Managerial Economics

Chapter One
Introducing Economics
What is Economics ?
• Economics is the study of how human beings
coordinate their wants and desires, given the
decision-making mechanisms, social customs,
and political realities of the society.
• Economics is the social science that studies the
choices that individuals, businesses, governments,
and entire societies make as they cope with scarcity
and the incentives that influence and coordinate
those choices.
What is Economics?
• Economics is the study of how societies use relatively
scarce resources to produce valuable products and
distribute them among different people.
• Economics is the study of how society manages its
scarce resources. In most societies, resources are
allocated not by governments but through the
combined actions of millions of households and firms.
Economics studies the use of relatively scarce resources
to satisfy unlimited needs and wants.
Economists study :

• How people make decisions: how much they

work, what they buy, how much they save,
and how they invest their savings.
• How people interact with one another
Coordination in Economics
Any economic system must solve three
coordination problems:
• What, and how much, to produce.
• How to produce it.
• For whom to produce it.
Coordination in Economics
• What, and how much, to produce?
Products are the objects that people value and
produce to satisfy human wants. Products could
be divided into goods and services.
• Goods are all tangible items being produced
• Services are intangible items produced.
Coordination in Economics
• How to produce it?
– Goods and services are produced by using productive
resources that economists call factors of production.
– Factors of production are grouped into four
categories:
 Land
 Labor
 Capital
 Entrepreneurship
Factors of Production
• The “gifts of nature” that we use to produce goods and
services are land.
• The work time and work effort that people devote to
producing goods and services is labor.
• The quality of labor depends on human capital, which is
the knowledge and skill that people obtain from education,
on-the-job training, and work experience.
• The tools, instruments, machines, buildings, and other
constructions that businesses use to produce goods and
services are capital.
• The human resource that organizes land, labor, and capital
is entrepreneurship. It is supplied by entrepreneur
Functions of Entrepreneur
• Take the initiative in combining the resources to
produce a good or service.
• Makes the strategic business decisions that set the
course of an enterprise.
• Innovates. He or she commercialize new products ,
new production techniques, or even new forms of
business organisations.
• Bears risk . Innovation is risky, as nearly all new
products and ideas are subject to failure or success.
Coordination in Economic
•For Whom to produce?
Who gets the goods and services depends on
the incomes that people earn.
 Land earns rent.
 Labor earns wages.
 Capital earns interest.
 Entrepreneurship earns profit.
The Economic Problem
• Scarcity exists because individuals want more
than can be produced.
– Scarcity – the goods available are too few to
satisfy individuals’ desires.
• The degree of scarcity is constantly changing.
• The quantity of goods, services, and usable
resources depends on technology and human
action.
 Economic Way of Thinking
•A Choice Is a Tradeoff
– The economic way of thinking places scarcity and its
implication, choice, at center stage.
– You can think about every choice as a tradeoff—an
exchange—giving up one thing to get something else.
– On Thursday night, will you study or have fun?
– You can’t study and have fun at the same time, so you
must make a choice.
– Whatever you choose, you could have chosen
something else. Your choice is a tradeoff.
 Economic Way of Thinking
•Making a Rational Choice
– A rational choice is one that compares costs and benefits
and achieves the greatest benefit over cost for the person
making the choice.
– Only the wants of the person making a choice are relevant
to determine its rationality.
– The idea of rational choice provides an answer to the first
question: What goods and services will be produced and
in what quantities?
– The answer is: Those that people rationally choose to buy!
 The Economic Way of Thinking
•How do people choose rationally?
•The answers turn on benefits and costs.
•Benefit: What you Gain
•The benefit of something is the gain or pleasure
that it brings and is determined by preferences
•Preferences are what a person likes and dislikes
and the intensity of those feelings.
 The Economic Way of Thinking
•Cost: What you Must Give Up
– The opportunity cost of something is the highest-
valued alternative that must be given up to get it.
– What is your opportunity cost of going to a live
concert?
– Opportunity cost has two components:
1. The things you can’t afford to buy if you purchase
the concert ticket.
2. The things you can’t do with your time if you attend
the concert.
 Production Possibilities Model
• Society uses its scarce resources to produce goods and services. The
alternatives and choices it faces can best be understood through a
macroeconomic model of production possibilities. To keep things simple,
let’s initially assume:
• Full employment The economy is employing all its available resources.
• Fixed resources The quantity and quality of the factors of production are
fixed.
• Fixed technology The state of technology (the methods used to produce
output) is constant.
• Two goods The economy is producing only two goods.
Some assume that countries produce consumer goods, products that
satisfy our wants directly or capital goods, products that satisfy our wants
indirectly by making possible more efficient production of consumer goods.
 Production Possibilities Model

• The production possibilities boundary(PPB) is the

boundary between those combinations of goods and
services that can be produced and those that cannot.
• To illustrate the PPB, we focus on two goods at a
time and hold the quantities of all other goods and
services constant.
• That is, we look at a model economy in which
everything remains the same except the two goods
we’re considering.
 Production Possibilities Model
•Production Possibilities Boundary
–Figure shows the PPB for two goods: cola and pizzas.
 Production Possibilities Boundary
–Any point on the boundary such as E and any point
inside the PPB such as Z are attainable.
–Points outside the PPB are unattainable.
 Production Possibilities Boundary
Production Efficiency
– We achieve
production efficiency
if we cannot produce
more of one good
without producing less
of some other good.
– Points on the
boundary are efficient.
 Production Possibilities Boundary
–Any point inside the
frontier, such as Z, is
inefficient.
–At such a point, it is
possible to produce
more of one good
without producing less
of the other good.
–At Z, resources are
either unemployed or
misallocated.
 Using Resources Efficiently
•Allocative Efficiency
–When we cannot produce more of any one good without
giving up some other good, we have achieved production
efficiency.
–We are producing at a point on the PPF.
–When we cannot produce more of any one good without
giving up some other good that we value more highly, we
have achieved allocative efficiency.
–We are producing at the point on the PPF that we prefer
above all other points.
Microeconomics vs Macroeconomics
• Microeconomics is the study of choices that
individuals and businesses make, the way those
choices interact in markets, and the influence of
governments.

• Macroeconomics is the study of the performance

of the national and global economies.
 Microeconomics vs Macroeconomics
• Microeconomics studies such things as:
– the pricing policy of firms.
– households decisions on what to buy.
– how markets allocate resources among alternative ends.

• Macroeconomics deals with:

– inflation.
– unemployment.
– economic growth.