MBA 502 Economic Analysis for Business

Instructor : Prof. A. T. Fonseka

Session 1: Introduction to Economics (Prof. A.T.F.)

Outline
• Introduction
• Fundamental Concepts of Economics
Production Possibility Frontier (PPF)
• Basic Questions facing an Economy
• Basic Economic Systems
• Challenge facing Management
 Introduction
• Economics studies how individuals, firms and societies
choose to employ the scarce resources that are available to
obtain the maximum benefit.
• It is rational behaviour on the part of the 3 key decision
makers in the economy i.e. consumers, firms, & Govt.
- Consumer: Ltd. income → Maximise utility
- Firm: Ltd. capital → Maximise profit
- Govt. Ltd. revenue → Maximise societal welfare (or votes?)
- Govt. policies: Have an impact on individuals & firms e.g.
↑ in income tax;
↑ corporate tax
↑ in interest rate (cost of borrowed funds)
Devaluation / Depreciation of Rupee
 Continued
• As a subject Economics has direct relevance to the decisions that we
make regarding our material well- being.
•Human beings have needs & wants to be satisfied.
The production process is aimed at satisfying human wants
An economic system provides the framework within which goods
& services will be produced to satisfy our needs & wants. For e.g.

• A free enterprise economy – Pvt. sector undertakes production

A centrally planned economy – State makes production decisions
Modern market economy – Goods & services are produced both by
the private sector and the State (public) sector.
 Fundamental Concepts
The 3 basic concepts in introductory economics are:
1.Scarcity= Not enough resources to satisfy all the wants of all the human beings
2.Choice= Choose between alternatives e.g. use of land
3.Opportunity Cost= cost or value of the next best alternative sacrificed
Relationship Between Concepts

Scarcity

Choice

Opp. Cost
Opportunity Cost (OC)

A decision to use a resource for one purpose

means that it is not available for another purpose
OC = cost or value of the next best alternative forgone
Understand its application to individuals, firms & the Govt.
Diagram below shows a case of equal opportunity cost
Opportunity Cost as Applied to the Consumer
Grapes (kg)

½ Budget Line (Consumption Possibility Line)

0
½ 1 Apples (kg)
 Production Possibility Frontier (PPF)

PPF concept is important as it illustrates the 3 basic concepts.

PPF shows the maximum output an economy can produce with
- the given resources
- the given technology &
- the resources being fully employed
Combination x (units of wheat) y ( units of cloth)
a 0 10
b 1 9
c 2 7
d 3 4
e 4 0
Production Possibility Curve
 Importance of PPF(PP Curve)
• Illustrates the fundamental concepts of Economics viz.
(1) scarcity (2) choice & (3) opp. cost
• Economic growth = an increase in value of output produced in
an economy. It is shown as an outward shift of PPF
• What factors cause a shift of PPF
- An outward (rightward) shift of PPF
- An inward shift of PPF
Economic Questions & Economic Systems

Unlimited Limited
Wants SCARCITY Resources
Gives rise to

Basic Econ. Questions

• What to Produce
• How to Produce
• For Whom to Produce

Answered by

Type of Economic System

• Free Enterprise Economy
• Fully planned Economy
• Mixed Mkt. Economy
 Fundamental Questions Facing an Economy

• What goods to produce & in what quantities (how much of each

commodity)
• How to produce (labour intensive vs capital intensive method of
production)
• For whom to produce (‘who gets what’)
• When to produce (this year or next year)
• Where to produce – location decision
 Economic Systems

1.Capitalist, free enterprise economy. Fully unregulated

* Private ownership of means of production
* Motive: profit maximization
* Allocation of resources done by price mechanism

2.Socialist, centrally planned (command) economy

* State ownership of means of production
* Motive: societal welfare
* Resource allocation by a planning authority
(Answers to basic econ. questions are provided by the State)
 Continued

3 Modern market economy (pvt. + public sector ownership of

enterprises)
Production is undertaken both by pvt. & public sectors
Pvt. Sector – guided by profit motive
Govt. services – provided at a ‘reasonable’ price
Prevailing philosophy in the West is neo- liberalism
Resources are owned both by Pvt. Sector & Govt. Both sectors have
a vital role to play in the modern economy
Pvt. sector plays the leading role
 Challenge facing Management
Managers must try to be both efficient & effective
Efficiency in utilizing resources… (↓cost & waste, ↑ speed) &
Effectiveness means the degree of achievement of goals (results)
Productive Efficiency - it is producing a given output at the lowest
cost for that level of output; It is producing the max. output with a
given quantity of input.
X- Inefficiency - it is the inefficient use of resources. Output is
produced at a higher average cost (cost per unit)
Productivity Ratio = output ÷ input. Produce more with same input
Best situation is increase output using less inputs
Both Pvt. & State enterprises must be run efficiently & effectively
 Circular Flow of Income

Real flows

Money flows
 Four – sector Economy
Flow of Factor Incomes

Flow of Factor Services

Households Firms

Flow of Goods & Services

Flow of Consumer Spending

Saving (s) for Investment (I)

Financial Sector
Taxes (T) Services (G)
Government
Imports (M) Exports (X)
Foreign Sector

Withdrawals / Leakages from circular flow W = S+T+ M

Injections into the circular flow J = I+G+X