AE11 – Managerial Economics

Module 1: Introduction to Managerial Economics

Ian Dave B. Custodio

Instructor
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Lesson 1: Economics and its Nature

Learning objectives:
a. Define Economics
b. Distinguish the two main branches of economics
c. Explain the basic economic models
d. Determine the various factors of production
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Outline
1.1 What is Economics?
1.2 Branches of Economics
1.3 The Economists’ Tool Kit
1.4 The Circular Flow Diagram
1.5 The Production Possibilities Frontiers
1.6 Factors of Production
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1.1 What is Economics?

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Defining “Economics”
- economics is derived from the Greek word “oikonomia”, which is comprised of two
words: “oikos” and “nomos”

“oikos” or “eco” = household / home / family

“nomos” or “nemein” = management

“Oikonomia” = household management

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- a social science that examines how people choose among the alternatives available
to them. It is social because it involves people and their behavior. It is a science
because it uses, as much as possible, a scientific approach in its investigation of
choices.

- is the study of how humans make decisions in the face of scarcity.

Scarcity means that human wants for goods, services and resources exceed what is
available. Resources, such as labor, tools, land, and raw materials are necessary to
produce the goods and services we want but they exist in limited supply.
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- allocation of wealth and scarce resources to satisfy unlimited human needs and
wants. Allocation is a mechanism of distribution used by society to address the needs
and wants of citizens in an environment characterized by scarcity of resources.

- creation and consumption of wealth – process of distribution and production

Process of distribution: how products are transacted in the market and the impact of
the relative power of actors in the market in determining the price
Process of production: transforming raw materials to new products
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- a science of choice – Optimization

Optimization: getting the best option from limited resources

All choices mean that one alternative is selected over another. Selecting among
alternatives involves three ideas central to economics:
1. Scarcity
2. Choice
3. Opportunity cost
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Basic Economic Questions

1. What to produce?
- refers to a productive activity of any society. The relative importance of human
needs and wants will have to be matched with the available resources for production.

- using the economy’s scarce resources to produce one thing requires giving up
another. Producing better education, for example, may require cutting back on other
services, such as health care. Every society must decide what it will produce given with
its scarce resources.
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2. How much to produce?

- concerned with the amount of goods and services that will be produced by the
society based on human wants, extent of wealth and technology used in production.

3. How will it be produced?

- there are all sorts of choices to be made in determining how goods and services
should be produced.
- focuses on the technology to be used, the process of combining resources, and also
the intensity of use of a resource relative with another resource.
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4. For whom to produce?

- if a good or service is produced, a decision must be made about who will get it. A
decision to have one person or group receive a good or service usually means it will
not be available to someone else.

Every economy must determine what should be produced, how and how much should
be produced, and for whom it should be produced.
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1.2 Branches of Economics

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Branches of Economics
The two main branches of economics are:
1. Microeconomics
2. Macroeconomics
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1. Microeconomics
- deals with the analysis on how the allocation of scare resources is conducted by
small economic units, sectors, and institutions in the economy.
- focuses on the actions of individual agents within the economy – like households,
workers, and businesses.
- give emphasis on the choices made by individual decision-making units in the
economy —typically consumers and firms — and the impacts those choices have on
individual markets.
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- What determines how households and individuals spend their budgets?

- What combination of goods and services will best fit their needs and wants, given
the budget they have to spend?
- How do people decide how much to save for the future, or whether they should
borrow to spend beyond their current means?
- What determines the products, and how many of each, a firm will produce and sell?
- What determines the prices a firm will charge?
- What determines how a firm will produce its products? What determines how many
workers it will hire?
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2. Macroeconomics
- looks at the economy as a whole and focuses on the impact of choices on the total,
or aggregate, level of economic activity.
- concerned about the allocation of scarce resources but takes the analysis at the
perspective of the entire economy.
- focuses on broad issues such as growth of production, the number of unemployed
people, the inflationary increase in prices, government deficits, and levels of exports
and imports.
- Central bank: Monetary policy, Government: Fiscal policy
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- What determines the level of economic activity in a society?

- What determines how many goods and services a nation actually produces?
- What determines how many jobs are available in an economy?
- What determines a nation’s standard of living?
- What causes the economy to speed up or slow down?
- What causes firms to hire more workers or to lay them off?
- What causes the economy to grow over the long term?
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1.3 The Economists’ Tool Kit

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Scientific method in Economics

Scientific Method:
1. Formulation of the problem - arise from existing issues or problems
2. Establishing hypothesis - can be accepted or rejected
3. Gathering data and information – historical approach, experimental approach, or
other methods
4. Treatment and analysis of data - use of statistics
5. Interpretation of results together with the conclusion - accept or reject
hypothesis based on the results of the analysis of data
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Using theories and models

- a theory is a simplified representation of how two or more variables interact with
each other.
- a model is a set of simplifying assumptions about some aspect of the real world,
given its complexity, economists make several assumptions which can sometimes
make the model unrealistic.
- despite shortcomings, their simplicity and logic is important in making a general
view on what is happening in the economy.
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Sometimes economists use the term model instead of theory.

Strictly speaking, a theory is a more abstract representation, while a model is more

applied or empirical representation.
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Use of Mathematics
- mathematics is used because it is very effective in describing the relationships of
economic variables and actors by means of equations to simplify complicated
concepts and relationships.

- to prevent misconceptions and confusions in the meaning of a certain theory.

Mathematics is used because it is more effective in giving formal, exact, and simple
illustration of a theory.
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Use of Graphs
- a 2-dimensional graph can
give a graphical illustration of
the relationship between 2
economic variables.
- Economists often use graphs
to represent economic models

Image source: https://www.investopedia.com/terms/s/supply-curve.asp

In this case, the graph shows a positive/direct relationship

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Use of Statistical Analysis

- to measure whether economic relationships are true in reality, there is a need to
empirically test these models.

- Econometrics is a branch of statistics used to empirically test the statistical

significance of these economic relationships
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Prediction and Ceteris Paribus

- “Ceteris Paribus” is a Latin phrase that translates to "holding other things
constant" or “all other things unchanged”.

For example, demand of a product is affected by different factors including the price
of the product, price of other products, income, taste and preference, etc. If we want
to single out the effect of price on the demand of the product, we have to make an
assumption that other factors are not changing while the price of the commodity is
changing.
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1.4 The Circular Flow

Diagram
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The Circular Flow Diagram

- a good model to start with in the study of economics
- pictures the economy as consisting of two groups—households and firms—that
interact in two markets:
1. goods and services market in which firms sell and households buy and
2. the labor market in which households sell labor to business firms

- demonstrates how money moves from producers to households and back again in
an endless loop.
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The circular flow diagram shows how

households and firms interact in the
goods and services market, and in
the labor market.

The direction of the arrows shows that

in the goods and services market, households
receive goods and services and pay firms for
them. In the labor market, households provide labor and receive payment from firms
through wages, salaries, and benefits.
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1.5 The Production

Possibilities Frontier
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The Production Possibilities Frontier (PPF)

- a graph that shows the combinations
of output that the economy can
possibly produce given the available
factors of production and the
available production technology.

Image source: https://www.investopedia.com/terms/p/productionpossibilityfrontier.asp

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- in business analysis, the production possibility frontier (PPF) is a curve illustrating the
varying amounts of two products that can be produced when both depend on the
same finite resources.

- the PPF demonstrates that the production of one commodity may increase only if
the production of the other commodity decreases.

- the PPF is a decision-making tool for managers deciding on the optimum product
mix for the company.
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Point X: Attainable but inefficient

Point Y: Unattainable and inefficient

Points A, B, and C are attainable and at the

same time efficient

Image source: https://www.investopedia.com/terms/p/productionpossibilityfrontier.asp

The curve is sloping downward (convex) which
implies that in order to produce more of one good, the other should be lessened.
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1.6 Factors of Production

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Factors of Production
- choices concerning what goods and services to produce are choices about an
economy’s use of its factors of production, or the resources available to it for the
production of goods and services.

- the value, or satisfaction, that people derive from the goods and services they
consume and the activities they pursue is called utility

- when an economy’s factors of production create utility; they serve the interests of
people.
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The factors of production in an economy are:

1. Labor
2. Capital
3. Land and natural resources
4. Entrepreneurial skills and technology
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1. Labor
- the human effort that can be applied to the production of goods and services.
- people who would like to work but have not found employment (unemployed) —are
also considered part of the labor available to the economy.

The amount of labor available to an economy can be increased in two ways.

1. Increase the total quantity of labor, either by increasing the number of people
available to work or by increasing the average number of hours of work per week.
2. Increase the amount of human capital possessed by workers.
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Human capital
- the skills a worker acquired as a result of education, training, or experience that can
be used in production

Students who are attending a college or university are acquiring human capital.
Workers who are gaining skills through experience or through training are acquiring
human capital.
Children who are learning to read are acquiring human capital.
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2. Capital
- does not consist solely of physical objects
- capital may thus include physical goods and intellectual discoveries. Any resource is
capital if it satisfies two criteria:
1. The resource must have been produced.
2. The resource can be used to produce other goods and services.

One thing that is not considered capital is money. A firm cannot use money directly
to produce other goods, so money does not satisfy the second criterion for capital.
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Firms can, however, use money to acquire capital. Money is a form of financial capital.

Financial capital includes money and other “paper” assets (such as stocks and bonds)
that represent claims on future payments.

These financial assets are not capital, but they can be used directly or indirectly to
purchase factors of production or goods and services.
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3. Land and natural resources

There are two essential characteristics of natural resources:

1. They are found in nature - that no human effort has been used to make or alter
them.

2. They can be used for the production of goods and services - which requires
knowledge; and we must know how to use the things we find in nature before they
become resources.
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Consider oil. Oil in the ground is a natural resource because it is found (not
manufactured) and can be used to produce goods and services.

However, 250 years ago, oil was a nuisance, not a natural resource. Pennsylvania
farmers in the eighteenth century who found oil oozing up through their soil were
dismayed, not delighted. No one knew what could be done with the oil. It was not
until the mid-nineteenth century that a method was found for refining oil into
kerosene that could be used to generate energy, and thus transforming oil into a
natural resource.
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The natural resources available to us can be expanded in three ways:

1. Discovery of new natural resources
2. Discovery of new uses
3. Discovery of new ways to extract natural resources in order to use them

Defining something as a natural resource only if it can be used to produce goods and
services does not mean that a tree has value only for its wood or that a mountain has
value only for its minerals. If people gain utility from the existence of a beautiful
wilderness area, then that wilderness provides a service and is thus, a natural resource.
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4. Technology and Entrepreneurship

Goods and services are produced using the factors of production available to the
economy. Two things play a crucial role in putting these factors of production to work:

1. Technology - the knowledge that can be applied to the production of goods and
services.
2. Entrepreneur - a person who, operating within the context of a market economy,
seeks to earn profits by finding new ways to organize factors of production.
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The interplay of entrepreneurs and technology affects all our lives. Entrepreneurs put
new technologies to work every day, changing the way factors of production are used.

Farmers and factory workers, engineers and electricians, technicians and teachers all
work differently than they did just a few years ago, using new technologies introduced
by entrepreneurs.

We can dispute whether all the changes have made our lives better. What we cannot
dispute is that they have made our lives different.
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References:
Greenlaw, S. A., Shapiro D., (2017). Principles of Economics, 2 nd Edition. OpenStax – Rice University
Principles of Economics (2016). University of Minnesota Libraries Publishing Edition
 THANK YOU!

Ian Dave B. Custodio Western Leyte College

Part-time Instructor College of Accountancy and Business
Western Leyte College A. Bonifacio St., Ormoc City, Leyte
E-mail: [email protected] E-mail: [email protected]
Website: iandavecustodio.github.io Website: wlcormoc.edu.ph
Telephone (Office): (053) 563 7064 local 1121 Telephone: (053) 561 5310 / 255-8549