Goals of Economics

1. To strengthen economic freedom

a. Economic freedom is the fundamental right of every human to control his or her own labor and
property.
2. Promote economic efficiency
a. Economic efficiency refers to the effective utilization of productive resources, such as
agricultural land, manufacturing capacity, raw materials, or labor.
3. Promote economic stability
a. Economic stability means that people have the resources essential to a healthy life.
4. To improve economic security
a. Economic security or financial security is the condition of having stable income or other
resources to support a standard of living now and in the foreseeable future.
5. Attaining a high level of growth in the economy
a. Economic growth – measured as an increase in people's real income – means that the ratio
between people's income and the prices of what they can buy is increasing: goods and services
become more affordable, and people become less poor.
b. As a result, the unemployment rate declines and inflation starts to increase.
Economic Principles
Gregory Mankiw, in his text Principles of Economics, describes 10 principles of Economics[1], which are
summarized below:
1. People Face Tradeoffs
○ To get one thing, we usually have to give up something else
■ Ex. Leisure time vs. work
2. The Cost of Something is What You Give Up to Get It
○ Opportunity cost is the second best alternative foregone.
■ Ex. The opportunity cost of going to college is the money you could have
earned if you used that time to work.
3. Rational People Think at the Margin
○ Marginal changes are small, incremental changes to an existing plan of action
■ Ex. Deciding to produce one more pencil or not
○ People will only take action of the marginal benefit exceed the marginal cost
4. People Respond to Incentives
○ Incentive is something that causes a person to act. Because people use cost and benefit
analysis, they also respond to incentives
■ Ex. Higher taxes on cigarettes to prevent smoking
5. Trade Can Make Everyone Better Off
○ Trade allows countries to specialize according to their comparative advantages and to
enjoy a greater variety of goods and services
6. Markets Are Usually a Good Way to Organize Economic Activity
○ Adam Smith made the observation that when households and firms interact in markets
guided by the invisible hand, they will produce the most surpluses for the economy
7. Governments Can Sometimes Improve Economic Outcomes
○ Market failures occur when the market fails to allocate resources efficiently. Governments
can step in and intervene in order to promote efficiency and equity.
8. The Standard of Living Depends on a Country's Production
○ The more goods and services produced in a country, the higher the standard of living. As
people consume a larger quantity of goods and services, their standard of living will
increase
9. Prices Rise When the Government Prints Too Much Money
 ○ When too much money is floating in the economy, there will be higher demand for goods
and services. This will cause firms to increase their price in the long run causing inflation.
10. Society Faces a Short-Run Tradeoff Between Inflation and Unemployment
○ In the short run, when prices increase, suppliers will want to increase their production of
goods and services. In order to achieve this, they need to hire more workers to produce
those goods and services. More hiring means lower unemployment while there is still
inflation. However, this is not the case in the long-run.

Methodologies of Economics

• Study of economics' function, potential, and intended functions.

• Examines key theoretical concepts like theory, model, assumption, causation, testing, rhetoric, truth, social
construction, and pluralism.

• Explores research goals, styles, and constraints like mathematical modelling, grounded theory, forecasting, policy,
ontological constraints, and institutional constraints.

• Examines fundamental concepts like rationality, choice, routine, trust, institution, evolution, coordination,
equilibrium, and path dependence.

Basic Economic Questions

1. What to produce?
2. How to Produce?
a. Labor-intensive- needing a large workforce or a large amount of work in relation to output.
b. Capital-intensive- requiring the investment of large sums of money.
3. For whom to produce?
4. How much to produce?
a. Shortages- excess demanded
b. Surplus- excess supplied

Economic Systems
1. Traditional Economy
a. a system that relies on customs, history, and time-honored believes
b. depend on agriculture, fishing, hunting, gathering, or some combination of them
2. Command Economy
a. the government determines what is produced, how it is produced, and how it is distributed
b. Private enterprise does not exist
3. Market Economy
a. an economic system where two forces, known as supply and demand, direct the production of
goods and services
b. not controlled by a central authority (like a government) and are instead based on voluntary
exchange
4. Socialism
a. a political and economic theory of social organization which advocates that the means of
production, distribution, and exchange should be owned or regulated by the community as a
whole.
5. Mixed Economy
a. an economic system that combines the elements of a market economy and the elements of a
planned economy
 b. synthesis of socialism and capitalism

Factors of Production
1. Land-all natural resources which are given by and found in nature
2. Labor-any human effort exerted in the production of goods and services
3. Capital-man made goods used in the production of other goods and services
4. Entrepreneur-a person who organizes, manages and assumes the risk of a firm

What is Managerial Economics

Managerial economics is a branch of economics involving the application of economic methods in the
organizational decision-making process. Economics is the study of the production, distribution, and
consumption of goods and services. It is concerned with the application of economic principles to key
management decisions. It provides guidance to increase value creation within an organization and allows for a
better understanding of the external business environment in which the organization operates.

The Roles of Microeconomics and Industrial Organization

Microeconomics studies the decisions of individuals and firms to allocate resources of production, exchange,
and consumption. Microeconomics deals with prices and production in single markets and the interaction
between different markets but leaves the study of economy-wide aggregates to macroeconomics.

Industrial organization is an analysis of factors, operational or otherwise, that contribute to a firm's overall
strategy and product placement. It involves a study of different areas, from market power to product
differentiation to industrial policy, that affect a firm's operations. One of its main focuses is to understand why
markets are not perfectly competitive, and what the interaction is between market structure and a firm's
behavior.

Goals of the Firm

The first and most important objective of any firm is to maximise its profit. The basic profit calculation is the
total revenue minus the total cost. In economics, profit refers to the returns over and above the opportunity
cost. It is also sometimes referred to as pure profits.
There are a few reasons why profit maximisation is the main objective of most firms:
● Re-investment: firms want to maximise their profit to re-invest the amount for further buying new
technology, research, and development, etc.
● Dividends: firms may wish to have better profits to allow for greater dividends for the shareholders.
● Maximum profit is also one form of reward for entrepreneurship for the owners’ risk-taking.

Separation of Ownership and Control of the Firm

The separation of ownership and control is a common practice in modern corporate governance, which keeps
the shareholders out of managerial responsibilities and empowers the directors to take day-to-day decisions to
run corporations smoothly.
It leads to a potential conflict of interests between directors and shareholders. The conflict of interests between
principal (shareholder) and agent (director) gives rise to the 'principal-agent problem' which is the key area of
corporate governance focus.

Accounting Profit vs Economic Profit

• Economists measure a firm’s economic profit as total revenue minus total cost, including both explicit
and implicit costs.
• Accountants measure the accounting profit as the firm’s total revenue minus only the firm’s explicit
costs.
• When total revenue exceeds both explicit and implicit costs, the firm earns economic profit.
• Economic profit is smaller than accounting profit.

Market Structures and Managerial Decisions

Market structure refers to how different industries are classified and differentiated based on their degree and
nature of competition for services and goods.
4 types:
perfect competition, oligopoly market, monopoly market, and monopolistic competition.

Managerial economics plays a crucial role in strategic decision-making. It equips managers with the tools and
techniques to analyze market demand, assess costs, determine pricing strategies, evaluate risks, and
understand competitive dynamics.

Defining a Market
Traditional Definition: A place of a regular gathering of people for the purchase and sale of provisions,
livestock, and other commodities.
Marketing Definition: Market is a set of actual and potential customers of a product
Market according to economics: Market is a mechanism through which the price of products is determined by
the direct or indirect bargaining of the buyers and sellers.

Demand Basics
● Quantity demanded is the amount of a good that buyers are willing and able to purchase
● Demand is a full description of how the quantity demanded changes as the price of the good changes.
● The law of demand states that the quantity demanded of a good fall when the price of the good
rises, and vice versa, provided all other factors that affect buyers’ decisions are unchanged

“Provided all other factors … are unchanged”

● That’s an important phrase in the wording of the Law of Demand
● The quantity demanded of a consumer goods such as ice cream depends on
○ The price of ice cream
○ The prices of related goods
○ Consumers’ incomes
○ Consumers’ tastes
○ Consumers’ expectations about future prices and incomes
○ Number of buyers, etc.
● The Law of Demand says that the quantity demanded of a good is inversely related to its price,
provided all other factors are unchanged
Shifts in the Demand Curve
● Consumer Income
○ As income increases the demand for a normal good will increase
○ As income increases the demand for an inferior good will decrease
● Prices of Related Goods
○ When a fall in the price of one good reduces the demand for another good, the two goods are
called substitutes
○ When a fall in the price of one good increase the demand for another good, the two goods are
called complements
There are two ways to explain the Law of Demand
● Substitution Effect
 ○ When the price of a good decreases, consumers substitute that good instead of
other competing (substitute) goods
● Income Effect
○ A decrease in the price of a commodity is essentially equivalent to an increase in
consumers’ income
○ Consumers respond to a decrease in the price of a commodity as they would to an
increase in income
○ They increase their consumption of a wide range of goods, including the good that
had a price decrease
Supply Basics
● Quantity supplied is the amount of a good that sellers are willing and able to sell
● Supply is a full description of how the quantity supplied of a commodity responds to changes in its price
● The law of supply states that, the quantity supplied of a good rise when the price of the good rises, as
long as all other factors that affect suppliers’ decisions are unchanged

Supply and Demand Analysis

● We have seen what demand and supply are
● We have seen why demand and supply may shift
● Now it is time to say something about how buyers and sellers collectively determine the market
outcome
● To do this, we assume equilibrium

Concept of Equilibrium
We assume that the price will automatically reach a level at which the quantity demanded equals the quantity
supplied

Markets Not In Equilibrium

● Surplus
○ When price exceeds equilibrium price, then quantity supplied is greater than quantity demanded
■ There is excess supply or a surplus
■ Suppliers will lower the price to increase sales, thereby moving toward equilibrium
● Shortage
○ When price is less than equilibrium price, then quantity demanded exceeds the quantity
supplied
■ There is excess demand or a shortage
■ Suppliers will raise the price due to too many buyers chasing too few goods, thereby
moving toward equilibrium
Law of Supply and Demand
The price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into
balance

Equilibrium: skepticism required

● Although the Law of Supply and Demand is a good place to start the discussion of prices, it should not
be taken to be the gospel truth.
● In some cases, the price might get stuck at some other level and quantity supplied and quantity
demanded may not be equal.
Example: unemployment Unemployment: a failure of equilibrium

Concept of Elasticity
Elasticity is an economic concept used to measure the change in the aggregate quantity demanded of a good
or service in relation to price movements of that good or service. A product is considered to be elastic if the
quantity demanded of the product changes more than proportionally when its price increases or decreases.

Basic Assumptions of Consumer Theory

The theory of consumer preferences is based on three main assumptions: completeness, transitivity, and
non-satiation.
Completeness: This assumption implies that consumers can rank all combinations of goods available to them.
In other words, given any two bundles of goods A and B, consumers can determine whether they prefer A to B,
B to A, or are indifferent between the two.
Transitivity: The transitivity assumption asserts that if a consumer prefers Bundle A to Bundle B, and Bundle
B to Bundle C, then the consumer will also prefer Bundle A to Bundle C. This assumption is essential for
rational consumer decision-making.
Non-satiation: Otherwise known as the "more is better" assumption, non-satiation implies that given two
bundles of goods, consumers will prefer the bundle offering more of at least one good and no less of other
goods.

The Utility Function

UTILITY- refers to the satisfaction or the pleasure that an individual or the consumer gets from consumption of
goods and services that he/she purchases
UTILS- measurement of utility
MARGINAL –means additional/extra MARGINAL UTILITY- additional satisfaction that an individual derives
from consuming an extra unit of good or service
TOTAL UTILITY- the total satisfaction that a consumer derives from the consumption of a given quantity of a
good or service in a particular time period

LAW OF DIMINISHING MARGINAL

UTILITY- states that as a consumer gets more satisfaction in the long run, he experiences a decline in his
satisfaction of goods and services; we consume more and more of a good or service, we like it less and less,
as we consumer increasing amounts of a good or service, we derive diminishing utility or satisfaction from
each additional unit consumed
Formula: MU= ∆TU = TU2-TU1
∆Q Q2-Q1

Indifference Curves
INDIFFERENCE CURVE- line that shows combination of goods among which a consumer is indifferent

Marginal Rate of Substitution

● rate at which a person will give up good y to get more of good x and vice versa

The Consumer’s Budget Constraint

● BUDGET- purpose of which is not to spend more than what you have
The budget constraint is the set of all the bundles a consumer can afford given that consumer's income. We
assume that the consumer has a budget—an amount of money available to spend on bundles. For now, we do
not worry about where this money or income comes from; we just assume a consumer has a budget.

Utility Maximization
Utility maximization is a strategic scheme whereby individuals and companies seek to achieve the highest level
of satisfaction from their economic decisions.
The maximization of satisfaction or utility given a limited budget or income

Optimization
The process of economic optimization entails striving to acquire the best from the economy in terms of profits,
production, and utility. In other words, it entails maximizing the objective functions which contribute towards the
best economic outcome.

Marginal Benefit
A marginal benefit is a maximum amount a consumer is willing to pay for an additional good or service. It is
also the additional satisfaction or utility that a consumer receives when the additional good or service is
purchased. The marginal benefit for a consumer tends to decrease as consumption of the good or service
increases.
In the business world, the marginal benefit for producers is often referred to as marginal revenue.

The Concept of Production

Production is the process by which different inputs, including capital, labor, and land, are used to create
outputs in the form of products or services.

The Production Function

● The production function shows the relationship between the quantity of inputs used to make a good and
the quantity of output of that good.
Marginal Product
● The marginal product of any input in the production process is the increase in output that arises from an
additional unit of that input.
Diminishing Marginal Product
● Diminishing marginal product is the property whereby the marginal product of an input declines as the
quantity of the input increases.
● The slope of the production function measures the marginal product of an input, such as a
worker.
● When the marginal product declines, the production function becomes flatter.
From the Production Function to the Total-Cost Curve
● The relationship between the quantity a firm can produce and its costs determines pricing
decisions.
● The total-cost curve shows this relationship graphically.

The Nature of Cost

Costs of production may be divided into fixed costs and variable costs.
● Fixed costs are those costs that do not vary with the quantity of output produced.
● Variable costs are those costs that do vary with the quantity of output produced.
Production and Cost in the Short Run
Short-run production costs are the total of fixed and variable costs incurred by the production of a good or
service where factors such as land and heavy machinery cannot change in the short term. Fixed costs remain
constant regardless of production output. Variable costs can change depending on production output.

Production and Cost in the Long Run

Long-run production costs refer to the costs over the length of time that it takes for all costs to be variable. The
difference between short-run and long-run production costs is that long-run production costs are all variable
costs whereas short-run production costs include at least one fixed variable.

Production and Cost Estimation

The total product cost formula is Total Product Cost = Cost of Raw Materials + Cost of Direct Labor + Cost of
Overhead. Another useful measure is the production cost per unit. This is calculated from the total production
cost divided by the total number of units produced.

Definition of market structures

Market structure is best defined as the organizational and other characteristics of a market. It is the
competitive environment in which buyers and sellers operate. We focus on those characteristics which affect
the nature of competition and pricing – but it is important not to place too much emphasis simply on the market
share of the existing firms in an industry

Traditionally, the most important features of market structure are:

1. The number of firms (including the scale and extent of foreign competition)
2. The market share of the largest firms (measured by the concentration ratio – see below)
3. The nature of costs (including the potential for firms to exploit economies of scale and also the
presence of sunk costs which affects market contestability in the long term)
4. The degree to which the industry is vertically integrated - vertical integration explains the process by
which different stages in production and distribution of a product are under the ownership and control of a
single enterprise. A good example of vertical integration is the oil industry, where the major oil companies own
the rights to extract from oilfields, they run a fleet of tankers, operate refineries and have control of sales at
their own filling stations.
5. The extent of product differentiation (which affects cross-price elasticity of demand)
6. The structure of buyers in the industry (including the possibility of monopsony power)
7. The turnover of customers (sometimes known as "market churn") – i.e. how many customers are
prepared to switch their supplier over a given time period when market conditions change. The rate of
customer churn is affected by the degree of consumer or brand loyalty and the influence of persuasive
advertising and marketing

Market Structure and Degree of Competition

Competition is rivalry among various sellers in the market. As students, we are familiar with the word
competition. We are exposed to competition in school: spelling bees, quiz bees, and sports fests. On the
television, we watch beautiful girls from all over the world compete for the Miss Universe or Miss World title.
We see how the various teams of the PBA compete to win the championship.
The market is a situation of diffused, impersonal competition among sellers who compete to sell their goods
and among buyers who use their purchasing power to acquire the available goods in the market.
There are varying degrees of competition in the market depending on the following factors:
• Number and size of buyers and sellers
• Similarity or type of product bought and sold
• Degree of mobility of resources
• Entry and exit of firms and input owners
• Degree of knowledge of economic agents regarding prices, costs, demand, and supply conditions

Perfect Competition
perfect competition implies an ideal situation for the buyers and sellers.
The following are characteristics of a perfectly competitive market..
• Large numbers of buyers and sellers in a standardized product market.
• Sellers offer homogenous goods, allowing easy entry and exit.
• Buyers and sellers are well-informed about prices and sources of goods.
• No individual decision-maker can significantly affect product price.
• Standardized products prevent buyers from noticing differences between sellers.
• No significant barriers or special costs discourage new entrants or sellers.
• Well-informed buyers and sellers have all necessary information for decision-making.
• Perfect competition is realistic, similar to the market for wheat.
• The model of perfect competition is powerful and many markets, though not strictly perfect, closely match it.

Managerial Decision in Competitive Markets

To explain firm behavior, we separated the decision process into 2 steps:
❖ Cost Minimization - firms try to produce a given output as cheap as possible
➢ Result: Factor demand functions and cost function C = C(w, r, Q)
➢ Optimal factor allocation
❖ Profit Maximization: firms decide how much output they produce
➢ Technological Restrictions
■ Already incorporated in the cost function, however, no assumptions about the market,
just assume that factor prices are exogenous
➢ Market Restrictions
■ Indicate how the output price is determined
● Different between market structures
● Complete vs incomplete markets

Competition in the Global Economy

Global competition refers to products and services provided by competing companies operating on the
International level. Every company has a core competency which is what they do best. In a more local setting,
companies may compete with just a couple of other companies that share a similar core competency.

Monopoly
A monopoly occurs when a single firm has no close substitutes in a market, leading to consumers fearing
increased prices and poor quality of goods. This lack of competition can also result in poor service from the
monopolist.
Monopoly can exist for the following reasons:
• A single seller has no control of the entire supply of raw materials.
• Ownership of patent or copyright is invested in a single seller.
• The producer will enjoy economies of scale, which are savings from a large range of outputs.
• Grant of a government franchise to a single firm.
Monopolists have limited market power due to indirect competition for consumer money. They can exist due to
legal barriers like government restrictions, patents, and copyrights. Monopolists determine their output level
and price, setting prices to maximize profits. They face a downward-sloping demand curve, where lower prices
lead to higher consumer quantity. To prevent abuses, stricter government laws are needed.

Monopolistic Competition
Monopolistic competition is an imperfectly competitive market where products are differentiated and entry and
exit are easy. Consumers enjoy a wide variety of goods, preferring expensive gadgets with latest features.
Monopolistic competition allows consumers to choose from many firms, allowing them to choose from brands
like Toyota, Honda, Mercedes-Benz, or Volkswagen. This market combines characteristics of perfect
competition and monopoly.
Its key characteristics are:
• a blend of competition and monopoly;
• firms sell differentiated products, which are highly substitutable but are not identical and satisfy the
same basic need;
• changes in product characteristics to increase appeal using brand, flavor, consistency, and packaging
as means to attract customers;
• there is free entry and exit in the market that enables the existence of many sellers; and
• it is similar to a monopoly in that the firm can determine characteristics of product and has some control
over price and quantity.
Monopolistic competition allows firms to set prices based on product differences, allowing them to sell more by
charging less and raise prices without losing customers. Non-price competition involves actions like better
service, product guarantees, and advertising to shift demand without sacrificing prices. Firms in this market
structure are price setters, but their demand curve is more elastic than a monopolist's.

Managerial Decisions for Firms with Market Power

Market power is a firm's ability to raise prices without losing sales, especially in a downward sloping demand
curve. It allows a firm to earn economic profit above average cost, provided demand and cost conditions are
favorable. To be a true monopolist, barriers to entry must be in place. Market power is varying degrees,
inversely related to the availability of close substitutes for a firm's product, measured by price and cross-price
elasticities of demand.

Oligopoly
An oligopoly is a market dominated by a few strategically interconnected firms, with few sellers accounting for
most or total production due to barriers to entry.
Its characteristics are:
• action of each firm affects other firms; and
• interdependence among firms.

Oligopolies are formed by firms that strategically interact to increase profits by colluding to raise prices, often at
the expense of consumers. For example, in the oil industry, producers can agree on prices, leading countries to
buy from them at high prices. Oligopolies can exist due to barriers such as economies of scale, reputation, and
strategic and legal barriers. Cooperative behavior in oligopolies often involves price-fixing or output-setting
agreements, such as those maintained by OPEC.