Managerial Economics

Unit 1: Economic Problemsand DecisionMaking

Learning Outcomes

• Define Economics and what the economic problem is.

• Explain briefly what Managerial Economics is all about.
• Define the important concepts of scarcity, choice and
opportunity cost.
• Construct a Production Possibility Curve (PPC) and use it
to explain scarcity, choice and opportunity cost.
• Explain the role of the market in allocating resources in
different economic systems.
ECONOMICS AND MANAGERIAL 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. – Samuelson
 Economics is the study of how society manages its scarce resources – Mankiw
Economics is the study how scarce resources are allocated among different uses –
Eckhaus
 Economics is the study of the use of scarce resources to satisfy unlimited human
wants – Lipsey.
Economics also seeks to describe, explain, analyse and predict a variety of
phenomena such as economic growth, poverty, 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
WANTSANDNEEDS: 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’s 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.
FACTORSOF 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.Capital / Man made resources (such as machines and equipment).

iv.Entrepreneurship
ECONOMICDECISIONSANDOPPORTUNITYCOST
Managerial 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, Food - Agriculture
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, Japan, USA.
 In conclusion, all economic decisions are DIFFICULT.
If you win a lotto of R1 000 000.00 rand. How would you spend it?

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.
ECONOMICDECISIONS &OPPORTUNITYCOSTCNT’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) MODEL
 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 , unattainable , attainable and opportunity cost

can be illustrated with the aid of a production possibilities curve (production
possibilities frontier).

 Think of the limitations and importance of this model in Managerial Economics.

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 (PCC)
POSSIBILITY ORANGES (Y) APPLES (X)
(TONS OF OUTPUT) (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 (PPC)
PRODUCTIONPOSSIBILITYCURVE 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 FURTHEREXPLANATION
 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 CURVEANDEFFICIENCES
PPCANDEFFICIENCES 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.
WHYDOECONOMISTSDISAGREE?
 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 , SACP – Communism.

 They might have different time perspectives e.g. Keynesian Economics

THECIRCULARFLOWOF INCOMEANDSPENDING

International
participants
Goods and services Product
demanded markets
Goods and services
supplied

Business
Consumers Governments
Firms

Factors of
production supplied
Factors of
Factor production demanded
International markets
participants
OPENVS CLOSEDECONOMIES
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.
GOVERNMENTINTERVENTION
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

BLACKMARKETS
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 ???

ADMINISTEREDPRICES
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. NERSA-
National 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.
ADMINISTEREDPRICES 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.
THANKYOU