David Begg, Foundations of Economics, Third Edition

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Topic/Chapter 1What is economics for business?
Business EconomicsFor School of Management
StudentsSpring Semester 2008

• David Begg, Foundations of Economics, Third
  Edition
• McGraw-Hill, 2006
• Power Point presentation by Peter Smith
• Adapted for the Third Edition by Lester C Hunt,
  UniS.

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Topic/Chapter 1What is Economics for Business?

• Will cover
• 1.1 What economists study
• 1.2 How business economists think
• 1.3 How markets work

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Topic 1.1 What economists studyLearning outcomes

• By the end of this section, you should
  understand
• That economics is the study of scarcity
• How opportunity cost reflects scarcity
• How society rations scarce goods and services
• Pros and cons of relying on the market
• Positive and normative economics
• Microeconomics and macroeconomics

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What is Economics?

• ECONOMICS addresses problems of RESOURCE
  ALLOCATION
• It is the study of how society decides
• What to produce
• How to produce
• and for whom to produce
• (i.e. how to share it)

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SCARCITY means that CHOICES have to be made

• A scarce resource
• one for which demand at a zero price would exceed
  available supply
• Opportunity cost
• for the economist, the true cost of a choice is
• the quantity of other goods that must be
  sacrificed to obtain another unit of a good

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Resource Allocation

• Resource allocation is handled in different ways
  in different societies e.g.
• Command economy
• the State decides what, for whom and how to
  produce
• Free market
• the State does not interfere, the market
  allocates resources
• Mixed economy
• the government and private sector interact

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The Role of Markets

• Markets
• bring together
• households decisions about consumption of
  alternative goods
• firms decisions about what and how to produce
• workers decisions about how much and for whom to
  work
• and reconcile them by the adjustment of prices

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Market Orientation
Sweden
USA
China
Hungary
UK
Cuba
Free market economy
Command economy
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Normative and Positive Economics

• Positive economics deals with objective
  explanation
• e.g. if a tax is imposed on a good its price will
  tend to rise
• Normative economics offers prescriptions based on
  value judgements
• e.g. a tax SHOULD be imposed on tobacco to
  discourage smoking

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Micro and Macro

• Microeconomics
• offers a detailed treatment of individual
  economic decisions about particular commodities
• Macroeconomics
• emphasizes the interactions in the economy as a
  whole

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Topic 1.2 How business economists thinkLearning
outcomes

• By the end of this section, you should
  understand
• Why theories deliberately simplify reality
• Nominal and real variables
• How to build a simple theoretical model
• How to interpret scatter diagrams
• How other things equal lets key influences be
  ignored but not forgotten

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Models and Data

• Model (Theories)
• a framework based on simplifying assumptions
• helps to organize our economic thinking
• Data
• pieces of evidence about the real world
• the economists link with the real world
• time series
• cross section

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Data

• Unemployment by Country, 2005

• UK House prices
• (Average price of a new house)

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Data Real or Nominal

• Many economic variables are measured in money
  terms
• Nominal values
• measured in current prices
• Real values
• adjusted for price changes compared with a base
  year
• measured in constant prices

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Data Index numbers

• Often data is converted to an index number
  format
• An index number expresses data relative to a
  given base value
• For example, the UK Consumer Price Index (CPI) is
  used to measure the basket of goods bought by a
  typical household.
• The rate of change of the CPI is a measure of UK
  inflation.

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Economic Models

• To organize our thinking we need a simplified
  picture of reality
• focusing on key elements
• e.g. Quantity of tube journeys demanded
  f(Prices, income, preferences)

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Scatter Diagrams
Diagrams help economists to explore
relationships between economic variables e.g. the
relationship between tube fares and tube revenues
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other things equal

• other things equal is a device for looking at
  the relation between two variables, but
  remembering other variables also matter.
• In other words all the other variables are held
  (or are assumed to be) constant
• Thus allowing the economist to focus on the
  relationship between the two variables of
  interest.
• also known by its Latin name
• Ceteris paribus

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This can be illustrated with the tube fare and
revenue example (figure 1.3)
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Topic 1.3 How markets work Learning outcomes

• By the end of this section, you should
  understand
• Demand and supply
• Equilibrium in a market
• How markets resolve what, how and for whom
  things are produced
• Price controls

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Some Key Terms

• Market
• an institution which brings buyers and sellers
  together to trade goods or services
• Demand
• the quantity of a good buyers wish to purchase at
  each conceivable price
• Supply
• the quantity of a good sellers wish to sell at
  each conceivable price
• Equilibrium price
• price at which quantity supplied quantity
  demanded and the market clears

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Market Adjustment 1

• Price is below the equilibrium price
• With a low price quantity demanded is high but
  quantity supplied is low.
• There is a shortage or excess demand.
• Sellers run out of stock and charge higher prices
  so that prices rise until the equilibrium price
  is reached.
• Excess demand is eliminated with the market
  clearing at the point where supply equals demand.

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Market Adjustment 2

• Price is above the equilibrium price
• With a high price quantity supplied is high but
  quantity demanded is low.
• Sellers have unsold stock so there is excess
  supply.
• Sellers have to cut prices to clear their stock
  so that prices fall until the equilibrium price
  is reached.
• Excess supply is eliminated with the market
  clearing at the point where supply equals demand.

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Market Adjustment 3

• By behaving in this way, prices help resolve the
  basic questions of economics
• What, how and for whom goods are produced.

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Price controls

• A price control is a government regulation to fix
  the price
• Price controls may be floor prices (minimum
  prices)
• These aim to raise the price for suppliers
• For example the national minimum wage is a floor
  price for labour.
• Price controls may be ceiling prices (maximum
  prices)
• These aim to reduce the price for consumers
• For example price ceilings set by governments for
  food due to shortages in war time.