Basic Training

Shahadat Hossain, PhD

CU CBA
University of Chittagong
Chapter Two: Basic Training

Contents:
 Functional relationship,
 Economic model,
 Calculus and optimization,
 Regression analysis.
Functional Relationships;
Total, Average, and Marginal
 In mathematics, an equation of the form
y =f(x)
is read "y is a function of x." This means that the value of y depends on the
value of x in a systematic way and that there is a unique value of y for each
value of x.

Usually the variable on the left-hand side of the equation, in this case, is
called the dependent variable and

The variable on the right-hand side is called the independent variable.

 Of course, y may depend on two or more independent variables, such as
 Y = g(x,z)
 y = h(x1,x2 ..... xn) These are multivariate function
 In many economic models, a special set of functional
relationships called total, average and marginal functions is used,
Such functions are involved in the theory of demand, cost,
production, and market structure.
 The following example will help in understanding these
relationships. Suppose that there is a small building containing four
machines and a stock of raw materials ready to be processed. Ten
equally skilled and diligent workers are lined up outside ready to go
to work in this factory.
 If there are no workers, output will be zero. As workers are added,
output increases, The total amount of output associated with a
particular input of labor working with those four machines is called
the total product of labor.
 For example, the total product of one worker might be two units of
output. As the labor input changes, so does total output. An example
of a total product schedule is shown in the following table-
Number of Total Product Average Marginal
workers (L) (Q) Product Product
0 0 - -
1 2 2 2
2 5 2.5 3
3 9 3 4
4 14 3.5 5
5 22 4.4 8
6 40 6.7 18
7 57 8.1 17
8 63 7.9 6
9 64 7.1 1
10 63 6.3 -1
 As just indicated, one person working alone in this factory
produces two units of output.
 Adding a second person and organizing the production
system so that the workers complement each other results in
total product increasing to five units.
 The first worker is associated with a two unit increase in
output: having two workers instead of one will increase output
by three units: three workers will increase output by four
units: and so on.
 The change in output associated with a one unit change in
workers is called the marginal product of labor . Using the
Greek capital letter delta (∆) to indicate a change.
 The marginal product function (MP) can be defined as
MP= ∆Q/ ∆L
where Q represents output and L represents the input of
labor.
 The average product of labor function (AP)
measures the average output per unit of labor used.
Average product is found by dividing total product
by labor input. That is,
 AP= TP/L
Fig: Total product, average product and marginal
product
Fig: Total product, average
product and marginal product
Total Product (Q)
70

60
A= 57/7=8.14

50

40 Total Product (Q)

30

20

10

0
0 2 4 6 8 10 12
 There are important relationships among the three functions that are
true for all total, average, and marginal functions.
 First, the value of the average function at any point along that curve
is equal to the slope of a ray drawn from the origin to the total
function at the corresponding point. For example, from previous
table, it is known that the average product of six workers is 6.7.
Thus. the slope of a line (OA) drawn from the origin to point A on the
total product function has a slope of 6.7.
 Another key relationship is that the value of the marginal function
is equal to the slope of the line drawn tangent to the total function at
a corresponding point. For example, the slope of the dashed line
CD, which is drawn tangent to the total function at E, is about 4. This
means that the marginal product corresponding to this point (i.e.,
between 2 and 3 units of labor) is 4.
 Point F on the total function is called an inflection point. To the left of
point F, the total function is increasing at an increasing rate; to the
right of F, the total function is increasing but at a decreasing rate.
Note that this inflection point, corresponding to about six workers,
occurs at the point where the marginal product function is at a
maximum (i.e., point H in lower part).
 If the marginal and average functions intersect, that point of
intersection will be at the minimum or maximum point on the average
function. In the Figure, the intersection occurs at point G, which is the
maximum point of the average product function.
 If the marginal function is positive, the total function must be rising.
Note that it does not matter whether the marginal function is
increasing or decreasing, as long as it is positive.
 Conversely, if the marginal function is negative, the total function
must be declining. Again, it does not matter if marginal is rising or
falling.
 If marginal is negative, the total function will be declining. For the
data in Table and Figure , the marginal product is positive for the first
nine workers. It declines after the sixth worker but remains positive
through the ninth. Note that total product increases until the tenth
worker is added. The marginal product of the tenth worker is –1, and
this negative marginal product is associated with a decline in total
product.
 Because the total function increases as long as the marginal
function is positive and decreases when marginal is negative,
it follows that total product is at a maximum when the marginal
function is zero.
 In Figure the maximum of the total product function occurs at
nine workers. This point corresponds to the point where the
marginal function intersects the horizontal axis, that is, where
marginal changes from being positive to negative.
Economic Model
 In economics, graphs and/or equations are used to explain economic relationships
and phenomena and to predict the effects of changes in such economic parameters
as prices. wage rates and the price of capital.
 Although such models are abstractions from reality and may seem unrealistic, they
are useful in studying the way an economic system works. An economic decision
should not be made without having first analyzed its implications by using an
economic model.
 An economic model usually consists of several related functions, some restrictions
on one or more of the coefficients of these functions, and equilibrium conditions.
 Recall the concepts of supply and demand from introductory economics. As shown in
Figure in next slide the demand curve (DD) slopes downward from left to right and
shows the quantity of output that consumers are willing and able to , buy at each price.
 The negative Slope implies that , larger quantity is, demanded at lower prices than at
higher prices. The supply curve (SS) shows the amount that firms will produce and
offer for sale at each price. This curve has a positive slope because firms will supply
a larger quantity at higher prices than at lower prices.
Graphical presentation of Supply and
Demand analysis:
 Equilibrium in a market exists when the quantity demanded
equals the quantity supplied.
 This is shown graphically as the intersection of the demand and
supply functions in previous Figure .
 In this example, P*, and Q*, are the equilibrium price and
quantity, respectively.
 In equilibrium there is no incentive for buyers or sellers to
change price or the quantity.
 At point [P*, Q*], buyers' demands are met exactly and
suppliers are selling exactly the number of units they desire to
sell at that price.
 The preceding example is an economic model depicted
graphically. A simple algebraic model can be used to describe
exactly the same economic phenomenon.
 The quantity demanded (Qd) and the quantity supplied (Qs) are both
functions of price. That is,
Qd= f(P) and Qs= f(P)
 Suppose that the demand function is
Qd = a +bP where b < 0 ………….. E1 and
the supply function is
Qs = c + dP where d > 0 ……………. E2
The restrictions on the parameters (i.e., b < 0 and d > 0) simply mean
that the demand curve must slope downward (i.e., have a negative
slope) and that the supply curve must slope upward (i.e., have a positive
slope).
By adding an equilibrium condition that the quantity supplied equals the
quantity demanded, that is,
 Qd = Qs, ………………..E3
the economic model, consisting of equations E1, E2 and E3, is complete.
 The equilibrium price (P,) can be determined. Substituting equations

a+ bP = c + dP
 Solving for P, the equilibrium price is
 Pe=(c-a)/(b-d)
And the equilibrium quantity Qe is
Qe = a+ b(c-a)/(b-d)
If the values of the parameters a, b, c, and d are known,
the actual values of Pe, and Qe, can easily be calculated.
Example:
 Determine the equilibrium price and quantity
from the following demand and supply
function:
Qd= 14-2P
Qs= 2+ 4P
Probability and Probability
Distribution:
 Managers are often faced with making decisions that have the potential for
a variety of outcomes.
 An outcome is a possible result of some action. For example, flipping a coin
will result in one of two outcomes—heads or tails.
 A management decision to introduce a new product could result in a range
of outcomes varying from wide consumer acceptance to no interest
whatsoever.
 The quality of any decision will be enhanced by identifying the possible
outcomes of the decision and then estimating the relative chances of each
occurring.
 This listing of outcomes and the chance of each occurring is a probability
distribution that can be evaluated using quantitative techniques.
 Probability and probability distributions are an important part of the
manager’s tool kit.
Probability:

 The probability of an event is the relative frequency of its occurrence in a large

number of repeated trials.
 For example, in repeated tossing of a coin, a head will appear about one-half the
time. That is, the relative frequency or probability of a head occurring is 0.50.
 In rolling a tie, there are six possible outcomes, 1.2,3.4,5.6.The relative frequency of
any one of these outcomes is 1/6, implying a probability of 0.167 for each outcome.
 The probability of some events is known or can be computed with certainty. For
example, the probabilities of most outcomes associated with rolling dice, and tossing
coins are easily determined using standard principles of probability.
 Other probabilities are not easily determined mathematically but can be determined
by repeating the process many times and observing how many times particular
outcomes occur. For instance, there may be no mathematical way to estimate the
probability of winning a particular game. But by playing the game many times and
noting the number of times it is won, the probability of winning can be determined.
 In other cases there is no accurate way to estimate probabilities
except by using judgment.
 Assessing the probability of a recession next year or a significant
change in consumer preferences falls into the same category. Based
on an analysis of current economic conditions, surveys of business
capital-spending plans and other information, a judgment can be
made as to that probability.
 This judgment is necessarily subjective and may differ significantly
among analysts, but Predictions of this type are made daily by
business managers, economists. and other decision makers.
Probability Distribution:
 For a decision or an experiment of some type with several possible
outcomes, the probability of the ith outcome occurring is indicated by Pi
where
0≤Pi≤1, where i= 1,2,3,…………,n
 That is the probability must take on a value in the range 0 to 1
 The sum of the probabilities of all possible outcomes or events of an
experiment must equal 1.

 This means that when the experiment is conducted, one of the outcomes
must occur. It then follows that the probability that an event will not occur is
1 minus the probability that it will occur.
 For example, if the probability of a 6 occurring when rolling a die is 1/6, this
implies that the probability of not rolling a six is 1- (1/6)= 5/6
 A listing of each outcome of an experiment and its probability defines a
probability distribution.
 For example, the probabilities of tossing 0,1,2 or 3 heads in three tosses of a
coin are shown as in the following table. X i is the number of heads observed in
each experiment of three tosses.

Number of Heads (Xi) Probability (Pi)

0 0.125
1 0.375
2 0.375
3 0.125
Total 1.00

Fig: Probability Distribution (Probability associated with tossing a

coin three times)
Statistics of a Probability Distribution

 For any probability distribution, there is a set of statistics or measures that

describes or provides summary information about the distribution.
 The most important of these are measures of central tendency and dispersion.
These have many applications in business, science, and engineering.
 In managerial economics they can be used to evaluate and compare the
returns associated with alternative strategies and thus help to make sound
managerial decisions.
 Expected Value:
The first of these statistics is the expected value or mean of a
probability distribution. It is a weighted average of the outcomes
using the probabilities of those outcomes as weights.
The expected value is a measure of central tendency because in
repeated trials of most experiments, the values of the outcomes tend
to be concentrated around this statistic.
 The expected value (µ) of any probability distribution is computed by
multiplying each outcome by its respective probability and then
summing the products.
µ =P1X1+P2X2+………….+PnXn =

 Thus Recall the probability distribution for the number of heads

observed in three tosses of

 From the previous example:

µ= 0.125 x 0 + 0.375 x 1 + 0.375 x 2 + 0.125 x 3 = 1.50
It means that if this experiment were repeated many times and the
number of heads observed for each trial recorded the average
number of heads would be 1.50.
Standard deviation:
 The second statistic of interest measures the dispersion of possible
outcome around the expected value This measure is called the standard
deviation (σ) and is given by the equation.
σ=
From the previous example
σ =
= 0.87
Because the standard deviation provides information about the dispersion of
the individual values or outcomes around the expected value, this measure
of variation can be of use in decision making.
 Suppose that a manager was considering two investment
alternatives, A and B. The probability distributions for each are
shown in Figure in the next slide.
 Note that the expected value of profit (i.e., $100) is the same for
both, but there is a much greater range of outcomes for B than A.
 This implies that standard deviation of B is greater than standard
deviation of A (i.e., B is a riskier investment than A).
 Most decision makers will pick A, although there may be others who
would select B because of differences in their preference for risk.
Fig: Probability distribution for the profits
associated with two alternative investments
Co-efficient of Variation:
 The third statistic is the coefficient of variation, which relates the variation of
outcomes to the mean.
 It is defined as the ratio of the standard deviation to the expected value.
This statistic provides a useful way to compare the variation to the
expected value of a probability distribution.
 It measures variation per unit of expected value. The use of the coefficient
of variation can be illustrated by considering two probability distributions,
C and D, having the following statistics:
 µC=100 σC=50
 µD=50 σD= 30
 Both the mean and standard deviation for distribution C are greater than for
distribution D, but the coefficient of variation is less than for C than for D
That is,
 vC=50/100=0.5 <vD =30/50=0.6
 This means that distribution C has less dispersion or risk relative to its mean
than does distribution D.
The End