Eco 26 Aug08

Economics Analysis for Economics Analysis for Managerial ApplicationsManagerial Applications

-Taught By:Ms.Dimple, Assistant Professor

FMS Department, NIFT Delhi

The Basic Decision-Making Units

A firm is an organization that transforms resources (inputs) into products (outputs). Firms are the primary producing units in a market economy.

An entrepreneur is a person who organizes, manages, and assumes the risks of a firm, taking a new idea or a new product and turning it into a successful business.

Households are the consuming units in an economy.

The Circular Flow of Economic Activity

The circular flow of economic activity shows the connections between firms and households in input and output markets.

Input Markets and Output Markets

Output, or product, markets are the markets in which goods and services are exchanged.

Input markets are the markets in which resources—labor, capital, and land—used to produce products, are exchanged.

• Payments flow in the opposite Payments flow in the opposite direction as the physical flow of direction as the physical flow of resources, goods, and services resources, goods, and services (counterclockwise).(counterclockwise).

Input Markets

Input markets include:The labor market, in which households

supply work for wages to firms that demand labor.

The capital market, in which households supply their savings, for interest or for claims to future profits, to firms that demand funds to buy capital goods.

The land market, in which households supply land or other real property in exchange for rent.

Determinants of Household Demand

• The price of the product in question.• The income available to the household.• The household’s amount of accumulated

wealth.• The prices of related products available

to the household.• The household’s tastes and preferences.• The household’s expectations about future

income, wealth, and prices.

A household’s decision about the quantity of a particular A household’s decision about the quantity of a particular output to demand depends on:output to demand depends on:

Quantity Demanded

Quantity demanded is the amount (number of units) of a product that a household would buy in a given time period if it could buy all it wanted at the current market price.

Demand in Output Markets

A demand schedule is a table showing how much of a given product a household would be willing to buy at different prices.

Demand curves are usually derived from demand schedules.

PRICE (PER

CALL)

QUANTITY DEMANDED (CALLS PER

MONTH)Rs 0 30

0.50 253.50 77.00 3

10.00 115.00 0

ANNA'S DEMAND SCHEDULE FOR

TELEPHONE CALLS

The Demand Curve

The demand curve is a graph illustrating how much of a given product a household would be willing to buy at different prices.

PRICE (PER

CALL)

QUANTITY DEMANDED (CALLS PER

MONTH)Rs 0 30

0.50 253.50 77.00 3

10.00 115.00 0

ANNA'S DEMAND SCHEDULE FOR

TELEPHONE CALLS

Rs

The Law of Demand

The law of demand states that there is a negative, or inverse, relationship between price and the quantity of a good demanded and its price.

• This means that This means that demand curves slope demand curves slope downward.downward.

Rs

Other Properties of Demand Curves

Demand curves intersect the quantity (X)-axis, as a result of time limitations and diminishing marginal utility.

Demand curves intersect the (Y)-axis, as a result of limited incomes and wealth.

Income and Wealth

• Income is the sum of all households wages, salaries, profits, interest payments, rents, and other forms of earnings in a given period of time. It is a flow measure.

• Wealth, or net worth, is the total value of what a household owns minus what it owes. It is a stock measure.

Related Goods and Services

Normal Goods are goods for which demand goes up when income is higher and for which demand goes down when income is lower.

Inferior Goods are goods for which demand falls when income rises.

Related Goods and Services

Substitutes are goods that can serve as replacements for one another; when the price of one increases, demand for the other goes up. Perfect substitutes are identical products.

Complements are goods that “go together”; a decrease in the price of one results in an increase in demand for the other, and vice versa.

Shift of Demand Versus Movement Along a Demand Curve

• A change in A change in demanddemand is is not the same as a change not the same as a change in in quantity demandedquantity demanded..

• In this example, a higher In this example, a higher price causes lower price causes lower quantity demandedquantity demanded..

• Changes in determinants Changes in determinants of demand, other than of demand, other than price, cause a change in price, cause a change in demanddemand, or a , or a shiftshift of the of the entire demand curve, from entire demand curve, from DDAA to to DDBB..

• When demand shifts to the right, demand increases. This causes quantity demanded to be greater than it was prior to the shift, for each and every price level.

A Change in Demand Versus a Change in Quantity Demanded

A Change in Demand Versus a Change in Quantity Demanded

To summarize:

Change in price of a good or service leads to

Change in quantity demanded(Movement along the curve).

Change in income, preferences, orprices of other goods or services

leads to

Change in demand(Shift of curve).

The Impact of a Change in Income

• Higher income decreases the demand for an inferior good

• Higher income increases the demand for a normal good

The Impact of a Change in the Price of Related Goods

• Price of hamburger rises

• Demand for complement good (ketchup) shifts left

• Demand for substitute good (chicken) shifts right

• Quantity of hamburger demanded falls

From Household to Market Demand

Demand for a good or service can be defined for an individual household, or for a group of households that make up a market.

Market demand is the sum of all the quantities of a good or service demanded per period by all the households buying in the market for that good or service.

From Household Demand to Market Demand

Assuming there are only two households in the market, market demand is derived as follows:

Supply in Output Markets

• A A supply schedulesupply schedule is a table is a table showing how much of a product showing how much of a product firms will supply at different firms will supply at different prices.prices.

• Quantity suppliedQuantity supplied represents the represents the number of units of a product that number of units of a product that a firm would be willing and able to a firm would be willing and able to offer for sale at a particular price offer for sale at a particular price during a given time period.during a given time period.

PRICE (PER

BUSHEL)

QUANTITY SUPPLIED

(THOUSANDS OF BUSHELS

PER YEAR)$ 2 0

1.75 102.25 203.00 304.00 455.00 45

CLARENCE BROWN'S SUPPLY SCHEDULE

FOR SOYBEANS

The Supply Curve and the Supply Schedule

• A A supply curvesupply curve is a graph illustrating how much is a graph illustrating how much of a product a firm will supply at different prices.of a product a firm will supply at different prices.

0

1

2

3

4

5

6

0 10 20 30 40 50Thousands of bushels of soybeans

produced per year

Pri

ce o

f so

ybea

ns

per

bu

shel

($)

PRICE (PER

BUSHEL)

QUANTITY SUPPLIED

(THOUSANDS OF BUSHELS

PER YEAR)$ 2 0

1.75 102.25 203.00 304.00 455.00 45

CLARENCE BROWN'S SUPPLY SCHEDULE

FOR SOYBEANS

The Law of Supply

The law of supply states that there is a positive relationship between price and quantity of a good supplied.

This means that supply curves typically have a positive slope.

0

1

2

3

4

5

6

0 10 20 30 40 50Thousands of bushels of soybeans

produced per year

Pri

ce o

f so

ybea

ns

per

bu

shel

($)

Determinants of Supply

• The price of the good or service.• The cost of producing the good, which

in turn depends on:•The price of required inputs (labor, capital, and land),

•The technologies that can be used to produce the product,

• The prices of related products.

A Change in Supply Versus a Change in Quantity Supplied

• A change in A change in supplysupply is is not the same as a not the same as a change in change in quantity quantity suppliedsupplied..

• In this example, a higher In this example, a higher price causes price causes higher higher quantity suppliedquantity supplied, and , and a a move alongmove along the the demand curve.demand curve.

• In this example, changes in determinants of supply, other In this example, changes in determinants of supply, other than price, cause an than price, cause an increase in supplyincrease in supply, or a , or a shiftshift of the of the entire supply curve, from entire supply curve, from SSAA to to SSBB..

• When supply shifts to the right, supply increases. This causes quantity supplied to be greater than it was prior to the shift, for each and every price level.

A Change in Supply Versusa Change in Quantity Supplied

A Change in Supply Versusa Change in Quantity Supplied

To summarize:

Change in price of a good or service leads to

Change in quantity supplied(Movement along the curve).

Change in costs, input prices, technology, or prices of related goods and services

leads to

Change in supply(Shift of curve).

From Individual Supplyto Market Supply

The supply of a good or service can be defined for an individual firm, or for a group of firms that make up a market or an industry.

Market supply is the sum of all the quantities of a good or service supplied per period by all the firms selling in the market for that good or service.

Market Supply

As with market demand, market supply is the horizontal summation of individual firms’ supply curves.

Market Equilibrium

The operation of the market depends on the interaction between buyers and sellers.

An equilibrium is the condition that exists when quantity supplied and quantity demanded are equal.

At equilibrium, there is no tendency for the market price to change.

Market Equilibrium

Only in equilibrium is quantity supplied equal to quantity demanded.

• At any price level At any price level other than other than PP00, the , the

wishes of buyers wishes of buyers and sellers do not and sellers do not coincide.coincide.

Market Disequilibria

Excess demand, or shortage, is the condition that exists when quantity demanded exceeds quantity supplied at the current price.

• When quantity demanded When quantity demanded exceeds quantity exceeds quantity supplied, price tends to supplied, price tends to rise until equilibrium is rise until equilibrium is restored.restored.

Market Disequilibria

Excess supply, or surplus, is the condition that exists when quantity supplied exceeds quantity demanded at the current price.

• When quantity supplied When quantity supplied exceeds quantity exceeds quantity demanded, price tends to demanded, price tends to fall until equilibrium is fall until equilibrium is restored.restored.

Increases in Demand and Supply

Higher demand leads to higher equilibrium price and higher equilibrium quantity.

Higher supply leads to lower equilibrium price and higher equilibrium quantity.

Decreases in Demand and Supply

Lower demand leads to lower price and lower quantity exchanged.

Lower supply leads to higher price and lower quantity exchanged.

Relative Magnitudes of Change

• The relative magnitudes of change in supply and The relative magnitudes of change in supply and demand determine the outcome of market equilibrium.demand determine the outcome of market equilibrium.

Relative Magnitudes of Change

• When supply and demand both increase, quantity When supply and demand both increase, quantity will increase, but price may go up or down.will increase, but price may go up or down.

Law of DemandLaw of Demand

Demand slopes downward according to the Demand slopes downward according to the law of law of demand.demand.

The law is demand is caused in part by the The law is demand is caused in part by the substitution effect.substitution effect.

The The substitution effectsubstitution effect of a price change, which of a price change, which occurs when a lower price on a good causes a occurs when a lower price on a good causes a person to buy more of that good instead of person to buy more of that good instead of alternative goods.alternative goods.

Likewise, the substitution effect of increasing the Likewise, the substitution effect of increasing the price of a good would drive consumers to buy more price of a good would drive consumers to buy more of the substitute good instead of the good with the of the substitute good instead of the good with the increased price.increased price.

o For a For a normal goodnormal good, the income effect of a , the income effect of a price change will also cause demand to price change will also cause demand to slope down.slope down.

o The income effect occurs when the price The income effect occurs when the price change affects consumer purchasing power, change affects consumer purchasing power, termed termed real incomereal income, and thus leads to a , and thus leads to a change in quantity demanded.change in quantity demanded.

o A higher price reduces real income, while a A higher price reduces real income, while a lower price increases real income.lower price increases real income.

Law of DemandLaw of Demand

UTILITY AND CONSUMER SATISFACTIONUTILITY AND CONSUMER SATISFACTION

Consumers buy in order to obtain Consumers buy in order to obtain utilityutility, which is the satisfaction , which is the satisfaction received from the consumption of a received from the consumption of a good.good.

The utility that people gain from their The utility that people gain from their purchases is subjective, varying from purchases is subjective, varying from person to person.person to person.

Utility is not measurable, since Utility is not measurable, since satisfaction is not measurable.satisfaction is not measurable.

Utility does not imply that a good is Utility does not imply that a good is useful.useful.

Total and Marginal UtilityTotal and Marginal Utility

• Although utility is not measurable, it Although utility is not measurable, it can be modeled as though it were, can be modeled as though it were, using the using the utilutil as its unit of measure.as its unit of measure.

• Total utilityTotal utility equals the sum of the equals the sum of the utils a person receives from utils a person receives from consuming a specific quantity of a consuming a specific quantity of a good.good.

• Marginal utilityMarginal utility equals the equals the increments to total utility from increments to total utility from changes in consumption.changes in consumption.

MarginalMarginal Utility = Utility =

Change in total utility_______Change in total utility_______Change in number of units consumedChange in number of units consumed


0

50

100

150

Utils

First Slice Second Slice Pizza

Marginal utility

TotalUtility


Diminishing Marginal UtilityDiminishing Marginal Utility

• The law of diminishing marginal The law of diminishing marginal utilityutility decrees that the first unit of a decrees that the first unit of a good is most satisfying, after which good is most satisfying, after which additional units provide progressively additional units provide progressively less and less additional utility.less and less additional utility.

• There is a There is a satiation pointsatiation point,, beyond beyond which additional consumption which additional consumption actually reduces utility.actually reduces utility.

• When marginal utility is negative we say When marginal utility is negative we say that a good provides that a good provides disutility, which disutility, which occurs beyond the satiation point.occurs beyond the satiation point.

• The total utility curve rises as long as The total utility curve rises as long as marginal utility is a positive number.marginal utility is a positive number.

• When marginal utility equals zero, the total When marginal utility equals zero, the total utility curve peaks because total utility is at utility curve peaks because total utility is at its maximum value.its maximum value.

• The total utility curve turns downward The total utility curve turns downward when marginal utility becomes negative.when marginal utility becomes negative.

Diminishing Marginal UtilityDiminishing Marginal Utility

Utility

Utility

Satiation point

Satiation point

Total Utility is Total Utility is maximized whenmaximized whenmarginal utility is marginal utility is zero.zero.


Marginal utility

Tota

l util

ity

You are given a box of donuts to eat You are given a box of donuts to eat and are asked to record how much and are asked to record how much utility you receive from eating each utility you receive from eating each one. It is likely that the marginal one. It is likely that the marginal utility you receive:utility you receive:

A) Increases with each additional donut you eat

B) Stays constant with each additional donut you eat

C) Decreases with each additional donut you eat

So wanna come with me for lunch?

Q. Did you ever see an “eat as much as you want” restaurant?A. They live on disutility and on that you reach your satiation point before they lose money on you.

Q. If you went to such a restaurant, did you have a stomachache later?

Q. What does that mean?

MAXIMIZING UTILITY SUBJECT TO A MAXIMIZING UTILITY SUBJECT TO A BUDGET CONSTRAINTBUDGET CONSTRAINT

• The The budget constraintbudget constraint, a consumer’s , a consumer’s income, curbs the amount of total utility income, curbs the amount of total utility that can be obtained.that can be obtained.

• Consumers must choose, while striving to Consumers must choose, while striving to spend their incomes so as to obtain the spend their incomes so as to obtain the greatest satisfaction from their incomes.greatest satisfaction from their incomes.

• Consumers maximize utility subject to their Consumers maximize utility subject to their budget constraint.budget constraint.

• Utility maximizationUtility maximization is achieved when the is achieved when the consumer’s choices provide the greatest consumer’s choices provide the greatest amount of total utility for a specific amount amount of total utility for a specific amount of time. of time.

Spending at the MarginSpending at the Margin

• When When marginal utilitymarginal utility is divided by is divided by the prices of goods and services, the the prices of goods and services, the result is called marginal utility per result is called marginal utility per dollar.dollar.

• The The rule of utility maximizationrule of utility maximization is… is…•To maximize utility, a consumer adjusts To maximize utility, a consumer adjusts

spending until the marginal utility from spending until the marginal utility from the last rupee spent on each good is the the last rupee spent on each good is the same.same.

Algebraic Statement of the Utility Algebraic Statement of the Utility Maximizing RuleMaximizing Rule

Marginal Utility of XMarginal Utility of X Price of XPrice of X Marginal Utility of YMarginal Utility of Y

Price of Y, Price of Y, =for all goods X and Yfor all goods X and Y

If the marginal utility per dollar of product X is greaterIf the marginal utility per dollar of product X is greaterthan the marginal utility per rupee of product, consumersthan the marginal utility per rupee of product, consumersshould purchase more of product X. should purchase more of product X. Conversely, if the marginal per rupee of product Y is greater Conversely, if the marginal per rupee of product Y is greater than the marginal utility of product Y, consumers shouldthan the marginal utility of product Y, consumers shouldpurchase more of product Y. purchase more of product Y.

Utility Maximization and DemandUtility Maximization and Demand

• When consumers When consumers maximize utilitymaximize utility their individual demand curves for a their individual demand curves for a good are downward sloping.good are downward sloping.

• In other words, the quantity In other words, the quantity demanded of a good will change in demanded of a good will change in the opposite direction to a change in the opposite direction to a change in its price.its price.

• The The law of diminishing marginal law of diminishing marginal utilityutility is another explanation for the is another explanation for the downward sloping demand curve.downward sloping demand curve.

Have you ever picked up an Have you ever picked up an item in a store or taken a piece item in a store or taken a piece of clothing off a store’s rack and of clothing off a store’s rack and then looked at the price tag and then looked at the price tag and decided it wasn’t worth it? decided it wasn’t worth it?

A) YES B) NO

Maximizing Utility – Do We Want What Maximizing Utility – Do We Want What We Choose?We Choose?

Consumers account for some 70% of total Consumers account for some 70% of total spending in the Indian economy.spending in the Indian economy.Predicting consumer’s choice is difficult as Predicting consumer’s choice is difficult as since they are determined by numerous since they are determined by numerous considerations.considerations.Time has utility.Time has utility.People try to allocate their time to attain People try to allocate their time to attain the greatest satisfaction, taking into the greatest satisfaction, taking into account time’s opportunity cost.account time’s opportunity cost.

Good Choice, Bad ChoiceGood Choice, Bad Choice

• Information also has utility.Information also has utility.• The last rupee spent on information should have a The last rupee spent on information should have a

marginal utility per rupee equal to the marginal marginal utility per rupee equal to the marginal utility per rupee of the last rupee spent on the utility per rupee of the last rupee spent on the consumer’s other purchases.consumer’s other purchases.

• Impulse buyersImpulse buyers make purchases on the spur of the make purchases on the spur of the moment without consulting information sources. moment without consulting information sources.

• Advertising is intended to affect consumer’s choices, Advertising is intended to affect consumer’s choices, generally with the goal of getting us to buy generally with the goal of getting us to buy something now.something now.

• A rupee saved can provide more satisfaction than a A rupee saved can provide more satisfaction than a rupee spent.rupee spent.

Addictive BehaviorAddictive Behavior

• Some people make choices that appear to be bad to Some people make choices that appear to be bad to others.others.

• Binging behavior like overeating, smoking, binging Binging behavior like overeating, smoking, binging on alcohol, drugs, shopping, etc., are examples.on alcohol, drugs, shopping, etc., are examples.

• One aspect of addiction problems is that we are One aspect of addiction problems is that we are unable to rationally control the things that give us unable to rationally control the things that give us utility. utility.

• A second aspect is A second aspect is “utility in hindsight”,“utility in hindsight”, where where immediate gratification comes now, but the immediate gratification comes now, but the disutility comes later.disutility comes later.

• The further into the future the disutility, the more The further into the future the disutility, the more we are inclined to brush it aside.we are inclined to brush it aside.

Addictive Behavior:Addictive Behavior:Utility in HindsightUtility in HindsightAddictive Behavior:Addictive Behavior:Utility in HindsightUtility in Hindsight

Utility

Disutility

Marginal utility perceived at the time

Marginal utility perceived later

Quantity of binge purchases

Point where all moneyhas been spent

Terms Along the WayTerms Along the Way

substitution substitution effecteffect

income effectincome effectUtility utilUtility utiltotal utilitytotal utilitymarginal utilitymarginal utilitydisutilitydisutility

law of law of diminishing diminishing marginal utilitymarginal utility

satiation pointsatiation pointmarginal utility marginal utility

per rupeeper rupee

ssuubbssttiittuuttiioonn eeffffeeccttiinnccoommee eeffffeeccttuuttiilliittyyuuttiillttoottaall uuttiilliittyymmaarrggiinnaall uuttiilliittyyddiissuuttiilliittyy

Test YourselfTest Yourself1.1. When the price of a normal good decreasesWhen the price of a normal good decreasesa.a. the income and substitute effects both prompt the the income and substitute effects both prompt the

consumer to purchase more of the good.consumer to purchase more of the good.b.b. the income and substitute effects both prompt the the income and substitute effects both prompt the

consumer to purchase less of the good.consumer to purchase less of the good.c.c. the income effect prompts the consumer to purchase the income effect prompts the consumer to purchase

less of the good, but the substitution effect prompts less of the good, but the substitution effect prompts the consumer to purchase more.the consumer to purchase more.

d.d. the income effect prompts the consumer to purchase the income effect prompts the consumer to purchase more of the good, but the substitution effect more of the good, but the substitution effect prompts the consumer to purchase less.prompts the consumer to purchase less.

Test YourselfTest Yourself

2.2. Which of the following best describes the Which of the following best describes the concept of utility?concept of utility?

a.a. Utility is measurable.Utility is measurable.b.b. The utility of a good must rise the more The utility of a good must rise the more

useful it is.useful it is.c.c. Utility is subjective.Utility is subjective.d.d. The utility provided by any particular The utility provided by any particular

good will be the same for most good will be the same for most consumers.consumers.


3.3. The util is The util is a.a. unrelated to the concept of unrelated to the concept of

utility.utility.b.b. measurable with highly sensitive measurable with highly sensitive

electronic equipment.electronic equipment.c.c. used by economist to to illustrate used by economist to to illustrate

diminishing marginal utility .diminishing marginal utility .d.d. a special kind of money used in a special kind of money used in

economic experiments.economic experiments.


4.4. Marginal utility will be negative Marginal utility will be negative when the total utility curve is when the total utility curve is

a.a. rising.rising.b.b. falling.falling.c.c. at its maximum.at its maximum.d.d. in the negative range.in the negative range.


5.5. Consumer equilibrium requires the Consumer equilibrium requires the consumer to consumer to

a.a. maximize total utility.maximize total utility.b.b. maximize marginal utility.maximize marginal utility.c.c. purchase amounts of each good so that purchase amounts of each good so that

their marginal utilities are equal.their marginal utilities are equal.d.d. ignore the price of a good in deciding how ignore the price of a good in deciding how

much to consume and consider only the much to consume and consider only the utility of a purchase.utility of a purchase.

55..

CCoonnssuummeerr

eeqquuiillii

bbrrii

uumm

rreeqquuiirreess

tthhee

ccoonnssuummeerr

ttoo

mmaaxxii

mmiizzee

ttoottaall

uuttiilliittyy..

mmaaxxii

mmiizzee

mmaarrggii

nnaall

uuttiilliittyy..

ppuurrcchhaassee

aammoouunnttss

ooff

eeaacchh

ggoooodd

ssoo

tthhaatt

tthheeiirr

mmaarrggii

nnaall

uuttiilliittiieess

aarree

eeqquuaall..

iiggnnoorree

tthhee

pprriiccee

ooff

aa

ggoooodd

ii

nn

ddeeccii

ddii

nngg

hhooww

mmuucchh

ttoo

ccoonnssuummee

aanndd

ccoonnssii

ddeerr

oonnllyy

tthhee

uuttiilliittyy

ooff

aa

ppuurrcchhaassee..


6.6. The marginal utility per rupee of a The marginal utility per rupee of a good equals the goods marginal good equals the goods marginal utility utility

a.a. multiplied by Rs.1.multiplied by Rs.1.b.b. divided by Rs.1.divided by Rs.1.c.c. divided by the price of the good.divided by the price of the good.d.d. multiplied by the price of the good.multiplied by the price of the good.

What is forecasting?

Forecasts translate business plans and decisions into actions:

Forecasts are needed in every step of the supply chain (e.g. for

controlling purchasing, production and inventory)

Plans can be definite, but forecasting always involves an element of

uncertaintyMarketview Plans and

decisions Forecast

Actions

Forecasting-related challenges

Producing the forecast

Creating an accurate and

timely forecast

Using the forecast

Managing forecastuncertainty

THANK YOUTHANK YOU

Eco 26 Aug08

Documents

Transcript of Eco 26 Aug08