Welcome to the foundation course in Managerial
Economics.
I am Dr. Barnali Nag from Vinod Gupta School
of Management, IIT Kharagpur.
This course is about, we are primarily going
to focus on microeconomic theories, which
I used in decision making in different organizations.
We are basically going to go through different
tools and concepts of economic theory to see
how the different organizations, people in
the organizations, the stake holders, the
government, the consumers, the producers,
firms, banks, how they interact with each
other.
So they make decisions at different, their
own levels, and these decisions interact with
each other in the market and result in certain
kinds of market outcomes.
So we are going to see how people make decisions
and how are choices made in the economy.
So, but this is about managerial economics.
Now what is economics all about?
Economics is about, it is actually many of
us might think that economics is about how
banks function, how investment is made, how
prices are determined.
Yes, but more importantly economics is about
how people make decisions.
It is about people actually and how people,
be it a homemaker, a student, an entrepreneur,
a policy maker who is in the government making
policies, how they make decisions.
So this is about, so economics is more about
how people make decisions, but why is it complicated?
Why is it complicated?
It is complicated because everyone is faced
with scarcity of resources.
There is scarcity of resources in the economy
and be it a person who is running a household,
be it a student who is basically surviving
on some stipend or some help from his home,
or be it a government who is surviving on
taxes, be it a nation which has its own endowments
of natural resources.
So everyone is faced with some amount of scarcity
and why are we using the term scarcity?
We are using the term scarcity because wants
and needs are unlimited and resources are
limited.
So that is the reason that scarcity is a problem
because everyone has his, everyone, a person
would like to has innumerable wants and desires
but he has limited income.
Similarly, a government would like to do everything.
It would like to eradicate poverty; it would
like to take care of its environment.
It would like to focus on its economic growth
and boost its producers to improve production.
So everyone has lot of goals in mind, but
resources are limited.
So scarcity of resources is a problem and
that leads to choices.
Basically you have to make a trade off.
You cannot have everything together and how
people make choices that is the question that
we are trying to understand through different
kinds of economic theories.
So before I move on to the various lectures,
we are going to discuss lot of economic theories
and concepts and we are going to study lot
of models later, but in the first module of
this lecture let me focus on certain principles,
some fundamental principles of economics.
There are 10 principles of economics which
has been laid down beautifully by Professor
Gregory Mankiw whose book also I have recommended
for this course and this is about principles
of how people make decisions, how people interact
with each other, and how different nations
how they interact and how what are the principles
which guide the nations, their macroeconomic
decisions.
So the first set of principles of how people
make decisions as I earlier already said,
it is principle number one is people face
tradeoffs, people face tradeoffs as I already
said there is scarcity of resources and you
have lot of goals and you have to make a choice.
So people make tradeoffs, people face tradeoffs
rather and they have to choose between two,
three kinds of options.
One of the very important tradeoff in economics
that which is a huge challenge for all economists
is a tradeoff between efficiency and equality.
I will give an example, I am not going to
discuss, this is a very vast area of research
and a huge problem, but I am not going to
focus too much on it, but I will, it is worth
a mention so I am going to just give a small
example.
Say for example the government decides that
everyone should be should have a minimum standard
of living, should have some minimum income.
Now, so it decides where is the government
going to give this money to the poor from?
So the government is basically going to tax
the rich.
Now when they tax the rich it is this incentive
for the rich to work hard.
So indirectly when the government is trying
to improve the equality in the economy by
taking the money away from the rich and distributing
in the poor what the government is doing is
it is basically reducing the efficiency in
the economy right?
So efficiency versus equality is a very important
and very challenging tradeoff that every economy
faces.
Second principle is the cost of something
is what you give up to get it, what you give
up to get it and this brings us to a very
important concept in economics which we are
going to come across frequently later in the
course, it is called the opportunity cost.
The opportunity cost of any item is whatever
must be given up to get it.
Say for example a student decides after completing
his engineering that I am going to instead
of taking the job that has been offered through
the campus interview, I am going to pursue
my pursue further education.
What is the opportunity cost of the further
education?
The opportunity cost is basically the salary
or the income that the student is foregoing
by taking up the option of doing higher education.
So this is what opportunity cost is.
So basically nothing comes for free.
It is every choice has a opportunity cost.
Third principle is rational people think at
the margin.
What does this mean?
This is, this is also very important principle
because later whenever we develop any kind
of models and any kind of decision making,
we are going to use this principle repeatedly.
Say for example, again taking the example
of the same student who is going to say he
decides that I am going to do a 1-year MBA
course, 1 year management education course
for which he has to pay some fee.
Now the decision is going to depend on only
the cost that he is going to incur during
this 1 year of education against the income
that he is foregoing for this 1 year of education.
He is not going to look at any other of its
expenses or his incomes in the past.
Or say another example, say a person is hiring
people, a person a producer he is a manufacturer
he is hiring people.
Now one more person whether he should hire
that person or not will depend on how much
salary or how much wage he has to pay to the
person against how much output he is going
to get from the person.
So it is always at the margin.
He does not think about the in totality what
his production is, what his cost is, no.
He is basically thinking at the margin.
This is what we all of us do.
So the fourth principle is people respond
to incentives.
This is easy to understand.
Say for example the government decides that
people need to smoke less.
So the government basically imposes a tax
on smoking cigarettes.
There is a tax on cigarettes, and smoking,
the amount of smoking comes down.
So this is a negative incentive to smoke.
Similarly you could have positive incentives
also.
Say the government wants people to save more.
So it has lot of, it offers a lot of tax benefits
for saving, saving more.
So people respond to incentives and this is
true everywhere, in all walks of life right?
Now second is principles of how people interact.
So people not only they make decisions for
themselves they also interact with others,
others in the sense they interact with other
consumers, other producers, firms, when they
go and go to look for job they interact with
the employers.
So there is always interaction across people,
different people interact and they these interactions
influence their decisions.
So these principles are going to guide us
to understand how people interact with each
other.
So one of the principles is trade can make
everyone better off.
Now when I say trade can make everyone better
off, I do not necessarily mean trade between
countries.
When I say trade it is basically exchange
of goods for money across different individuals
also.
What this basically means is if I am good
at producing something and another person
is good at producing something else, it makes
sense for us to exchange the goods that we
are good at making instead of trying to make
everything myself okay?
So principle 5 is trade can make everyone
better off and this is so true for countries
also like the countries they do not have to
if what whatever they are good at making they
basically manufacture that and export those
commodities and they import commodities which
other countries are good at making.
So as a result what is happening?
We are getting cheaper products from other
countries and other countries are being able
to utilize the efficient production or the
quality of production that we are able to
offer.
So the next principle is markets are usually
a good way to organize economic activity.
Here 2 things are important.
One is what do I mean by organize economic
activity and the second is the word usually.
So that means it is not always the case that
markets are good way to organize economic
activity, but mostly they are.
So what do you mean by organize economic activity?
Now organize economic activity means basically
what to produce in the economy?
How much to produce of anything?
How to produce it and who is going to buy
it?
As I said in the beginning that there are
unlimited needs and wants in the economy and
various things are demanded in the economy
right from fundamental basic stuff like food,
clothes, and shelter to something as fancy
as having a birthday party on moon.
So there is maybe it is possible to have at
least some consumers at some part of the world
who would like to have something like as fancy
as this, but whether it gets produced in the
economy or not that gets easily decided in
the market.
So market is a good way to organize economic
activity and it decides, but how does it do
so?
How does the market do so?
So basically people can go to the market with
their demands.
They can go to the market looking for stuff
they would like to buy and they have certain
willingness to pay.
They would like to pay a certain price for
every stuff.
So they can go to the market and express their
needs and wants and the firms can decide that
whether it is it makes sense for me to produce
this these stuff and sell in the market or
not and if they do so then there is the stuff
gets produced in the market.
So this is how the market basically resolves
the problem of what gets produced in the market,
but how does it do so?
It does by the demand.
There is a demand for a certain product, people
are willing to pay a certain price for it
and price acts as a signal in the market.
So when price acts as a signal in the market
the basically the producer decides that if
I am able to provide this stuff at this price
and if he does so then that stuff gets produced
in the market and this is how the price is
acting as signal in the market.
They are like the invisible hand, the term
coined by Adam Smith which says that basically
the market guides people where they are basically
trying to satisfy their own interest.
People are satisfying their own interest,
the consumer is trying to meet his own interest.
Producer is trying to meet his own interest
of maximizing profit and the people and the
product that are being demanded in the market
they get produced in the market.
So this is how the market are, is usually
a good way to organize economic activity.
But, now the second, the next principle basically
talks about it is the continuation of the
previous principle where we used the term
usually.
Now, markets are usually a good way but not
always and when the markets are not good way
to organize economic activity, governments
can sometimes improve market outcomes.
So when do governments improve market outcomes?
Basically governments improve market outcomes
when markets fail.
What do I mean by markets failing?
When do markets fail?
Markets fail under lot of situations like
externalities, public goods, the government’s
attempt to have more equality in the economy.
These are certain situations where the markets
may fail and what do I mean by externality,
what is externality?
Externality basically means that a certain,
all activities do not have do not always it
is not that when say for let me explain through
example.
Say for example a tannery.
It is producing, it is tanning leather and
it is polluting the nearby stream, water stream.
Now the people who are buying the products
from this tannery, they are not affected by
maybe may or may not be affected by this pollution.
Similarly tannery itself it is it will be
charging the price depending price of tannery
depending on how much cost it is incurring.
It is not going to take into account the fact
that it is polluting the water stream nearby.
So who pays for it?
So basically an activity is causing or affecting
people or stakeholders who are not directly
involved in this economic activity.
These are not people who are either producing
the leather.
These are not people who are consuming the
leather nevertheless they are getting affected.
These are maybe people staying nearby who
are using the water from the stream.
So there is a cost to the economy.
There is someone has to incur that cost and
who is going to incur that cost?
Who is going to impose that cost on this activity,
the government.
So the government can impose a certain so
the government can come and say to the tannery
that look you are polluting the nearby stream
and so you have to pay certain taxes extra
with which we will clean the stream or the
government might say that you have to directly
pickup incur the cost of cleaning this stream.
So this is where the government has to intervene
in the market.
Another example is public goods.
Say for example keeping the air clean.
Who is going to do it?
It is a public good.
Public good is something from which you cannot
exclude anyone.
So if an organization says that look I am
going to clean the air, air nearby and you
pay for it.
Can it exclude people who are not paying for
it?
No it cannot.
So these are examples of public good where
the government needs to step in and it needs
to take the initiative to produce because
here you cannot exclude people from consuming
these goods and another example is say the,
say the government wants more equality.
Say for example in the labour market or where
people are getting hired, people are willing
to work for a very low wage which is not acceptable
to the government or which is not acceptable
to the society in general because it is inhuman.
So there the government needs to step in and
say that look you have to pay a wage which
is minimum, the minimum amount should be this
amount.
So these are situations where the government
can intervene and these are situation where
the markets fail.
Now the third set of principles is principle
of how the economy works as a whole, basically
how the economy works as a whole.
This, these principles are more applicable
in macroeconomics, which we are not going
to focus on, which is beyond the scope of
this course, but nevertheless I am going to
go through the through these principles.
One is that a country’s standard of living
depends on its ability to produce goods and
services.
So how well an economy does or what is the
amount of economic growth in a for a country
solely depends on how the country is able
to produce out of its limited resources.
Every country has certain amount of say certain
amount of natural endowment of resources,
some amount of labour, some amount of capital
stock, say for example machineries, equipment,
infrastructure that a country has and given
all these all this setup the economy basically
produces.
Now how well the economy does and how the
economy growth can be rapid in a country depends
on how efficiently the country is able to
produce out of its limited resources.
So and that would basically depend on the
productivity of these countries.
So if a country is able to improve the productivity
of its economic activities, then it is able
to do well.
Another principle is that prices rise when
the government prints too much money.
Price rise is what?
Price rise is basically inflation.
So inflation happens when the government prints
too much money.
That means there is too much money in the
economy which is chasing too little goods.
You are not producing enough but government
has printed lot of money.
So lot of money is chasing little amount of
goods so the prices of these goods go up.
So this is the general principle that prices
rise when the government prints too much money
and that the last but not the least the principle
that society faces a short-run tradeoff between
inflation and unemployment.
So it has been seen very often that various
policies of the government which try to address
unemployment or unemployment is basically
what?
When economic activity is falling when the
not enough is getting produced in the economy
then the organizations are going to lay off
workers.
So when they lay off workers unemployment
is going to rise.
So basically there the what does the government
do to target improvement in employment, in
the economy?
Basically they try to boost economic activity
in the short run.
So when the government tries to boost economic
activity through various policies it has been
seen that in the short run they cause inflation
or price rises and it is easy to understand
because from principle 8 we already know that
you cannot increase your output or economic
activity from your resources unless and until
you improve your productivity which is not
possible in the short run and if you are not
able to increase your productivity other ways
of trying to increase output in the short
run is done at the cost of inflation.
So these are the 10 principles of how the
economy works, how people interact, how the
different stakeholders they make decisions
in the economy and later we are going to study
various economic models to see how managerial
decisions are made and we are going to use
these principles often.
We are going to come back and revisit these
principles while we discuss the different
kinds of different models and quickly since
I have gone through these 10 principles another
thing that I would like to emphasize is that
this course is on primarily on microeconomics
and we are calling it managerial economics
because this is about decision making process
of individuals or managers who are who need
to understand how consumers make decisions,
how governments make decisions, how the producers
they themselves need to make decisions in
different kinds of market structures.
So this is more about microeconomics where
the individual is involved.
So the first 2 types of principles are more
relevant here but nevertheless we are going
to keep on referring to the first 7 principles
that we have discussed here and macroeconomics
is more about understanding the overall economy.
Macroeconomics is more about understanding
the how the economy in totality functions.
The different so we are going to primarily
focus on microeconomics and the another thing
that I would like to emphasize is we are going
to develop various models.
These models say for example we would like
to see how is price determined in the market.
We would like to see what kind of markets,
what are the different kinds of market structures.
So there are various products that are sold.
So each we are going to see these products,
the nature of these products determine what
kind of market they have.
Say for example they are I am going to explain
them later but like say they say monopoly
or oligopoly or competitive market a monopolistic
competition.
So to understand each of these market structures
we are going to develop models.
Now what are these models?
These models are basically they try to replicate
the reality and we are going to make certain
assumptions to make it very simple to understand
the basic functioning of these markets.
So they do not necessarily mean that they
take into account all the problems associated
with this market but it is like if you are
building an airplane you would like to first
see how the plane functions, how it takes
off from the ground and flies in the, so you
are not going to look at the small intricacies
how the seats are laid and how the window
shutter works and so similarly we are going
to exclude some, many of the details of a
market, yet try to understand what is the
fundamental functioning of these models.
So this is what we are going to do and in
the next module I am going to start with the
supply demand framework.
Thank you.
