Principles of Economics

Introduction Introduction Introduction Introduction

Principles of Principles of EconomicsEconomics

Principles of Principles of EconomicsEconomics

Faculty of Business and Economics, The IIPM, New DelhiFaculty of Business and Economics, The IIPM, New DelhiFaculty of Business and Economics, The IIPM, New DelhiFaculty of Business and Economics, The IIPM, New Delhi

Faculty of Business and Economics (FBE), The IIPM, New Delhi

Fundamentals of EconomicsFundamentals of Economics

“The Age of Chivalry is gone; that of sophisters, economists, and calculators has succeeded. ”

---Edmund Burke

“The Age of Chivalry is gone; that of sophisters, economists, and calculators has succeeded. ”

---Edmund Burke


HOW PEOPLE MAKE DECISIONS?HOW PEOPLE MAKE DECISIONS?

Study of economics starts with 4 principles of individual decision making: People face tradeoffs The cost of something is what you give up to get it.

Rational people think at the margin.

People respond to incentives.

Study of economics starts with 4 principles of individual decision making: People face tradeoffs The cost of something is what you give up to get it.

Rational people think at the margin.

People respond to incentives.


# 1: People# 1: People Face Tradeoffs Face Tradeoffs

“There is no such thing as a free lunch”

To get something we like we usually have to give up something we don’t like.

A student and her time: Studying vs. napping.

Society’s tradeoffs: Guns vs. Butter Clean environment and higher GDP

“There is no such thing as a free lunch”

To get something we like we usually have to give up something we don’t like.

A student and her time: Studying vs. napping.

Society’s tradeoffs: Guns vs. Butter Clean environment and higher GDP


… … People Face TradeoffsPeople Face Tradeoffs

Society’s tradeoffs (cont’d): Efficiency vs. Equity Efficiency: Society getting the most it can from its scarce resources.

Equity: Distributing economic prosperity fairly among the members of society.

Society’s tradeoffs (cont’d): Efficiency vs. Equity Efficiency: Society getting the most it can from its scarce resources.

Equity: Distributing economic prosperity fairly among the members of society.


# 2: The Cost of Something is # 2: The Cost of Something is what You Give Up what You Give Up

Making decisions requires comparing the costs and benefits of alternative courses of actions. To go to university or not to go?

Opportunity cost: Whatever must be given up to obtain some item.

Making decisions requires comparing the costs and benefits of alternative courses of actions. To go to university or not to go?

Opportunity cost: Whatever must be given up to obtain some item.


Marginal changes: Small incremental adjustments to marginal changes.

Individuals and firms can make better decisions by thinking at the margin.

By comparing the marginal benefits (MB) with the associated marginal costs (MC) of a decision.

Marginal changes: Small incremental adjustments to marginal changes.

Individuals and firms can make better decisions by thinking at the margin.

By comparing the marginal benefits (MB) with the associated marginal costs (MC) of a decision.

# 3: Rational People Think at # 3: Rational People Think at the Margin the Margin


• Marginal changes in costs or benefits motivate people to respond.– When the price of apples rise…………

• The decision to choose one alternative over another occurs when that alternative’s marginal benefits exceed its marginal costs!

• Marginal changes in costs or benefits motivate people to respond.– When the price of apples rise…………

• The decision to choose one alternative over another occurs when that alternative’s marginal benefits exceed its marginal costs!

# 4: People Respond to # 4: People Respond to IncentiveIncentive


Principles ofPrinciples of EconomicsEconomics• Consider leisure, often defined as “time which one can spend as one pleases”. Leisure brings out personal eccentricities. Suppose that, after satisfying all your obligations, you have 3 hours a day of free time and can devote it to gardening, laying bricks, or writing history. What is the best way to allocate your time? Lets’ ignore the possibility that time spent on some of these activities might be an investment that will enhance your earning power in the future. Rather, assume that these are all pure consumption or utility-yielding pursuits.

• Consider leisure, often defined as “time which one can spend as one pleases”. Leisure brings out personal eccentricities. Suppose that, after satisfying all your obligations, you have 3 hours a day of free time and can devote it to gardening, laying bricks, or writing history. What is the best way to allocate your time? Lets’ ignore the possibility that time spent on some of these activities might be an investment that will enhance your earning power in the future. Rather, assume that these are all pure consumption or utility-yielding pursuits.


Principles ofPrinciples of EconomicsEconomics• Consider yourself the

marketing President of a multi-market seller like TCS which sells software services in various foreign markets. The marginal revenues, marked in US $ billion (through sale of software) of TCS are mentioned in the format.

• Work out the revenue maximizing combination/allocation/behaviour, wherein TCS plans to have presence in all these markets and is guided by that assumption that ‘marginal revenue is a monotonically decreasing function of selling.’

• Consider yourself the marketing President of a multi-market seller like TCS which sells software services in various foreign markets. The marginal revenues, marked in US $ billion (through sale of software) of TCS are mentioned in the format.

• Work out the revenue maximizing combination/allocation/behaviour, wherein TCS plans to have presence in all these markets and is guided by that assumption that ‘marginal revenue is a monotonically decreasing function of selling.’

Units

Asia

N.A E.U.

1 10 9 8

2 9 8 7

3 8 7 6

4 7 6 5

5 6 5 4

6 5 4 3

7 4 3 2


Equi-Marginalism (Relative Activity Equi-Marginalism (Relative Activity Level Principle)Level Principle)

• Multi-market Seller (MR1 = MR2 = MR3 = MR4 = MRN)

• Multi-plant monopolist (MC1 = MC2 = MC3 = MC4 = MCN)

• Multi-factor employer (MP1 = MP2 = MP3 = MP4 = MPN)

• Multi-product firm (Mπ1 = Mπ2 = Mπ3 = Mπ4 = MπN)

• Multi-commodity consumer (MU1 = MU2 = MU3 = MU4 = MUN)

• Multi-market Seller (MR1 = MR2 = MR3 = MR4 = MRN)

• Multi-plant monopolist (MC1 = MC2 = MC3 = MC4 = MCN)

• Multi-factor employer (MP1 = MP2 = MP3 = MP4 = MPN)

• Multi-product firm (Mπ1 = Mπ2 = Mπ3 = Mπ4 = MπN)

• Multi-commodity consumer (MU1 = MU2 = MU3 = MU4 = MUN)


Principles of EconomicsPrinciples of Economics

Tom Cruise's savings consist of $10,000 in a savings account that yields 2% a year interest and another $10,000 in a money market fund that pays interest of 5% a year. Tom Cruise has just received a gift of $10,000 from his mother. His bank pays 4% interest on savings accounts with a minimum deposit of $20,000.The money market fund pays 5% interest on investments up to $100,000.

Tom Cruise's savings consist of $10,000 in a savings account that yields 2% a year interest and another $10,000 in a money market fund that pays interest of 5% a year. Tom Cruise has just received a gift of $10,000 from his mother. His bank pays 4% interest on savings accounts with a minimum deposit of $20,000.The money market fund pays 5% interest on investments up to $100,000.


Principles of EconomicsPrinciples of Economics• Calculate the average interest rate (= dollar

amount of interest divided by amount of investment) from the savings account if Tom Cruise deposits the additional $10,000 in the savings account and qualifies for the higher interest rate.

• Calculate the average interest rate if Tom Cruise deposits the additional $10,000 in the money market fund.

• Calculate the marginal interest rate (= increase in dollar amount of interest divided by additional investment) from the savings account if Tom Cruise deposits the additional $10,000 in the savings account.

• Calculate the marginal interest rate if Tom Cruise deposits the additional $10,000 in the money market fund.

• From the viewpoint of maximizing his total interest income, where should Tom Cruise deposit the additional money?

• Calculate the average interest rate (= dollar amount of interest divided by amount of investment) from the savings account if Tom Cruise deposits the additional $10,000 in the savings account and qualifies for the higher interest rate.

• Calculate the average interest rate if Tom Cruise deposits the additional $10,000 in the money market fund.

• Calculate the marginal interest rate (= increase in dollar amount of interest divided by additional investment) from the savings account if Tom Cruise deposits the additional $10,000 in the savings account.

• Calculate the marginal interest rate if Tom Cruise deposits the additional $10,000 in the money market fund.

• From the viewpoint of maximizing his total interest income, where should Tom Cruise deposit the additional money?


Boundaries of FirmBoundaries of Firm

• General Motors divested Delphi Automotive Systems, which manufactures auto components, systems and modules

• Daimler Chrysler took over the import and wholesale distribution of Benz cars in Asia Pacific

• ISP AOL merged with Time Warner, a producer of films and music, and provider of cable television services

• General Motors divested Delphi Automotive Systems, which manufactures auto components, systems and modules

• Daimler Chrysler took over the import and wholesale distribution of Benz cars in Asia Pacific

• ISP AOL merged with Time Warner, a producer of films and music, and provider of cable television services


Organizational BoundariesOrganizational Boundaries

• There are two sets of boundaries

• Vertical Boundaries: delineate activities closer to or further from the end user

• Horizontal Boundaries: define the scale and scope of an firm’s operations

• There are two sets of boundaries

• Vertical Boundaries: delineate activities closer to or further from the end user

• Horizontal Boundaries: define the scale and scope of an firm’s operations


SummarySummary• When individuals make decisions, they face tradeoffs among alternative goals.

• The cost of any action is measured in terms of foregone opportunities.

• Rational people make decisions by comparing marginal costs and marginal benefits.

• People change their behavior in response to the incentives they face.

• When individuals make decisions, they face tradeoffs among alternative goals.

• The cost of any action is measured in terms of foregone opportunities.

• Rational people make decisions by comparing marginal costs and marginal benefits.

• People change their behavior in response to the incentives they face.

Principles of Economics

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