What is Economics?

Dr. Akshay Dhume

01/19/2025 1
Reading
 1.1.1. S_N_Chapter01
 1.1.2. S_N_Chapter02
 1.2.1.P_R_Chapter01
 1.3.1.Sal_Chapter01

01/19/2025 2
Economics: First Thoughts
Government and
Development Policy
and Growth - Fiscal
Banking
- Monetary
and
- International
Financial
Institutions Trade and
Finance

Markets
- Stock Macroeconomic
- Goods & Aspects
Services - Output
- Forex - Money
- Unemployment
- Inflation

01/19/2025 3
 Why Study Economics? You cannot have
everything!
Doesn’t Resources are Scarce.
scarce mean No!! Not
rare? Quite!!

I want to have
everything!!

That is the
distinguishing Then?
characteristic of
any economic
good.

01/19/2025 4
Scarcity
 What is Scarcity?
◦ A good is said to be scarce if it is limited with respect to the demand for the good
◦ Such goods are not freely available
◦ Rationed either by price or by some other means

 Is water scarce??
◦ Depends on the type of water
◦ Approximately 71% of Earth’s surface is covered by water - water is neither rare
nor scarce
◦ Water that can be utilized is scarce
◦ You have to pay a price for water – tax or price for bottled water

 Scarcity does not mean merely ‘limited’, but limited with respect to the
demand for the good

01/19/2025 5
Implications of Scarcity I have 3 hours at
my disposal. I
need 3 hours to
prepare for the
You are facing exam.
a trade-off!!!

But I also want to

watch the new movie
that is 3 hours long.

I don’t know what I

should do?

01/19/2025 6
Implications of Scarcity – Trade-off
 Bollywood understands trade-off

“Kabhi kabhi jeetne keliye kuch haarna padta hai”

(Remember SRK in Baazigar!!!)

 Grades versus Satisfaction in the previous example as time is a

scarce resource

 Agents are required to give up something in order to get

something else as resources are scarce

 Trade-off is commonly expressed in terms of opportunity cost

01/19/2025 7
Implications of Scarcity – Opportunity
Cost
 Opportunity cost of a decision is the value of the next best alternative
foregone

 Opportunity cost of watching the movie is the ‘value’ of the grades

forgone

 The opportunity cost of choosing to attend college/university are the lost

wages/salaries that would have been earned for the duration of the
program

 Reflect on the following statement

“Compute the cost of your decision to pursue college/university education”

01/19/2025 8
Implications of Scarcity – Efficiency
 Scarce resources – efficient use needed

 What is efficiency?
◦ Most effective use of society’s resources in satisfying people’s wants
and needs
◦ No Shortage No Excess
◦ Highest quantity and quality of goods and services given technology
and resources

“An economy is producing efficiently when no individual’s

economic welfare can be improved unless someone else is
made worse off”

01/19/2025 9
Application of Efficiency and
Opportunity Cost - PPF
 Production Possibility Frontier (PPF)
◦ Curve showing the maximum possible combinations of two
goods that can be produced with the given amount of resources
(inputs) and technology

01/19/2025 10
Application of Efficiency and
Opportunity Cost - PPF
 PPF shows all efficient
combinations of outputs
◦ Points A-F: Efficient Points
◦ Point U: Inefficient
◦ Point I : Infeasible
◦ PPF is downward sloping –
efficient combination and
scarce resources
◦ PPF is concave – slope  Marginal rate of transformation
increases as the level of (MRT) – Slope of PPF – Amount
production of food of a good that must be foregone in
increases order to create one unit of another
good – Opportunity cost
01/19/2025 11
Economics: Formally
“Study of how the societies allocates scarce resources to
produce valuable good and services and distribute them
among the different sections of the society”

Production Allocation Distribution

What to Functions
How toof For Whom to
Produce? Economics
Produce? Produce?

Central
Questions of
Economics

01/19/2025 12
Central Questions of Economics
 What to Produce?
◦ Pizza or Dosa or Shirts or Jeans or …
◦ High quality shirts or cheap quality shirts?
◦ Capital Goods or Consumption Goods

“What to produce and in what quantity?”

 How to Produce?
◦ Who farms and who teaches?
◦ Should electricity be generated from coal, oil or renewable resources?
◦ Will factories be run by humans or by robots?

“Who will do the production, with what resources and what production techniques?”

 For Whom to Produce?

◦ Poor or Rich
◦ Males or Females
◦ Adults or Children

“Who gets to eat the fruit of economic activity?”

01/19/2025 13
Economics: Revisited
“Study of how the societies allocates scarce resources to
produce valuable good and services and distribute them
among the different sections of the society”

Production Allocation Distribution

What to How to For Whom to

Produce? Produce? Produce?

01/19/2025 14
Who Answers the Central Questions?
Types of Economic Systems

Market Command
Major decisions Mixed Major decisions
regarding production regarding production
and consumption are Combination of and distribution are
taken by individuals Market and Command taken by Government
and firms

01/19/2025 15
Command Economy
 China, Cuba, North Korea, …

 Government plays a central role in making economic

decisions
◦ Owns most of the means of production (land, labor and capital)
and decides on how these should be used
◦ Own and directs the operations of enterprises in most the
industries

01/19/2025 16
Market Economy
 Market is a mechanism through which buyers and sellers
interact to determine prices and exchange goods and services

 Governed by price mechanism

◦ System where the forces of demand and supply determine the prices of
goods and services
◦ Prices serve as signal
 If consumers demand more, price rises signaling the producer that more
quantity is required.
◦ Prices coordinate decisions of consumers and producers

 Extreme form of market economy – government keeps its hands

off economic decision – is called laissez-faire

01/19/2025 17
Market Economy: Market Mechanism

01/19/2025 18
Market Economy: Invisible Hand
Principle

“Every individual… neither intends to promote the public

interest, nor knows how much he is promoting it… he
intends only his own security; and by directing that
industry in such a manner as its produce may be of the
greatest value, he intends only his own gain, and he is in
this, as in many other cases, led by an invisible hand to
promote an end which was no part of his intention”
Adam Smith (1783), The Wealth of Nations, Book IV, Chapter II

01/19/2025 19
Central Questions and Economic Systems
Command Economy Market Economy
What to • Government based on their • Consumers and Producers decide
produce? assessment of resources and • Consumers want to maximize
what the people should consume satisfaction
• If the government feels that • Producers want to maximize
certain commodities should be profits – maximize revenue given
consumed, then those would be cost
produced • ‘$’ vote
How to • Government decides the input • Producers decide
produce? mix • Input mix that will maximize
• In case of excess labor, labor profit by minimizing cost given
intensive techniques will be used revenues
For • Government decides who should • Depends on supply and demand
whom to get the goods and in what in factor market and factor
produce? quantity incomes received
• Rationing • Factor incomes determine who
and how much will be consumed

01/19/2025 20
Command Economy
 Inequality may be low as  Preferences of central planner
government has control of may not be the same as that of
the resources and factor people and may lead to
incomes resources being channelized in
the wrong sectors
 Promote low unemployment  Lack of competition may
level
inhibit innovations which is
 Production is not profit essential for economic progress
driven and commodities  Bureaucracy and red-tapism
essential societal welfare creates inefficiencies in the
would be produced without economy
regard to profits or losses
Advantages Disadvantages

01/19/2025 21
Market Economy
 Brings about efficiency as  Failure of Market Economy
competition forces firms to
utilize resources optimally  Inefficiencies
◦ Monopoly
◦ Externalities
 Increased productivity as
◦ Public Goods
factor inputs are motivated by
performance-linked incentives  Inequity
 Increased innovation as firms  Macroeconomic Issues
need to find ways to remain ◦ Business Cycles
competitive ◦ Slow Economic Growth

Advantages Disadvantages

01/19/2025 22
Market Economy: Market Failure and
Government Interventions

01/19/2025 23
Mixed Economy
 Command and Market Economies have limitations

 Economy organized with some free market elements and

some command economy elements

 Maintain private ownership and control of most of the

means of production, but often under government
regulations

 Socialize select industries that are deemed essential or that

produce public goods

01/19/2025 24
Branches of Economic Analysis
 Describes facts of an economy  Involves value judgements,
ethics precepts and norms of
 Can be resolved by reference to fairness
analysis and empirical evidence  No right or wrong answer
 Deals with ‘what is’  Deals with ‘what ought to be’

 Questions/Statements like  Questions/Statements like

◦ Why do doctors earn more than ◦ Should doctors earn more than
janitors? janitors?
◦ Do high interest rates lower ◦ Should unemployment be raised to
inflation? reduce inflation?

Positive Economics Normative Economics

01/19/2025 25
Logic of Economics
 Post Hoc Fallacy
“The post hoc fallacy occurs when we assume that, because one
event occurred before another event, the first event caused the
second event”

 Failure to hold other things constant

◦ Can lead to incorrect inference about a policy

 Fallacy of Composition
“When you assume that what is true for the part is also true for
the whole, you are committing the fallacy of composition”

01/19/2025 26
Managerial Economics

01/19/2025 27
Managerial Economics
 The application of economic theory and the tools of
decision science to examine how an organization can
achieve its aims or objectives most efficiently.
◦ applications of economic theory
◦ quantitative methods
◦ statistical methods
◦ computational methods

01/19/2025 28
Importance of Managerial Economics
 Evaluating managerial policies
◦ Timely evaluation of policies which yield no return or are not important in
altering market conditions and ensuring that policies do not pose obstacles in
business decision-making and operational aspects

 Advantageous in business organization

◦ Beneficial in organizing and managing the tasks, events related to the smooth
functioning of business
◦ Helps in taking the accurate decisions related to the business organization

 Recognizes the economic strength and weakness

◦ Defines the advantages and pitfalls of the business economy
◦ By exercising managerial economics the business managers can be sure of
the effects of certain activities for growth of business

01/19/2025 29
Importance of Managerial Economics
 Computing the economic relationship
◦ Relationship among factors viz. income, profit, acquisitions, loss,
demand elasticity etc. are estimated with the help of managerial
economics

 Makes business planning much easier

◦ Helps in planning to achieve rewarding results and operations
◦ Business planning plays an important role in connecting the tools of
production and systems of operation

 Helps in managing the cost

◦ Helps in deciding the correct and appropriate way for operating a
business and controlling costs

01/19/2025 30
Importance of Managerial Economics
 Systemization of business activities
◦ Several business activities need to be coordinated and managed
in a systematic manner

 Resolves problem related to business taxation

◦ Giant problem solving tool in various types of issues related to
taxation in the business.

 Helps in computing firm’s efficiency

◦ Helps business managers to measure the ability and efficiency
of the firm

01/19/2025 31
Nature of Managerial Economics

01/19/2025 32
Economic Theory
 Microeconomics
◦ Study of the economic behavior of individual decision-making
units.
◦ Relevance to Managerial Economics.

 Macroeconomics
◦ Study of the total or aggregate level of output, income,
employment, consumption, investment, and prices for the
economy viewed as a whole.

01/19/2025 33
Economic Methodology
 Economic Models
◦ Abstract from details
◦ Focus on most important determinants of economic behavior –
cause and effect

 Evaluating Economic Models

◦ A model is accepted if it predicts accurately and if the
predictions follow logically from the assumptions.

01/19/2025 34
Decision Sciences
 Mathematical Economics
◦ Expresses and analyzes economic models using the tools of
mathematics.

 Econometrics
◦ Employs statistical methods to estimate and test economic
models using empirical data.

01/19/2025 35
Basic Process of Decision Making

01/19/2025 36
The Changing Environment of
Managerial Economics
 Globalization of Economic Activity
◦ Goods and Services
◦ Capital
◦ Technology
◦ Skilled Labor

 Technological Change
◦ Telecommunications Advances
◦ The Internet and the World Wide Web

01/19/2025 37
Further reading
 Managerial Economics: Meanings, Scope, Techniques,
etc.
https://www.yourarticlelibrary.com/managerial-economic
s/managerial-economics-meaning-scope-techniques-othe
r-details/24730

01/19/2025 38