POST GRADUATE DIPLOMA IN BUSINESS

MANAGEMENTNovember 2013

Lesson 1

WHAT IS ECONOMICS? Economics is the study of how society managed its scare resources.

Decisions – A household and an economy face many decisionsWho 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 at?

Scarcity 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 want.

1: PEOPLE FACE TRADE-OFFS

To get one thing, we usually have to give up another thing.guns or butterleisure or workefficiency or equityProductivity or a clean environment

‘There is no such thing as a free lunch!’

THE DILEMMA

Efficiency or 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.

2: THE COST OF SOMETHING IS WHAT YOU GIVE UP TO GET IT

Decisions require comparing costs and benefits of alternatives.Whether to come to class or go home?Whether to watch the cricket match or take your family for dinner?

The opportunity cost of an item is what you give up to obtain that item.

3: RATIONAL PEOPLE THINK AT THE MARGIN

Marginal changes are small incremental adjustments to an existing plan of action.

What is a rational person?

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.

MB > MC – an action is performed

What are incentives?

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.The oranges and apples example!

6: MARKETS ARE USUALLY A GOOD WAY TO ORGANISE ECONOMIC ACTIVITY

A market economy is an economy that allocates resources through the decentralised decisions of many firms and households as they interact in markets for goods and services.

Firms decide who to hire and what to produce.

Households decide what to buy and who to work for.

A command economy is when a centralized body decides the above.

Adam Smith's invisible hand!

7:GOVERNMENTS CAN SOMETIMES IMPROVE MARKET OUTCOMES

Market failure occurs when the market fails to allocate resources efficiently.

When the market fails (breaks down) government can intervene to promote efficiency and equity.

Externalities – Positive vs Negative

Market Power – Monopolies

8: THE STANDARD OF LIVING DEPENDS ON A COUNTRY’S PRODUCTION

A country’s standard of living may be measured in different ways:

By comparing personal incomes.

By comparing the total market value of a nation’s production.

Productivity is the amount of goods and services produced from each hour of a worker’s time.

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.

• 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

Markets and CompetitionWhat happens

1. To the price of petrol when war breaks out in Iran2. To the price of mangoes when farmers have an

abundant year3. To the number of tourists when the tsunami hit Sri-

Lanka

All of the above show the workings of Supply and Demand

Supply and Demand are the forces that make market economies work. They determine the following

• Quantity of Goods produced• Price of which goods are sold

• Supply and demand are economists favourite words.

• Supply and demand are the forces that make market economies work.

• Modern microeconomics is about supply, demand and market equilibrium.

SUPPLY AND DEMAND

A group of buyers and sellers of a particular good or service. Characteristics of marketsOrganized markets Less Organized markets. A competitive market is a market which has many buyers and sellers so that each has a negligible impact on price. For today’s class we will assume that markets are perfectly competitive.The goods offered for sale are exactly the same so that no single buyer or seller has influence over price.

WHAT IS A MARKET?

• Buyers determine demand.

• Sellers determine supply.

Quantity demanded is the amount of a good that buyers are willing and able to purchase.

Quantity supplied is the amount of a good that sellers are willing and able to sell.

Quantity Demanded – the amount of a good that buyers are willing and are able to pay.

Market Demand – the sum of all individual demand for a particular good or service

Law of Demand

The claim that other things equal the quantity

Demanded of a good falls when the price of

The good increases.

DEMAND

Shifts in the demand curve

Demand curves can shift

•To the RIGHT (A)

•To the LEFT (B)

Shifts to the right means demand has

increased

Shift to the left means demand has

decreased

DEMAND

• Income• Prices of Related goods• Tastes• Expectations• Number of Buyers

VARIABLES THAT CAUSE DEMAND CURVES TO SHIFT

Quantity SuppliedThe amount of a good that sellers are willing and able to sell.

Law of Supply

The claim that other things equal the quantity

Supplied of a good increase when the price of

The good increases.

SUPPLY

Shifts in the Supply Curve

•Shifts to the right increase supply

•Shifts to the left decrease supply

SUPPLY

• Input Prices• Costs of inputs. If they increase production

decreases, if they decrease production will increase

• Technology• Machinery increases productivity

• Expectation• Number of Sellers

SHIFTS IN THE SUPPLY CURVE

Equilibrium – A situation which the market price has reached the level at which quantity supplied equals the quantity demanded. Equilibrium price – the price that balances Qd and Qs

Equilibrium quantity – the quantity that balances Pd and Ps

Law of Supply and Demand

The claim that the price of any good adjusts

to bring the Qd and the Qs for the good into

balance.

MARKET EQUILIBRIUM

At $2.00, the quantity demanded is equal to the

quantity supplied!

Demand schedule Supply schedule

SUPPLY AND DEMAND TOGETHER

Price Elasticity of

Demand

We use absolute numbers even though Qd is negatively related to its price. |Ped|= △Q/△P

= 20/10 = 2

PRICE ELASTICITY OF DEMAND

• Perfectly Inelastic Demand• Inelastic Demand• Unitary Elastic Demand• Elastic Demand• Perfectly Elastic Demand

DIFFERENT TYPES OF DEMAND

• Sustainability• Nature of the Product• Proportion of Income• Definition of Market• The Possibility of new purchases• Time Horizons• Addiction• Complementary goods• Price expectations

DETERMINANTS OF PRICE ELASTICITY