Managerial

Economics

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Chapter 2

Thinking Like an Economist

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Economics trains you to. . . .

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• Be mindful about the choices that you make.

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• Evaluate the cost of individual and social choices.

• Examine and understand how certain events and

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issues are related.

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 The Economist as a Scientist
• The economic way of thinking . . .
 Involves thinking analytically and objectively.

 Makes use of the scientific method.

 Involves the use of abstract models to focus the discussion on a

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main idea or theme in the complexity of the real world.

• To apply the scientific method in economics,

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assumptions are used to make the world easier to
understand.
 Ceteris Paribus Assumption-All else equal.
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 Role Play Scenario-Purchasing something at a store.
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Two Simple Rules for Movements vs. Shifts

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• Rule One
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 When an independent variable changes and that

variable does not appear on the graph, the curve on
the graph will shift.
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• Rule Two
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 When an independent variable changes and does

appear on the graph, a movement along the existing
curve will occur. The curve will not shift.

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 Two of the Most Basic Economic Models
Are
• The Circular Flow Diagram

• The Production Possibilities Frontier.

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The Circular-Flow Diagram

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Revenue Spending
Market for
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Goods
Goods & Goods &
Services sold and Services Services
bought
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Firms Households
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Inputs for Labor, land,

production Market for and capital
Factors
Wages, rent, of Production Income
and interest 6

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 The Production Possibilities Frontier

Shows the various combinations of two goods that

can be produced by one firm.

Assumes two goods

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Assumes fixed technology and fixed factors of
production.

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The Production Possibilities Frontier

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Quantity of
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Computers
Produced
3,000 D
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2,200
C
2,000 A
A

B
1,000

0 300 600 700 1,000 Quantity of

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Cars Produced

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 The Production Possibilities Frontier

Quantity of
Computers
Produced
3,000 D

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2,200 C
2,000 A
Production
possibilities

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frontier
B
1,000

0 300
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600 700 1,000 Quantity of
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Cars Produced
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Concepts Illustrated by the Production

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Possibilities Frontier
• Efficiency
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• Tradeoffs

• Opportunity Cost
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• Economic Growth
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Quantity
The Production
of Computers Possibilities Frontier
Produced
4,000
An outward shift
in the production
3,000 possibilities
frontier
Increase in

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2,100
E technology to
2,000 produce
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computers.

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0
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700 750 1,000 Quantity of
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Cars Produced
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Microeconomics & Macroeconomics

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• Microeconomics is the study of individual consumers and

producers in specific markets.
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• How households and firms make decisions and how they

interact in specific markets
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 Supply and demand

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 Pricing of output

 Production processes

 Cost structure

 Distribution of income and output

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 Microeconomics & Macroeconomics
• Macroeconomics is the study of the aggregate
economy.

• How the markets, as a whole, interact at the

national level.

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 National Income Analysis (GDP)

 Unemployment

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 Inflation

 Fiscal and Monetary policy

 Trade and Financial relationships among nations

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The Many Facets of Microeconomics

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The Many Facets of Macroeconomics

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Two Roles of Economists

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• When they are trying to explain the world, they are

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scientists.
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• When they are trying to change the world, they are

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policymakers.

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 Positive versus Normative Analysis
• Positive statements are statements that describe
the world as it is.
 Called descriptive analysis

• Normative statements are statements about how

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the world should be.
 Called prescriptive analysis

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Nature and Scope

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of Economics
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Give me a one-handed economist! All my

economist say, "on the one hand... on the other."
H. S. Truman

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• Divided into

• classical (Adam Smith, J B Say, J S Mill …)

• Neo-classical (Marshall, Robbins, Hicks …) and

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• Modern (Milton Friedman)

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Classical View
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• “Nature and causes of wealth of nations proposes to

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enrich both the people and the sovereign.” Adam Smith

• “The study of laws which governs wealth.” J B Say

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• “Economics is that body of knowledge which relates

to wealth.” F A Walker
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• “Writers in Political Economics profess to teach the

nature of wealth and the laws which govern its
production, distribution and exchange.” J S Mill

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 Welfare Definition

• “Political economy or Economics is the study of

mankind in the ordinary business of life; it examines
that part of individual and social action which is most
closely connected with the attainment and with the

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use of the material requisites of well-being. Thus, it is
on the one side a study of wealth; and on the other,

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a part of the study of man.” Marshall

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Scarcity Definition
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• “Economics is the science which studies human

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behaviour as a relationship between ends and

scarce means which have alternative use.” Robbins
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 Scarcity Definition

• “Economics is the study of how men and society

choose, with or without the use of money, to employ
scarce productive resources to produce various
commodities over time and distribute them for

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consumption, now and in future, among various
people and groups in society.” Samuelson

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Scope and Subject Matter

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• The study of the problems of :

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• Consumption

• Production
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• Exchange and distribution of wealth

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• Determination of values of goods and services

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 Scope and Subject Matter

• The volume of employment and

• Determination of economic growth.

• Causes of poverty, unemployment,

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underdevelopment, inflation, etc. and steps for
their removal.

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Basic Economic Concepts

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• Goods – all things that have value and satisfy

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human wants.

• Material goods – economic and non-economic

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goods (free in nature)

• Non-material goods – intangible

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• Consumer’s goods and Producer’s goods

• Intermediate goods and final goods

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Utility
Utility is subjective
• Want satisfying power of a
commodity / service.

 Form utility

 Place utility

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 Time utility

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 Possession utility
Utility is abstract
 Natural utility

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Basic Economic Concepts…

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• Value - value-in-use : want satisfying capacity of

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goods and services.

• Value-in-exchange : the power that goods and

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services have to exchange other goods and services.

• Three characteristics to have value:

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 Utility

 Scarcity and

 Tansferability

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 Basic Economic Concepts…
• Wealth – in economics is used to describe all things
that have value.
• Forms of wealth –
 Individual
 Social

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 National
 International
 Financial

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• Some differences –
 Wealth and capital
 Wealth and income
 Wealth and moneya n 29
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Basic Economic Concepts…

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• Stocks and Flow –

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• Stock has no time dimension – related to a specific

point in time.
• Flow has time dimension – related to specific
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period of time.
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• National income is a flow and national wealth is a

stock.

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 Basic Economic Concepts…

Scarcity is the condition in which resources are

not available to satisfy all the needs and wants of
a specified group of people.

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Basic Economic Concepts…

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Opportunity cost is the amount or subjective

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value that must be sacrificed in choosing one

activity over the next-best alternative.
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 Review of Economic Terms

Resources
 Factors of production or inputs

 land, labor, capital, entrepreneurship

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Entrepreneurship is the willingness to take
certain risks in the pursuit of goals.

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