UNIT – 1 Preliminaries in Economics

Academic Year 2014- 15 Trimester I

Course Title Micro Economics for Managers Course Code 14MT12
Course Facilitator Dr. Vidya Suresh Credits 3
Total no. of
E-Mail [email protected] 25
sessions

CASE STUDY-I

Adam smith and the invisible hand

The eighteenth-century philosopher Adam smith is regarded as the father of modern
economics. He understood clearly how a decentralised market economy would function with
little, if any, outside regulation required. In particular, he saw that by seeking to maximise the
self interest, the individual participants in the economy would achieve socially desirable
results. In this book an enquiry into the nature and causes of wealth of nations

It is not from the benevolence of the butcher, the brewer, or the baker that we expect our
dinner, but from their regard to their own self interest. We address ourselves not to their
humanity but to the self-love, never talk to them of our own necessities, but of their
advantages.

The coordinating mechanism in the economy, the price system, was described by smith as an
invisible hand that guided private decisions in socially beneficial ways:

Every individual endeavours to employ his capital so that it produce may be of greatest value.
He generally neither intends to promote the public interest, nor knows how much he is
promoting it. he intends only his own security, only his own gain. And he is in this led by end
invisible hand to promote and end which was no part of his intention. By pursuing his own
interest he frequently promotes that of society more effectually than when he really intends to
promote it.

In addition to this rational for market system and unfettered by outside (e.g., government)
influence or controlled, smiths example of the efficiency associated with the mass protection

Trimester-1 Micro Economics for Managers 1

UNIT – 1 Preliminaries in Economics

of pins provides insight into the role of the firm in market economy and the advantages of
mass production.

To take the example ...the trade of the pin-maker; a work men not educated to his business...
nor acquainted with the use of the machinery employed in it... could scarce, perhaps with his
utmost industry , make one pin in the day , and certainly could not make twenty. But in the
way in which this business is now carried on not only the whole work is a peculiar trade , but
it is divided into a number of branches , of which the greater part are likewise peculiar trades.
One man draws out the wire, another straightens it, the third cuts it, a fourth points it, a fifth
grinds it at the top for receiving the head: to make the head requires two or three distinct
operations: ... and the important business of making a pin is, in this manner, divided into
about eighteen distinct operations ... I have seen a small manufactory of this kind where ten
men only were employed making upwards of forty-eight thousand pins in a day. Each person,
therefore, making a tenth part of forty eight thousand pins, might be considered as making
four thousand eight hundred and pins a day. But if they had all wrought separately and
independently and without any of them having been educated to this peculiar business, they
certainly could not each of them have made twenty, perhaps not one pin in a day.

CASE STUDY-II

PROFITS IN THE PERSONAL COMPUTER INDUSTRY

In 1976, Steven jobs, then 20 years old, dropped out of college and, with a friend, developed
a prototype desktop computer. With financing from an independent investor, the Apple
Computer Company was born, revolutionizing the computer industry. Sales of Apple
computers jumped from $3 million in 1977 to more than $1.9 billion in 1986, with profits of
more than $150 million. The immense success of Apple was not lost on potential competitors,
and by 1984, more than 75 companies had jumped into the market. Even IBM, which had
originally chosen not to enter the market, soon put all its weight and muscle behind the
development of its own version of the personal computer, the IBM PC.

Because of increased competition however many of the early entrants had dropped out by
1986and profits fell sharply. Profits margins for the 11 largest U.S. computer companies
averaged 11.5 percent from 1980 to 1985 but only 6.5 percent from 1986 to 1990.Afterward,

Trimester-1 Micro Economics for Managers 2

UNIT – 1 Preliminaries in Economics

PC makers became engaged in a brutal price war with PC prices falling by as much as 20 to
40 percent per year and this cut profit margins even further. PCs soon became practically a
commodity, and as such, they no longer provided large profits to most of their makers as they
did before.

In 1985, Jobs was ousted after a nasty power struggle with john Scully, Apple president at
the time. After unsuccessfully trying a comeback with his Next computer in 1986,the 43-
year-old Jobs was called back to lead Apple in 1997,after it had suffered years of loses and
several CEO changes. Jobs revived Apple by simplifying its confusing product line to a few
basic models and by introducing a series of highly successful new products, such as the iPod,
iPhone, and iPad, which gave Apple huge profits. This event in the newly born PC market is
a classic example of the source, function and important of profits in our economy. Job’s huge
rewards from the setting up of Apple resulted from correctly anticipating, promoting and
satisfying an important type of market demand. Competitors, attracted by the huge early
profits, were quick to follow, thereby causing profits in the industry to fall sharply. In the
process, however, more and more of society’s resources were attracted to the computer
industry, which supplied consumers with rapidly improving personal computers at sharply
declining prices.

Business Ethics at Boeing

For its program called “Questions of Integrity: The Boeing Ethics Challenge,” the large
Chicago-based aerospace company compiled a large number of ethical situations that
employees might face. Supervisors present each situation and then ask employees to choose
among four possible responses, after which the correct responses is discussed. Following is
an example regarding the proper use of the company’s resources:

You are a manager, and one of your employees is selling Amway products to co-workers.
The employee shows catalogs and takes orders during lunch. He also leaves an order form on
table in the break room and collects money and distributes products during lunch after work.
As the employee’s manager, should you say anything about this?

A. No. place your order

B. No. The employee appears not to be disrupting the workplace.

Trimester-1 Micro Economics for Managers 3

UNIT – 1 Preliminaries in Economics

C. Yes. Employees are not permitted to use company premises for outside business
activities.
D. Yes. You should tell your employee that he may only continue the business on the
premises with your approval and discuss with him the way the business is being
conducted at the workplace.

Preferred Answer : C

Rationale

A. As a manager, you should set a good example and stop this type of activity.

B. It could be difficult to restrict this activity to break and lunch periods. There is a
possibility that it will escalate and disrupt the workday.

C. Sales for personal gain on company premises are strictly prohibited. The distributor is
also taking advantage of a “captive audience”.

D. Even a manager cannot authorize for-profit sales on company property. However, the
manager can permit nonprofit activities, such as Girl Scout cookies or candies, as long as
it doesn’t interfere with work.

Despite its ethics program, a Boeing manager misused Lockheed documents to win a
government contract and was fired in 2003,and in 2005 Boeing’s chief executive, who had
spearheaded the drive to restore the company’s reputation after a series of ethics scandals,
was himself ousted for having an office affair.

CASE STUDY-III

ENRON DISASTER IN INDIA

Before its collapse at the end of 2001, Enron, the Houston-based energy -trading company,
was so good at selling itself that it led to unrealistic expectations about its growth and
profitability. In trying to live up to these unrealistic expectations, Enron started to falsify its
financial reports. It infated earnings by using outside partnerships to monetize the assets (and
counting the proceeds as earnings) and to move its debt off its balance sheet. But deceit
required growing falsification until it all became unsustainable. Enron was then forced to

Trimester-1 Micro Economics for Managers 4

UNIT – 1 Preliminaries in Economics

restate its earnings sharply downward, and this caused its stock to collapse. By giving its
auditor’s stamp of approval, and then quickly shredding the evidence once Enron’s troubles
began, Andersen, the huge consulting firm with world wide offices, also collapsed.

The last week of 2000 was eventful for the financially strapped Maharashtra Government.
Having decided not to help the Maharashtra State Electricity Board pay for Enron’s
expensive power, the consequent default led to a two-notch downgrade in the state’s credit
rating. It also led to Enron invoking its sovereign guarantee and asking the central
government to pay the controversial Dabhol power company (DPC).

Not paying DPC’s extortionate bills was a good idea, but it had to be followed up with a
tough and credible action plan to free the government from its commitment and the political
will to follow it through. The DPC project is one of the worst examples of political greed and
naivete – right from the negotiation of a one-sided contract by one political party to the
cancellation of the contract and re-negotiation of a much larger project by another set of
political parties. A third political formation is now left to clean up the mess and face the
political consequences of paying steep power bills to it.

The danger is that instead of working on a plan to deal with the Enron problem, the only
news emanating from the state secretariat is the constant wrangling between the leaders of the
allies of the two major ruling parties. The leader of the ruling party, who first brought Enron
into india, has mounted enormous pressure to keep it going, no matter what the
consequences.

As India begins to review the project once again, the economic-political situation today is
dramatically different from that of 1994, when Enron, with the support of U.S. Government
and other multinational corporation’s (MNC’s) mounted enormous political pressure against
the cancellation and helped ignominy on India.

Unlike Enron, scores of top MNC’s have gained a smooth entry into Indian marketplace and
are doing business without any fuss or controversy. From food to pharmaceuticals, consumer
products to fizzy drinks, IT to clothes and cosmetics, no other company has faced the
allegations that Enron has.

Trimester-1 Micro Economics for Managers 5