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Global Economics for Managers
MBA 505
1
 Stephen E. Margolis
MBA 505 Economics for
Managers
Economics
It’s not about the money
2
MBA 505 Economics for
Managers
Economics Defined
The study of:
• Responses of humans to unlimited
wants and limited resources.
• Scarcity
Elaborations:
• Exchange (James Buchanan)
• Optimization and coordination
3
MBA 505 Economics for Managers
So, what are we?
• Greedy materialists?
MBA 505 Economics for Managers
So, what are we?
• Greedy materialists?
Or
• Noble visionaries?
MBA 505 Economics for Managers
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…
MBA 505 Economics for Managers
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?
MBA 505 Economics for Managers
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”
MBA 505 Economics for Managers
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 methodology
As an ethical foundation
9
MBA 505 Economics for Managers
Today’s Lecture
•
•
•
•
•
•
•
•
10
Definition (done)
Course operation
Approach to economics
Law of demand
Supply and demand
Prices
Costs
Comparative Advantage
MBA 505 Economics for Managers
Course Operation
•
•
•
•
•
11
Syllabus
Groups
Evaluation
Moodle
Paper
MBA 505 Economics for Managers
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.
MBA 505 Economics for Managers
P
(Don’t copy this down)
Pm
MC
Q
MR
13
D
MBA 505 Economics for
Managers
P
(This either)
5675
Pm
MC
Q
456550
12389
MR
14
D
MBA 505 Economics for
Managers
Objectives
• Understand how markets work
• Understand the economic logic in business
decisions.
In other contexts this is expressed as organization
and optimization, respectively.
MBA 505 Economics for Managers
Normative and Positive
Economics
• Positive
• Normative
• Prescriptive
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MBA 505 Economics for Managers
Normative and Positive
Economics
• Positive: What is
• Normative: What’s good
• Prescriptive: What to do
(See Normative)
17
MBA 505 Economics for Managers
Managers Are Teachers
 Stephen E. Margolis
Mathematics
Algebra 1?
y = mx + b
p = a - bq
19
MBA 505 Economics for Managers
This will become familiar
P
a
P = a - bQ
a/b
Q/t
MBA 505 Economics for Managers
This will become familiar
P
a
P = a - bQ
-b is the slope,
a is the vertical
intercept
a/b
Q/t
MBA 505 Economics for Managers
More math
I will use some calculus. It will always
be optional.
Some things are easier and more
persuasive that way.
MBA 505 Economics for Managers
Back to Economics
Demand, Supply, and Equilibrium
A very quick overview.
Incentives matter.
We pick the low
hanging fruit first.
The fundamental structure of economics
MBA 505 Economics for Managers
The fundamental structure of economics
Incentives matter.
Law of demand
We pick the low
hanging fruit first.
The law of diminishing
marginal product
Supply behavior
MBA 505 Economics for Managers
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?
26
MBA 505 Economics for
Managers
Suppose
Green Peppers
Regular Price: $.99 per pound
Today Only: $1.49
MBA 505 Economics for Managers
Demand as a Diagram
Price
0
A flow
28
Q/t
MBA 505 Economics for
Managers
Demand as a Diagram
(My coffee consumption)
Price
3.00
*
2.00
*
1.00
0
29
*
1
2
3
A flow
Q/t
MBA 505 Economics for
Managers
Demand as a Diagram
Hillsborough St. Shops
Price
3.00
*
2.00
*
1.00
0
30
*
1,000
2,500
5000A flow Q/t
MBA 505 Economics for
Managers
It’s not (just) about the money
• Extensions to the law of demand
–
–
–
–
Seatbelts
Meetings
Emily’s Band-Aids
Insulin
– Shaving
31
MBA 505 Economics for Managers
P
Supply
S
Q/t
32
MBA 505 Economics for
Managers
P
S and D
S
Po
D
Qo
33
Q/t
MBA 505 Economics for
Managers
Price Adjustment
P
Po
D
Q/t
34
MBA 505 Economics for
Managers
More price Adjustment
P
Po
D
Q/t
35
MBA 505 Economics for
Managers
S and D
S’
P
S
P’
Po
D
Qo
36
Q/t
MBA 505 Economics for
Managers
S and D
P
S
S’
Po
P1
D
Qo
37
Q1 Q/t
MBA 505 Economics for
Managers
S and D
P
S
Po
D1
D
Qo
38
Q1
Q/t
MBA 505 Economics for
Managers
S and D (one more time)
P
S
Po
P1
D’
Q1
39
Q0
D
Q/t
MBA 505 Economics for
Managers
About Prices
40
MBA 505 Economics for
Managers
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
41
MBA 505 Economics for Managers
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?
MBA 505 Economics for Managers
Movie
Ticket
1 lb.
Coffee
43
2008
2013
6.00
9.00
10.00
12.00
MBA 505 Economics for
Managers
What Is Pure Inflation?
A balanced increase in the prices of all goods,
services and non money- denominated assets.
44
MBA 505 Economics for
Managers
Does that ever happen?
45
MBA 505 Economics for
Managers
Does that ever happen?
Well actually, No.
46
MBA 505 Economics for
Managers
What about the overall price
level?
Suppose some prices went up 20%
and some prices went up 50%, and
you wanted to know what happened
to the price level?
47
MBA 505 Economics for
Managers
Laspeyres Index
The cost of the old bundle at the new prices X 100
The cost of the old bundle at the old prices
MBA 505 Economics for Managers
A price index
N
L
P
qi , 0
P
qi , 0
i 1
N
i 1
49
i ,t
i ,0
 100
MBA 505 Economics for
Managers
Even Steven
Vegetarians, 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?
50
MBA 505 Economics for
Managers
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
MBA 505 Economics for Managers
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
52
MBA 505 Economics for
Managers
Comparative Advantage
Motor
Paint
Paul
40
30
Steve
30
45
53
MBA 505 Economics for
Managers
Comparative Advantage
Motor
Paint
Paul
40
30
Steve
30
50
54
70
80
MBA 505 Economics for
Managers
Specialization
Paul
Steve
Motor
Paint
40
30
30
50
70
80
Steve does both motors and finishes in 60
hours, Paul does both paint jobs; 60 hours.
MBA 505 Economics for
55
Managers
Costs
Motor
Paint
Paul
40
30
70
Steve
30
50
80
If Paul paints both cars he takes 60 hours
If Steve reworks both motors, he also
takes 60 hours.
56
MBA 505 Economics for
Managers
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
57
MBA 505 Economics for
Managers
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.
58
MBA 505 Economics for
Managers
Now, Suppose Steve is worse
at both activities.
Motor
Paint
Paul
40
30
70
Steve
45
75
120
CAN THEY TRADE?
59
MBA 505 Economics for
Managers
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 opportunity
costs haven’t changed.
60
MBA 505 Economics for
Managers
Lesson
Your can be better at everything and
still be the high cost provider, in terms
of opportunity cost, of something.
You can be worse at everything and
still be the low cost provider, in terms
of opportunity cost, in something.
You may have an absolute advantage
in no activity and still have a
comparative advantage in something.
61
MBA 505 Economics for
Managers
Consumer Theory
•
•
•
•
Foundations of demand
Illustrates choice under uncertainty
A tool for conceptualizing certain problems
Used in business fields
– Finance
– Marketing
62
MBA 505 Economics for Managers
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.
63
MBA 505 Economics for Managers
Introducing…
MBA 505 Economics for Managers
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:
DONUTS
There is also something slightly odd about the man
behind the counter.
There is a display case that might once have
displayed prices.
MBA 505 Economics for Managers
You order your coffee and then
you ask,
“How much is a donut?”
MBA 505 Economics for Managers
A march down the demand curve
.80
.70
.60
.50
.40
.30
MBA 505 Economics for Managers
A march down the demand curve
.80
.70
.60
.50
So the donut seller says, $.80.
and then, if you want a second,
$.70. And if you want a third…
.40
.30
MBA 505 Economics for Managers
A march down the demand curve
$
.80
.80 + .70 + .60 + .50 + .40 + .30 = $3.30
.70
.60
.50
And yet, to sell six donuts with simple
pricing, you would have to charge how
much per donut?
And revenue would be what?
.40
.30
Donuts
MBA 505 Economics for Managers
A march down the demand curve
$
.80
.80 + .70 + .60 + .50 + .40 + .30 = $3.30
.70
.60
.50
Conventional pricing would require a
price of $.30 to get the buyer to purchase
six donuts, yielding revenue
of 6*.30 = 1.80
.40
.30
Donuts
MBA 505 Economics for Managers
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
MBA 505 Economics for Managers
We will see the donut seller again
• Consumer surplus
• Price discrimination
MBA 505 Economics for Managers
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.
MBA 505 Economics for Managers
Examples of applied economics
• Opportunity cost (p. 33, 109)
• Marginal analysis (p. 107)
• Comparative advantage (p. 35-6 and
elsewhere)
MBA 505 Economics for Managers
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 elasticity
of demand.
77
Dreaded Elasticity
78
Scared as a Child?
Q1
Q1
 
P1
P1
79




Q2
Q2
P2
P2
MBA 505
Hear Elasticity…
Think
Responsiveness
80
P
P
P’
D
Elastic
Q
P
P
Q’
Q
Inelastic
P’
Q
81
Q’
Q
P
Responsive
P
P’
D
Elastic
Q
P
Q’
Q
Not so responsive
P
Inelastic
P’
Q
82
Q’
Q
Is it just slope?
Suppose price goes up $1 and the number
of units sold goes down 100,000 units.
Responsive or not?
83
We need to know not just the change
in quantity and the change in price,
but also the price and quantity. We get

84

Q
 100
Q
P
 100
P

%Q
% P


Q
Q
P
P
Rearranging:
Q P
Q P


Q P
P Q
Or, letting P and Q get small:
dQ p
 
dp q
85
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?
86
A simple numerical example
Q=4000-.5P
What is the price elasticity of demand when P
is 1500?
87
A simple numerical example
Q=4000-.5P
What is the price elasticity of demand when P
is 1500?
dQ P

dP Q
88
Q=4000-.5P
What is the price elasticity of demand when P
is 1500?
dQ P

dP Q
  .23

1500
 .5
3250
  .23
89
Now consider the relationship between price
changes and revenue.
For example, if you raise price, what happens to
revenue?
Does revenue always go up?
90
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.
91
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:
.
  1,
Then the proportionate change in quantity is
greater than the proportionate change in
price. Revenues will increase when price
decreases.
92
On the other hand, IF:
 1
.
Then the proportionate change in quantity is
less than the proportionate change in price.
Revenues will decrease when price
decreases.
93
NC State MBA Program Fall
2002
Elasticity varies along a straight-line
demand curve.
P
P/Q is large
P/Q is small
D
Q
94
NC State MBA Program Fall
2002
Here’s a useful mnemonic;
The arrows point in the
direction of increased revenues.
P
Elastic
Revenues are maximized
where   1
 1
Inelastic
D
Q
95
NC State MBA Program Fall
2002