Economics for Managers (ECO1708)

L01 – An Introduction
Prawesh Singh
[email protected]
An Introduction
Ten Principles of Economics
 What is
Economics?
Economics is
the study of
everything!
Let's get started!
• What kinds of questions does
economics address?
In this lecture,
• What are the principles of how people
look for the make decisions?
answers to
• What are the principles of how people
these interact?
questions:
• What are the principles of how the
economy as a whole works?
What is Economics all about?

Scarcity refers to the limited nature of society’s resources.

Economics is the study of how society manages its scarce resources,

including:
• how people decide how much to work, save and spend, and what to
buy
• how firms decide how much to produce how many workers to hire
• how society decides how to divide its resources between national
defense, consumer goods, protecting the environment, and other needs
How People Make Decisions

Decision making is at the heart of

economics.

The first four principles deal with

how people make decisions.
How People Make Decisions

Principle 1: People Face Tradeoffs

All decisions involve tradeoffs. For example,

• Going to a party the night before your midterm leaves less time for
studying.

• Having more money to buy stuff requires working longer hours,

which leaves less time for leisure.

• Protecting the environment requires resources that might otherwise

be used to produce consumer goods.
How People Make Decisions

Principle 1: People Face Tradeoffs

• Society faces an important tradeoff: Efficiency vs. Equity

• Efficiency: getting the most out of scarce resources

• Equity: distributing prosperity fairly among society’s members

• Tradeoff: To increase equity, can redistribute income from the well-

off to the poor. But this reduces the incentive to work and produce
and shrinks the size of the economic “pie.”
How People Make Decisions

Principle 2: The Cost of Something Is What You

Give Up to Get It

• Making decisions requires comparing the costs and benefits of

alternative choices.

• The opportunity cost of any item is whatever must be given up to

obtain it.

• It is the relevant cost for decision making.

How People Make Decisions

Principle 2: The Cost of Something Is What You

Give Up to Get It

For example, The opportunity cost of…

…going to college for a year is not just the tuition, books, and fees, but
also the foregone wages.

…seeing a movie is not just the price of the ticket, but the value of the
time you spend in the theater.
How People Make Decisions

Principle 3: Rational People Think at the Margin

• A person is rational if she systematically and purposefully does the
best she can to achieve her objectives.

• Many decisions are not 'all or nothing’ but involve marginal changes
– incremental adjustments to an existing plan.

• Evaluating the costs and benefits of marginal changes is an

important part of decision making.
How People Make Decisions

Principle 3: Rational People Think at the Margin

For example,
• A student considers whether to go to college for an additional year,
comparing the fees & foregone wages to the extra income he could
earn with an extra year of education.

• A firm considers whether to increase output, comparing the cost of

the needed labor and materials to the extra revenue.
How People Make Decisions

Principle 4: People Respond to Incentives

• Incentive: something that induces a person to act, i.e. the prospect of

a reward or punishment.

• Rational people respond to incentives because they make decisions

by comparing costs and benefits. Examples:
§ In response to higher gas prices, sales of ‘hybrid’ cars (e.g., Toyota
Prius) rise.
§ In response to higher cigarette taxes, teen smoking falls.
How People Interact

An economy is just a group of

people interacting with each other.

The next three principles deal with

how people interact.
How People Interact

Principle 5: Trade Can Make Everyone Better Off

• Rather than being self-sufficient, people can specialise in producing
one good or service and exchange it for other goods.

• Countries also benefit from trade & specialisation:

§ Get a better price abroad for goods they produce
§ Buy other goods more cheaply from abroad than could be
produced at home
How People Interact

Principle 6: Markets Are Usually A Good Way to

Organise Economic Activity

• A market is a group of buyers and sellers. (They need not be in a

single location.)

• 'Organise economic activity' means determining:

What goods to produce
How to produce them
How much of each to produce
Who gets them
How People Interact

Principle 6: Markets Are Usually A Good Way to

Organise Economic Activity

• In a market economy, these decisions result from the interactions of

many households and firms.

• Famous insight by Adam Smith in The Wealth of Nations (1776):

Each of these households and firms acts as if 'led by an invisible
hand' to promote general economic well-being.
How People Interact

Principle 7: Governments Can Sometimes Improve

Market Outcomes

Important role for Govt: Enforce property rights (Through police & courts)

People are less inclined to work, produce, invest, or purchase if large risk
of their property being stolen.
• A restaurant won’t serve meals if customers do not pay before they
leave.
• A music company won’t produce CDs if too many people avoid
paying by making illegal copies.
How People Interact

Principle 7: Governments Can Sometimes Improve

Market Outcomes

• Govt may alter market outcome to promote efficiency.

• Market failure: When the market fails to allocate society’s resources

efficiently. Causes:
• Externalities: When the production or consumption of a good affects
bystanders. (E.g. pollution)
• Market power: A single buyer or seller has substantial influence on
market price. (E.g. monopoly)
In such cases, public policy may increase efficiency.
How People Interact

Principle 7: Governments Can Sometimes Improve

Market Outcomes

• Govt may alter market outcome to promote equity.

• If the market’s distribution of economic well-being is not desirable,

tax or welfare policies can change how the economic 'pie' is divided.
How the Economy as a Whole
Works

The last three principles deal with

the economy as a whole.
How the Economy as a Whole Works

Principle 8: A country’s standard of living depends

on its ability to produce goods & services

Huge variation in living standards across countries and over time:

• Average income in rich countries is more than ten times average
income in poor countries.

• The U.S. standard of living today is about eight times larger than 100
years ago.
How the Economy as a Whole Works

Principle 8: A country’s standard of living depends

on its ability to produce goods & services

• The most important determinant of living standards: productivity, the

amount of goods and services produced per unit of labor.

• Productivity depends on the equipment, skills, and technology

available to workers.

• Other factors (E.g., labor unions, competition from abroad) have far
less impact on living standards.
How the Economy as a Whole Works

Principle 9: Prices rise when the government prints

too much money

• Inflation: increases in the general level of prices.

• In the long run, inflation is almost always caused by excessive

growth in the quantity of money, which causes the value of money to
fall.

• The faster the Govt. creates money, the greater the inflation rate.
How the Economy as a Whole Works

Principle 10: Society faces a short-run tradeoff

between inflation and unemployment

• In the short-run (1 – 2 years), many economic policies push inflation

and unemployment in opposite directions.

• Other factors can make this tradeoff more or less favourable, but the
tradeoff is always present.
Summary
• People face tradeoffs.

The principles • The cost of any action is measured in

terms of foregone opportunities.
of decision
making are: • Rational people make decisions by
comparing marginal costs and marginal
benefits.

• People respond to incentives.

Summary
• Trade can be mutually beneficial.

The principles • Markets are usually a good way of

coordinating trade.
of interactions
among people • Govt. can potentially improve market
outcomes if there is a market failure or
are: if the market outcome is inequitable.
Summary
• Productivity is the ultimate source of
living standards.
The principles
• Money growth is the ultimate source of
of the economy inflation.
as a whole are:
• Society faces a short-run tradeoff
between inflation and unemployment.
Thank You!