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Master of Business Administration
MBA NQF NINE(9)
ECONOMICS : 2016 WORKSHOP 1
Lecturer : H. Matsongoni
Time: 0800hrs to 1200hrs
Date: 16/ 07/2016
WORKSHOP INFORMATION : MBA ECONOMICS
1.
Workshop One - Overview of the Complete Module – Microeconomics
2.
Workshop Two - Overview of the Complete Module – Macroeconomics
3.
Workshop Three - Case Study Analysis and Assignment Guidelines
4.
Workshop Four - Group Presentation(s) and Exam Preparation
 For the respective dates see the MBA Course and Assignment Handbook (CAAH)
ROAD MAP / AGENDA TIME :240 MINUTES
1. Introduction to Managerial Economics
(i) What managerial economics is all about?
(ii) The interdependence between the major sectors, markets and flows in the economy.
2.
Understanding Market Forces : Demand, Supply and Price Elasticity.
(i) The circular flow of income and spending (ii) Government intervention (iii) Elasticity of demand
3.
4.
5.
6.
Production and Optimisation Analysis
Market Structures
The Factor Markets: The Labour Market
Key Macroeconomic Concepts – Economic Indicators
(i) Inflation (ii) Economic growth and development (iii) Unemployment
7.
8.
9.
10.
11.
The Monetary Sector and the Government Sector
Macroeconomic Theory and Policy
Economic Environment and Globalisation
International Trade / Foreign Sector
Exchange Rates
12. Economic Growth and Environmental Protection
BROAD AIMS OF THE MODULE: ECONOMICS
1. Appreciate and understand the importance of managerial economics in decision
making.
2. Understanding market forces: demand and supply analysis and price elasticity of
demand.
3. Describe the basic production, cost concepts and market structures.
4. Identify major role players in the macro – economy.
5. Describe the factor markets especially the labour market.
6. Appreciate macroeconomic variables / economic indicators.
7. Understand monetary sector and public sector.
8. Explain economic growth, development and environmental protection.
9. Explain macroeconomic theory and policy.
10. Describe international trade and its impact on the economy.
11. Appreciate the determination of exchange rates – direct and indirect quotes.
12. Analyze the impact of international trade in the economy
13. Appreciate economic environment and globalization.
14. Critical analysis of case studies to highlight key economic problems, solutions and
policies.
1. WHAT IS ECONOMICS ?
The word economics is derived from the Greek word oikos, meaning house and
nemein, meaning manage.
Economics is the study of how societies use scarce resources to produce valuable
commodities and distribute them among different people. – Paul Samuelson
Economics is the study of how society manages its scarce resources – Ngregory
Mankiw
Economics is the study how scarce resources are allocated among different uses –
Richard Eckhaus
 Economics is the study of the use of scarce resources to satisfy unlimited human
wants – Richard Lipsey.
Economics also seeks to describe, explain, analyse and predict a variety of
phenomena such as economic growth, economic development, unemployment,
inflation, trade between individuals and countries, the prices of different goods and
services, poverty, wealth, money, interest rates, exchange rates and business cycles.
MICROECONOMICS VS MACROECONOMICS
Microeconomics – focus is on individual parts of the economy.
The prefix micro comes from the Greek word mikros meaning small.
Macroeconomics is concerned with the economy as a whole.
The prefix comes from the Greek word makros meaning large.
TYPES OF ECONOMIC SYSTEM
Planned economy (Marxist Economics – Socialist economic theories) e.g Cuba
Free Market economy (Neo – classical theory) e.g near free market USA
Mixed economy (Keynesian economics) e.g South Africa , Botswana , Zambia
WANTS AND NEEDS : DIFFERENCES
Economics is concerned with scarcity. The basic fact of economic life is that there are
simply not enough goods and services to satisfy everyone wants .
Wants are unlimited but the means with which the wants can be satisfied are
limited.
Needs are necessities, the things that are essential for survival, such as food, water,
shelter and clothing. Needs unlike wants, are not absolutely unlimited.
FACTORS OF PRODUCTION
Resources are limited.
There are four (4) factors of production
i. Natural e.g. agricultural land, minerals and fishing resources
ii. human resources (such as labour).
iii. Man made resources (such as machines and equipment).
iv. Entrepreneurship
ECONOMIC DECISIONS AND OPPORTUNITY COST
Economic Decisions
In many cases it has to be decided which of the available alternatives will have to be
sacrificed.
Three core choices confront every nation:
o WHAT to produce with our limited resources e.g Electricity
o HOW to produce the goods and services we select
o FOR WHOM goods and services are produced; that is, who should get them e.g
China.
 In conclusion, all economic decisions are difficult.
Opportunity Cost
Since resources are scarce, the use of resources can never be costless. The are
always costs involved even if these costs are not always apparent to consumers of the
goods or services in question.
Scarcity must not be confused with poverty. Scarcity affects everyone. The rich are
also subject to scarcity.
ECONOMIC DECISIONS & OPPORTUNITY COST CNT’D
 Although scarcity is an essential element of the economic problem, the need for
decision making only arises when the scarce resources have to be allocated between
competing alternatives.
 However, with only one goal you will not have an economic problem to solve, since
you do not have a problem on how to allocate your limited resources.
This is not a realistic example since no-one has only one goal in life, but it does
illustrate the importance of choosing between alternatives in making economic
decisions.
The opportunity cost of a choice is the value to the decision maker of the best
alternative that could have been chosen but was not chosen. In other words, the
opportunity cost of a choice is the value of the best forgone opportunity.
Every time a choice is made, opportunity costs are incurred and economists always
measure costs in terms of opportunity costs.
PRODUCTION POSSIBILITY CURVE (PPC)
 Describes the various output combinations that could be produced in a given time
period with available resources and technology.
 Critical assumptions of the model.
 Represents a menu of output choices an economy confronts.
Scarcity, choice, efficient, inefficient and opportunity cost can be illustrated with the
aid of a production possibilities curve (production possibilities frontier).
EXAMPLE: PRODUCTION POSSIBILITY CURVE (PPC)
Consider the example where a farmer has to make a choice between planting
oranges or apples.
What are the scarce resources?
There are different possibilities with different levels of output per year for the
different types of fruits, shown as follows:
PRODUCTION POSSIBILITY CURVE
POSSIBILITY
ORANGES
(TONS OF OUTPUT)
APPLES
(TONS OF OUTPUT)
A
20.00
0.0
B
19.0
10.0
C
16.5
18.0
D
12.5
24.0
E
6.5
28
F
0.0
30.0
PRODUCTION POSSIBILITY CURVE
PRODUCTION POSSIBILITY CURVE EXPLANATION
Each point on the production possibility curve represents an alternative mix of
output. It shows the combination of oranges and apples that can be produced with the
available resources.
To produce 10 tons of apples, the farmer had to give up 1 ton of oranges (the
movement for possibility point A to B).
To produce a further 8 tons of apples (movement from B to C), the farmer had to
give up 3.5 tons of oranges.
The opportunity cost to produce an additional ton of apples increases as we move
along the production possibility curve. This is why the curve bulges outwards
from the origin (concave).
PPC FURTHER EXPLANATION
The production possibility curve illustrates two important principles;
 Scarce resources: There is a limit to the amount that we can produce in a given
time period with the available resources and technology;
Opportunity costs: We can obtain additional quantities of any desired good only
by reducing the potential production of another good.
The Production Possibility Curve shows potential output and does not necessarily
reflect actual output.
At every point along the production possibility curve, we are getting the maximum
output from available resources.
Thus we say that all points on the production possibility curve are efficient.
PRODUCTION POSSIBILITY CURVE AND EFFICIENCES
PPC AND EFFICIENCES CONTINUED
If the farmer is operating at less than the potential output, illustrated by a point
inside or below the production possibility curve, some of the available resources are
unemployed or not employed efficiently.
 In such a case, it is possible to expand production simply by using the existing
resources fully and more efficiently (given the state of technology).
The production possibilities curve indicates the combinations of any two goods or
services that are attainable when the community’s resources are fully and efficiently
employed.
WHY ECONOMISTS DISAGREE?
They might make different value judgments
They might not agree on the facts e.g. ANC, EFF and DA on electricity and water
policies.
They might be biased
They might hold different views about how the economy operates e.g. EFF’s Malema
– Nationalization; Hugo Chavez – Socialism
They might have different time perspectives e.g. Keynesian Economics
THE CIRCULAR FLOW OF INCOME AND SPENDING
Goods and services
demanded
Consumers
Product
markets
Governments
International
participants
Goods and services
supplied
Business
Firms
Factors of
production supplied
International
participants
Factor
markets
Factors of
production demanded
OPEN VS CLOSED ECONOMIES
The participation of foreigners results in a distinction between open and closed
economies. In a closed economy, foreigners do not participate in buying and selling of
goods and services.
Thus a closed economy does not take into account international trade while an open
economy takes into consideration imports and exports.
GOVERNMENT INTERVENTION
The changes in demand and supply can only occur if the market forces of supply and
demand are free to establish the equilibrium prices and quantity of goods and services.
Quite frequently, however, consumers, trade unions, farmers, business people and
politicians are not satisfied with the prices and quantities determined by market demand and
supply.
Their dissatisfaction leads them to put pressure on government to intervene to influence
prices and quantities in the market. This intervention can take different forms, including:
Setting maximum prices (price ceilings)
Setting minimum prices (price floors)
Subsidizing certain products or activities
Taxing certain products or activities
BLACK MARKETS
Not all black markets are illegal, but in the case of maximum price fixing by government, black
market activity is outlawed.
A black market is therefore often defined as an illegal market in which goods are sold above
the maximum price set by the government.
All price controls (including controls on interest rates, exchange rates and other less obvious
forms of prices) stimulate black market activity as unsatisfied potential purchasers seek to
obtain the good or service concerned.
Price controls are invariably implemented in the sincere belief that they are in the best
interests of society – in many cases they are motivated by an honest concern for the well-being
of poor consumers or low-income citizens.
 Is it always the case ???
ADMINISTERED PRICES
ADMINISTERED PRICES
Following the abolishment of price controls in South Africa, government departments or other
public sector agencies still determine the price of a range of goods and services in South Africa.
These prices are usually called administered prices, to indicate that they are the result of
administrative processes rather than of market forces of supply and demand. e.g. NERSANational Energy Regulator of South Africa.
Administered prices often feature strongly in the debate on the causes of inflation in South
Africa and appropriate anti-inflation policy.
20% of the goods and services in the CPI basket in South Africa can be classified as
administered prices. e.g. prices of medical services, petrol and diesel, communication services,
electricity, and education.
Other prices administered by the public sector include those of public transport services,
water and licences.
ADMINISTERED PRICES CONTINUED
The term administered prices was first coined in the USA in the 1930s to indicate private
sector prices that were determined discretionally by suppliers of goods and services instead of
by market forces.
In SA, however, the term is used exclusively to indicate government involvement in price
determination.
The different prices are administered according to different conventions, rules and formulae.
For example, a specific formula is used to determine the monthly adjustments in fuel prices,
while other administered prices are determined in other ways, often on a cost-plus basis.
2. DEMAND AND FACTORS AFFECTING DEMAND
Demand is defined as the ability and willingness to buy specific quantities of a good at
alternatives prices in a given time period, ceteris paribus (holding all things else constant).
 Ceteris paribus: The assumption of nothing else is changing
The demand curve illustrates how the quantity demanded changes in response to a
change in the price of that good, if nothing else changes (ceteris paribus).
Demand curve slope downwards.
Factors affecting demand
Changes in Income
Prices of Complementary /Substitute Products
Changes in the number of buyers
Changes in preferences and tastes
Expectations of future prices
The market demand refers to the total quantities of a good or service that people
are willing and able to buy at alternative prices in a given time period. i.e. the sum of
individual demands
SUPPLY AND FACTORS AFFECTING SUPPLY
The law of supply states that the quantity of a good or service supplied in a given
time period increases as its price increases, ceteris paribus.
The supply curve is upward sloping suggesting a positive relationship between price
and quantity.
Factors affecting supply
Technology
Factor costs (prices of inputs)
Taxes and subsidies
Expectations (change in the price)
Number of sellers
Market supply: The total quantities of a good that sellers are willing and able to sell
at alternative prices in a given time period, ceteris paribus.
EQUILIBRIUM POSITION
Only one price / quantity combination is compatible with buyer’s and seller’s intentions.
This is where the demand and supply curves intersect to determine the equilibrium price and
equilibrium quantities that are bought and sold in this particular market.
Price
$50
Market demand
45
40
35
30
25
Surplus
x
y
20
15
10
5
0
Market supply
Equilibrium price
Shortage
25
39
50
75
100
125
Quantity
DISEQUILIBRIUM POSITION
Whenever the market price is set above or below the equilibrium price, the market will be in
disequilibrium.
To overcome a surplus or shortage, buyers and sellers will change their behaviour and the
market will tend towards equilibrium where no further adjustments will be required.
MOVEMENTS VS SHIFTS
PRICE
Shift in
demand
d2
$45
40
d1
35
30
Movement along
curve
25
g1
D2
20
Increased
demand
D1
Initial demand
15
10
5
0
2
4
6
8
10
12
14
16
18
20
22
Quantity
ELASTICITY
Elasticity is the measure of the responsiveness of demand to a change in price.
 It measures the relationship as the ratio of percentage changes between quantity
demanded of a good and changes in its price.
Price Elasticity (EP) = % change in quantity demanded
% change in price
In practise goods are categorised according to their relative elasticity – whether Ep
is larger or smaller than 1. If Ep is larger than 1, demand is elastic.
If Ep is less than 1, demand is inelastic. When demand is inelastic, the percentage
change in quantity demanded is less than the percentage in price, consumers are not
responsive to price changes.
PRICE ELASTICITY OF DEMAND AND TOTAL REVENUE
The price elasticity of demand can be used to determine by how much the total expenditure
by consumers on a product (which is also the total revenue of the firms producing that product)
changes when the price of the product changes.
This is probably the most important reason why economists, business people and
policymakers are so interested in information concerning the price elasticity of demand.
The total revenue (TR) accruing to the suppliers of a good or service (or the total expenditure
by the consumers ) is equal to the price (P) of the good or service multiplied by the quantity (Q)
sold.
There is an inverse relationship between the quantity demanded (Q) and the price of a
product (P). Any change in price leads to a change in the quantity demanded in the opposite
direction to the change in price.
The effect of a price change on total revenue will thus depend on the relative sizes of the price
change and the change in the quantity demanded.
PRICE ELASTICITY OF DEMAND AND TOTAL REVENUE
If the change in price P leads to a proportionately greater change in quantity demanded Q
(i.e. if the price elasticity of demand is greater than one ), total revenue TR will change in the
opposite direction to the price change.
If the change in price leads to an equi-proportional change in the quantity demanded (i.e if
the price elasticity of demand is equal to one ), total revenue will remain unchanged.
If the change in price leads to a proportionally smaller change in the quantity demanded (i.e if
the price elasticity of demand is smaller than one), total revenue will change in the same
direction as the price change.
CHANGES IN TOTAL REVENUE VS PED
As long as the price elasticity of demand is greater that one, total revenue TR (or the total
expenditure by consumers) increases as the quantity sold Q increases.
TR reaches a maximum when the price elasticity of demand is equal to one.
When the price elasticity of demand is less than one, TR falls as the quantity sold Q increases.
The relationship between the price elasticity of demand and total revenue can be explained
further by distinguishing five different categories of price elasticity of demand (PED).
RELATIONSHIP BETWEEN PED AND TOTAL REVENUE
DETERMINANTS OF PRICE ELASTICITY OF DEMAND
Price elasticity of demand is influenced by all the determinants of demand.
The five factors particularly worth noting are;
i.Substitution possibilities
ii.The degree of complementarity of the product
iii.The type of want satisfied by the product.
iv.The time period under consideration
v.The proportion of income spent on the product.
OTHER DETERMINANTS OF PRICE ELASTICITY OF DEMAND
The following factors can also affect the price elasticity of demand.
The definition of the product
Advertising
Durability
Number of uses of the product
Addiction
OTHERS : INCOME AND CROSS ELASTICITIES
Income elasticity
The income elasticity of demand relates the percentage change in quantity demanded to
the percentage change in income that is;
Income elasticity of demand = % change in quantity demanded
% change in income
As is the case with price elasticity, income elasticity is computed with average values for
changes in quantity and income.
Cross elasticity
Cross elasticity is a different type of elasticity and involves two related products.
It is defined as the relative change in the quantity demanded of product A, in relation to the
relative change in the price of product B, which caused the change in the quantity demanded
of product A.
Cross-price elasticity of demand is given by % change in quantity demanded of good X
% change in the price of good Y
OTHERS : INCOME AND CROSS ELASTICITIES CN’TD
the cross-price elasticity of demand makes it easy to distinguish substitute and
complementary goods. If cross price elasticity is positive, the two goods are substitutes; if the
cross-price elasticity is negative, the two goods are complements.
Coca-cola and hamburgers are complements because a fall (-) in the price of one leads to an
increases (+) in the demand for the other, in other words, the cross-price elasticity is negative
3. PRODUCTION AND OPTIMISATION ANALYSIS
Fixed costs vs Variable costs
Total costs
Short –run e.g Capital is fixed and labour is variable.
Total product
Law of diminishing returns
Average total cost
Average variable cost
Average fixed cost
Marginal cost
Marginal revenue
SHORT TERM AND LONG TERM
 Productivity and costs
 Returns to scale measures the change in output for a given change in inputs.
 Increasing returns to scale
 Decreasing returns to scale
 Constant returns to scale
 PRODUCTION TECHNIQUES : economies of scale vs diseconomies of scale.
4. MARKET STRUCTURE & COMPETITION
The behaviour of a firm depends on the features of the market in which it sells its
product(s) and on its production costs.
The major organizational features of markets are called market structure.
Four standard forms of market structure will be introduced;
•Perfect competition
•Monopoly
•Monopolistic competition
•Oligopoly
The concept of perfect competition is a theoretical one, which serves as a norm
against which to compare other types of markets.
The latter three types of competition are collectively referred to as imperfect
competition
MARKET STRUCTURE & COMPETITION – CNT’D
BARRIERS TO ENTRY
Obstacles, such as patents, that make it difficulty or impossible for would be
producers to enter a particular market.
Barriers make it expensive, risky or impossible for new firms to enter an industry.
MARKET POWER
The ability to alter the market price of a good or service.
Determinants of market power
Number of producers
Size of each firm
Barriers to entry
Availability of substitutes
Examples : Perfect Competition – foreign exchange market, financial markets (JSE)
Monopolistic – clothing, footwear, fast food outlets, restaurants.
Oligopoly – cement, car rental service, cellular phones, motorcars, banks
Monopoly – Eskom, DSTV, local water supply (Umgeni Water & Rand
Water
MARKET STRUCTURE - SUMMARISED
5. THE FACTOR MARKETS: THE LABOUR MARKET
DEFINITIONS
Factor markets operate like product markets with supply and demand interacting to
determine prices and quantities .
In factor markets , however , resource inputs rather than products are exchanged.
Exchange s determine the wages paid to workers and the rent, interest and profits paid to
other inputs.
Wages and salaries are often blamed as the root causes of the increases in costs and prices.
LABOUR SUPPLY
Motivation to work arises from social, psychological and economic forces .
 As human beings we need to pay bills and also to feel a sense of achievement and as a
consequence, people are willing to work by supplying their labour.
DETERMINANTS OF LABOUR SUPPLY
 Tastes (leisure , income and work )
 Wealth
 Expectations (for income or consumption)
 Prices of consumer goods and taxes
THE FACTOR MARKETS:THE LABOUR MARKET– CNT’D
Higher wage rates induce people to work more, that is, substitute labour for leisure.
The substitution effect may be offset by an income effect.
Higher wage rates also enable a person to work fewer hours with no loss of income.
When income effects outweigh substitution effects , the labour supply curve bends
backward.
LABOUR DEMAND
A firms demand for labour reflects labour ‘s marginal revenue , which refers to the change
in total revenue associated with one additional of input.
A profit –maximising employer wont pay a worker more than the worker produces .
EQUILIBRIUM IN THE LABOUR MARKET
 The intersection of the market supply and demand curve establishes the equilibrium wage
in a competitive labour market.
 All firms in the industry can hire as much labour as they want at the equilbrium wage.
THE FACTOR MARKETS: THE LABOUR MARKET – cnt’d
MINIMUM WAGE
Wage determination is an emotional process.
The imposition of a minimum wage causes a decrease in the quantity of labour demanded
6. CASE STUDY ANALYSIS – GROUP WORK
Strategies Used by Microsoft to Leverage its Monopoly Position in Operating Systems to
Internet Browsers Markets - Managerial Economics Module : Page 133 – 141
 Read – Case Study – 20 Minutes
 Class experiences of how you analysed
the case study.
 REMEMBER THE FOUR (4) PILLARS
 Describe
 Diagnose
 Frame prescriptions
 Prescribe
THANK YOU
QUESTIONS