MANAGERIAL ECONOMICS

CHAPTER 1 (PART 1): TEN PRINCIPLES OF ECONOMICS

Economy: Greek word oikonomos, meaning “one who manages a household”
Scarcity: the limited nature of society’s resources
: kakulangan, insufficient supply of resources
Economics: the study of how society manages its scarce resources
: In most society, resources are allocated through the combined actions of millions of households and
firms.
: 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.
 Analyze forces and trends that affect the economy as a whole, including growth in average
income, the fraction of the population that cannot find work, and the rate at which the prices are
rising.

HOW PEOPLE MAKE DECISIONS

Principle 1: People Face Trade-offs
“There ain’t no such thing as free lunch.”
To get one thing that we like, we usually give up something else that we like. Making decisions means trading off
one goal for another.

A trade-off society faces: efficiency and equality.

Efficiency: the property of society getting the most it can from its scarce resources
: getting the maximum benefit out of something limited
: refers to the size of the economic pie
Equality: the property of distributing economic prosperity uniformly among the members of society
: how fairly resources are divided
: refers to how the pie is divided into individual slices

If we want to achieve equality, we have to give up efficiency (trade-off efficiency for equality). We have to take
resources from those people who earned it to give to those who did not earn it, but needs it. For example,
government taxes, the government deducts a certain amount of tax from professionals so they can use it to help
those who are in need.

Principle 2: The Cost of Something Is What You Give Up to Get It

Making decisions requires comparing the costs and benefits of alternative courses of action. There is always a
cost to do something or to get something.
Opportunity cost: whatever must be given up to obtain some item
: it does not only refer to the monetary cost of getting the item, opportunity cost refers to every factor that
you have to give up in order to get something (the effort, the time it took, or the next best alternative); the
money is only part of what you give up

Principle 3: Rational People Think at The Margin

Margin: edge of decision making
Rational people: people who systematically and purposefully do the best they can to achieve their objectives
Marginal change: a small incremental adjustment to a plan of action

Marginal benefit vs. marginal cost

: You take an action or make a decision if and only if the marginal benefit is bigger than the marginal
cost. It does not matter how high/big each margin is on their own, what matters is how relevant they are
to each other.

Principle 4: People Respond to Incentive

Incentives: something that induces a person to act (a punishment or a reward)
Note: not everyone reacts to the same incentive, what you see as a reward or a good incentive may not
induce the same reaction for others.
Example: The price of apple increases, naturally you as a consumer would buy/consume less, but it would make the
suppliers/producers supply more of the good for more profit.
If the cost of something increases:

-
-
You as a consumer would buy less.
Sellers see it as an opportunity to earn more, and thus, they would sell more.

HOW PEOPLE INTERACT

Principle 5: Trade Can Make Everyone Better Off
: Trade is not a zero-sum game, where one wins, and the other loses. Both side wins in a trade.
Think of things you would not have if you don’t trade and you just isolate yourself. It would mean that
you’d have to grow your own food, make your own clothes, provide yourself with other necessities like
electricity, education, and etc.
Trade also allows each firm to be better at what they do or they produce due to the presence of
competition, and allows for more variety of goods available.

Principle 6: Markets Are Usually a Good Way to Organize Economic Activity

Market economy: an economy that allocates resources through the decentralized decisions of many firms and
households as they interact in markets for goods and services
: market forces (supply and demand) direct the production of goods and services
: Sellers are allowed to sell whatever they want as long as it is within the bounds of the laws. And buyers are
allowed to buy whatever they want as long as it is within the bounds of the law, (meaning not illegal.)

Principle 7: Governments Can Sometimes Improve Market Outcomes

The invisible hand can only work its magic only if the government enforces the rules and maintains the
institutions that are key to a market economy.
Property rights: the ability of an individual to own and exercise control over scarce resources
: Governments are needed to enforce rights on things that are produced and bought. A seller would
not sell goods if they expect it to be stollen.

Market failure: a situation in which a market left on its own fails to allocate resources efficiently
One possible cause of market failure:
Externality: the impact of one person’s actions on the well-being of a bystander
Market power: the ability of a single economic actor (or small group of actors) to have a
substantial influence on market prices

HOW THE ECONOMY WORKS AS A WHOLE

Principle 8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services
Productivity: the quantity of goods and services produced from each unit of labor input
: The more productive people are in producing goods and services for the nation, the faster they gain
revenue and the richer they get. The richer they get, the higher their standard of living is.

Formula for unit of labor input:

Unit of labor = total labor cost ÷ total units produced

Principle 9: Prices Rise When the Government Prints More Money

Inflation: an increase in the overall level of prices in the economy
When the amount of money in the economy increases, it stimulates the overall level of spending and
thus demand for more goods and services.
: more money puts an upward pressure on prices
The more money the consumers have, the more goods they purchase and the more they demand, the higher the
demand of goods the higher the price of the goods, the higher the prices of goods the more supply there is
available, because the sellers would want higher revenue.

Principle 10: Society Faces a Short-run Tradeoff Between Inflation and Unemployment
: If the government tries to reduce inflation, it may lead to higher unemployment
Reducing inflation would mean lowing the prices of goods, lowering the price of goods would mean less revenue for
firms, and less revenue for firms might induce them to employ less workers leading to higher unemployment.
Business cycle: fluctuations in economic ability, such as employment and production

(PART 2): THINKING LIKE AN ECONOMIST

THE ECONOMMIST AS SCIENTIST

Much like scientist, economists use theories, collect data, and analyze these data in an attempt to verify
of refute their theories.
The Scientific Method: Observation, Theory, and More Observation
Economists observe their surroundings so they can develop theories, once they have a theory, they would use more
observation to verify the theory by using experiments—natural experiments offered by history (because
conducting experiments in a laboratory would not work).

The Role of Assumption

Using assumptions can simplify the complex world and make it easier to understand.

Economic Models
: Economists use models composed of diagrams and equations.
: All models are built with assumption.
Our First Model: The Circular Flow Diagram
: a visual model of the economy that shows how
dollars flow through markets among households
and firms

Our Second Model: The Production

Possibilities Frontier
: 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

THE TWO FIELDS OF ECONOMICS: Microeconomics and Macroeconomics

Microeconomics
 : The study of how households and firms make decisions and how they interact in markets
Macroeconomics
: The study of economywide phenomena, including inflation, unemployment, and economic growth

THE ECONOMIST AS POLICY ADVICER

Positive versus Normative Analysis
Positive statements
: claims that attempt to describe the world as it is
Normative statements
: claims that attempt to prescribe how the world should be

Why Economists’ Advice Is Not Always Followed

WHY ECONOMISTS DISAGREE

 Economists may disagree about the validity of alternative positive theories about how the world works.
 Economists may have different values and therefore different normative views about what policy should
try to accomplish.

Differences in Scientific Judgements

Differences in Values
Perception versus Reality
CHAPTER 2: THE MARKET FORCES OF SUPPLY AND DEMAND
Supply and Demand: the two forces that make market economies work. They determine the quantity of each
good produced and the price at which it is sold.
: refers to the behavior of the people as they interact with one another in competitive markets.

What Is a Market?
Market: a group of buyers and sellers of a particular good or service.
: Buyers, determine the demand for the product
: Sellers, determine the supply of the product
: Some are highly organized, like farmers market or the fish market, where buyers and sellers meet at a
specific time and place.
: Other markets are less organized, like ice cream vendors, buyers and sellers do not have a specific time
and place where they meet.

What Is Competition?
Most markets in the economy are highly competitive, each buyer knows that there are several sellers
from which to choose, and each seller is aware that his/her product is similar to that offered by other
sellers. As a result, the price of the product and the quantity sold are not determined by a single buyer
or seller. Rather, price and quantity are determined by all buyers and sellers as they interact in the
marketplace.
Competitive market: a market in which there are many buyers and sellers so that each has a negligible impact
on the market price
 Perfectly competitive: many sellers and many buyers, the goods offered are al exactly the same
 Monopoly: a market with only one seller of a particular good, and the seller sets the price

Demand
Quantity demanded: the amount of a good that buyers are willing and able to purchase
Law of demand: the higher the price the lower the quantity demanded
Demand schedule: a table that shows the relationship between the price of a good and the quantity demanded
Demand curve: a graph of the relationship between the price of a good and the quantity demanded
: relationship of price and quantity demanded is indirect/inverse, downward slope

Market Demand versus Individual Demand

: the sum of all individual demand for a particular good or service
Shifts in the Demand Curve
: shifts to the right – increase in demand
: shifts to the left – decrease in demand
 Variables that can shift the demand curve:
Income
 Normal good: an increase in income leads to an increase in demand
 Inferior good: an increase in income leads to a decrease in demand
Price of Related Goods
: a fall in the price of one good reduces the demand for another good
 Substitutes: two goods for which an increase in the price of one lead to an increase in the
demand for the other
: a fall in the price of one good raise the demand for another good
 Complements: two goods for which an increase in the price of one lead to a decrease in
the demand for the other
Tastes
: if you like the good, you buy more of it
Expectations
: your expectations about the future
: if you expect the price of the good to fall tomorrow, you may be less willing to buy one at
today’s price
Number of Buyers
: market demands depend the number of buyers

Supply
Quantity supplied: the amount of good that sellers are willing and able to sell
Law of supply: the higher the price the higher the quantity supply
Supply schedule: a table that shows the relationship between the price of a good and the quantity supplied
Supply curve: a graph that shows the relationship between the price of a good and the quantity supplied

Market Supply versus Individual Supply

: the sum of the supplies of all sellers
Shifts in the Supply Curve
: shifts to the right – increase in supply
: shifts to the left – decrease in supply

Variables that can shift the supply curve:

Input prices
: when the price of one of the inputs (raw materials) rises, producing is less profitable, and firms
supply less of the good
 Technology
: the use of technology, like machines, in producing a good reduces the labor necessary, thus
reducing the cost. The advance technology raises the supply of a good
Expectations
: the amount of good supplied by the firm today may depend on its expectations, if a firm expects
the price of the good to increase in the future, it will put some of its current production into
storage and supply less to the market today
Number of sellers
: market supply depends on the number of sellers

Equilibrium
: a situation in which the market price has reached the level at which quantity supplied equals quantity
demanded
Equilibrium price: the price that balances quantity supplied and quantity demanded
Equilibrium quantity: the quantity supplied and the quantity demanded at the equilibrium price
Surplus: a situation in which quantity supplied is greater than quantity demanded
Shortage: a situation in which quantity demanded is greater than quantity supplied

Law of supply and demand

: the claim that the price of any good adjusts to bring the quantity supplied and quantity demanded for
that good into balance
CHAPTER 3: ELASTICITY AND ITS APPLICATIONS

The law of demand, “as price rise, quantity demanded falls”.

Elasticity: measure of the responsiveness of quantity demanded or supplied to a change in one of its
determinants.
Demand for good is:
Elastic - if the quantity demanded responds substantially to changes in the price.
Inelastic - if the quantity demanded responds only slightly to changes in the price.

Price Elasticity of Demand (PED): a measure of how much the quantity demanded responds to a change in the
price.

Influencers of price elasticity of demand:

- Elastic
1. Availability of close substitute

- Inelastic; elastic
2. Necessities vs. luxuries

- Narrow: elastic
3. Definition of the market

- Broad: inelastic

- More elastic over longer time horizons

4. Time horizon

Computing PED:
%ΔQ
PED =
%ΔP
Using mid-point method:
Q 2−Q 1
Q2−Q2 [ ]
2
PED =
P 2−P 1
P2−P1 [ ]
2

The Variety of Demand Curves

Perfectly Inelastic Demand: E = 0 Inelastic Demand: E < 1
Unit Elastic Demand: E = 1 Elastic Demand: E > 1

Perfectly Elastic Demand: E = ∞

Total Revenue and the Price Elasticity of Demand

Total revenue is the amount paid by the buyers and received by the sellers. Computed as the
price of the good multiplied by the quantity sold. (P × Q = TR)

Income Elasticity of Supply (IED): measurement of percent increase in the quantity demanded of goods and
services when there is a percent change in the income
%ΔQ
IED =
%Δ I
Using mid-point method:
Q 2−Q 1
Q2−Q2 [ ]
2
IED =
I 2−I 1
I 2−I 1 [ ]
2

Cross-Price Elasticity of Demand (CPED): a measurement of percent increase in the quantity demanded
when there is a percent increase in the price of related goods of a commodity
 Complementary good
 Substitute good
%ΔQdX
CPED =
%Δ PY
Using mid-point method:
CPED = (Q𝑦2 – Qy1) / [(Q𝑦2 + Qy1)/2] ÷ (Qx2 – Qx1) / [(Qx2 + Qx1)/2]

Price Elasticity of Supply (PES): measure of percent increase in the quantity supplied when there is a percent
increase in the price
%ΔS
PES =
%Δ P
Using mid-point method:
S 2−S 1
S 2−S 2 [ ]
2
PES =
P2−P1
P 2−P1 [ ]
2

The Variety of Supply Curves

CHAPTR 4: SUPPLY, DEMAND, and GOVERNMENT POLICIES

Economists have two roles:

1. Scientist – develop and test theories to explain the world around them.
2. Policy Advisers – use their theories to help change the world for the better

Controls on Prices
Price Ceiling – a legal maximum on the price at which a good can be sold.
Example: rent-control laws dictate the maximum rent that landlords may charge tenants.
Price Floor – a legal minimum at which the price of a good can be sold.
Example: minimum-wage laws dictate the lowest wage that firms may pay workers.

How Price Ceiling Affects Market Outcomes

 Price ceiling above equilibrium: not binding
 Price ceiling below equilibrium: binding, causes shortage in the market

Rent control in the short run and the long run:

In the short run, landlords have a fixed number of apartments to rent, and they cannot adjust this number
quickly as market conditions change. Moreover, the number of people searching for housing in a city may not be
highly responsive to rents in the short run because people take time to adjust their housing arrangements.
Therefore, the short-run supply and demand for housing are relatively inelastic and the initial shortage caused
by rent control is small.
The long-run story landlords respond to low rents by not building new apartments and by failing to maintain
existing ones and also low rents encourage people to find their own apartments and induce more people to
move into a city. Therefore, both supply and demand are more elastic in the long run and the shortage caused by
rent control is large.

How Price Floor Affects Market Outcome

 Price floor above equilibrium: binding
 Price floor below equilibrium: not binding, causes surplus in the market

Minimum wage:
Just like rent control sets a ceiling on what landlords can charge for rent, a minimum wage sets a floor on the
lowest pay workers can legally receive. In the short-run, this ensures workers earn a living wage, providing
immediate financial relief for low-income earners. Yet, in the long-run, it can result in fewer job opportunities
as employers may cut back on hiring due to increased labor costs. Small businesses might struggle, and some
companies could turn to automation to save costs, potentially reducing job availability even further.
The minimum wage is not the best way to combat poverty. A high minimum wage causes following:
ii. Unemployment
iii. Encourages teenagers to drop out of school
 iv. Prevents some unskilled workers from getting the on-the job training they need.

Why economists usually oppose price ceilings and price floors

To economists, prices are not the outcome of some haphazard process. Prices are the result of the
millions of business and consumer decisions that lie behind the supply and demand curves. Prices have
the crucial job of balancing supply and demand and, thereby, coordinating economic activity. When
policymakers set prices by legal decree, they obscure the signals that normally guide the allocation of
society’s resources as a result price controls often hurt those governments are trying to help such as
poor or middle-income people.

How policy makers can help poor or middle-income people from price control
Policy makers can provide subsidies such as rent subsidies, wage subsidies (earned income tax credit). Unlike
price control, such subsidies do not reduce or increased the quantity supplied or demanded and therefore do
not lead to shortage or surplus

Taxes
Why policy makers enact tax? types of tax?
Policy makers use taxes to:
I. Raise revenue for public purposes
II. Influence market outcomes.
There are basically two types of tax:
I. Tax on buyers
II. Tax on sales

Tax incidence: the manner in which the burden of a tax is shared among participants in a market
There are Three Steps of calculating Tax incidence:
Step One: Decide whether the law affects the supply curve or demand curve.
Step Two: Decide which way the curve shifts
Step Three: Examine how the shift affects the equilibrium price and quantity.

How taxes on sellers affect market outcomes

 The tax reduces the size of the market. When a good is taxed, sellers sell less and buyers buy less as a result the
equilibrium quantity will reduce. Buyers and sellers share the burden of taxes. In the new equilibrium, buyers
pay more for the good, and sellers receive less.

Compare and contrast between tax on buyer and tax on seller

Taxes levied on sellers and taxes levied on buyers are equivalent, in both cases following things will happen:
• The tax places a wedge between the price that buyers pay and the price that sellers receive
 • The tax reduces the size of the market. When a good is taxed, Sellers sell less and buyers buy less as a
result the equilibrium quantity will reduce.
• Buyers and sellers share the burden of taxes. In the new equilibrium, buyers pay more for the good,
and sellers receive less.
The only difference between taxes on sellers and taxes on buyers is who sends the money to the government

The incidence of a tax depends on what things why?

The incidence of a tax depends on the price elasticities of supply and demand. Most of the burden falls on the
side of the market that is less elastic because that side of the market can respond less easily to the tax by
changing the quantity bought or sold.
• When supply inelastic but demand elastic then most of the burden will fall to supplier such as taxes on luxury.
• When Supply elastic but demand inelastic the then most of the burden will fall to buyer such as taxes on
necessity products.

CHAPTER 5: CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS

Welfare economics: the study of how the allocation of resources affects market well-being
Consumer surplus: the amount a buyer is willing to pay for a good minus the amount the buyer actually pays
for it
Willingness to pay: the maximum amount that a buyer is willing to pay for a good

- Measures the benefit that buyers receive from the good as the buyer themselves perceive it

Producer surplus: the amount a seller is paid for a good minus the sellers cost of providing it
Cost: the value of everything a seller must give up to produce a good
Marginal seller: seller who leaves market first if price were any lower

Market efficiency
The benevolent social planner: an all-knowing, all-powerful, well-intentioned dictator who wants to maximize
economic well-being of everyone

Consumer surplus = value to buyers – amount paid by buyers

Producer surplus = amount received by sellers – cost to sellers
Total surplus = (value to buyers – amount paid by buyers) + (amount received by sellers – cost to sellers)
Total surplus = value to buyers – cost to sellers

Efficiency: the property of a resource allocation of maximizing the total surplus received by all members of
society
Equality: the property of distributing economic prosperity uniformly among the members of society

Three insights:
Free markets;
1. Allocate supply of goods to buyers who value them most highly
2. Allocate the demand for goods to the sellers who can produce them at least cost
3. Produce the quantity of goods that maximises the sum of consumer and producer surplus i.e. the equilibrium
outcome is efficient

The cost of taxation:

A tax;
- Causes the buyer’s price to rise and sellers’ price to fall
- Causes quantity sold and bought to fall
- Allows government to collect revenues and fund goods and services for its civilians

We must take into account the effect of tax on the market participants:
1. Consumers
2. Producers
3. The government

CHAPTER 6: EXTERNALITIES
 I. Definition of externality: the uncompensated impact of one person’s actions on the well-being of a
bystander.
If the effect on the bystander is adverse, we say that there is a negative externality.
If the effect on the bystander is beneficial, we say that there is a positive externality.
Externalities cause markets to be inefficient, and thus fail to maximize total surplus.
II. Externalities and Market Inefficiency
a) Welfare Economics: A Recap
The demand curve for a product reflects the value of that product to consumers, measured
by the price that buyers are willing to pay.
The supply curve for a product reflects the cost of producing the product.
In a free market, the price of a good brings supply and demand into balance in a way that
maximizes total surplus (the difference between the total value to buyers and the total
costs to sellers).
b) Negative Externalities
 Example: an aluminium firm emits pollution during production.
 Social cost is equal to the private cost to the firm of producing the aluminium plus the
external costs to those bystanders affected by the pollution. Thus, social cost exceeds the
private cost paid by producers.
 The optimal amount of aluminium in the market will occur where total surplus is
maximized.
 Total surplus is equal to the value of aluminium to consumers minus the cost (social
cost) of producing it.
 This will occur where the social cost curve intersects with demand curve.

 Negative externalities lead markets to produce a larger quantity than is socially optimal.
 This negative externality could be internalized by a tax on producers for each unit of
aluminium sold.
 Internalizing an externality: altering incentives so that people take account of the external
effects of their actions.

c) Positive Externalities
  Example: education.
 If there is a positive externality, the social value of the good is greater than the private value.
 The intersection of the supply curve and the social-value curve determines the optimal
output level.
 Positive externalities lead markets to produce a smaller quantity than is socially optimal.
 To internalize a positive externality, the government could use a subsidy.

III. Public Policies toward Externalities

When an externality causes a market to reach an inefficient allocation of resources, the government can
respond in two ways: command-and-control policies (regulate behavior directly) and market-based policies
(provide incentives so that private decision makers will choose to solve the problem on their own.
a. Command-and-Control Policies: Regulation
Externalities can be corrected by making certain behaviors either required or forbidden.
Example: The Environmental Protection Agency (EPA) develops and enforces regulations aimed at protecting
the environment.
Environmental regulations can sometimes be: (1.) EPA dictates the maximum level of pollution that a
factory may emit; (2.) EPA requires firms to adopt a particular technology to reduce emissions.

b. Market-Based Policy 1: Corrective Taxes and Subsidies

 Externalities can be internalized through the use of taxes and subsidies.
 Corrective taxes: a tax designed to induce private decision makers to take account of the social costs
that arise from a negative externality
 Pigovian Taxes (Arthur Pigou, 1877-1959): a tax enacted to correct the effects of a negative
externality.
 Pigovian taxes are preferred by economists over regulations as a way to deal with pollution.
 Pigovian taxes can reduce pollution at a lower cost to society.
 Pigovian taxes give the factories incentives to develop cleaner technologies.
 Unlike other taxes, corrective taxes (Pigovian taxes) correct incentives for the presence of
externalities and thereby enhance economic efficiency, and raises revenue for the government.

c. Market-Based Policy 2: Tradable Pollution Permits

 Tradable pollution permits allow the voluntary transfer of the right to pollute from one firm to
another.
 A market for these permits will eventually develop.
 The final allocation will be efficient in this new market, whatever the initial allocation.
 Tradable pollution permits and Pigovian taxes are similar in effect. In both cases, firms must pay for
the right to pollute.
 In the case of a Pigovian tax, the government basically sets the price of pollution and firms then
choose the level of pollution (given the tax) that maximizes their profit.
 If tradable pollution permits are used, the government chooses the level of pollution (in total, for all
firms) and firms then decide what they are willing to pay for these permits.
  In some circumstances, selling pollution permits may be better than levying a Pigovian tax.

IV. Private Solutions to Externalities

We do not necessarily need government involvement to correct externalities.
 The Types of Private Solutions
o Moral codes and social sanctions.
o Charities
o Integrating different types of businesses
o Contracting between parties
 The Coase Theorem: the proposition that if private parties can bargain without cost over the allocation
of resources, they can solve the problem of externalities on their own.
o Whatever the initial distribution of rights, the parties involved in an externality can solve the
problem themselves and reach an efficient outcome where both parties are better off.
 Why Private Solutions Do Not Always Work
o Transaction costs: the costs that parties incur in the process of agreeing and following through
on a bargain.
o Coordination of all of the interested parties may be difficult so that bargaining breaks down.
This is especially true when the number of interested parties is large.