Economics Analysis and Business Decisions

XO-512

Resource Person: Khalil A. ArbiFor class assignment contact:

khalilarbi@gmail.comFor general purpose contact:

khalil.arbi@umt.edu.pk

University of Management and Technology LahoreSchool of Professional Advancement

University of Management and Technology Lahore

The dissection of the title• Economics: Greek word Oiko nomous• Analysis: analusis, ana, lysis (up, throughout-

loosning)• Business: Etymology is state of busy• Decision: A point for turn, based on a cognitive

process of future course of action

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What is Economics?

• Scarcity – a basic human dilemma– Limited resources vs. unlimited wants– The human condition requires making choices

• Definitions of Economics– N. G. Mankiw’s definition

• …is the study of how society manages its scarce resources

– Alternative definitions• …is how society chooses to allocate its scarce resources among

competing demands to improve human welfare• … is the study of choice.• .... is the study of understanding issues of production and

consumption of goods and services

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Economic Definition

• The Economics is the science that deals with the consequences of resources scarcity.

• The discipline of economics deals with use of scarce resources to satisfy human wants and needs how best to use the resources available.

• Economics is a social science that studies how individuals and organizations in society engage in– the production– distribution and– consumption of goods and services.

Objectives of Economics

1. To ensure prosperity and welfare of all human being on earth

2. Equal distribution of wealth

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• Fundamental Questions of Economics - Scarcity requires all societies to answer the following questions:– What is to be produced?

– How is to be produced?

– For whom will it be produced

WHFM Questions

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How Do Economists Study Human Behavior?

• Economics as a Science– The scientific method

• Observation→Theory→Data→Testing– Rational Behavior

• Weighing benefits and costs and maximizing total net benefits• Marginal vs. Total Thinking

– Economic Theory and Models• Simplification by assumption• Ceteris Paribus – Holding other factors constant• Prediction vs. realism

– Microeconomic versus Macroeconomics• Thinking on individual or firm level• Thinking on sector or country level

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– Bias towards use of natural rather than controlled experiments

– The specialized language of economics (e.g. “He has lots of money.”)

• Money – medium of exchange• Wealth – accumulated financial and non-financial assets• Income – the purchasing power earned during a given period

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Why do Economists Study Human Behavior?

• Scientists versus policy makers• Positive Economics

– Descriptive - what the world is like.– Objective- value judgments need not be made– Positive statements can theoretically be tested by

appealing to the facts • Normative Economics

– Prescriptive - what the world ought to be like– Subjective – value judgments must be made– Normative statements cannot be tested appealing to

facts.

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Categories of Basic Principles of Economics

• How do people make decisions?

• How do people interact?

• How does the economy work overall?

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How Do People Make Decisions?

• Principle #1 - People face tradeoffs– Time allocation – an example of tradeoffs– Efficiency versus equity– Production Possibilities Frontier

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• Principle #2 - The cost of something is what you have to give up to get it– Opportunity costs come from Von Weiser, a

German economist late 1800s– Opportunity costs are independent of monetary

units– TINSTAAFL– The real costs of going to college

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• Principle #3 - Rational people think at the margin– Rational or irrational decision-making– Marginal benefits and costs versus total

benefits and costs– Weighing marginal costs and benefits leads to

maximizing net benefits (total welfare)

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• Principle #4 –People respond to incentives– Reactions to changes in marginal benefits and costs

– Increases (decreases) in marginal benefits mean more (less) of an activity

– Increases (decreases) in marginal costs mean less (more) of an activity

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How Do People Interact?

• Principle #5 - Trade can make everybody better off– Adam Smith author of the “An Inquiry into the

Causes and Consequences of the Wealth of Nations” 1776

– Gains from the division of labor and specialization

– Mercantilists perspectives

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• Principle #6 - Markets are usually a good way of organizing economic activity– feudal times where feudal states were self-supporting, also

haciendas in the new world– the benefits of trade are so powerful that people began to

trade– markets for economists are more abstract than the notion of

a middle eastern bazaar or a flea market and simply determine the prices and quantities traded of different goods and services

– the “failure” of centrally planned economies and the movement towards markets for the WHFM questions

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Markets

– Principles 1-5 combine with markets to turn the pursuit of self-interest into promoting the interests of society

– Adam Smith and the “invisible hand”

– creativity and productivity are stimulated by the pursuit of self-interest into improving resource allocations

– “set it and forget it” becomes “compete or be obsolete”

– in some cases markets fail to allocate resources effectively so, need intervention (but minimized)

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• Principle #7 Governments can sometimes improve interaction that occurs in markets– there are circumstances when market signals fail to

allocate resources efficiently or equitably– Public Goods, Externalities and Income Distribution– Some goods or services that people desire will not be

produced by markets (e.g. lighthouses).– Some goods or services will either be underproduced

(vaccines or other necessary goods) or overproduced (pollution) because markets fails to register certain benefits or costs.

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– markets may also fail to provide an equitable or fair distribution of resources

– government intervention with its ability to coerce (the opposite of voluntary) can regulate, tax and subsidize to change market outcomes

– efficiency and equity: the pie analogy

– if government intervention always the proper solution?

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Factors of Production

The factors of production: land or natural resources, labor, capital, entrepreneurship

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• Principle #9 – The general level of prices rises when the government prints and distributes too much money– definition of money, a vehicle for exchange– inflation is an increase in the general or average level

of prices in an economy– “not worth a continental” and recent example in

Argentina– the establish of the Federal Reserve and the

introduction of sustained inflation in the US

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• Principle #10 – Society faces a short-run tradeoff between inflation and unemployment– Short-run and the long-run

– demand and supply shocks

– short-run increases (decreases) in output above (below) long-run potential output lead to adjustments

– countercyclical stabilization versus pro-cyclical destabilization

– political business cycles

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1. Economic Variables;

• Examples ( prices, costs, incomes, and quantities of commodities)

• Can be measured along a scale.

• Once appropriate unites of measurement have been chosen ( Riyals, visits, days).

Tools Used In Economic Analysis-i

Tools Used In Economic Analysis-ii

2. Relationships between economic variables;

• Relationship show how one variables changes in relation to another variable.

• The relationships can be specified in a causal or non-causal manner.

• Causal relationships – if …., then….

Tools Used In Economic Analysis-iii

3. Graphical representation of relationships;

• Step function is solid line relates diagrammatically to only specified values.

• We can draw a continuous curve joining all the points specified in the relationship.

Tools Used In Economic Analysis-iv

4. The direction of the relationships;

• Positive relationship.

• Opposite or negative relationship.

• Non-relation or constant relationship in “Y”.

• Non-relation or constant relationship in “X”.

0

2

4

6

8

10

12

1 2 3 4

constant Y

positive

negative

constant X

Tools Used In Economic Analysis-v

5. The slope of the relationships;

6. The position of the relationship;

7. The shape of the relationships;

8. The nature of economic propositions;

Types of Economics-i• Economics offers an overall viewpoint

about toward understanding many problems, all of which relate to scarcity in one form or another.

• Economics can be Macroeconomics or Microeconomics.• Various Disciplines in Economics: Environmental Economics,

Agricultural Economics, Institutional Economics

Types of Economics-iiA. Macroeconomics is the study of aggregate

economic activities, such as:1. The economy level of outputs;– We can measure that by some variables such as;

GDP, Rate of depression, Rate of slackness ..ets. – Real GDP is the market value of all final goods

and services produced in the domestic economy during a one year period measured with constant prices.

Types of Economics-iii Macroeconomics is the study of aggregate

economic activities, such as:2. Level of national income;– We can measure that by some variables

such as N.I.– National income (N.I) is the income earned

by the factors of production.– Income earned of the sold or consumed

GDP.

Types of Economics-iv• Macroeconomics is the study of aggregate

economic activities, such as:

3. Level of employment;– We can measure that by some variables such

as the rate of unemployment.

– The Rate of Unemployment is the percent of the total labor force which is unemployed.

Types of Economics• Macroeconomics is the study of aggregate

economic activities, such as:

4. General price level;– We can measure that by some variables such as

Inflation or Deflation Rate etc.

– Inflation is the annual rate of increase in a price index.

– Deflation is the annual rate of decrease in the price level.

Types of Economics-vB. Microeconomics the study of economic behavior

of individual decision making units such as:– Consumers– resource owners and – business firms in a free –enterprise economy.

• We can measure that by some studies such as market , pilot and feasibility studies.