Lecture 1
Introduction & Basics of Economics
Dr. Rajeev Dhawan
Director
Given to the
EMBA 8400 Class
March 19, 2010

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


Week 1 – Basic Economic Concepts and
Microeconomics I

Week 2 – Microeconomics II and Basics
Macroeconomics I

Week 3 – Macroeconomics II


TWO RULES:
– No Early or Makeup Exams
– All Exams are Open Book

20% Quiz #1 (30 minutes)

30% Quiz #2 (45 minutes)

50% Final Comprehensive
Exam (2 hours)


Households : Consume & Work

Firms : Production & Investment

Government : Money Supply,
Taxes, Expenditures

Foreign Sector : Exports,
Imports & Exchange Rate

The 10 Principles of 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


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?


Opportunity Cost: Things are Scarce
– Next Best Alternative

Ex: Party on Friday night vs. study for exams
– Cost of Time

Ex: 1 hour wait time at the dentist


Marginal Concept: At the Margin
Shot
1
Shots of Wild Turk ey
Satisfaction
50
Marginal
Satisfaction
20
2 70
10
3 80
5
4 85
1
5 86
0
6 86

Utility: Level of Satisfaction (here, drunkenness)


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?

Winnick ’ s Voyage to the Bottom of the Sea
WSJ; by Andy Kessler

First Mover, FCC regulated + fixed costs
 Regulated utility
 Price protection
 You can ’ t lose
 Traffic / use was of low economic value or cashless
 Global 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 …… .

1.
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 item
3.
People make decisions at the margins – increments matter
4.
People respond to incentives – e.g. cigarette laws, communism
5.
Free Trade is good (for everybody)

6.
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


Micro: The Study of One Entity
(firm, business, people)

Macro: The Study of a Collection of Things
(national, aggregate)


Decision-Makers
–
Firms, governments

Markets
–
Place where exchange takes place

Winnick’s Voyage to the Bottom of the Sea by Andy Kessler (p.14)

First Mover, FCC regulated + fixed costs

Regulated utility

Price protection
 You can’t lose

Traffic / use was of low economic value or cashless
Global 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…….

Production


What is production?
–
The activity by which we convert inputs (labor, land & capital) into goods and services

What limits production?
–
Inputs (resources)
–
Technology

Government interference

Revenue
Goods and services sold
MARKETS
FOR
GOODS AND SERVICES
•Firms sell
•Households buy
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
MARKETS
FOR
FACTORS OF PRODUCTION
Labor, land, and capital
•Households sell
•Firms buy
Income

Production Possibilities Frontier

Definition: the amount of goods a firm or society can produce given a fixed amount of land, labor and other inputs.

Production Possibilities Frontier
Quantity of
Pretzels
Produced
4,000
3,000
2,200
2,100
2,000
1,000
D a
B d
.
C
A
E b Production possibilities frontier c
0 300
600 700 750 1,000 Quantity of
Beer Produced

Input Y MP Y (Production) = F (Inputs) Y = I
0 0
1.00
Production Function
1
2
1
2
1.00
1.00
12
10
8
6
4
2
0 3 3
0 2 4 6 8
1.00
Input
4 4
1.00
Marginal Product: it is the increase in output that arises from an additional unit of input.
5 5
Marginal Product (MP) = ∆ Output / ∆Input
10

Y = I 2
Input Y MP
0 0
1.00
1 1
3.00
2 4
5.00
3 9
7.00
4 16
9.00
5 25
120
100
80
60
40
20
0
0 2
Production Function
4
Marginal Product (MP) =
Input
6 8
∆ Output / ∆Input
10

Input Y MP
0 0
1.00
1 1
0.41
2 1.4
0.32
3 1.7
0.27
4 2
0.24
5 2.2
3.5
3
2.5
2
1.5
1
0.5
0
0
Y =
2
√I
Production Function
4
Marginal Product (MP) =
Input
6 8
∆ Output / ∆Input
10


Returns to Scale: the property of the production function that when you double your inputs, your output either doubles, more than doubles, or less than doubles.
DRS
7
6
5
9
8
4
3
2
1
0
0
MP ↑ 
IRS
MP ↓ 
DRS
1 2
Y=F
IRS
2
3 4 5
Y=F
CRS
6 7
Y = √F
8 9 10

Demand & Supply


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


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…)

Quantity demanded (Q): the amount of a good that buyers are willing and able to purchase at a given price (P).
Demand for Beer
Pints of Beer
P Q
D
$10.00
0
7.00
5.00
4.00
2.00
0.00
1
3
6
11
19
$10.00
$8.00
$6.00
$4.00
$2.00
$0.00
0 5 10
Quantity (Pints)
15 20


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


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)


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


Variables that shift the demand curve:

Price of
Beer
Increase in demand
0
Decrease in demand
Demand curve, D
2
Demand curve, D
3
Demand curve, D
1
Quantity of
Beer

Quantity supplied (Q): the amount of a good that sellers are willing and able to sell at a given price (P).
Pints of Beer
P Q
S
$10.00
12
7.00
5.00
4.00
2.00
0.00
1
0
7
4
3
$10.00
$8.00
$6.00
$4.00
$2.00
$0.00
0
Supply of Beer - Neighbors
2 4 6 8
Quantity (Pints)
10 12


Supply graph for another bar
Pints of Beer
P Q
S
$10.00
8
7.00
5.00
4.00
2.00
0.00
1
0
5
4
3
$10.00
$9.00
$8.00
$7.00
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
Supply of Beer - Hand in Hand
0 2 4 6 8
Quantity (Pints)
10 12


Your own Price

Input Prices
–
Cost of bottle of beer: labor, capital, rent

Technology
–
Smoking laws
 separation of smoking & drinking

Expectations
–
Future outlook


Variables that shift the supply curve:

Price of
Beer
Supply curve, S
3
Supply curve, S
1
Decrease in supply
Supply curve, S
2
Increase in supply
0
Quantity of
Beer


Equilibrium: the price where quantity supplied is equal to quantity demanded
Market for Beer
$10.00
$8.00
$6.00
$4.00
$2.00
$0.00
0 15
Equilibrium
20 5
6
10
Quantity (Pints)

Excess Supply
Price of
Beer Supply
Surplus
$6.50
4.00
0
Demand
2
Quantity demanded
6 10
Quantity supplied
Quantity of
Beer

Excess Demand
Price of
Beer Supply
$4.00
2.50
Shortage
Demand
2
Quantity supplied
6 10
Quantity demanded
Quantity of
Beer


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.

Price of
Beer
$6.50
4.00
0
An increase in wealth
An increase in the price of hops reduces the supply of beer increases demand for beer
Price of
Beer
S
2
S
1
Suppl
New equilibrium equilibrium
$6.50
Initial equilibrium
Initial equilibrium
4.00
D
2
Demand
6
D
1
10 Pints of Beer
Pints of Beer
0 2 6

$10.00
$8.00
$6.00

New
Equilibrium
Market for Beer
S
2
$2.00
$0.00
0
4
5 10
Quantity (Pints)
15 20
S
1

Controls on Prices


Price Ceiling (e.g. rent control)
– A legal maximum on the price at which a good can be sold.
–
If the price ceiling is set below the equilibrium price, it leads to a shortage.

Price Floor (e.g. minimum wage)
–
A legal minimum on the price at which a good can be sold.
–
If the price ceiling is set above the equilibrium price, it leads to a surplus.

Price Ceiling: Beer Shortage
…Rent Control Too
Beer
Supply
Equilibrium price
$3
2
Shortage
Price ceiling
Demand
0 75
Quantity supplied
125
Quantity demanded
Pints

Price of
Beer
Equilibrium
$4 price
$3
Surplus
Supply
Price floor
0
75
Quantity demanded
125
Quantity supplied
Demand
Quantity of
Beer