Economics for Business Decision Making

Transcription

1 Week 1: Explain that: People are rational Consumers and firms use as much of the available information as they can to achieve their goals rational individuals weigh the benefits and costs of each action, and they choose the action only if the benefits outweigh the costs People respond to incentives If there is an incentive to purchase or sell a good or service (eg. medicine to get over a disease), an individual would purchase or sell that good or service Moreover, if the price of a good or service is subsidized and hence lower than the price of substitutes, consumers would be incentivized to purchase that good or service Optimal decisions are made at the margin Economists reason that the optimal decision is to continue any activity up to the point where the marginal benefit (MB) equals the marginal cost (MC) What extra benefit would I get from purchasing one more of these goods? Marginal analysis involves comparing marginal benefits and marginal costs Understand the issues of scarcity and trade-offs, and how the market makes decisions on these issues Scarcity is the situation in which unlimited wants exceed the limited resources available to fulfill those wants Resources are inputs used to produce goods and services, including natural resources such as land, water and minerals, labour, capital and entrepreneurial ability Trade-off is the idea that, because of scarcity, producing one good or service means producing less of another good or service o Trade offs force society to make choices, particularly when answering the following three fundamental questions: What goods and services will be produced? When analyzing decisions to choose between alternative options, economists use the concept of opportunity cost which is the highest-valued alternative that must be given up to engage in an activity The good with the lowest opportunity cost is the one which will be demanded most, and hence produced How will the goods and services be produced? Firms must choose between employing capital-intensive or labour-intensive production chains Who will receive the goods and services produced? In Australia, this largely depends on how income is distributed the individuals with the highest amount of income have the ability to buy the most goods and services However, this can be argued as being unequal, and hence the government intervenes through programs such as transfer payments and a progressive taxation system so as to redistribute some of the income of higher-income earners to those who do not earn as much 1

2 To answer these questions, societies organize their economies in two ways: 1. Centrally planned an economy in which the government decides how economic resources will be allocated 2. Market an economy in which the decisions of households and firms interacting in markets allocate economic resources, based on consumer sovereignty (which occurs because firms must produce goods and services that meet the wants of consumers or the firms will go out of business therefore it is ultimately the consumer who decides what goods and services will be produced) Efficiency and equity: Productive efficiency occurs when a good or service is produced using the least amount of resources Allocative efficiency occurs when production reflects consumer preferences; in particular every good or service is produced up to a point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it Dynamic efficiency occurs when new technologies and innovation are adopted over time Voluntary exchange occurs when both the buyers and sellers of a product are made better off by the transaction occurs in a market economy Equity refers to the fair distribution of economic benefits between individuals and between societies An efficient outcome may or may not be considered by society to be equitable Understand the role of models in economic analysis Economic models are simplified versions of reality used to analyse real-world economic situations To develop a model, economics 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 A hypothesis in an economic model is a statement that may be either correct or incorrect about an economic variable An economic variable is something measureable that relates to resource use that can have different values, for example wages, prices, litres of water In testing hypotheses, economists distinguish between correlation and causality. Correlation does not imply causation o Eg. sleeping with shoes on is strongly correlated with waking up with a headache. Does sleeping with one s shoes on cause headaches? Positive and normative analysis Positive analysis is analysis concerned with what is, and involves value-free statements that can be checked by using the facts o Eg. a fall in incomes will lead to a rise in demand for own-brand supermarket foods Normative analysis is analysis concerned with what ought to be, and involves value judgments, which cannot be tested o Eg. climate change is the most significant economic issue 2

3 Distinguish between microeconomics and macroeconomics Microeconomics is the study of how households and firms make choices, how they interact in markets and how the government attempts to influence their choices Macroeconomics is the study of the economy as a whole, including topics such as inflation, unemployment and economic growth Economics is the science of choice: Society has unlimited wants but limited resources which leads to scarcity Because of scarcity, we must make choices Use a production possibility frontier to analyse opportunity costs and trade-offs The production possibility frontier is a curve showing the maximum attainable combinations of two products that may be produced with available resources Opportunity cost is the highest-valued alternative that must be given up to engage in an activity Points A, B, C, D and E are efficient as all resources are being used 3

4 Point F is inefficient as not all available resources are being used Point G is unattainable with the current amount of resources The bowed out shape of the production possibility frontier reflects the concept of increasing marginal opportunity costs Increasing marginal opportunity costs demonstrate an important economic concept: o The more resources already devoted to an activity, the smaller the payoff of devoting additional resources to that activity NOTE: if the PPF is a straight line function, draw a straight line Economic growth: Economic growth refers to the increase in an economy s productive capacity over time. This can be represented on the PPF: Furthermore, growth in a particular industry (eg. due to technological shifts favouring that industry) can also be represented on the PPF: 4

5 A PPF may also shift inwards if an economy experienced a reduction in its productive resources, causing the maximum amount of output that could be produced to fall Opportunity costs include both explicit and implicit costs o Explicit costs are direct payments made to others in the course of running a business o Implicit costs are those that do not involve funds, eg. the time or energy required for something. This is measured through opportunity cost the opportunity cost of going to university is working right now and earning more money More formally defined, implicit costs are non-monetary opportunity costs Opportunity costs do not include unrecoverable or sunk costs o Sunk costs are those which are already paid and unrecoverable Understand comparative advantage and explain how it is the basis for trade Trade is the act of buying or selling a good or service in a market Specialization is a method of production where a business or area focuses on the production of a limited scope of products or services in order to gain greater degrees of productive efficiency within the entire system of businesses or areas Comparative advantage is the ability of an individual, firm or country to produce a good or service at a lower opportunity cost than other producers Absolute advantage is the ability of an individual, firm or country to produce more of a good or service than competitors using the same amount of resources The basis for trade is comparative advantage individuals, firms or countries would gain from trade if they specialized in the production of the good or service in which they have a comparative advantage and trade to obtain other desirable goods or services Example: 5