Chapter 1

Introduction to Economic
Analysis

Presented by
Sanchita Som
‘Infosys Q2 beats street
expectations; net profit at
Rs 1540 crore’ -----
The Economic Times,9th Oct.2009
Introduction to Economics

The Science of
Economics is made for
the benefit and
development of the
world.
 - Kautilya Chanakya
The Economic Problem

• Unlimited Wants
• Scarce Resources – Land,
Labour, Capital, …..
• Resource Use
• Choices
Economic Problems

The problem of choice making arising out of limited means

and unlimited wants is called economic problem.

Why do economic problems arise?

Unlimited wants
Different priorities
Limited means
Means having alternative uses.

Multiplicity of want
Types of Resources

Land: all naturally occurring resources whose

supply is inherently fixed (i.e., does not respond
to changes in price)
Labor: the physical work that is needed to make
the products or provide the services.
Capital: the machines that is used to produce the
products.
Entrepreneurial Talent: the bright ideas that
people contribute to making or improving the
goods and services.
Economic Problems
The Economic Problem
What goods and services should an economy produce?
– should the emphasis be on agriculture, manufacturing or
services, should it be on sport and leisure or housing?

How should goods and services be produced? – labour

intensive, land intensive, capital intensive? Efficiency?

Who should get the goods and services produced? –

even distribution? more for the rich? for those who work
hard?
What is Economics?

Oikonomous – ‘one who manage

household’

Economics is the study of how societies use scarce

resources to produce valuable commodities and
distribute them among different people.
 Objectives

To understand the subject matter & the

essence of Economics and Managerial
Decision-Making

Managerial Economics : It refers to the application of

economic theory & the tools of analysis of decision
science to examine how an organisations can achieve its
aims or objectives most efficiently. It studies the
economic aspects of managerial decision making
Managers’ Objectives

Maximizing the value of the firm

(Through profit maximization)

Alternative objectives:
=>Market share maximization
=>Growth Maximization
=>Maximizing their own benefits
 Economic
Market Conditions Factor
Conditions Prices

Managerial
Problems

Managerial Decision

Company’s Market
Performance Conditions
Why do we study Economics?

You are the manager of your own business firm.

For taking any decision for your firm what
variables should you consider?
Why do we study Economics?

• To Learn a Way of Thinking

• To Understand the Society

• To Understand Global Affairs

• To Be An Informed Voter
To Learn a Way of
Thinking
• Opportunity Cost

• Marginalism

• Sunk Cost

• Efficient Market
 Opportunity Cost
Definition – the cost expressed in terms of the next
best alternative sacrificed
When a particular alternative is chosen from a set of
alternatives it implies sacrificing the other alternatives
The cost of the forgone alternatives is the opportunity
cost of the decision
Helps us view the true cost of decision making
Implies valuing different choices
Example : Firm purchases a new piece of equipment
for Rs.10,0000 to generate more profit, this amount
could have been deposited in an interest- earning
account.
 Marginalism
Definition : The process of analysing the additional or
incremental costs or benefits arising from a choice or
decision

It should not be confused with average.

Example : Marginal labour unit 

Marginal output of labour , Marginal
revenue  Additional unit sold
Sunk Cost

• Definition : Costs that can not be avoided,

regardless of what is done in the future,
because they have already been incurred

Example : For an airplane that is about to take off with

empty seats,the marginal costs of an extra passenger is
zero, but giving a big discount for few seats will be
profitable
Efficient Market

• Definition : A market in which profit

opportunities are eliminated almost
instantaneously
Why do we study Economics?

• Economic knowledge serves us in

managing our personal lives, in
understanding society and in improving the
world around us.

• The ways that economics can help us

individually will be as different as are our
personal lives.
Why do we study Economics?

• Learning about stock market may help

people manage their own finances.

• Better awareness of the determinants of

cost and revenue will produce better business
decisions.

• The doctor, the investor and the farmer all

need to know about profit from their businesses.
 Why study Managerial Economics

• The selection of product and service to be offered

for sale
• The choice of production methods and optimum
combination of substitute resources
• The determination of best combination of price
and quantity
• Promotional strategy and activities
• The selection of plant location and distribution
centres
Scope of Economics: Micro
Economics

• The study of how households and firm

make decisions and how they interact in
specific markets

• Examples: impact of foreign competition

on the Indian automobile industry
Scope of Economics: Macro
Economics

• The study of economy-wide phenomena

• Examples: the effect of borrowing by the

Indian government, When politicians talk
about “the economy” being in recession
they are talking about Macroeconomics.
 Methods of Economics

Positive Economics
Purely descriptive statements or scientific predictions; “If
A, then B,” a statement of what is (attempts to describe the
world as it is )
Ex : Minimum wage law cause unemployment

Normative Economics
Analysis involving value judgments; relates to whether
things are good or bad, a statement of what ought to be
(attempts to prescribe how the world should be)
Ex : The Govt. should raise the minimum wage
 Descriptive Economics and
Economics Theory
Descriptive Economics
The compilation of data that describe phenomena and
facts
Ex : Economic survey of India publish many data
related to economics

Economic Theory
A statement or set of related statements about cause
and effect ,action and reaction
Ex : The Law of Demand ,Law of Supply
 Theories and Models

Model is a formal statement of a theory, usually a

mathematical statement of a presumed relationship
between two or more values

Variable is a measure that can change from time to

time or from observation to observation

Ceteris Paribus / all else equal : A device used to

analyse the relationship between two variables while the
values of other variables are held unchanged
Pitfalls in Economic Reasoning

 In all areas of economics, old and new, certain

pitfalls lie in the path of the serious economist.
• Falling to keep “others Things Equal”
• The Post Hoc Fallacy
• Fallacy of Composition
others Things Equal

Most of economic problems involve

several forces interacting at the same.
E.g.: the number of cars bought in a given
year is determined by the price of cars,
consumer incomes, gasoline prices etc.
How can we isolate the impact on car sales
of a single variable such as the price of
gasoline.
The Post Hoc Fallacy

• A common mistake in studies of cause-and-effect

relationships is the Post Hoc Fallacy.
E.g.: Dr. Optimist’s observation is that after the
Govt. has cut tax rates, the Govt.s total tax revenues
began to rise. Dr.Optimist then claims “Aha, if we
lower the tax rates, we will rise revenues and reduce
the budget deficit.”
The Post Hoc Fallacy

Dr.Optimist fallacy was to assume that the

tax cut was responsible for the increase in
Govt.s revenues; overlooked was the fact that
the growing economy was raising people’s
income and might have increased tax
revenues even more had taxes not been cut.
The Fallacy of Composition

The erroneous belief that what is true for

a part is necessarily true for the whole

Example : Increasing saving is obviously

good for an individual, since it provides for
retirement or a "rainy day," but if everyone
saves more, it may cause a recession by
reducing consumer demand.
 Economic Policy

Efficiency : An efficient economy is one that produces

what people want at the least possible cost

Equity : It is a concept or idea of fairness in Economics

Economic Growth : A sustainable rise in per Capita

Income overtime

Stability : A condition in which national output is

growing steadily , with low inflation and full employment
of resources
The Circular-Flow Diagram
Revenue Spending
Market for
Goods
Goods & Goods &
Services sold and Services
Services
bought

Firms Households

Inputs for Labor, land,

production Market for and capital
Factors
Wages, rent, Income
of Production
interest and
profit
COMBINATION CLOTH STEEL
(METER) (TON)

A 0 18
B 1 17
C 2 15
D 3 12
E 4 7
F 5 0
COMBINATION CLOTH STEEL OPPORTUNITY COST OF
(METER) (TON) CLOTHS (TONS OF STEEL)

A 0 18 0
B 1 17 1
C 2 15 2
D 3 12 3
E 4 7 5
F 5 0 7
 PRODUCTION POSSIBILITY
FRONTIER
PRODUCTION POSSIBILITY FRONTIER
20
A graph that shows all
the combination of
18

goods and services that

16

14

12
can be produced if all of
society's resources are
STEEL

10

8
used efficiently - P.P.F.
6
Slope = Marginal rate
4
of Transformation
2

0 Law of Increasing
0 1 2 3 4 5 6

CLOTH Opportunity Cost

 Alternative
Economic System

Economic
System

Command
Market Economy Mixed Economy
Economy
 General Equilibrium

A General equilibrium is defined as a

situation in which all markets and all decision
making units are simultaneously in
equilibrium and each market is interrelated.
 Theories of International
Trade

Absolute Advantage : A producer has an

absolute advantage over another in the
production of a good or services if it can
produce the same amount of output with less
input relative to other countries.

Comparative Advantage : A producer has a

comparative advantage over another in the
production of a good or services if it can
produce that product at a lower opportunity cost
 Theory of Absolute
Advantage

Country Commodity

A B

Country 1 80 100

Country 2 120 90
 Theory of Comparative
Advantage

Country Commodity

A B

Country 1 80 90

Country 2 120 100

`Laissez-Faire Economics

An economy in which individual

people and firms pursue their own
interests without any central
direction or regulation
 Reference

1.   Case and Fair, Principles of Economics, 8e,

Pearson Education
2. N. Gregory Mankiw, Principles of Economics,
4e,Thomson
3.Lipsey and Chrystal, Economics, 10e (2003),
Oxford University Press
4.Brue and McConnell, Essentials of Economics,
2007, Tata McGraw Hill
5.Dominik Salvatore, Managerial Economics in a
Global Economy, 4e, Thomson South-Western
Thank You