Lecture 1 Slides - Economics for Business Decision Making - PDF

2/2/2023 ECO10005-Economics for Business Decision Making Introduction (Main Concepts) Professor Abbas Valadkhani Week 1 1 Economics: foundations and models (2 of 2) Economics is the study of the choices people and societies make to attain their unlimited w...

2/2/2023 ECO10005-Economics for Business Decision Making Introduction (Main Concepts) Professor Abbas Valadkhani Week 1 1 Economics: foundations and models (2 of 2) Economics is the study of the choices people and societies make to attain their unlimited wants, given their scarce resources. In economics we study how people make choices and interact in markets. – Market: A group of buyers and sellers of a good or service and the institution or arrangement by which they come together to trade. Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 2 1  2/2/2023 Three key economic ideas 1. People are rational. 2. People respond to economic incentives. 3. Optimal decisions are made at the margin. – Marginal analysis: Analysis that involves comparing marginal benefits and marginal costs. Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 3 Scarcity and trade-offs Scarcity: The situation in which unlimited wants exceed the limited resources available to fulfill those wants. Resources: Inputs used to produce goods and services, including natural resources such as land, water and minerals, labour, capital, and entrepreneurial ability. Trade-off: The idea that, because of scarcity, producing more of one good or service means producing less of another good or service. Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 4 2  2/2/2023 Trade-offs force society to make choices (2 of 3) 1. What goods and services will be produced?  When choosing between alternative options, economists use the concept of opportunity cost. – Opportunity cost: The opportunity cost of any activity is the highest-valued alternative that must be given up to engage in that activity. Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 5 Efficiency and equity (1 of 2)  Productive efficiency: When a good or service is produced using the least amount of resources.  Allocative efficiency: When production reflects consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.  Dynamic efficiency: Occurs when new technology and innovation are adopted over time. Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 6 3  2/2/2023 Economic models  Economic models: Simplified versions of reality used to analyse real-world economic situations.  Economic variable: Something measurable that relates to resources that can have different values, for example, wages, prices, litres of petrol.  Economic models make behavioural assumptions about the motives of consumers and firms. Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 7 Economic models To develop a model economists generally follow these steps: 1. Decide on the assumptions to be used in developing the model. 2. Formulate a testable hypothesis. 3. Use economic data to test the hypothesis. 4. Revise the model if it fails to explain the economic data. 5. Retain the revised model to help answer similar economic questions in the future. Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 8 4  2/2/2023 Normative and positive analysis  Positive analysis: Analysis concerned with what is, involving value-free statements that can be checked by using the facts.  Normative analysis: Analysis concerned with what ought to be, involving value judgements which cannot be tested. Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 9 Microeconomics and macroeconomics  Microeconomics: The study of how households and firms make choices, how they interact in markets, and how the government attempts to influence their choices.  Macroeconomics: The study of the economy as a whole, including topics such as inflation, unemployment, and economic growth. Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 10 5  2/2/2023 Using graphs and formulae Economic models, like graphs and formulas, can be compared to maps—they provide a simplified guide to reality. Reproduced with the kind permission of National Roads and Motorists’ Association Limited. Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 11 Plotting price and quantity on a graph: Figure 1A.3 Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 12 6  2/2/2023 Calculating the slope of a line: Figure 1A.4 Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 13 Showing three variables on a graph: Figure 1A.5 Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 14 7  2/2/2023 A positive relationship between two variables: Figure 1A.6 Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 15 The slope of a non-linear curve: Figure 1A.7 Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 16 8  2/2/2023 Ch2-Learning objectives 2.1 Use a production possibility frontier to analyse opportunity costs and trade-offs. 2.2 Understand comparative advantage and explain how it is the basis for trade. 2.3 Explain the basic idea of how a market system works. 2.4 Understand why property rights are necessary for a well-functioning market. Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 17 Production possibility frontiers and real-world trade-offs Graphing the production possibility frontier  Production possibility frontier: A curve showing the maximum attainable combinations of two products that may be produced with available resources.  Opportunity cost: The highest-valued alternative that must be given up to engage in an activity. Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 18 9  2/2/2023 Tesla’s production possibility frontier: Figure 2.1 Quantity of sedans Quantity of SUVs Choice produced produced A 80 0 B 60 40 C 40 50 D 20 57 E 0 60 Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 19 Figure 2.1 cont. Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 20 10  2/2/2023 Production possibility frontiers and real-world trade-offs Increasing marginal opportunity costs  The bowed-out shape of the production possibility frontier illustrates the concept of increasing marginal opportunity costs.  Increasing marginal opportunity costs demonstrates an important economic concept: The more resources already devoted to an activity, the smaller the payoff to devoting additional resources to that activity. Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 21 Increasing marginal opportunity cost: Figure 2.2 Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 22 11  2/2/2023 Production possibility frontiers and real-world trade-offs Economic growth  Economic growth: The expansion of society’s production potential.  Economic growth can be illustrated using the production possibility frontier. Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 23 Shifting out the production possibility frontier: Economic growth: Figure 2.3 Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 24 12  2/2/2023 Comparative advantage and trade  We use the production possibility frontier and the concept of opportunity cost to explain the economic gains from specialisation and trade.  Trade: The act of buying or selling a good or service in a market. Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 25 Specialisation and gains from trade  We use a simple example of two people—you and your neighbour.  And two goods, apples and cherries, measured in kilograms (kgs). Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 26 13  2/2/2023 Fruit picked each month without trade: Table 2.1 You Your neighbour Apples Cherries Apples Cherries All time picking apples 20 kg 0 kg 30 kg 0 kg All time picking cherries 0 kg 20 kg 0 kg 60 kg Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 27 A summary of the gains from trade: Table 2.2 You Your Neighbour Apples (kg) Cherries (kg) Apples (kg) Cherries (kg) Production and consumption 8 12 9 42 without trade Production with trade 20 0 0 60 Consumption with trade 10 15 10 45 Gains from trade 2 3 1 3 Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 28 14  2/2/2023 Absolute advantage versus comparative advantage  Absolute advantage: The ability of an individual, firm or country to produce more of a good or service than competitors using the same amount of resources.  Comparative advantage: The ability of an individual, firm, or country to produce a good or service at a lower opportunity cost than other producers. Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 29 Opportunity cost of picking apples and cherries: Table 2.3 You Your neighbour Apples Cherries Apples Cherries All time picking apples 20 kg 0 kg 30 kg 0 kg All time picking cherries 0 kg 20 kg 0 kg 60 kg 1 kg of apples 1 kg of cherries You 1 kg of cherries 1 kg of apples Your neighbour 2 kg of cherries 0.5 kg of apples Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 30 15  2/2/2023 Comparative advantage and the gains from trade  The basis for trade is comparative advantage, not absolute advantage.  Individuals, firms, or countries are better off if they specialise in producing goods and services for which they have a comparative advantage and obtain other desirable goods and services by trading. Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 31 The market system  Market: A group of buyers and sellers of a good or service and the institution or arrangement by which they come together to trade.  Product markets: Markets for goods, such as computers, and services, such as medical treatment.  Factor markets: Markets for the factors of production, such as labour, capital, natural resources, and entrepreneurial ability. Copyright © 2019 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488616983/Hubbard/Essentials of Economics/4e 32 16