Economics: An Orientation Sunitha.S Assistant Professor School of Management Studies, National Institute of Technology (NIT) Calicut Industrial Economics.

Economics: An Orientation

Sunitha.SAssistant Professor

School of Management Studies,National Institute of Technology (NIT) Calicut

Industrial EconomicsLecture 01.01.2010

A quick glance about EcoMicro Economics

Individual units: how a consumer gets satisfaction ? how a single producer maximizes profit? etc

Macro EconomicsAggregate units: national income, inflation, employment

Monetary EconomicsHow money, credit ,banks, stock markets function?

Public FinanceGovt expenditure, budget, taxation, public debt

International EconomicsExchange rate, foreign trade, IMF, World Bank, WTO,GATT

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Books for Reference

• Principles of Micro Economics, (Gregory. N. Mankiw)

• Principles of Macro Economics , (Gregory. N.Mankiw)

• Economics, Samuelson, P.A. and W.D. Nordhaus

• Books on Financial Management/Managerial Economics

Additional books for reference would be informed later

Central problems of an economy

• What to produce?• should the emphasis be on agriculture, manufacturing or services,

should it be on health, manufacturing or housing?

• How to produce?• labour intensive, land intensive, capital intensive? Efficiency?

• Whom to produce?• Should income distribution be :evenly distributed? or more for the

rich? Or for those who work hard?

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Buzz words• Marginalism• Incrementalism• Opportunity Principle• Discounting• Time perspective

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Marginalism• Marginal analysis is related to a unit change in independent

variable, say increase in costs as a result of a unit change in output.• Marginal output of labour: output produced by the last unit of

labour• Marginal cost of production: cost incurred for producing the

additional unit of output

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Profit of a firm using principle of marginalism

Units of output(1)

Total Revenue(Rs) (2)

Marginal revenue (Rs)(3)

Total costs (Rs)

(4)

Marginal cost (Rs)(5)

Total profits(Rs) (6)=(2)-(4)

Average profit (Rs) (7)=(6) / (1)

Marginal profits(Rs) (8)

1 20 - 15 5 5.0 -

2 40 20 29 14 11 5.5 6

3 60 20 42 12 18 6.0 7

4 80 20 52 10 28 7.0 10

5 100 20 65 13 35 7.0 7

6 120 20 81 16 39 6.5 4

7 140 20 101 20 39 5.6 0

8 160 20 125 24 35 4.4 -47

Incrementalism• Incremental reasoning involves estimating the impact of

decision alternatives.• Usually, changes occur in “chunk” rather than unit changes.• Incrementalism is more general whereas marginalism is more

specific.

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Incrementalism..

• Incremental costs :change in total costs as a result of change in the level of output, investment etc.

• Incremental revenue is a change in total revenue resulting from a change in the level of output, price etc.

While taking a decision, always incremental revenue should always be greater than incremental costs

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Opportunity Principle

• Cost of next best alternative foregone• Definition – the cost expressed in terms of the next best

alternative sacrificed• Helps us view the true cost of decision making• Implies valuing different choices• Highest valued benefit that must be sacrificed as a result

of choosing an alternative

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Opportunity cost• Suppose a machine can produce either X or Y .The opportunity

cost for producing a given quantity of X is the quantity of Y,which the resource would have produced.

• If the machine can produce 10 units of X and or 20 units of Y, the the opportunity cost of 1x is 2Y.

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Production Possibility Frontiers

• Show the different combinations of goods and services that can be produced with a given amount of resources

• No ‘ideal’ point on the curve

• Any point inside the curve – suggests resources are not being utilised efficiently

• Any point outside the curve – not attainable with the current level of resources

• Useful to demonstrate economic growth and opportunity cost12

Production Possibility Frontiers

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Capital Goods

Consumer Goods

Yo

Xo

A

BY1

X1

Assume a country can produce two types of goods with its resources – capital goods and consumer goods

If it devotes all resources to capital goods it could produce a maximum of Ym.

If it devotes all its resources to consumer goods it could produce a maximum of Xm

Ym

Xm

If the country is at point A on the PPF It can produce the combination of Yo capital goods and Xo consumer goods

If it reallocates its resources (moving round the PPF from A to B) it can produce more consumer goods but only at the expense of fewer capital goods. The opportunity cost of producing an extra Xo – X1 consumer goods is Yo – Y1 capital goods.

Production Possibility Frontiers

Capital Goods

Consumer Goods

Yo

Xo

A

.B

CY1

X1

Production inside the PPF – e.g. point B means the country is not using all its resources

It can only produce at points outside the PPF if it finds a way of expanding its resources or improves the productivity of those resources it already has. This will push the PPF further outwards.

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Discounting• The concept of discounting is based on the fact that a rupee

now is worth more than a rupee earned a year after.

• Even if one is sure about future income, yet it has to be discounted because to wait for future implies a sacrifice for the present

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• Suppose a sum of Rs 100 is due after one year. Let the rate of interest be 10 percent. Then we can determine the sum to be invested now so as to produce the return (R) of Rs 100 at the end of the year. The present value or the discounted values of Rs100 will then be

V1 = R

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(1+i)

V1 = R

V1= 100

= Rs.90.90

A present value of Rs100 due two years later would be

V2 = Rs100

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(1+.10)

(1+.10)2

=82.64

(1+i)

Time perspective• Short run Versus long run

• Very short run• Short run• Long run

• Fixed versus variable costs of production

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Circular Flow of Income• Y = Income

• C = Consumption Expenditure

• S = Savings

• I = Investment

• T = Taxation

• G = Government Expenditure

• M = Imports

• X = Exports

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Circular Flow - Simple• Assumptions:

• Only two sectors - Consumers and Producers• All production is sold to the consumers• Producers provide all the Goods and Services• Consumers spend all their Income on goods an services• No government and no overseas sectors• Consumers are the owners of productive resource - land, labour,

capital and enterprise

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Circular Flow - Simple

Consumers Producers

Resources

Goods and Services

Consumption Expenditure

Income

Resources

Goods and Services

Circular Flow - Savings and Investment

Income

Consumption Exp

Capital MarketSavings Investment

Consumers Producers

Circular Flow - Government Sector

Income

GOVERNMENTTAXATION

CAPITAL MARKETSavings Investment

Consumption

SPENDINGSUBSIDIES

TAXATIONConsumers Producers

Circular Flow - Four SectorsIncome

CAPITAL MARKETSavings Investment

OVERSEAS SECTOR

GOVERNMENTTaxes

Imports

Govt subsidies

Exports

LE

AK

AG

ES

INJE

CT

ION

S

Consumption exp

Consumers Producers

Thank You