mm session 1

8/4/2019 MM Session 1

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1

MICROECONOMICS FOR

MANAGERSYEAR 2011-12 TERM 1

RAHUL NILAKANTAN


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Rules of the game

Please be on time

No mobile phone or laptop usage

Class participation welcomed

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Say your name before you say anything else

Quantity / quality trade-off

Read before coming to classWe will not cover all the material from the book

ALL the material from the book can be tested


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Why Economics? Economics provides the intellectual foundations of

many management subjectsMarketing RUM, hedonic utility models

Strategy game theory / industrial organization

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OB & HR contract theory, information economics Finance asset pricing, auction theory

International Business international trade & finance

Understanding Economics concepts and toolsenhances managerial decision making

See SUV example in your book pg.14


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This course Textbook

Pindyck and Rubinfeld Evaluation

Mid-term exam 35%

4

n -term exam Surprise quizzes 20%

Class participation 10%

Makeup policy

Only if you were on leave with approval of PGP chair

Instructor will decide the nature of the makeup


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Session plan

Preliminaries

Basic economic concepts 1

Consumer behavior 2, 3

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Demand and supply analysis 4, 5

Elasticity of demand and supply 6

Impact of taxes and subsidies 7


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Session plan

Producers

Theory of production 8

Theory of cost 9, 10

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Profit maximization and competitive supply 11

Monopoly and market power 12, 13

Pricing with market power 14

Monopolistic competition and oligopoly 15, 16

Game theory and competitive strategy 17


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Principles of EconomicsCourtesy Tilman Slembeck (Univ. of St. Gallen)

Scarcity

Situation where needs exceed means Goods are not freely available to take Does scarce mean the same thing as rare?

Rationality

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Individual acts as ifbalancing costs against benefits toarrive at action that maximizes personal advantage Goal oriented behavior

Compare costs and benefits of alternatives

Preferences People can assign utilities to all options and choose the

option that maximizes net utility


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Operationalizing notion of rationality

Three managers are discussing a possible increase

in TV production. A: we should examine the effect of the increase on

productivity (TV output per worker)

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B: we should examine the effect of the increase onaverage cost of TVs

C: we should examine whether the extra revenue

exceeds the extra costs Who is on the right track and why?


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Principles of Economics Restrictions

Choice set is constrained e.g. budget constraint, non-negative profit constraint, etc.

Opportunity cost Cost of next best foregone alternative

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What is the opportunity cost of coming here for PGDM? The Economic Principle Application of rationality to situations of scarcity Maximize profit given input availability and prices

Minimize costs for a given level of output Maximize utility for given income

Minimize expenditure for given utility


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Principles of Economics Efficiency

In production (Economic Principle) or in distribution(Pareto criterion)

Marginal analysis

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Analyze decisions in terms of marginal benefits andmarginal costs

Equilibrium

Situation where no one has an incentive to change hisbehavior

Stable outcome after interactions have taken place


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Marginal analysis example 1 Average vs. marginal analysis

Cost of adding one more passenger to an existingflight is Rs.100 (cost of drinks and snacks)

Average cost of a passenger per flight is Rs.2,000

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(Rs.1,00,000 per flight, 50 passenger capacity) At the boarding gate, there are still some seats to be

filled. A passenger shows up and is willing to pay only

Rs.200 for the ticket. Should he be allowed to fly? Short term analysis

Long term analysis


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Marginal analysis example 2 Sunk costs

You have invested Rs.10 crore in a housing project inMumbai

Real estate crash occurs expected sales revenue from

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selling completed project Rs.5 crore Project has no value if not completed

If completing the project costs Rs.2 crore, should you

complete the project or abandon it?What is the most you should pay to complete the

project?


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Sunk costs continued DRDO has spent Rs.125 crores on RnD and product

development for Arjun MBT Insists that the army should order at least 500 tanks so

that money spent so far does not go to waste

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Army argues that Arjun tank is approachingobsolescence, so huge costs of adoption outweigh

the expected future benefits

Who is using the Economic way of thinking?


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Positive vs. normative issues Positive

Cause and effect analysis Normative

What ought to be (value judgment)

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Statement 1: LPG rationing is a poor social policybecause it interferes with the workings of thecompetitive market system

Statement 2: LPG rationing is a policy under whichmore people are made worse off than are madebetter off


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Real vs. nominal prices Inflation

Situation in which overall price level is rising Makes inter-temporal comparison of prices difficult

Nominal price

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rice una juste or in ation

Real price

Price adjusted for inflation

Consumer price index (CPI)

Measure of the aggregate price level

Can thus be used to measure inflation rate


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Consumer Price Index CPI CPI is a measure of overall cost of goods and

services bought by a typical consumer Comes in different flavors: IW, UNME, AL/RL

Uses retail rices

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Covers goods and services

Lower fuel, higher food weights

CPI calculated by Labor Bureau of Ministry of

Labor & Employment


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Table 1.1 The Real Price of Eggs and of a College Education

1970 1980 1990 2000 2007

Consumer Price Index 38.8 82.4 130.7 172.2 205.8

Nominal Prices

Grade A Large Eggs $0.61 $0.84 $1.01 $0.91 $1.64

Real vs. nominal prices19

38.8$1.01 $0.30

130.7= =

, , , , ,

Real Prices ($1970)


College Education $2,530 $2,313 $3,568 $4,548 $5,196

1970

1980

Real price of eggs in 1980 nominal price in 1980CPI

CPI=

1970

1990

Real price of eggs in 1990 nominal price in 1990CPI

CPI=

38.8$0.84 $0.40

82.4= =

The real price of eggs in 1970 dollars is calculated as follows:


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The Real Price of Eggs and of a College Education (continued)

1970 1980 1990 2000 2007

Consumer Price Index 38.8 82.4 130.7 172.2 205.8

Nominal Prices


Real vs. nominal prices20

, , , , ,

Real Prices ($1980)


College Education $2,530 $2,313 $3,568 $4,548 $5,196

real price in 2007 real price in 1970Percentage change in real price

real price in 1970

=

The percentage change in real price is calculated as follows:

1.04 2.050.49

2.05

= =


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Practice question 1 Why did real price of eggs fall?

Why did real price of college degrees rise?

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Practice question 2 Suppose INR rises against USD i.e. fewer INR to buy

1 USD Why does this simultaneously

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consumers? Decrease the real price of US cars for Indian

consumers?


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Practice answer 3 Nominal price of STDs fell from Rs.5 per minute in 1996 to

Rs.3 per minute in 1999, a 40% decrease

CPI increased by 20% over this period

What happened to real price of STDs?

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Let 1996 CPI be 100 and 1999 CPI be 120 i.e. 20% increase

Real price of STDs as expressed in 1996 rupees

1996 real price = 1996 nominal price = Rs.5 per minute

1999 real price = (CPI 1996 / CPI 1999)*1999 nominal price Rs. (100 / 120) * 3 = Rs. 2.50 per minute

Real price fell from Rs. 5 per minute to Rs.2.50 per minute i.e. a 50%decline

mm session 1

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