Business Economics

Introduction to
Economics
Learning Goals
 Learn that Economics is about the allocation of scare
resources
 Examine some of the trade offs people face
 Learn the meaning of ‘Opportunity Cost’
 See how to use marginal reasoning when making
decisions
 Discuss how incentives affect people’s behaviour
 Consider why trade among people or nations can be
good for everyone
 Discuss why markets are good but not a perfect way to
allocate resources
 Learn what determines some trends in the overall
economy
Why did you choose Surana
PG Centre to pursue your
MBA?

How did you choose Surana

PG Centre to peruse your
MBA?
Choosing between ‘Alternatives’
 Reputation of the School
 Quality of Infrastructure
 Faculty
 Previous Results
 IT infrastructure
 Placement History
 Distance form residence / home town
 Cost of Education
Resources
 I have
I/II grade in Bachelor's degree
High / Average score in the Entrance exam
Limited Time
Limited Money
Distance factor from residence / home town
 Study of Choice-Making Behaviour

As a Social Science, Economics studies

Human Behaviour in relation to
optimizing allocation of available
resources to achieve given objectives.
Economy. . .

. . . The word economy comes from a

Greek word for “one who manages a
household.”
A household has to make many
decisions:

 Who will work?

 With the limited income
What to consume
how much to consume?

Similarly …
An economy has to make many
decisions:
 What goods and how many of them should
be produced?
 What resources should be used in
production?
 Where to set up production plants?
 What market segments to cater?
 At what price should the goods be sold?
Society and Scarce Resources:

The management of society’s

resources is important because
resources are scarce.
Scarcity . . .

. . . means that society has limited

resources and therefore cannot
produce all the goods and services
people wish to have.
 Economics

Economics is the study of

how society manages its scarce
resources.
Economics is a Science of

Scarcity
 Unemployment …
 Inflation…
 Unsold Inventory…
 Under-utilised Production Capacity…
Economists study. . .

How people make decisions.

How people interact with each other.

The forces and trends that affect the

economy as a whole.
Ten Principles of Economics

How People Make Decisions

 People face tradeoffs.
 The cost of something is what you give
up to get it.
 Rational people think at the margin.
 People respond to incentives.
 Ten Principles of Economics

How People Interact

 Trade can make everyone better off.

 Markets are usually a good way to
organize economic activity.
 Governments can sometimes improve
economic outcomes.
 Ten Principles of Economics

How the Economy as a Whole Works

 The standard of living depends on a

country’s production.
 Prices rise when the government prints
too much money.
 Society faces a short-run tradeoff
between inflation and unemployment.
How People Make Decisions?
1. People face tradeoffs.

“There is no such thing

as a free lunch!”
1. People face tradeoffs.
To get one thing, we usually
have to give up another thing.
 Guns v. Grains
 Food v. clothing
 Leisure time v. work
 Efficiency v. equity

Making decisions requires trading

off one goal against another.
1. People face tradeoffs.
Efficiency v. Equity

 Efficiency means society gets the most

that it can from its scarce resources.
 Equity means the benefits of those
resources are distributed fairly among
the members of society.
Describe some of the ‘Trade-Offs’
faced by the following

 A family deciding whether to buy a new

car.

 MP’s in the Parliament deciding how

much to spend on National Parks.

 A company president deciding whether to

open a new factory.
 2. The cost of something is
what you give up to get it.

Decisions require comparing costs and

benefits of alternatives.
 Whether to go to college or to work?
 Whether to study or go out on a date?
 Whether to go to class or sleep in?
2. The cost of something is
what you give up to get it.

The opportunity cost of an

item is what you give up to
obtain that item.
What is the Cost of…

 Pursuing MBA?

 Building a residential complex in a

commercial area?
 3. Rational people think at the
margin.

Marginal changes are small, incremental

adjustments to an existing plan of action.

People make decisions by comparing

costs and benefits at the margin.
 It takes One Lakh Rupees to produce
Ten Lakhs ‘Paracetemol’ Tablets
 i.e. cost of production on each tablet is 10 Ps

 Company sells 10 lakh tablets to Rs. 10

lakh
i.e. Company gains 90 Ps on each tablet
 How much it takes to produce 11 lakh
tablets?
i.e. 11 lakh tablets X 10 Ps = Rs. 1,10,000=00
Cost of producing additional one lakh tablets
is only Rs. 10,000=00

 How much Company makes by selling

extra one lakh tablets?
1,00,000 tablets X 90 Ps = Rs. 90,000
 Hence,
The Marginal Cost of producing One Lakh
extra tablets in only Rs. 10,000
Whereas the Marginal Benefit the company
is making is Rs. 90,000

Marginal Cost is “Cost of Producing

One extra piece of a product”
4. People respond to incentives.

 Marginal changes in costs or benefits

motivate people to respond.
 The decision to choose one alternative
over another occurs when that
alternative’s marginal benefits exceed its
marginal costs!
4. People respond to incentives.
Basketball star Kobe Bryant
chose to skip college and go
straight to the NBA from high
school when offered a $10
million contract.

Sachin Tendulkar decided to

pursue Cricket and decided
to skip the college, when he
was selected to National
Team
4. People respond to incentives.

 When price of petrol goes up, people to use

mass transportation system.

 Sale of Khadi fabrics is very high, when

government announces 20 – 40 % discount in
the month of October.

 Increase in the tax on cigarettes decreases the

demand for cigarettes.
How People Interact?
 5. Trade can make everyone
better off.
People gain from their ability to
trade with one another.
Competition results in gains from
trading.
Trade allows people to specialize in
what they do best.
 India has an edge in producing milk
 Sri Lanka has an edge in producing coconuts
 Let us trade milk for coconuts!

 China is better placed in producing computer

hardware
 India is better placed in producing computer
software
 So, why not buy hardware from China and load our
software and sell it in the world market?
6. Markets are usually a good
way to organize economic
activity.

In a market economy, households

decide what to buy and who to work
for.
Firms decide who to hire and what
to produce.
6. Markets are usually a good
way to organize economic
activity.

Adam Smith made the

observation that households
and firms interacting in
markets act as if guided by an
“invisible hand.”
The circular flow of goods and incomes
Goods and services
The circular flow of goods and incomes
Goods and services

Rs.
Consumer
expenditure
The circular flow of goods and incomes
Goods and services

Rs.
Consumer
expenditure

Services of factors of production (labour, etc)

The circular flow of goods and incomes
Goods and services

Rs.
Consumer
expenditure

Wages, rent
dividends, etc.
Rs.

Services of factors of production (labour, etc)

 6. Markets are usually a good
way to organize economic
activity.
 Because households and firms look at prices
when deciding what to buy and sell, they
unknowingly take into account the social
costs of their actions.
 As a result, prices guide decision makers to
reach outcomes that tend to maximize the
welfare of society as a whole.
 7. Governments can
sometimes improve market
outcomes.
When the market fails (breaks
down) government can intervene to
promote efficiency and equity.
 When Stock Market tumbled because of
Harshad Mehta’s operations,
Government intervened in the market to
make corrective actions.

 When Global Trust Bank, was in trouble

with liquid cash, Government intervened
and merged GTB with another bank to
protect the interest of the customers
 7. Governments can
sometimes improve market
outcomes.

Market failure occurs when

the market fails to allocate
resources efficiently.
 Most of Indian PSU’s failed to allocate its
resources efficiently.

 Hence Govt took corrective actions, in

terms of disinvestment, winding up, sell
off,…
 7. Governments can
sometimes improve market
outcomes.

Market failure may be caused by an

externality, which is the impact of
one person or firm’s actions on the
well-being of a bystander.
 A Chemical factory emitting harmful
gases to environment…
 Who will bear the cost of environment
pollution?
 In such case, Govt have to intervene and
impose heavy taxes apart from making it
mandatory to all Chemical industries to
adopt measures to check emission of
harmful gases to environment
 7. Governments can
sometimes improve market
outcomes.

Market failure may also be caused by

market power, which is the ability of
a single person or firm to unduly
influence market prices.
 Crude Oil Market is in the hands of few
countries (OPEC) and because of their
‘Market Power’ they can unduly
influence the market prices and bring
economies of many developing countries
to their knees.
How The Economy As A
Whole Works?
 8. The standard of living
depends on a country’s
production.

Standard of living may be measured in

different ways:
 By comparing personal incomes.
 By comparing the total market value of a
nation’s production.
In the year 1997,
 An American earned $ 29,000 per annum
 A Mexican earned $ 8,000 per annum
 An Indian earned $ 700 per annum
 A Pakistaani earned $ 250 per annum

Now compare the ‘Standard of Living’ of

people of each country, by yourself.
8. The standard of living
depends on a country’s
production.

Almost all variations in living

standards are explained by
differences in countries’
productivities.
 8. The standard of living
depends on a country’s
production.

Productivity is the amount of goods

and services produced from each
hour of a worker’s time.

Higher productivity  Higher standard of living

 A factory in China can produce 5000
motor cycles, whereas similar factory in
India can produce 7000 motor cycles.

 A weaver in India can produce one silk

saree per day, where as weaver in China
can produce three similar sarees per day.
 In what ways is your standard of living
different from that of your parents or
grand parents when they were of your
age? Why have these changes occurred?
 9. Prices rise when the
government prints too much
money.
Inflation is an increase in the overall
level of prices in the economy.
 One cause of inflation is the growth in the
quantity of money.
 When the government creates large quantities
of money, the value of the money falls.
 In Germany in Jan 1921, a daily news
paper cost 0.30 marks. In Nov 1922 Price
of same daily newspaper rose to
70,000,000 marks !

Inflation – Too much of Money chasing too

less goods.
 Suppose that when everyone wakes up
tomorrow, they discover that the Government
has given them an additional amount of money
equal to the amount they already had. Explain
what effects this doubling of the money supply
will likely have on the following?

Total amount spent on necessary goods and

luxury goods
Quantity of goods purchased if prices are
unchanged
 10. Society faces a short-run
tradeoff between inflation and
unemployment.

The Phillips Curve illustrates the tradeoff

between inflation and unemployment:

Inflation  Unemployment
It’s a short-run tradeoff!
 Summary

Economics is a Science of Scarcity

When individuals make decisions,
they face tradeoffs.
Rational people make decisions by
comparing marginal costs and
marginal benefits.
 Summary

People can benefit by trading with

each other.
Markets are usually a good way of
coordinating trades.
Government can potentially improve
market outcomes.
 Summary

A country’s productivity determines

its living standards.
Society faces a short-run tradeoff
between inflation and
unemployment.