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Lecture 3 Economic Principles and Management Decision Making

Session Outline
Defining Economics Why is Economics important? Classifying Economic Systems Economic Tools to Make Strategic Business Decisions Fundamental Concepts of Managerial Economics How the Principles of Economics Affect Decision Making

What is Economics about?

The study of economics is about much more than money Economics provides insight not only into financial matters, but the world at large Economics is a powerful tool for understanding how human beings behave Economics helps people understand individual, business and government decisions.

Economics is the social science that examines the ways in which individuals and entire societies allocate scarce resources to meet their needs and wants. Resources are by nature limited. People do not have the time, money or materials to do or acquire all of the things they need and want. This means individuals, families, companies and entire nations have to prioritize their needs and wants, deploying their available resources accordingly.

Lord Lionel Robbins Definition

Economics is a social science which studies human behaviour as a relationship between ends and scarce means that have alternative uses

Why is Economics important?

People make economic decisions daily. Studying economics prepares you to be a more knowledgeable and informed participant in the modern economy. A basic understanding of economics can make you a smarter consumer, worker and investor This understanding allows the projection of future economic conditions based on current indications. News and Current Events

Other Considerations
Life Decisions Household budgeting etc. Informed citizens A knowledge of economics helps a person become a more knowledgeable participant in the political process. Nation Building In building a nation, a national identity must be created to unify the citizens. Divide and Rule Symbols Cohesion

Economics is not solely about money. The discipline concerns itself with scarcity and allocation of resources, which have applications beyond monetary concerns. However, economic theory is not foolproof because it is a social science based on the interplay between culture and money. Economic effects change as cultural customs change.

Resource allocation
Type of resources Labour (wage) Land (rent) Capital (interest) Entrepreneur (profit)


Different Ideologies
Social reformism & intervention Laissez-faire economics Marxist political economy

Classifying Economic Systems Completely Planned System All resources controlled by government Completely Free (Capitalist) system All resources controlled by private sector Mixed Market System Resources controlled by both private and public sectors in varying degrees

Classifying Economic Systems

Early 1980s
N. Korea

China Cuba Poland

UK France USA

Hong Kong

Totally planned Economy

Totally Freemarket Economy

Classifying Economic Systems

Early 1980s

N. Korea

China Cuba Poland




Hong Kong

Totally planned econom y

N. Korea




France UK


China (Hong Kong)

Totally Freemarket economy

Early 2000s

Economic Tools to Make Strategic Business Decisions

Econometric Tools Economic indicators Economic Graphs Shift-share Model Location Quotient Economic Base Technique

Fundamental Concepts of Managerial Economics

Microeconomic Principles Scarcity, choice and opportunity cost Production possibility frontier Marginal Analysis

What to Produce and where How to Produce How to Finance the Production Who will get what is produced Distribution Achieving the three Es Efficiency, Effectiveness and Equity

Scarcity and choice

Human wants, e.g. housing, clothing food, transport Relatively unlimited wants-insatiable Limited resources, e.g. land & finance Scarcity and need to choose Choosing among alternatives


Rationalise choices Making judgements about relative worth of alternative resources Scale of preference Utility-satisfaction from good or resource


Opportunity cost
Opportunity costs Sacrifice of alternative use Sacrifice of next best Real cost measure


Production possibility curve

Illustrates economic concepts (e.g. scarcity, choice, OC) Factor combination Attainable and unattainable output Sacrificing present for future consumption


Production Possibilities Curve

Marginal Analysis
Total utility (TU) Marginal utility (MU) Diminishing Marginal Utility
TU & MU from consuming water

Figure 1.1: Marginal Utility

No of Glasses TU 1 30 2 43 3 50 4 54 5 54 6 49

MU 30 13 7 4 0 -5

30 25 20

15 10 5 0 -5 -10 No of Glasses of water 1 2 3 4 5 6

Optimal Allocation of Resources

Deciding on conversion of a dual carriageway to motorway: How many miles should be converted?

1 mile

2 3 4 5 6 miles miles miles miles miles

Total benefit 5 (m) Total cost 3 (m)








Weighing Marginal Benefits & Marginal Costs

1 mile 2 miles 3 miles 4 miles 5 miles 6 miles Total benefit (m) Total cost (m) Marginal benefit (m) Marginal cost (m) 5 3 8 4.5 3 1.5 11 6 3 1.5 15 8 4 2 16 16.5 10 12 1 0.5 2 2

Trade-off Choosing entails trading off a target against another and is a fundamental issue of the decision-making process. Marginal Benefits and Costs Adjustments to the existing status quo. e.g. changing jobs for higher wages Response to Incentives Indices of elasticity show changes in people's behaviour as a response to certain incentives. Opportunity Cost The decision-making process requires comparing the costs and benefits of alternative courses of action

How the Principles of Economics Affect Decision Making

How the Principles of Economics Affect Decision Making Making Capital Investments Using the Laws of Supply and Demand Assessing a Companys Investment Potential Using Price Elasticity Determine Whether to Enter a New Market Using Marginal Analysis


Seminar Questions
How to Make a Decision at the Margin in Economics Calculating marginal utility