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Economic Analysis of Business TBS 905

Session 1, Autumn 2012

Welcome to Economic Analysis for Business. This Autumn the course will be delivered over 13 weeks as per your schedule. There will be a Mid-semester test on: Saturday November 17th Any make-up classes due to public holiday clashes will be delivered as advised. The required text for this course is: Stonecash, R., Gans, J., King, S., and Mankiw N. G. (2009) Principles of Macroeconomics, 4th Edition. Cengage Learning, Australia.

The objective of todays session is to provide an overview of the course, outline assessment tasks and discuss the use of library resources and turn-it-in. The overview will centre on the course learning objectives before turning our focus on the economic approach the material covered in the first 2 chapters of your text (& chapter 4 time permitting) . For future classes try to read the relevant chapters before class, this will enable you to get the maximum value out of each session and help facilitate an interactive learning environment. The text has an online companion site which has various other resources to help you with the material covered in this course (see your texts Resources Guide)

The slides that follow are primarily linked to the text but we will supplement these from time to time with other slides and resources depending on the topic. The broad objective of the course is to introduce to students, and develop their understanding of, core economic concepts relevant to business and managerial decision-making, in order that they may identify and interpret those economic events and circumstances which influence the operations of business. See your subject outline for a more detailed break-down of the learning objectives. We hope you find this course enjoyable, rewarding, stimulating and challenging!

Introduction: 10 lessons from Economics

Chapter 1

The word economy is defined in the Concise Oxford Dictionary as: economy management (of a house) L. conomia Gr. oikonom , f. oikonmos manager of a household, steward. Economics is essentially the study of how society manages its scarce resources. It is a complex and many faceted subject however Gregory N. Mankiw, the primary author of your text, has helpfully listed 10 central ideas that unify the economic approach which differentiate the economic way of thinking.

Economic behaviour
These ideas are based on observation of human behaviour and interaction key observations are as follows: A household and an economy face many decisions: Who will work? What goods and how many of them should be produced? What resources should be used in production? At what price should the goods be sold?

Society and scarce resources: The management of societys resources is important because resources are scarce. Individuals tend to have unlimited wants. Scarcity means that society has limited resources and therefore cannot produce all the goods and services people want. This leads us to the definition that Economics is the study of how society manages its scarce resources.

Ten lessons from economics

How people make decisions. 1. People face trade-offs. 2. The cost of something is what you give up to get it. 3. Rational people think at the margin. 4. People respond to incentives.

Ten lessons from economics

How people interact with each other. 5. Trade can make everyone better off. 6. Markets are usually a good way to organise economic activity. 7. Governments can sometimes improve market outcomes.

Ten lessons from economics

How the economy as a whole works. 8. A countrys standard of living depends on its ability to produce goods and services. 9. Prices rise when the government prints too much money. 10. Society faces a short-term trade-off between inflation and unemployment.

Why should managers and business students study economics?

To develop the economic insight necessary to identify your business competitive advantage. To identify how the ups and downs in economy-wide economic activity will impact your business. To improve your business profitability. In essence, our aim must be to understand the impacts and effects of the external economic environment on the operation of business.

The economic environment


Source: Nellis and Parker (2005)

Structure: Roadmap
Concepts Tools &

The Economy Overall

The Open Economy

The Short Run Economy

Trade-offs Costs Models

Markets D&S Efficiency

Growth Savings Government actions

Exchange rates Foreign investment

Aggregate D&S Monetary & Fiscal policy

How to Measure GDP CPI other key variables

Money Types Role

Structure: Assessment
Assessment is detailed in the subject outline: You have a major written assignment (30%) which involves the analysis of two economies (the UAE and Australia) we will discuss this in class at regular intervals. There is a class test (20%) on Saturday the 17th November And a final exam worth 50%


Thinking like an Economist


Chapter 2

Thinking like an economist

Every field of study has its own jargon: Mathematics integrals, axioms, vector spaces Psychology ego, id, cognitive dissonance Law promissory estoppel, torts, venues Economics supply, demand, opportunity cost, elasticity, consumer surplus, comparative advantage, deadweight loss

Thinking like an economist

Economics trains you to Think in terms of alternatives. Evaluate the cost of individual and social choices. Examine and understand how certain events and issues are related.

The economist as a scientist

The economic way of thinking involves thinking analytically and objectively makes use of the scientific method

The scientific method

Uses abstract models to help explain how a complex, real world operates. Develops theories, collects and analyses data to evaluate the theories.

The role of assumptions

Economists make assumptions in order to make the world easier to understand. The art in scientific thinking is deciding which assumptions to make. Economists use different assumptions to answer different questions.

Economic models
Economists use models to simplify reality in order to improve our understanding of the world. Two of the most basic economic models include: The circular-flow diagram The production possibilities frontier

Our first model: The circular-flow diagram

The circular-flow diagram is a visual model of the economy that shows how dollars flow through markets among households and firms. Popular model for many years, even physical apparatus built it emphasises the bilateral nature of all transactions


The circular-flow diagram

MARKETS FOR GOODS AND SERVICES Firms sell Goods Households buy and services sold Revenue Spending Goods and services bought

FIRMS Produce and sell goods and services Hire and use factors of production

HOUSEHOLDS Buy and consume goods and services Own and sell factors of production

Factors of production Wages, rent, and profit


Labour, land, and capital Income = Flow of inputs and outputs = Flow of dollars

Copyright 2004 South-Western

The circular-flow diagram: key elements

Firms Produce and sell goods and services. Hire and use factors of production. Households Buy and consume goods and services. Own and sell factors of production.

The circular-flow diagram: key elements

Markets for goods and services Firms sell Households buy Markets for factors of production Households sell Firms buy Factors of production Inputs used to produce goods and services. Land, labour and capital.

Our first model: The circular-flow diagram

In this session we have illustrated a simple two-sector circular flow model in later sessions we will expand it to include other sectors such as the government and financial sectors.

Our second model: The PPF

The Production Possibilities Frontier (PPF) is a graph that shows the various combinations of output that the economy can possibly produce given the available factors of production and the available production technology.

Quantity of computers produced

The production possibilities frontier

3,000 C

2,200 2,000

A Production possibilities frontier



600 700


Quantity of cars produced Copyright2003 Southwestern/Thomson Learning

Our second model: key elements

Concepts illustrated by the production possibilities frontier:
efficiency trade-offs opportunity cost economic growth

Bare in mind this is a generalised model it does not cope well with elements such as:
economies of scale specialisation etc.

Quantity of computers produced 4,000

A shift in the PPF


2,100 2,000


700 750


Quantity of cars produced

Copyright 2004 South-Western

Other models
Models proliferate the economics literature, perhaps the most common is demand and supply a simple illustration of market interaction. Others models may focus on more conceptual elements such as utility (indifference curves) or distribution (Lorenz curves). We will focus more on markets in the next session but the next slide presents a simple illustration of the demand and supply framework:

Economics typically represents the interaction of buyers and sellers in a market using demand (D) and supply (S) curves

Source: St John and Fargher (2004)


Microeconomics and macroeconomics

Economics is divided into two key strands or sub-fields: Microeconomics focuses on the individual parts of the economy. How households and firms make decisions and how they interact in specific markets. Macroeconomics looks at the economy as a whole. Economy-wide phenomena, including inflation, unemployment and economic growth.

Markets and the macroeconomy

The macroeconomy can be viewed as the interaction of a raft of markets

Source: St John and Fargher (2004)






Individual economic entities



National Economies Interaction between Economies

Economic aggregates

Strands of Economics

The economist as policy adviser

When economists are trying to explain the world, they are scientists. When economists are trying to improve the world, they are policy advisers.

Positive versus normative analysis

Positive statements are claims that attempt to describe the world as it is. Called descriptive analysis. Normative statements are claims that attempt to describe how the world should be. Called prescriptive analysis.

Positive versus normative analysis

Positive or normative statements? An increase in the minimum wage will cause a decrease in employment among the least skilled. POSITIVE Higher federal budget deficits will cause interest rates to increase. POSITIVE

Positive versus normative analysis

Positive or normative statements? The income gains from a higher minimum wage are worth more than any slight reductions in employment. NORMATIVE State governments should be allowed to collect from tobacco companies the costs of treating smokingrelated illnesses among the poor. NORMATIVE

Economists in government
serve as advisers in the policy-making process of federal, state and local government and in independent government agencies. Examples include UAE:
Central bank of the United Arab Emirates Ministry of Economy Ministry of labour

Treasury Productivity Commission Reserve Bank of Australia

Why economists disagree

They may disagree about the validity of alternative positive theories about how the world works. They may have different values and, therefore, different normative views about what policies should try to accomplish.

Ten propositions with which most economists agree

Copyright 2004 South-Western

Economists try to address their subjects with a scientists objectivity:
They make appropriate assumptions and build simplified models in order to understand the world around them. Two simple economic models are the circular-flow diagram and the production possibilities frontier.

Economics is divided into two subfields:

Microeconomists study decision making by households and firms in the marketplace. Macroeconomists study the forces and trends that affect the economy as a whole.

The economist variously tries to explain the environment we operate in and suggest improvements:
A positive statement is an assertion about how the world is. A normative statement is an assertion about how the world ought to be. When economists make normative statements, they are acting more as policymakers than scientists.

Economists who advise policymakers offer conflicting advice either because of differences in scientific judgments or because of differences in values. At other times, economists are united in the advice they offer, but policymakers may choose to ignore it.

In this session we have provided a general overview of the subject and an introduction to the economic way of thinking. Over the remaining sessions we will develop these themes further in the next session we will focus on demand and supply and market structure. We will also introduce the concept of elasticity and look at the role of government in the economy. In preparation please read chapters 4 & 5 in the text. Also start planning for your assignment by coming up with a list of web-sites that will help you access relevant data