MBA Managerial Economics Unit 1 - Economic Problems and Decision Making
MBA Managerial Economics Unit 1 - Economic Problems and Decision Making
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.
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.
Consider the example where a farmer has to make a choice between planting
oranges or apples.
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.
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 hold different views about how the economy operates e.g. EFF’s Malema
– Nationalization; Hugo Chavez – Socialism , SACP – Communism.
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.
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.
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.
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