Overview

First Principles of
Economics
Basics of Economics
Learning Goals and Objectives
 LG2: Global Management Perspective
 LO1. Be able to identify and describe global
management issues related to policies, culture,
cross border trade, competition, customer,
suppliers, people management practices, global
markets, etc.
 LO2. Be able to analyze impact of global
management issues (as opposed to the domestic
environment) and their impact on management
decisions

Assurance of Learning (AOL)

 LG3: Analytical and Integrative
Thinking
 LO1. Be able to identify symptoms and
key factors of a business problem. Clearly
define a business problem using key facts.
 LO3. Be able to propose potential
alternative solutions, evaluate them and
recommend an appropriate solution

Assurance of Learning (AOL)

 Economics – analyses and provides
answers to basic fundamental question of
scarcity
 Scarcity arises out of two basic
fundamental facts of life
a)Wants unlimited
b) Economic Resources limited
 Three questions
A) What to produce
B) How to produce
C) For whom to produce
What is the ‘Economic Problem’?
The ECONOMIC PROBLEM is the problem of
allocating resources efficiently
◼ to achieve objectives
◼ while satisfying constraints, such as
◼ scarcity
◼ requirement

◼ feasibility
 Economic Analysis are important to a
variety of public and private sector
activities. For e.g.
1. analysing costs and benefits of a project, or a
scheme,
2. Pricing strategy of a product
3. user fees (price) for public parks, water, toll road,
4. designing scholarship program,
5. causes of unemployment, inflation,
6. tax rate from revenue and equity point
 1. EFFICIENCY
 2. EQUITY

CRITERIA FOR EVALUATING

THESE DECISIONS
 Formalizing economic behaviour into some
model
 Two types –
 Operational or Internal Use
(Microeconomics)
 Environmental or External
(Macroeconomics)

Economic Tools
 The study of the behaviour of individual
entities in a market economy
◦ Consumers
◦ Firms
 Real estate
 Banking
 FMCG
◦ Markets
◦ Market failures
Caselet: Is the Private Doctor’s Office going to
disappear (Related to LG3)
https://www.ted.com/talks/david_autor_why_a
re_there_still_so_many_jobs
Microeconomics
 A study of the aggregate economy
◦ Aggregate output
◦ Aggregate employment
◦ Inflation

Analyze the report of “Oil price benchmarks are

defying laws of Supply and Demand”

Related to LG2

Macroeconomics
 Exports and Imports
 Capital flows – FDI and FII
 Exchange rate
 Balance of Payments

International Economics
 Divya: Minimum wage laws cause
unemployment
 Tara: The government should raise the
minimum wage

Positive statements are descriptive

Normative statements are prescriptive

Positive versus Normative

Analysis
 Three Groups of Principles
➢ Individual Choice – 4 principles
➢ Interactions between Economic Agents
➢ Economic Interactions at large

12 Principles
 How People Make Decisions
 How People Interact
 How Economy as a Whole Works

Principles of Economics
 Resources are Scarce
 Decisions at Margin
 The Real Cost of Something is what you
must give up to get it: Opportunity Cost
 Exploit opportunities to be better off

Individual Choice
 Decision making is a process of making
optimal tradeoffs because resources are
scarce
◦ Cost versus quality
◦ Employee versus customer
◦ Etc.
 How to make the optimal tradeoff?

 “There is no free lunch.”

1. Tradeoffs
 Should I watch the second half of the Uruguay
Italy game or should I study?
 Should Apple ship out 300,000 more ipods?
 ‘Marginal’ means incremental, or additional
 Marginal benefit - individual
 Marginal revenue - firm
 Marginal cost
 So optimal tradeoff involves equalizing marginal
benefit/revenue and marginal cost

2. Optimal tradeoff: Decision at the

Margin
“How much?” is a decision at the margin.

◼You make a trade-off when you compare the costs with the
benefits of doing something.
◼Decisions about whether to do a bit more or a bit less of an
activity are marginal decisions.
Marginal Analysis
◼Making trade-offs at the margin: comparing the
costs and benefits of doing a little bit more of an
activity versus doing a little bit less.
◼The study of such decisions is known as
marginal analysis.
Ex.: Hiring one more worker, studying one more
hour, eating one more cookie, buying one more CD
 3. The real cost of something is what you
must give up to get it.
◼The real cost of an item is its opportunity cost: what
you must give up in order to get it.
◼Opportunity cost is crucial to understanding individual
choice:
◼Ex.: The cost of attending the economics class is
what you must give up to be in the classroom during
the lecture.
◼Sleep? Watching TV? Rock climbing? Work?
◼All costs are ultimately opportunity costs.
 Opportunity Cost
I WOULD RATHER BE SURFING THE INTERNET.

◼In fact, everybody thinks about opportunity cost.

◼The bumper stickers that say:
◼“I would rather be ….{fishing, golfing, swimming,
etc…}” are referring to the “opportunity cost.”
◼It is all about what you have to forgo to obtain your
choice.
 Cars at a toll bridge
 Assumption of ‘rationality’
 Behavioural economics
 Role of ethics
 Example combining the two - Slaughter of
animals
 Demonetization in India – Any incentive
associated with it?

4. Entities respond to incentives

 Gains from Trade
 Market moves towards equilibrium
 Efficient use of Resources to achieve
society’s goal
 Markets lead to efficiency
 Government intervention during Market
failure

Interactions
 Economies consist of individuals, firms,
families, countries, that interact with each
other
 Interaction makes things interesting

Interaction Changes Things

 Case 1: Boss better than secretary at decision
making, secretary better at typing, boss
focuses on decision making alone and lets
secretary focus on typing alone

Case 2: Boss better than secretary at both

typing and decision making but ‘more better’ in
decision making, so focuses on decision making
alone and lets secretary focus on typing alone

5. Gains from trade

 MARKETS AS A DEVICE TO RESOLVE THE THREE
BIG
ISSUES
 MARKETS AS MECHANISM FOR COORDINATING
AND
RECONCILING INDIVIDUAL CHOICES IN A
MANNER THAT
PROVIDES ANSWERS TO THE THREE SOCIAL
DECISIONS

6. Markets organize economic

activity
 Markets can lead to efficient outcomes, but there
are collective action failures
◦ Blood donation
◦ Traffic
◦ Price wars
 Markets need not lead to equity
 Markets can fail on account of externalities
◦ Smoking
◦ Vaccinations

7. Government intervention is
sometimes necessary
 Buyer Seller
Factor markets Firms individuals
Goods markets individuals Firms

Do markets achieve efficiency ?

Do markets achieve equity?

Types of markets
 Markets usually lead to efficiency.
◼The incentives built into a market economy already
ensure that resources are usually put to good use.
◼Opportunities to make people better off are not wasted.
◼Exceptions: market failure, the individual pursuit of self-
interest found in markets makes society worse off
→ the market outcome is inefficient.
Resources should be used as efficiently as
possible to achieve society’s goals.
◼ An economy is efficient if it takes all opportunities to
make some people better off without making other
people worse off.
◼ Should economic policy makers always strive to
achieve economic efficiency?
◼ Equity means that everyone gets his or her fair
share. Since people can disagree about what’s “fair,”
equity isn’t as well-defined a concept as efficiency.
Efficiency vs. Equity
◼ Ex.: Handicapped-designated parking spaces in a
busy parking lot
A conflict between:
equity, making life “fairer” for handicapped people, and
efficiency, making sure that all opportunities to make
people better off have been fully exploited by never
letting parking spaces go unused.
How far should policy makers go in promoting equity
over efficiency?
When markets don’t achieve efficiency, government intervention
can improve society’s welfare.

◼Why do markets fail?

◼Individual actions have side effects not taken into
account by the market (externalities).
◼One party prevents mutually beneficial trades from
occurring in the attempt to capture a greater share of
resources for itself.
◼Some goods cannot be efficiently managed by
markets.
Ex.: Defence, Public Goods
(Case 3: Government and the Market)
 Public sector monopoly
◦ railways
 Both public and private sector with
independent regulator
◦ Telecommunications
 Community ownership

Alternatives to market mechanism

 Econ without interaction Econ with
interaction
More choice good More choice can be
bad
Individual rationality leads to good There could be
collective outcomes collective action
failure
Markets need to be unfettered Markets need to be
designed

Impact of interaction
 Principles for the
Aggregate Economy
 One Person’s spending=Other person’s
Income
 Overall spending gets out of line with the
Economy’s Productive Capacity
 Government policies can change spending

Economic Interactions at large

 Capitalist Economy
 Socialist Economy
 Mixed Economy
 Market Economy
 Centrally Planned Economy
 Socialist Market Economy

Economic System
 Classical school of thought
 Keynesian school of thought
 Neo-classical school of thought
 Neo-Keynesian school of thought
 Neo-liberalism

Evolution of different schools of

thought
Some Economic concepts
 Land
 Labour
 Capital
 Organization

Factors of Production
 Land – Rent
 Labour – Wages
 Capital – Interest/Rental on Capital
 Organization - Profit

Costs associated with Factors of

Production
 Consumption – Aggregate of all final
products and services that we buy and
consume.
 Savings – the money that we save out of
our income in the form of monetary
assets
 Investment – two types – Investment in
physical capital and money capital. The
capital assets we buy for future
production.

Consumption, Investment, Savings

 Investment – we buy a building to set up
an office to operate
 Cost of production – we hire a building
and monthly rent becomes the operational
costs
 What is the difference?

Difference between investment

and cost of production
 Person’s Wealth- Stock; Income and
Expenditure – Flow
 Capital – Stock; Investment – Flow
 Number of people unemployed – Stock;
People losing job – Flow
 Government debt is a stock; Fiscal deficit
is a flow

Stock and Flow

 Money is what money does
 Four functions of money
➢ Medium of Exchange
➢ Measurement Unit
➢ Store of value
➢ Standard for deferred payments

Definition of Money
 Price of a product – Value/ unit of the
product which the buyer pays a seller
 Price level – Macro concept of General
Price level of all prices of commodities
taken together. It is a weighted Index
number
 Difference between price of a product and
cost of a product

Price
 Rate of increase in the Price level
 It may be measured taking into
consideration the change for the last two
months (WPI, CPI)
 Deflation is rate of decrease in the Price
level
 Interpreting “Inflation rate going down”
does not imply deflation

Inflation