Economics: An Orientation

Industrial Economics Lecture 01.01.2010 Economics: An Orientation Sunitha.S Assistant Professor School of Management Studies, National Institute of Technology (NIT) Calicut

A quick glance about Eco • Micro Economics • Individual units: how a consumer gets satisfaction ? how a single producer maximizes profit? etc • Macro Economics • Aggregate units: national income, inflation, employment • Monetary Economics • How money, credit ,banks, stock markets function? • Public Finance • Govt expenditure, budget, taxation, public debt • International Economics • Exchange rate, foreign trade, IMF, World Bank, WTO,GATT

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?

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

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

Profit of a firm using principle of marginalism

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.

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

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

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.

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 cost

Production Possibility Frontiers Assume a country can produce two types of goods with its resources – capital goods and consumer goods Capital 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 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. If the country is at point A on the PPF It can produce the combination of Yo capital goods and Xo consumer goods Ym A Yo B Y1 Consumer Goods Xo X1 Xm

Production Possibility Frontiers Production inside the PPF – e.g. point B means the country is not using all its resources Capital Goods 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. C Y1 A .B Yo Xo X1 Consumer Goods

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

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 (1+i)

V1 = R (1+i) V1= 100 = Rs.90.90 A present value of Rs100 due two years later would be V2 = Rs100 (1+.10) =82.64 (1+.10)2

Time perspective • Short run Versus long run • Very short run • Short run • Long run • Fixed versus variable costs of production

Circular Flow of Income • Y = Income • C = Consumption Expenditure • S = Savings • I = Investment • T = Taxation • G = Government Expenditure • M = Imports • X = Exports

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

Income Circular Flow - Simple Resources Resources Consumers Producers Goods and Services Goods and Services ConsumptionExpenditure

Income Circular Flow - Savings and Investment Consumers Producers Consumption Exp Investment Savings Capital Market

Income Circular Flow - Government Sector Producers TAXATION Consumers TAXATION GOVERNMENT SPENDING SUBSIDIES Consumption Savings CAPITAL MARKET Investment

Income Circular Flow - Four Sectors Consumers Producers Consumption exp Savings CAPITAL MARKET Investment LEAKAGES INJECTIONS Taxes GOVERNMENT Govt subsidies Imports OVERSEAS SECTOR Exports Thank You

Economics: An Orientation