Crossing couldn't cut prices without running
the risk of either failing to cover its debt or being
unable to raise more capital
 Accounting Tricks…….
10 Principles of Economics
1. People face tradeoffs :
• “No such thing as free lunch”
• Give up one thing to get another –
Opportunity Cost (OC)
2. Everything has an OC – whatever must be given
up to get that item
3. People make decisions at the margins –
increments matter
4. People respond to incentives – e.g. cigarette
laws, communism
5. Free Trade is good (for everybody)
10 Principles of Economics
6. Markets organize economic activity
- Adam Smith “Invisible Hand”
7. Governments can sometimes improve market
outcome
8. A country’s standard of living depends upon its
production power (productivity)
9. Prices rise when government prints too much
money
10. Phillips curve – short run tradeoff between
inflation and unemployment
Branches of Economics
Micro: The Study of One Entity
(firm, business, people)
Macro: The Study of a Collection of Things
(national, aggregate)
How are Theories Developed?
Decision-Makers
– Firms, governments
Markets
– Place where exchange takes place
Winnick’s Voyage to the Bottom of the Sea
by Andy Kessler (p.14)
 First Mover, FCC regulated + fixed costs
Regulated utility
Price protection
You can’t lose
 Traffic / use was of low economic value or cashless
Global Crossing couldn't cut prices without running the
risk of either failing to cover its debt or being unable to
raise more capital
Accounting Tricks…….
Chapter 2
Production
Production
What is production?
– The activity by which we convert inputs (labor,
land & capital) into goods and services
What limits production?
– Inputs (resources)
– Technology
Government interference
Circular Flow Diagram
Revenue
Goods
and services
sold
MARKETS
FOR
GOODS AND SERVICES
•Firms sell
•Households buy
Spending
Goods and
services
bought
HOUSEHOLDS
•Buy and consume
goods and services
•Own and sell factors
of production
FIRMS
•Produce and sell
goods and services
•Hire and use factors
of production
Factors of
production
Wages, rent,
and profit
Labor, land,
capital
MARKETS
and
FOR
FACTORS OF PRODUCTION
•Households sell
•Firms buy
Income
= Flow of inputs
and outputs
= Flow of dollars
Production Possibilities Frontier
Definition: the amount of goods a firm or
society can produce given a fixed amount of
land, labor and other inputs.
Production Possibilities Frontier
Quantity of
Pretzels
Produced
4,000
D
3,000
a
C
2,200
2,100
2,000
E
A
b
B
1,000
0
300
d
.
600 700 750
Production
possibilities
frontier
c
1,000
Quantity of
Beer Produced
Production Function I
Input Y
0
0
MP
Y (Production) = F (Inputs)
1.00
1
Production Function
1
12
10
1.00
2
1.00
3
5
5
2
0
1.00
4
6
4
0
3
4
8
Y
2
Y=I
2
4
6
8
Input
Marginal Product: it is the increase in output that
1.00 arises from an additional unit of input.
Marginal Product (MP) = ∆ Output / ∆Input
10
Production Function II
Input Y
0
0
Y = I2
MP
1.00
1
Production Function
1
120
3.00
80
4
5.00
3
9
60
40
20
7.00
4
Y
2
100
0
0
16
2
4
6
8
Input
9.00
5
25
Marginal Product (MP) = ∆ Output / ∆Input
10
Production Function III
Input Y
0
0
Y = √I
MP
1.00
1
Production Function
1
3.5
0.41
2.5
1.4
Y
2
3
0.32
3
1.5
1
1.7
0.5
0.27
4
2
2
0
0
2
4
6
8
Input
0.24
5
2.2
Marginal Product (MP) = ∆ Output / ∆Input
10
Returns to Scale
 Returns to Scale: the property of the production function
that when you double your inputs, your output either
doubles, more than doubles, or less than doubles.
9
DRS
Y=F
8
MP ↑  IRS
MP ↓  DRS
7
6
CRS
Y = √F
5
4
Y=F2
3
2
IRS
1
0
0
1
2
3
4
5
6
7
8
9
10
Chapter 4
Demand & Supply
Some Basic Definitions
Market: a group of buyers and sellers of a
particular good or service
– E.g. Warren Buffet has been buying up junk
bonds
– E.g. Bars, parties – informal market
Stock market – organized market
Example of Supply & Demand
 Hong Kong chicken flu scare? Price of chicken 
 Mad cow disease in US? Price of beef 
 Oprah bad mouths beef? Price of beef 
– Amarillo farmers sue her.
SARS? (Macro issue…)
Demand
Quantity demanded (Q): the amount of a good that
buyers are willing and able to purchase at a given
price (P).
Demand for Beer
$10.00
$8.00
Price
Pints of Beer
P
QD
$10.00
0
7.00
1
5.00
3
4.00
6
2.00
11
0.00
19
$6.00
$4.00
$2.00
$0.00
0
5
10
15
Quantity (Pints)
20
Graph Results
Demand curve/schedule is downward
sloping and shows the relationship between
price of a good and the quantity demanded
Why downward sloping?
– Law of demand: Ceteris Paribus (all other
things being equal) the quantity demanded falls
when price rises
Other Determinants of Demand
Income (I) :
– I  , D   Normal Goods: car, Ferrari
– I  , D   Inferior goods: bus rides, potatoes
Price of related goods
– Substitutes (inversely correlated)
– Compliments (directly correlated)
Other Determinants of Demand
Tastes – taken as above
– You get old and prefer Lincoln Town cars to
sports cars
Expectations – about future
– Income potential with EMBA degree 
– Loss of jobs, layoffs prospects
Market Demand
– More players  Increase in demand
– Buy IPO’s in 90’s
Shifts in Demand Curve
Variables that shift the demand curve:
Shifts in the Demand Curve
Price of
Beer
Increase
in demand
Decrease
in demand
Demand
curve, D2
Demand
curve, D1
Demand curve,D3
0
Quantity of
Beer
Supply
Quantity supplied (Q): the amount of a good that
sellers are willing and able to sell at a given price (P).
Supply of Beer - Neighbors
$10.00
$8.00
Price
Pints of Beer
P
QS
$10.00
12
7.00
7
5.00
4
4.00
3
2.00
1
0.00
0
$6.00
$4.00
$2.00
$0.00
0
2
4
6
8
Quantity (Pints)
10
12
Supply
Supply graph for another bar
Supply of Beer - Hand in Hand
Price
Pints of Beer
P
QS
$10.00
8
7.00
5
5.00
4
4.00
3
2.00
1
0.00
0
$10.00
$9.00
$8.00
$7.00
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
0
2
4
6
8
Quantity (Pints)
10
12
Determinants of Supply
Your own Price
Input Prices
– Cost of bottle of beer: labor, capital, rent
Technology
– Smoking laws  separation of smoking &
drinking
Expectations
– Future outlook
Shifts in The Supply Curve
Variables that shift the supply curve:
Shifts In Supply Curve
Price of
Beer
Supply curve,S3
Decrease
in supply
Supply
curve, S1
Supply
curve, S2
Increase
in supply
0
Quantity of
Beer
Equilibrium
Equilibrium: the price where quantity
supplied is equal to quantity demanded
Market for Beer
$10.00
Price
$8.00
Equilibrium
$6.00
$4.00
$2.00
$0.00
0
5
6
10
Quantity (Pints)
15
20
Markets Not In Equilibrium
Excess Supply
Price of
Beer
Supply
Surplus
$6.50
4.00
Demand
0
2
Quantity
demanded
6
10
Quantity of
Quantity
Beer
supplied
Markets Not In Equilibrium
Excess Demand
Price of
Beer
Supply
$4.00
2.50
Shortage
Demand
0
2
Quantity
supplied
6
10
Quantity
demanded
Quantity of
Beer
Changes in Equilibrium
 Decide whether the event shifts the supply or demand
curve (or both).
 Decide whether the curve(s) shift(s) to the left or to the
right.
 Use the supply-and-demand diagram to see how the shift
affects equilibrium price and quantity.
Changes in Equilibrium
An increase in the
price of hops reduces
the supply of beer
An increase in wealth
increases demand for beer
Price of
Beer
Price of
Beer
Suppl
y
New
equilibrium
$6.50
S2
S1
New
equilibrium
$6.50
4.00
Initial
equilibrium
Initial equilibrium
4.00
D2
Demand
D1
0
6
10 Pints of Beer
0
2
6
Pints of Beer
One bar closes…
New
Equilibrium
Market for Beer
$10.00
S1
S2
Price
$8.00
$6.00
$5.00
$4.00
$2.00
$0.00
0
4
5
10
Quantity (Pints)
15
20
Chapter 6
Controls on Prices
Controls on Prices
Price Ceiling (e.g. rent control)
– A legal maximum on the price at which a good
can be sold.
– If the price ceiling is set below the equilibrium
price, it leads to a shortage.
Price Floor (e.g. minimum wage)
– A legal minimum on the price at which a good
can be sold.
– If the price ceiling is set above the equilibrium
price, it leads to a surplus.
Price Ceiling: Beer Shortage
…Rent Control Too
Beer
Supply
Equilibrium
price
$3
2
Price
ceiling
Shortage
Demand
0
75
125
Quantity
supplied
Quantity
demanded
Pints
Price Floor: Beer Surplus
Price of
Beer
Supply
Surplus
Equilibrium$4
price
Price
floor
$3
Demand
0
75
125
Quantity
demanded
Quantity
supplied
Quantity of
Beer