mba 505 economics for managers 1 global economics for managers mba 505 stephen e. margolis

MBA 505 Economics for Managers1

Global Economics for Managers

MBA 505

Stephen E. Margolis

Economics

It’s not about the money

Economics DefinedThe study of:

• Responses of humans to unlimited wants and limited resources.

• ScarcityElaborations:• Exchange (James Buchanan)• Optimization and coordination

So, what are we?

• Greedy materialists?

MBA 505 Economics for Managers

So, what are we?

• Greedy materialists?

• Noble visionaries?

Our concern is with anything that people value.

• Yes, it’s all the stuff we buy: food, shelter, clothing, entertainment, education, medical care, automobiles, travel, jewelry, art, gadgets and so on.

• It is also everything else we value. Security, health, clean air and water, leisure, privacy, …children…

But isn’t scarcity temporary?

• No• We will live in scarcity – in the economists

sense of it, so long as we can imagine things we would like to have….more food, better food, better health, safer cars, cleaner air, faster travel, more free time.

• So again, is it greed? Imagination?

Adam Smith on self interest:

He advocates generosity in The Theory of Moral Sentiments, but in The Wealth of Nations famously offers this:

“It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest”

What Makes Economics Different?

• Scarcity: The inevitability of choice.

Cost is the value of what is given up— Opportunity Cost

• Rationality: People pursue their own interests as they know it.

• Competition• Individualism:

As a methodologyAs an ethical foundation

• Definition (done)• Course operation• Approach to economics• Law of demand• Supply and demand• Prices• Costs• Comparative Advantage

Today’s Lecture

Course Operation

• Syllabus• Groups• Evaluation• Moodle• Paper

About this course

• Economics for business• Primarily microeconomics, but with some

coverage of macroeconomics and the principles of trade

• Introductory—intermediate level• Economics of business decisions• Applied as opposed to theoretical• It can be a first course in economics.

(Don’t copy this down)

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(This either)

Objectives

• Understand how markets work• Understand the economic logic in business

decisions.

In other contexts this is expressed as organization and optimization, respectively.

Normative and Positive Economics

• Positive• Normative

• Prescriptive

Normative and Positive Economics

• Positive: What is• Normative: What’s good

• Prescriptive: What to do

(See Normative)

Managers Are Teachers

Stephen E. Margolis

Mathematics

Algebra 1?

y = mx + b

p = a - bq

This will become familiar

P = a - bQ

This will become familiar

P = a - bQ

-b is the slope, a is the vertical intercept

More math

I will use some calculus. It will always be optional.

Some things are easier and more persuasive that way.

Back to Economics

Demand, Supply, and Equilibrium

A very quick overview.

The fundamental structure of economics

Incentives matter. We pick the low

hanging fruit first.

The fundamental structure of economics

Incentives matter. We pick the low

hanging fruit first.

Law of demand The law of diminishing marginal

product

Supply behavior

The Law of Demand

If the price of some good goes up, all other things equal, the quantity of the good that is consumed will fall.

Incentives Matter

What would the alternative be?

Suppose

Green Peppers

Regular Price: $.99 per pound

Today Only: $1.49

Demand as a Diagram

Q/tA flow

Demand as a Diagram(My coffee consumption)

Q/tA flow

Demand as a DiagramHillsborough St. Shops

Q/tA flow

1,000 2,500 5000

It’s not (just) about the money

• Extensions to the law of demand– Seatbelts– Meetings– Emily’s Band-Aids – Insulin

– Shaving

SupplyP

S and DP

Price AdjustmentP

More price AdjustmentP

S and D

PoS’

S and D

S and D (one more time)

About Prices

About Prices• Chapter 2 material.• What matters is relative price.

– How many restaurant meals per month do I give up to make payments on an Cayman S.

– How many loaves of bread do I give up to get a bottle of wine?

– How many hours of leisure do I give up to get a 60” HDTV

Suppose every price doubles

• You wage is a price, that doubles too. • So do all your stocks. • And your bonds too. (Although that one is

more of a fantasy)

What Happens?

2008 2013

Movie 6.00 9.00Ticket

1 lb.Coffee 10.00 12.00

What Is Pure Inflation?

A balanced increase in the prices of all goods, services and non money- denominated assets.

Does that ever happen?

Well actually, No.

What about the overall price level?

Suppose some prices went up 20%and some prices went up 50%, andyou wanted to know what happenedto the price level?

Laspeyres Index

The cost of the old bundle at the new prices

The cost of the old bundle at the old prices

A price index

Even StevenVegetarians, just make believe for a minute.

Suppose the price of beef goes up dramatically, but no other price changes. Suppose further that the cost of the bundle that you consume goes up exactly 5%. And finally, suppose you get a raise of exactly 5%, just to keep things even. Are things even?

Opportunity Cost Again

• Again, it is the concept of cost in economics.

• If taking an action does not impose any forgone opportunity, it has no cost.

• The empty factory floor

Exchange and Production

“The division of labour is limited by the extent of the market” Adam Smith

Specialization is a fundamental issue in economics, a fundamental characteristic of modern life

Comparative Advantage

Motor Paint

Comparative Advantage

Motor Paint

Specialization

Motor Paint

Steve does both motors and finishes in 60hours, Paul does both paint jobs; 60 hours.

Costs Motor Paint

Paul 40 30 70

Steve 30 50 80

If Paul paints both cars he takes 60 hoursIf Steve reworks both motors, he alsotakes 60 hours.

Costs Motor Paint

Paul 40 30 70

Steve 30 50 80

Steve’s cost of a motor is 3/5 of a paint job.Paul’s cost of a motor is 4/3 of a paint job.Steve is the low cost provider of motor work

Costs Motor Paint

Paul 40 30 70

Steve 30 50 80

Steve’s cost of a paint job is 5/3 of a motor overhaul. Paul’s cost of a paint job is 3/4 of a motor overhaul.

Paul is the low cost provider of painting.

Now, Suppose Steve is worse at both activities.

Motor Paint

Paul 40 30 70

Steve 45 75 120

CAN THEY TRADE?

Steve’s comparative advantage?

Motor Paint

Paul 40 30 70

Steve 45 75 120

Steve does both motors, finishes in 90 hours. Paul does both paint jobs, finishes in 60. Notice that Steve’s opportunitycosts haven’t changed.

LessonYour can be better at everything and still be the high cost provider, in termsof opportunity cost, of something.

You can be worse at everything and still be the low cost provider, in termsof opportunity cost, in something.

You may have an absolute advantage in no activity and still have a comparative advantage in something.

Consumer Theory

• Foundations of demand• Illustrates choice under uncertainty• A tool for conceptualizing certain problems• Used in business fields

– Finance– Marketing

What we assume about preferences.

• More is preferred to less• Consumers are willing to substitute• If A is preferred to B, and P is preferred to

C, then A is preferred to C• The more x you have and the less y, the

more x you would be willing to give up to get additional units of y.

Introducing…

The donut seller

from hell

So, you’re driving to work….

In need of coffee. You pull into the parking lot of an odd shop marked only by the sign:

DONUTSThere is also something slightly odd about the man

behind the counter.

There is a display case that might once have displayed prices.

You order your coffee and then you ask,

“How much is a donut?”

A march down the demand curve

So the donut seller says, $.80. and then, if you want a

second,

$.70. And if you want a third…

.80 + .70 + .60 + .50 + .40 + .30 = $3.30

And yet, to sell six donuts with simple pricing, you would have to

charge how much per donut?

And revenue would be what?

Donuts

.80 + .70 + .60 + .50 + .40 + .30 = $3.30

Conventional pricing would require a price of $.30 to get the buyer

to purchase six donuts, yielding revenue

of 6*.30 = 1.80

Donuts

OK, swell, what’s the point?

• Diminishing marginal valuation

• The step function that we see is also the individual’s demand curve.

• So, downward sloping demand originates in diminishing marginal evaluation

We will see the donut seller again

• Consumer surplus

• Price discrimination

The Science of Success.Why this book?

• The theme of this course is, what ideas that are accepted principles in economics are readily carried into business management?

• And related, to that, how does economics help us to better understand accepted business principles?

Market Based Management

• Views the firm as a miniature societies.

• Uses the principles that permit societies to prosper.

• These principles include the principles of markets.

Examples of applied economics

• Opportunity cost (p. 33, 109)

• Marginal analysis (p. 107)

• Comparative advantage (p. 35-6 and elsewhere)

And still more

Comparative advantage:

Unless two people (nations) are exact multiples of each other in terms of productivity, they will each have a comparative advantage, even if one is absolutely better in each activity.

The more productive party will benefit from practicing the activity in which it has the greatest advantage. The less productive party will benefit from practicing the activity in which it is least disadvantaged.

Elasticity

How we characterize demand and supply functions.

Here we will deal with price elasticityof demand.

Dreaded Elasticity

MBA 505 79

Scared as a Child?

PPPPQQQQ

Hear Elasticity…

Responsiveness

DPP’

Q Q’

Elastic

PInelastic

Q Q’

DPP’

Q Q’

Elastic

PInelastic

Q Q’

Responsive

Not so responsive

Is it just slope?

Suppose price goes up $1 and the numberof units sold goes down 100,000 units.

Responsive or not?

We need to know not just the changein quantity and the change in price, but also the price and quantity. We get

Rearranging:

Or, letting DP and DQ get small:

Examples

• Your sales force reports that if they were to cut price by 10%, units sold would increase by 14%. What is the elasticity of demand?

• You are given a study that says that the elasticity of demand for one of your products is –2.5. A price increase of 4% will do what to units sold?

A simple numerical example

Q=4000-.5P

What is the price elasticity of demand when P is 1500?

A simple numerical example

Q=4000-.5P

15005.

For example, if you raise price, what happens to revenue?

Does revenue always go up?

Now consider the relationship between price changes and revenue.

For example, if you raise price, what happens to revenue?

Does revenue always go up?

If you said no, you’re correct. If demand is very responsive, then the decrease in quantity will more than offset the increase in price.

Elasticity informs us about the effect of price changes on revenues. For this purpose, its more convenient to talk about the absolute values of elasticity. IF:

Then the proportionate change in quantity is greater than the proportionate change in price. Revenues will increase when price decreases.

NC State MBA Program Fall 200293

On the other hand, IF:

Then the proportionate change in quantity is less than the proportionate change in price. Revenues will decrease when price decreases.

P/Q is large

P/Q is small

Elasticity varies along a straight-line demand curve.

Here’s a useful mnemonic;

Elastic

Inelastic

The arrows point in the direction of increased revenues.

Revenues are maximized where 1

mba 505 economics for managers 1 global economics for managers mba 505 stephen e. margolis

managers mba

course economics

global economics

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normative slide

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