lecture 1 introduction & basics of economics given to the emba 8400 class classroom south #600...

Lecture 1 Introduction & Basics of Economics

Given to theGiven to theEMBA 8400 ClassEMBA 8400 Class

Classroom South #600Classroom South #600January 5, 2007January 5, 2007

Dr. Rajeev DhawanDr. Rajeev DhawanDirectorDirector

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 First 2 Weeks - Basic Micro Economic

Concepts Weeks 3&4 - Macro Basics and Basic

Workings of an Economy with the Help of a “Basic” Macromodel (weeks 5-7) that can Perform Real-Life Fiscal And Monetary Experiments

Mandatory Field Trip to the Economic Forecasting Conference on Feb. 22nd

Wrap up with Model Training, Special Topics and Project Presentations

Background Articles

My Economics Why Journalists Can't Add Where Presidents Have No Power Their Money Our Strength How to Stop Relatives from Bragging About

their Big Profits in Real Estate

Grading Policy

60% 3 Quizzes in Class20% Group Presentations on a

Selected Industry20% Take Home Final Exam

–Macroeconomic Model Exercise

–Based on Field Trip

Group PresentationsThe objectives of this group project are :

1. To help you bridge the gap between the economic theory and

models discussed in class and the “real world”

2. To confront the problems of trying to find data which are

appropriate for the questions under consideration and to deal

with the problems of incomplete information

3. To showcase your oral and written communication skills

4. To identify how the problems faced and the decisions made by

other firms are similar to your own.

Suggested Industries1. Wireless Communication

2. Networking & Security Systems

3. Oil Industry

4. Healthcare Industry

5. Hospitality Industry

6. Paper & Pulp Industry

7. Utility & Power Industry

8. Consumer Products

9. Insurance

10. REIT (Real Estate Investment Trust)

Macro Framework

Households: Consume & WorkFirms: Production & InvestmentGovernment: Money Supply,

Taxes, ExpendituresForeign Sector: Exports,

Imports & Exchange Rate

Macroeconomic Model For Teaching

Section 1: A Model Simulation Approach to Macroeconomics Section 2: Classification of Equations Section 3: Glossary of Variables Section 4: Listing of Equations in the Integrated Macro Model Section 5: Flow Diagram of Integrated Macro Model Section 6: Policy Experiments with Integrated Macro Model Section 7: Guidelines to Use the Model

Variable Meaning Units

C Consumption Billions of $

EX Exports Billions of $

EXCH Exchange Rate Index

G Government Purchases Billions of $

GDP Gross Domestic Product Billions of $

GDP@FULL

GDP @ Full Employment Billions of $

GDP@ROW

GDP in Rest of the World Billions of $

I Investment Billions of $

IM Imports Billions of $

M Money supply Billions of $

NETEX Net Exports Billions of $

P Price Level Index

P% Inflation Percent

P@ROW Price Level, Rest of the World Index

R Real Interest Rate Percent

R@ROW Real Interest Rate, Rest of the World Percent

T Tax Revenues Billions of $

TAX% Tax Rate Fraction

YDP Disposable Income Billions of $

GLOSSARY OF VARIABLES

world interest

rateworld GDP

IMPORTS

price level lag 1

worldprice

money

government

tax rate

capital stock lag 1

EXCHANGE RATE

INTEREST RATE

INVESTMENT

TAX REVENUES

investmentlag 1

EXPORTS

NETEXPORTS

REAL GDP

CONSUMPTION

DISPOSABLE INCOME

CAPITAL STOCK

inflationlag 1

PRICE LEVEL

INFLATION

EXPECTED INFLATION

UNEMPLOYMENT

POTENTIAL GDP

labor force

~~Typical Macro-ModelTypical Macro-Model~~

world interest

rateworld GDP

IMPORTS

price level lag 1

worldprice

government

tax rate

capital stock lag 1

EXCHANGE RATE

INTEREST RATE

INVESTMENT

TAX REVENUES

investmentlag 1

EXPORTS

NETEXPORTS

REAL GDP

CONSUMPTION

DISPOSABLE INCOME

CAPITAL STOCK

inflationlag 1

PRICE LEVEL

INFLATION

EXPECTED INFLATION

UNEMPLOYMENT

POTENTIAL GDP

labor force

~~Typical Macro-ModelTypical Macro-Model~~

money

world interest

rateworld GDP

IMPORTS

price level lag 1

worldprice

government

tax rate

capital stock lag 1

EXCHANGE RATE

INTEREST RATE

INVESTMENT

TAX REVENUES

investmentlag 1

EXPORTS

NETEXPORTS

REAL GDP

CONSUMPTION

DISPOSABLE INCOME

CAPITAL STOCK

inflationlag 1

PRICE LEVEL

INFLATION

EXPECTED INFLATION

UNEMPLOYMENT

POTENTIAL GDP

labor force

~~Typical Macro-ModelTypical Macro-Model~~

money

world interest

rateworld GDP

IMPORTS

price level lag 1

worldprice

government

tax rate

capital stock lag 1

EXCHANGE RATE

INTEREST RATE

INVESTMENT

TAX REVENUES

investmentlag 1

EXPORTS

NETEXPORTS

REAL GDP

CONSUMPTION

DISPOSABLE INCOME

CAPITAL STOCK

inflationlag 1

PRICE LEVEL

INFLATION

EXPECTED INFLATION

UNEMPLOYMENT

POTENTIAL GDP

labor force

~~Typical Macro-ModelTypical Macro-Model~~

money

world interest

rateworld GDP

IMPORTS

price level lag 1

worldprice

government

tax rate

capital stock lag 1

EXCHANGE RATE

INTEREST RATE

INVESTMENT

TAX REVENUES

investmentlag 1

EXPORTS

NETEXPORTS

REAL GDP

CONSUMPTION

DISPOSABLE INCOME

CAPITAL STOCK

inflationlag 1

PRICE LEVEL

INFLATION

EXPECTED INFLATION

UNEMPLOYMENT

POTENTIAL GDP

labor force

~~”New Economy” Macro-Model”New Economy” Macro-Model~~

money

Tech/ProfitOpportunities

STOCK MARKET

CONSUMPTION

world interest

rateworld GDP

IMPORTS

price level lag 1

worldprice

government

tax rate

capital stock lag 1

EXCHANGE RATE

INTEREST RATE

INVESTMENT

TAX REVENUES

investmentlag 1

EXPORTS

NETEXPORTS

REAL GDP

CONSUMPTION

DISPOSABLE INCOME

CAPITAL STOCK

inflationlag 1

PRICE LEVEL

INFLATION

EXPECTED INFLATION

UNEMPLOYMENT

POTENTIAL GDP

labor force

~~”New Economy” Macro-Model”New Economy” Macro-Model~~

money

Tech/ProfitOpportunities

EUPHORIA

STOCK MARKET

world interest

rateworld GDP

IMPORTS

price level lag 1

worldprice

government

tax rate

capital stock lag 1

EXCHANGE RATE

INTEREST RATE

INVESTMENT

TAX REVENUES

investmentlag 1

EXPORTS

NETEXPORTS

REAL GDP

CONSUMPTION

DISPOSABLE INCOME

CAPITAL STOCK

inflationlag 1

PRICE LEVEL

INFLATION

EXPECTED INFLATION

UNEMPLOYMENT

POTENTIAL GDP

labor force

~~”New Economy” Macro-Model”New Economy” Macro-Model~~

money

Tech/ProfitOpportunities

EUPHORIA

STOCK MARKET

EUPHORIA

world interest

rateworld GDP

IMPORTS

price level lag 1

worldprice

government

tax rate

capital stock lag 1

EXCHANGE RATE

INTEREST RATE

INVESTMENT

TAX REVENUES

investmentlag 1

EXPORTS

NETEXPORTS

REAL GDP

CONSUMPTION

DISPOSABLE INCOME

CAPITAL STOCK

inflationlag 1

PRICE LEVEL

INFLATION

EXPECTED INFLATION

UNEMPLOYMENT

POTENTIAL GDP

labor force

~~””New Economy” Macro-ModelNew Economy” Macro-Model~~

money

Tech/ProfitOpportunities

STOCK MARKET

EUPHORIA

Field Trip to the Forecasting

Center’s Quarterly Forecast Conference on Feb. 21nd!

The Economic Forecasting Center at Georgia State University collects and analyzes macroeconomic data and develops procedures to forecast the national, regional and local economies.

What Products Do We Offer?The Center offers:

–Forecast ReportsGeorgia and Atlanta (Quarterly)Nation (Quarterly)Southeast Indicators (Bi-Annual)

–Quarterly Conferences– Sponsorships– Custom Consulting Services

Quarterly Conferences

Consortium of GSU Experts and the Business Executives

My Forecast! 4 Industry Speakers Forecast Reports Networking Breakfast, at

Break and at Lunch

How to Attend Our Conferences?How to Attend Our Conferences?

It Costs Money! $150 per Person Institutional Discounts Available.

BUT MY STUDENTS ARE IN FOR FREE!Check Our Website for Latest Program:

www.robinson.gsu.edu/efc

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 examsEx: Party on Friday night vs. study for exams

– Cost of Time Ex: 1 hour wait time at the dentistEx: 1 hour wait time at the dentist

Basic Concepts Marginal Concept: At the Margin

Shot SatisfactionMarginal

Satisfaction1 50

202 70

103 80

54 85

15 86

06 86

Shots of Wild Turkey

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?

10 Principles of Economics1. 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 item3. People make decisions at the margins –

increments matter4. People respond to incentives – e.g. cigarette

laws, communism5. Free Trade is good (for everybody)

10 Principles of Economics6. 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 WSJ; by Andy Kessler

First Mover, FCC regulated + fixed costsRegulated utilityPrice protection

You can’t lose Traffic / use was of low economic value or

cashlessGlobal 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…….

Who REALLY Owns that WineryTIME Magazine; by Terry McCarthy

Consolidation is the Norm 60% of U.S. wine is produced by the top five

companies– Consolidation among distributors is squeezing out the

medium-sized producers, who make from 100,000 to 1 million cases a year

Market is not growing– Only 10% of adults drink 86% of the wine

Fixed Costs– Some wineries do not have enough volume to get a

priority from distributors

Reshuffling to scarce resources– He can make lots of money just by shifting more of his

production - and more of his customers – from 1.5L jugs of generic red that sell for less than $5 retail to smaller bottles of $7 Merlot

The Future– The higher end is where the profits and the growth are to

be found– The Italians have figured it out – how to create tastes

that suit the American palate

Who REALLY Owns that Winery TIME Magazine; by Terry McCarthy

Chapter 3

Comparative Advantage & Trade

Positive vs. Normative Economics

Positive :– Descriptive statement ( is, was)– Refer to data– Examples of positive statements:

GDP in the U.S. economy was about $7 trillion last year The New York City rent control laws have created a shortage

of housing in the city Normative:

– Value judgment (ought to be, shall, will)– Examples of normative statements:

Higher interest rates would be good for the U.S. economy in the next six months

The U.S. government should be required to balance its budget every year

The classic tale of the farmer and the rancher…or a better example if you have one.

What should each produce? Why should they trade?

Production Possibilities Frontier

Potatoes (ounces)

4

16

8

32

A

0

Meat (ounces)

(a) The Farmer’s Production Possibilities Frontier

If there is no trade, the farmer chooses this production and consumption.

Production Possibilities Frontier

FARMER:32 oz. of Potatoes in 8 hours8 oz. of Meat in 8 hours

Potatoes (ounces)

12

24

B

0

Meat (ounces)

(b) The Rancher’s Production Possibilities Frontier

48

24 If there is no trade, the rancher chooses this production and consumption.

Production Possibilities Frontier

RANCHER:48 oz. of Potatoes in 8 hours24 oz. of Meat in 8 hour

Trade Example

Without trade:

““Farmer, my friend, have I got a deal for you! I know Farmer, my friend, have I got a deal for you! I know how to improve life for both of us. I think you should how to improve life for both of us. I think you should stop producing meat altogether and devote all your stop producing meat altogether and devote all your

time to growing potatoes. According to my time to growing potatoes. According to my calculations, if you work 8 hours a day growing calculations, if you work 8 hours a day growing potatoes, you’ll produce 32 ounces of potatoes. potatoes, you’ll produce 32 ounces of potatoes.

Specialization & Trade

If you give me 15 of those 32 ounces, I’ll give you 5 If you give me 15 of those 32 ounces, I’ll give you 5 ounces of meat in return. In the end, you’ll get to eat ounces of meat in return. In the end, you’ll get to eat 17 ounces of potatoes and 5 ounces of meat every 17 ounces of potatoes and 5 ounces of meat every week, instead of the 16 ounces of potatoes and 4 week, instead of the 16 ounces of potatoes and 4

ounces of meat you now get. If you go along with my ounces of meat you now get. If you go along with my plan, you’ll have more of both foods.”plan, you’ll have more of both foods.”

How Trade Increases Consumption

Potatoes (ounces)

4

16

5

17

8

32

A

A*

0

Meat (ounces)

(a) The Farmer ’s Production and Consumption

Farmer's production & consumption without trade

Farmer's consumption with trade

Farmer's production with trade

How Trade Increases Consumption

Potatoes (ounces)

12

24

13

27

B

0

Meat (ounces)

(b) The Rancher ’s Production and Consumption

48

24

12

18

B*

Rancher's consumption with trade

Rancher's production with trade

Rancher's production and consumption without trade

Example Continued..

With trade:

Trade According to Comparative Advantage (CA) or Opportunity Cost (OC)

CA is OC of two products – whatever must be given up to obtain a product

The producer who has the smaller OC of producing a good has a CA in producing that good

– Rancher has CA in producing meat

– Farmer has CA in producing potatoes

Absolute Advantage: Rancher beats the farmer in producing both meat and potatoes

Let’s Calculate OC(Meat in terms of Potatoes)

Benefits of Trade

Whenever potential trading parties have differences in opportunity costs, they can each benefit from trade.

Trade can benefit everyone in a society because it allows people to specialize in activities in which they have a comparative advantage.

Better Answer to Tough Questions WSJ; by David Wessel

“What do you say to someone…who has lost his job to someone overseas who’s being paid a fraction of what that job paid here?”

Those of us who benefit from low-cost imports – or who have well-paid export jobs that wouldn’t exist if we don’t allow imports and outsourcing – must not ask those who lose jobs to go it alone.

If trade and technology make us richer, then we can afford to help pay for health insurance and protect pensions forced to bear the cost.

Better Answer to Tough Questions WSJ; by David Wessel

That means pushing China and others to stop bending trade rules or manipulating currencies and pressing Europe and Japan to get their people spending so the U.S. Isn’t always the consumer of last resort. It means setting U.S. taxes so they cover government spending at least in good times, rewriting perverse tax laws that encourage companies to invest elsewhere and managing the unquenchable American thirst for health care without giving employers new excuses.

Discuss: wage insurance and role of education

Economic Focus – Trade Disputes (p.7)

Suppose the poor country, spurred by technical progress, improves productivity in the rich country’s export goods: think of China’s advances in semiconductors or India’s in financial services/ Then, says the theory, trade can turn entirely to the poor country's advantage. The improvement in productivity in the poor country can reduce the price of the rich country’s exports by enough to make it worse off, despite the increased availability or cheaper goods.

Europeans worried about American growth in the 1950’s for this reason, and Americans later worried about Japan.

Move of textile manufacturing to the American South may have caused net losses in the North. OR that Malaysia’s leap in rubber production may have had the same effect on Brazil . Might the new wave of outsourcing to poor countries be different, and make rich countries poorer?

Forrester Research claims that 3.4 million jobs will be outsourced by 2015, but considering that the American economy destroys 30 million jobs EACH YEAR and then creates slightly more, this dwarfs the effect of outsourcing.

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…)

DemandQuantity demanded (Q): the amount of a good that buyers are willing and able to purchase at a given price (P).

Pints of BeerPints of Beer

P QD

$10.00 07.00 15.00 34.00 62.00 110.00 19

Demand for Beer

$0.00

$2.00

$4.00

$6.00

$8.00

$10.00

0 5 10 15 20Quantity (Pints)

Pri

ce

Market Demand versus Individual Demand

Market demand refers to the sum of all individual demands for a particular good or service.

Graphically, individual demand curves are summed horizontally to obtain the market demand curve.

The Market Demand Curve

Price of Beers

Price of Beers

Price of Beers

5.00 5.00 5.00

3 4 7

4.00 4.004.00

6 7 13

Quantity of Beers Quantity of Beers Quantity of Beers

Catherine’s Demand Nicholas’s Demand Market Demand+ =

When the price is $5.00, Catherine will demand 3 beers.

When the price is $5.00, Nicholas will demand 4 beers.

The market demand at $5.00 will be 7 beers.

When the price is $4.00, Catherine will demand 6 beers.

When the price is $4.00, Nicholas will demand 7 beers.

The market demand at $4.00, will be 13 beers.

The market demand curve is the horizontal sum of the individual demand curves!

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 CurvePrice of

Beer

Quantity ofBeer

Increasein demand

Decreasein demand

Demand curve, D3

Demandcurve, D1

Demandcurve, D2

0

SupplyQuantity supplied (Q): the amount of a good that sellers are willing and able to sell at a given price (P).

Pints of BeerPints of Beer

P QS

$10.00 127.00 75.00 44.00 32.00 10.00 0

Supply of Beer - Neighbors

$0.00

$2.00

$4.00

$6.00

$8.00

$10.00

0 2 4 6 8 10 12Quantity (Pints)

Pri

ce

Supply

Supply graph for another bar

Supply of Beer - Hand in Hand

$0.00$1.00$2.00$3.00$4.00$5.00$6.00$7.00$8.00$9.00

$10.00

0 2 4 6 8 10 12Quantity (Pints)

Pri

ce Pints of BeerPints of Beer

P QS

$10.00 87.00 55.00 44.00 32.00 10.00 0

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 CurvePrice of

Beer

Quantity ofBeer0

Increasein supply

Decreasein supply

Supply curve, S3

curve, Supply

S1Supply

curve, S2

Equilibrium

Equilibrium: the price where quantity supplied is equal to quantity demanded

Market for Beer

$0.00

$2.00

$4.00

$6.00

$8.00

$10.00

0 5 10 15 20Quantity (Pints)

Pri

ce

Equilibrium

6

Markets Not In Equilibrium

Price ofBeer

0

Supply

Demand

Excess Supply

Quantitydemanded

Quantitysupplied

Surplus

Quantity ofBeer

2

$6.50

10

4.00

6

Markets Not In EquilibriumPrice of

0

Supply

Demand

Excess Demand

Quantity ofBeer

Beer

0Quantitysupplied

Quantitydemanded

2.50

10

$4.00

62

Shortage

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

Price ofBeer

0 Pints of Beer

Supply

Initialequilibrium

An increase in wealth

increases demand for beer

0

Demand

Newequilibrium

Initial equilibrium

S1

S2

An increase in the

price of hops reduces

the supply of beer

4.00

6

$6.50

2

D1

Price ofBeer

D2

Pints of Beer

4.00

6

New equilibrium

$6.50

10

Market for Beer

$0.00

$2.00

$4.00

$6.00

$8.00

$10.00

0 5 10 15 20Quantity (Pints)

Pri

ce

S2

S1

One bar closes…New

Equilibrium

4

$5.00

Market and Federal Govt. have given energy customers enough incentives to use natural gas. But, Oil and Gas Industry has got little encouragement to produce more.

Fed’s efforts to promote clean air and US energy independence meant surge in demand of Natural Gas.

Increase in oil prices has curtailed oil and gas exploration. Thus, there has been an increase in imports of natural gas, mainly from Canada. Net result is prices go from $2.17 to $8 per million BTUs

– Nation’s record long economic expansion – accompanying surge in energy consumption

– Cold winter weather over much of US (2001)

Article: Federal Policies, Industry Shifts Produced Natural-Gas Crunch WSJ; by: Barrionuevo, Fialka, Smith

Federal govt. ordered the pipeline companies to become “open access” carriers. The move lowered the prices, which was a boon to the customers but a nightmare for the producers

Marketers emerged as a new breed of middlemen that took more profits without boosting gas production. As a result of narrow margins, some producers were forced to close and others to consolidate.

– Seasonal Relief– Crackdown on Coal– Bankers Balk

  Drilling for natural gas exploration, prohibited by federal agencies.

Alaskan producers pushing for a pipeline to continental US, but it will take another decade for that to materialize.

Article: Federal Policies, Industry Shifts Produced Natural-Gas Crunch WSJ; by: Alexi Barrionuevo, Fialka, Smith