ECONOMICS & DECISION MAKING Dr. R. JAYARAJ, M.A., Ph.D., COMES, UPES

1. ECONOMICS & DECISION MAKINGDr. R. JAYARAJ, M.A., Ph.D.,COMES, UPES

2. What Is Economics? Economics is the study of how people choose to use resources. Resources include the time and talentpeople have available, the land, buildings, equipment, and other tools on hand, and the knowledge of how to combine them to create useful products and services. Important choicesinvolve how much time to devote to work, to school, and to leisure, how many dollars to spend and how many to save, how to combine resources to produce goods and services, and how to vote and shape the level of taxes and the role of government. Often, people appear to use their resources to improve their well-being. Well-being includes the satisfaction people gain from the products and services they choose to consume, from their time spent in leisure and with family and community as well as in jobs, and the security and services provided by effective governments. Sometimes, however, people appear to use their resources in ways that don't improve their well-being.

3. Definitions of Economics In short, economics includes the study of labor, land, and investments, of money, income, and production, and of taxes and government expenditures. Economists seek to measure well-being, to learn how well-being may increase overtime, and to evaluate thewell-being of the rich and the poor. The most famous book in economics is the Inquiry into the Nature and Causes of The Wealth of Nations written by Adam Smith, and published in 1776 in Scotland. The term “wealth” has a special meaning in Economics. In the ordinary language, by “wealth”, we mean money, but in economics, wealth refers to those goods which satisfy human wants. But we should remember all goods which satisfy human wants are not wealth. For example, air and sunlight are essential for us. We cannot live without them. But they are not regarded as wealth because they are available in abundance and unlimited in supply. We consider only those goods which are relatively scarce and have money value as wealth.

4. "Economics is the study of people in the ordinary business of life.”--Alfred Marshall, Principles of economics; an introductory volume (London: Macmillan, 1890) "Economics is the science which studies human behaviour as a relationship between given ends and scarce means which have alternative uses.”-- Lionel Robbins, An Essay on the Nature and Significance of Economic Science (London: MacMillan, 1932) Economics is the "study of how societies use scarce resources to produce valuable commodities and distribute them among different people.”-- Paul A. Samuelson, Economics (New York: McGraw-Hill, 1948)

5. What do my students have to say about Economics? Economics is studying how people choose to spend their limited incomes on unlimited wants. Economics is about the world around us, how people spend their money to benefit themselves. However, its complicated and makes life very difficult for us. Economics is about the economy and how it works. It seems to be purely about efficiency. Economics is about the relationship between producers & consumers and the way in which the forces of supply & demand affect prices & products in the economy. Economics is the study of how a country runs globally and within itself. How we use our limited resources ( in our country & globally ) to satisfy the infinite wants of people living within the country. Economics is the rotation, management and analysis of money.

6. Economics does require a brain! Don’t be fooled. Economics is an interesting social science that is relevant to our everyday lives. As you start learning more about it, you will realise how it does apply to our lives. Economics is awesome because of the deeper understanding it helps us to reach the way we function in our daily lives. Economics is about discovering new things, understanding them and challenging those we believe in as a global economy. Economics is everywhere. Economics is a way of looking at how societies organise And finally, If your demand for the best quality education is inelastic, UPES has the supply. Make the right decision.

7. Difference between Micro and Macroeconomics Macro and microeconomics are the two vantage points from which the economy is observed. Macroeconomics looks at the total output of a nation and the way the nation allocates its limited resources of land, labor and capital in an attempt to maximize production levels and promote trade and growth for future generations. After observing the society as a whole, Adam Smith noted that there was an "invisible hand" turning the wheels of the economy: a market force that keeps the economy functioning. Microeconomics looks into similar issues, but on the level of the individual people and firms within the economy. It tends to be more scientific in its approach, and studies the parts that make up the whole economy. Analyzing certain aspects of human behaviour, microeconomics shows us how individuals and firms respond to changes in price and why they demand what they do at particular price levels.

8. Managerial Economics vs. Microeconomics: Common and Different Computer Manufacturer (e.g.: IBM) Similarconcepts Microeconomics Managerial Economics In which way were the prices set? How should the prices be set?

9. The nature of managerial economic decision making Economic concepts Theory of consumer behaviour Theory of firm Theory of market structures and pricing Decision making tools Numerical analysis Statistical analysis Forecasting Game theory Optimisation Managerial Economics Use of economics concepts and decision making tools to solve managerial decision problems Optimal solutions The role of managerial economics in managerial decision making Managerial decision problems Product price and output Make or buy Production technique Internet strategy Advertising media and intensity Investment and financing Managerial Economics Is a Tool for Improving Management Decision Making

10. Categories of Basic Principles of Economics How do people make decisions? How do people interact? How does the economy work overall?

11. How Do People Make Decisions? • Principle #1 - People face tradeoffs • Time allocation – an example of tradeoffs • Efficiency versus equity • Production Possibilities Frontier

12. Principle #2 - The cost of something is what you have to give up to get it • Opportunity costs come from Von Weiser, a German economist late 1800s • Opportunity costs are independent of monetary units • The real costs of going to college

13. Principle #3 - Rational people think at the margin • Rational or irrational decision-making • Marginal benefits and costs versus total benefits and costs • Weighing marginal costs and benefits leads to maximizing net benefits (total welfare)

14. Principle #4 –People respond to incentives • Reactions to changes in marginal benefits and costs • Increases (decreases) in marginal benefits mean more (less) of an activity • Increases (decreases) in marginal costs mean less (more) of an activity

15. How Do People Interact? • Principle #5 - Trade can make everybody better off • Adam Smith author of the “An Inquiry into the Causes and Consequences of the Wealth of Nations” 1776 • Gains from the division of labor and specialization • Mercantilists perspectives

16. Markets • Principles 1-5 combine with markets to turn the pursuit of self-interest into promoting the interests of society • Adam Smith and the “invisible hand” • creativity and productivity are stimulated by the pursuit of self-interest into improving resource allocations • in some cases markets fail to allocate resources effectively

17. Principle #6 - Markets are usually a good way of organizing economic activity • Feudal (military security) times where feudal states were self-supporting, also haciendas (domestic factory) in the new world • the benefits of trade are so powerful that people began to trade • markets for economists are more abstract than the notion of a middle eastern bazaar or a flea market and simply determine the prices and quantities traded of different goods and services

18. Principle #7 Governments can sometimes improve interaction that occurs in markets • there are circumstances when market signals fail to allocate resources efficiently or equitably • Public Goods, Externalities and Income Distribution • Some goods or services that people desire will not be produced by markets (e.g. light houses). • Some goods or services will either be under produced (vaccines) or overproduced (pollution) because markets fails to register certain benefits or costs.

19. How Does the Economy Work as a Whole? • Principle # 8 – A country’s standard of living depends upon its ability to produce goods and services • Adam Smith’s “An Inquiry into the Nature and the Consequences of the Wealth of Nations” • wealth: a necessary or sufficient condition for happiness (are rich people happier, children with lots of toys) • productivity

20. Principle #9 – The general level of prices rises when the government prints and distributes too much money • definition of money, the concept of inflation, and economic language • inflation is an increase in the general or average level of prices in an economy • the establish of the Federal Reserve and the introduction of sustained inflation in the US

21. Principle #10 – Society faces a short-run tradeoff between inflation and unemployment • Short-run and the long-run • demand and supply shocks • short-run increases (decreases) in output above (below) long-run potential output lead to adjustments • countercyclical stabilization versus pro-cyclical destabilization

22. Markets • In economics, a market is not a place but rather a group of buyers and sellers with the potential to trade with each other • Market is defined not by its location but by its participants • First step in an economic analysis is to define and characterize the market or collection of markets to analyze • Economists think of the economy as a collection of individual markets

23. How Broadly Should We Define The Market • Defining the market often requires economists to group things together • Aggregation is the combining of a group of distinct things into a single whole • Markets can be defined broadly or narrowly, depending on our purpose • How broadly or narrowly markets are defined is one of the most important differences between Macroeconomics and Microeconomics

24. Defining Macroeconomic Markets • Goods and services are aggregated to the highest levels • Macro models lump all consumer goods into the single category “consumption goods” • Macro models will also analyze all capital goods as one market • Macroeconomists take an overall view of the economy without getting bogged down in details

25. Defining Microeconomic Markets • Markets are defined narrowly • Focus on models that define much more specific commodities • Always involves some aggregation • But stops it reaches the highest level of generality that macroeconomics investigates

26. Buyers and Sellers • Buyers and sellers in a market can be • Households • Business firms • Government agencies • All three can be both buyers and sellers in the same market, but are not always • For purposes of simplification this text will usually follow these guidelines • In markets for consumer goods, we’ll view business firms as the only sellers, and households as only buyers • In most of our discussions, we’ll be leaving out the “middleman”

27. Demand Demand is: the willingness and ability of buyers to purchase different quantities of a good at different prices during a specific period of time. The Law of Demand: as the price of a good rises, quantity demanded of that good falls; as the price of a good falls, quantity demanded of that good rises.

28. Demand • A household’s quantity demanded of a good • Specific amount household would choose to buy over some time period, given • A particular price that must be paid for the good • All other constraints on the household • Market quantity demanded (or quantity demanded) is the specific amount of a good that all buyers in the market would choose to buy over some time period, given • A particular price they must pay for the good • All other constraints on households

29. Quantity Demanded • Implies a choice • How much households would like to buy when they take into account the opportunity cost of their decisions? • Is hypothetical • Makes no assumptions about availability of the good • How much would households want to buy, at a specific price, given real-world limits on their spending power? • Stresses price • Price of the good is one variable among many that influences quantity demanded • We’ll assume that all other influences on demand are held constant, so we can explore the relationship between price and quantity demanded

30. The Law of Demand • The price of a good rises and everything else remains the same, the quantity of the good demanded will fall • The words, “everything else remains the same” are important • In the real world many variables change simultaneously • However, in order to understand the economy we must first understand each variable separately • Thus we assume that, “everything else remains the same,” in order to understand how demand reacts to price

31. The Demand Schedule • Demand schedule • A list showing the quantity of a good that consumers would choose to purchase at different prices, with all other variables held constant • Demand V.S. Quantities demanded - demand is the entire relationship between price and quantity - quantities demanded are specific amount of goods buyers want to buy

32. The Demand Curve • The market demand curve (or just demand curve) shows the relationship between the price of a good and the quantity demanded , holding constant all other variables that influence demand • Each point on the curve shows the total buyers would choose to buy at a specific price • Law of demand tells us that demand curves virtually always slope downward

33. Price per Bottle When the price is $4.00 per bottle, 40,000 bottles are demanded (point A). At $2.00 per bottle, 60,000 bottles are demanded (point B). Number of Bottles per Month Figure 1: The Demand Curve A $4.00 B 2.00 D 40,000 60,000

34. “Shifts” vs. “Movements Along” The Demand Curve • Move along the demand curve • From a change in the price of the good we analyze • In maple syrup example, Figure 1 • A fall in price would cause a movement to the right along the demand curve (point A to B)

35. Price Price increase moves us leftward alongdemand curve Price increase moves us rightwardalongdemand curve Quantity Figure 3(a): Movements Along and Shifts of The Demand Curve P2 P1 P3 Q2 Q1 Q3

36. “Shifts” vs. “Movements Along” The Demand Curve • Shift of demand curve • a change in other things than price of the good causes a shift in the demand curve itself, for example, income • In Figure 2 • Demand curve has shifted to the right of the old curve (from Figure 1) as income has risen • A change in any variable that affects demand—except for the good’s price—causes the demand curve to shift

37. An increase in income shifts the demand curve for maple syrup from D1 to D2. At each price, more bottles are demanded after the shift Price per Bottle D2 D1 Number of Bottles per Month Figure 2: A Shift of The Demand Curve B C $2.00 60,000 80,000

38. Income: Factors That Shift The Demand Curve • An increase in income has effect of shifting demand for normal goods to the right • However, a rise in income shifts demand for inferior goods to the left • A rise in income will increase the demand for a normal good, and decrease the demand for an inferior good • Normal good and inferior good are defined by the relation between demand and income

39. Wealth: Factors That Shift The Demand Curve • Your wealth—at any point in time—is the total value of everything you own minus the total dollar amount you owe - Example • An increase in wealth will • Increase demand (shift the curve rightward) for a normal good • Decrease demand (shift the curve leftward) for an inferior good

40. Prices of Related Goods: Factors that Shift the Demand Curve • Substitute—good that can be used in place of some other good and that fulfills more or less the same purpose • Example • A rise in the price of a substitute increases the demand for a good, shifting the demand curve to the right • Complement—used together with the good we are interested in • Example • A rise in the price of a complement decreases the demand for a good, shifting the demand curve to the left

41. Other Factors That Shift the Demand Curve • Population • As the population increases in an area • Number of buyers will ordinarily increase • Demand for a good will increase • Expected Price • An expectation that price will rise (fall) in the future shifts the current demand curve rightward (leftward) • Tastes • Combination of all the personal factors that go into determining how a buyer feels about a good • When tastes change toward a good, demand increases, and the demand curve shifts to the right • When tastes change away from a good, demand decreases, and the demand curve shifts to the left

42. Small Summary-- Factors Affecting Demand Income (depends on good’s nature: normal or inferior) Wealth (depends on good’s nature) Prices ofsubstitutes (positively related) Prices of complements (negatively related) Population (positively related) Expected price (positively related) Tastes (positively related)

43. Price Quantity Figure 3(b): Movements Along and Shifts of The Demand Curve • Entire demand curve shifts rightward when: • income or wealth ↑ • price of substitute ↑ • price of complement ↓ • population ↑ • expected price ↑ • tastes shift toward good D2 D1

44. Price Quantity Figure 3(c): Movements Along and Shifts of The Demand Curve • Entire demand curve shifts leftward when: • income or wealth ↓ • price of substitute ↓ • price of complement ↑ • population ↓ • expected price ↓ • tastes shift toward good D1 D2

45. Supply • Supply is the willingness and ability of sellers to produce and offer to sell different quantities of a good at different prices during a specific period of time • Law of Supply: As the price of a good rises, the quantity supplied of the good rises; and as the price of a good falls, the quantity supplied of the good falls.

46. Supply • A firm’s quantity supplied of a good is the specific amount its managers would choose to sell over some time period, given • A particular price for the good • All other constraints on the firm • Market quantity supplied (or quantity supplied) is the specific amount of a good that all sellers in the market would choose to sell over some time period, given • A particular price for the good • All other constraints on firms

47. The Law of Supply • States that when the price of a good rises and everything else remains the same, the quantity of the good supplied will rise • The words, “everything else remains the same” are important • In the real world many variables change simultaneously • However, in order to understand the economy we must first understand each variable separately • We assume “everything else remains the same” in order to understand how supply reacts to price

48. The Supply Schedule and The Supply Curve • Supply schedule—shows quantities of a good or service firms would choose to produce and sell at different prices, with all other variables held constant • Supply curve—graphical depiction of a supply schedule • Shows quantity of a good or service supplied at various prices, with all other variables held constant

49. Price per Bottle When the price is $2.00 per bottle, 40,000 bottles are supplied (point F). At $4.00 per bottle, quantity supplied is 60,000 bottles(pointG). Number of Bottles per Month Figure 4: The Supply Curve S $4.00 G 2.00 F 40,000 60,000

50. Shifts vs. Movements Along the Supply Curve • A change in the price of a good causes a movement along the supply curve • In Figure 4 • A rise (fall) in price would cause a rightward (leftward) movement along the supply curve • A drop in transportation costs will cause a shift in the supply curve itself • In Figure 5 • Supply curve has shifted to the right of the old curve (from Figure 4) as transportation costs have dropped • A change in any variable that affects supply—except for the good’s price—causes the supply curve to shift