Basic Concepts and

Principles

Dr.N.Prakash
Kongu Engineering College
 What is Economics in General?

• Economics is the science of scarcity

Scarcity Means There Is Not Enough For
Everyone
 Scarcity Problem

Land, Labor, Capital, Entrepreneur

Food, clothing, shelter, Rent, Wages, Interest, Profits
jewelry, iPod, projector, digital camera,
good health, children, laptop
warmth, indoor plumbing, rollerblades,
a sense of personal worth, Plasma TV,
literacy, high economics grade, cell
phone, compact discs, home appliances

Unlimited Human Wants Limited Resources

“Need” those first
three to survive.
 Economics is the study of choices
Why Choices?
Wants and Needs??
• NEEDS – “stuff” we must
have to survive, generally:
food, shelter, clothing
VS.
• WANTS – “stuff” we
would really like to have
(Fancy food, shelter,
clothing, big screen TVs,
jewelry, conveniences . . .
Also known as LUXURIES`
 Examples:
❑You must choose between
buying jeans or buying shoes.
❑Businesses must choose
how many people to hire
❑Governments must choose
how much to spend on
welfare.

Rank options according to a person’s preference order

• Option 1 Going to Cinema
• Option 2 Facebook / Surfing with Internet
• Option 3 Sleeping at home
 Economics?
✓ Oikonomos – Greek Word
✓ Discusses how a society tries to
solve the human problems of
unlimited wants and scarce
resources.
✓ Scientific study of the choices made
by individuals and societies with
regard to the alternative uses of
scarce resources employed to satisfy
wants.
✓ Not an exact science; An “art” as well
✓ A social science - Deals with the
society as a whole and human
behaviour in particular, and Studies
the production, distribution, and
consumption of goods and services.
✓ A science in its methodology, and art
in its application.
 Evolution
✓ Adam Smith (1723 – 1790) –
Classical Stage ** Wealth
Concept

✓ Alfred Marshall (1842 – 1924) –

Neo- classical Stage ** Welfare
Concept

✓ Lionel Robbins (1898 – 1984) –

New Stage ** Scarcity

✓ Paul Samuelson – Modern

Stage ** Growth Aspect
 Basic Assumptions
• Ceteris Paribus
– Latin phrase
– “With other things (being) the
same” or “all other things being
equal”.

• Rationality (Optimization)
– Consumers - maximizing utility
and minimizing sacrifice.
– Producers/Firm - maximize profit
subject to given resources or
minimize cost subject to target
return.
 Types of Economic Analysis
• Micro and Macro
– Microeconomics (“micro” meaning small):
study of the behaviour of small economic
units
• An individual consumer, a seller/ a
producer/ a firm, or a product.
• Focus on basic theories of supply and
demand in individual markets
– Macroeconomics (“macro” meaning
large): study of aggregates.
• Industry as a unit, and not the firm.
• Focus on aggregate demand and
aggregate supply, national income,
employment, inflation, etc.
 Types of Economic Analysis

• Positive and Normative

– Positive economics: “what is” in economic matters
• Establishes a cause and effect relationship between variables.
• Analyzes problems on the basis of facts.

– Normative economics: “what ought to be” in economic

matters.
• Concerned with questions involving value judgments.
• Incorporates value judgments about what the economy should be
like.
 Types of Economic Analysis
• Short Run and Long Run
– Short run: Time period not enough for consumers and
producers to adjust completely to any new situation.
• Some inputs are fixed and others are variable
– Long run: Time period long enough for consumers and
producers to adjust to any new situation.
• All inputs are variable
• Decisions to adjust capacity, to introduce a larger plant
or continue with the existing one, to change product
lines.
 Types of Economic Analysis
• Partial and General Equilibrium
– Partial equilibrium analysis: Related to micro analysis
• Studies the outcome of any policy action in a single
market only.
• Equilibrium of one firm or few firms and not necessarily
the industry or economy.
– General equilibrium: explains economic phenomena in an
economy as a whole.
• State in which all the industries in an economy are in
equilibrium.
• State of full employment
 Kinds of Economic Decisions
The fundamental problem faced by economy :
• What to produce? (make) - Choice
• How to Produce?(manufacture) - Efficiency
• For Whom to Produce? (who gets what) - Distribution
• Are Resources used economically? - Scarcity
• Are resources fully employed?
• Is the economy growing?
The way these question are answer determines the
economic system
 Managerial Economics
• Application of economic theory and the tools of analysis of
decision science to examine how an organisation can achieve
its objectives most effectively
• Study of allocation of the limited resources available to a firm
or other unit of management among the various possible
activities of that unit
• Applies economic theory and methods to business and
administrative decision-making
• Application of economic principles and methodologies to the
decision-making process within the firm or organization
 Economic Principles Relevant to
Managerial Decisions
• Concept of Scarcity
– Unlimited human wants
– Limited resources available to satisfy such wants
– Best possible use of resources to get:
• maximum satisfaction (from the point of view of consumers) or
• maximum output (from the point of view of producers or firms)
• Concept of Opportunity cost
– Opportunity cost is the benefit forgone from the alternative
that is not selected.
– Highlights the capacity of one resource to satisfy multitude
of wants
– Helps in making rational choices in all aspects of business,
since resources are scarce and wants are unlimited
 Opportunity Costs =
The Value of the Next Best Choice
• This is really IMPORTANT – when you choose to do ONE thing,
its value (how much it is worth) is measured by the value of
the NEXT BEST CHOICE.
– This can be in time, energy, or even MONEY

If I buy a Then I
pizza… can’t afford
the
movies…

Q: What is the opportunity cost of buying pizza?

 Production Possibilities Curve (PPC)/Production Possibility
Frontier (PPF)/Transformation Curve
❑ Shows the different combinations of the quantities of two goods
that can be produced (or consumed) in an economy at any point of
time.
❑ Depicts the trade off between any two items produced (or
consumed).
❑ This model graphically demonstrates scarcity, trade-offs,
opportunity costs, and efficiency.
❑ Highlights the concepts of scarcity and opportunity cost
❑ Indicates the opportunity cost of increasing one item's production (or
consumption) in terms of the units of the other forgone
❑ Slope of the curve in absolute terms
❑ Key Assumptions
❑ Only two goods can be produced
❑ Full employment of resources
❑ Fixed Resources (Ceteris Paribus)
❑ Fixed Technology
The Factors of Production
 Budget Line
Number of hamburgers & pizzas that can be bought for $30.
Production Possibilities Curve

Food

Technically
P Infeasible Area
FP

FQ Q

Productively
Inefficient Area

O
CP CQ Clothing
PPC for the Society
 PRODUCTION POSSIBILITIES
How does the PPG graphically demonstrates
scarcity, trade-offs, opportunity costs, and
efficiency?
Impossible/Unattainable
A (given current resources)
14
B
12
G
C
Bikes

10

8
Efficient
6 D

4 Inefficient/
Unemployment
2
E
0
0 2 4 6 8 10
Computers 21
Production Possibilities Curve
Contd…

• All points on the PPC (like P and Q) are points of maximum

productive efficiency.
• In the figure, OFp of food and OCp of clothing can be produced
at Point P and OFQ of food and OCQ respectively at point Q,
when production is run efficiently.
• All points inside the frontier are feasible but productively
inefficient.
• All points to the right of (or above) the curve are technically
impossible (or cannot be sustained for long).
• A move from P to Q indicates an increase in the units of
clothing produced and vice versa.
• It also implies a decrease in the units of food produced. This
decrease in the units of food is the opportunity cost of
producing more clothing.
 Economic Principles Relevant to
Managerial Decisions
• Concept of Margin or Increment
– Marginality: a unit increase in cost or revenue or
utility.
• Marginal cost: change in Total Cost due to a unit
change in output.
• Marginal revenue: change in Total Revenue due to a
unit change in sales.
• Marginal utility: change in Total Utility due to a unit
change in consumption.
– Incremental: applied when the changes are in
bulk, say 10% increase in sales. (Decision is right
or wrong)
 Economic Principles Relevant to
Managerial Decisions
• Discounting Principle
– Time value of money : Value of money depreciates with
time
• A rupee in hand today is worth more than a rupee received
tomorrow.
– Outflow and inflow of money and resources at different
points of time
1
PVF =
(1 + r) n
where
PVF = Present Value of Fund,
n = period (year, etc.)
R = rate of discount
 Managerial Economics and Functions of
Management
• All functional areas have to find the most
efficient way of allocating scarce
organizational resources
• Managerial economics:
– Facilitates the process of evaluating
relationships between functional areas
– Helps in making rational decisions across
managerial functions.
 Managerial Economics and Functions of
Management
• Financial Management
– From where to collect resources
• Equity
• Debt
– How to allocate resources
– How much profit to be retained/distributed
• Human Resource Management
– Recruitment
– Wage and Salary
– Training and development
– Retirement
Managerial Economics and Functions
of Management
• Marketing Management
– Which product
– For whom
– What price
– How to sell
• Operations Management
– Which technology
– Inputs
– Processing
• Information System Management
– Communication channels
– Use of information Technology
 Relationship Other Disciplines
Economic Theory
Microeconomics Quantitative Analysis
•Theory of firm •Numeric and algebraic analysis
•Theory of consumer behaviour (demand) •Optimization
•Production and cost theory (supply) •Discounting and time value of money
•Market structure and competition techniques
•Price theory •Statistical estimation and forecasting
Macroeconomics •Game theory
•National income and output
•Business cycle
•Inflation

Managerial Economics

Solutions to Managerial Decision Making

•Quantity and quality of product
•Price of product
•Marketing Management
•Financial Management
•Human Resource Management
•Research and Development