Lecture%201%20Basics%20of%20Economics%20

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Lecture 1 Basics of Economics Elasticity
Dr. Rajeev Dhawan Director
Given to the EMBA 8400 Class Buckhead
Center March 7, 2009
2
Course Objective Teaching Philosophy

• Practical Course to Comprehend the Economic
  Environment so that Managers can make their
  Decisions
• Philosophy is that Micro Sectors Add Up to a
  Macro Environment
• Optimal Blend of Economics and Real World
  Experience/Common Sense
• Train You to Critically Evaluate and Interpret
  Business Press Writings

3
Course Layout

• First Part (Lectures 1 2) - Basic Micro
  Economic Concepts
• Second Part (Lectures 3 4) Basics of
  Macroeconomics
• Third Part (Lectures 5 6) Basic Workings of an
  Economy with the Help of a Basic Macromodel
  that can Perform Real-Life Fiscal And Monetary
  Experiments
• Wrap up Project Presentations (Lecture 7)

4
Background Articles

• My Economics
• Why Journalists Can't Add
• Where Presidents Have No Power
• Their Money Our Strength
• How to Stop Relatives from Bragging About their
  Big Profits in Real Estate

5
Grading Policy

• 40 Midterm
• 30 Group Presentations on a Selected Industry
• 30 Take Home Final Exam
• Macroeconomic Model Exercise

6
Group Presentations

• The objectives of this group project are
• To help you bridge the gap between the economic
  theory and models discussed in class and the
  real world
• To confront the problems of trying to find data
  which are appropriate for the questions under
  consideration and to deal with the problems of
  incomplete information
• To showcase your oral and written communication
  skills
• To identify how the problems faced and the
  decisions made by other firms are similar to your
  own.

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Suggested Industries

• 1. Wireless Communications
• 2. Networking Security Systems
• 3. Aerospace Industry
• 4. Healthcare Industry
• 5. Hospitality Industry
• 6. Heavy Equipment
• 7. Banking
• 8. Consumer Products
• 9. Online / E-commerce
• 10. Real Estate (any topic)
• 11. Entertainment Industry
• 12. Shipping Industry

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Macro Framework

• Households Consume Work
• Firms Production Investment
• Government Money Supply, Taxes, Expenditures
• Foreign Sector Exports, Imports Exchange Rate

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Macroeconomic Model For Teaching

• Section 1 A Model Simulation Approach to
  Macroeconomics
• Section 2 Classification of Equations
• Section 3 Glossary of Variables
• Section 4 Listing of Equations in the Integrated
  Macro Model
• Section 5 Flow Diagram of Integrated Macro Model
• Section 6 Policy Experiments with Integrated
  Macro Model
• Section 7 Guidelines to Use the Model

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GLOSSARY OF VARIABLES
Variable Meaning Units
C Consumption Billions of
EX Exports Billions of
EXCH Exchange Rate Index
G Government Purchases Billions of
GDP Gross Domestic Product Billions of
GDP_at_FULL GDP _at_ Full Employment Billions of
GDP_at_ROW GDP in Rest of the World Billions of
I Investment Billions of
IM Imports Billions of
M Money supply Billions of
NETEX Net Exports Billions of
P Price Level Index
P Inflation Percent
P_at_ROW Price Level, Rest of the World Index
R Real Interest Rate Percent
R_at_ROW Real Interest Rate, Rest of the World Percent
T Tax Revenues Billions of
TAX Tax Rate Fraction
YDP Disposable Income Billions of
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Typical Macro-Model
price level lag 1
world interest rate
IMPORTS
world GDP
inflation lag 1
world price
EXPORTS
EXCHANGE RATE
PRICE LEVEL
NET EXPORTS
money
INTEREST RATE
INFLATION
government
INVESTMENT
REAL GDP
EXPECTED INFLATION
UNEMPLOYMENT
CONSUMPTION
DISPOSABLE INCOME
tax rate
TAX REVENUES
POTENTIAL GDP
capital stock lag 1
investment lag 1
CAPITAL STOCK
labor force
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Typical Macro-Model
price level lag 1
world interest rate
IMPORTS
world GDP
inflation lag 1
world price
EXPORTS
EXCHANGE RATE
PRICE LEVEL
NET EXPORTS
money
INTEREST RATE
INFLATION
government
INVESTMENT
REAL GDP
EXPECTED INFLATION
UNEMPLOYMENT
CONSUMPTION
DISPOSABLE INCOME
tax rate
TAX REVENUES
POTENTIAL GDP
capital stock lag 1
investment lag 1
CAPITAL STOCK
labor force
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Typical Macro-Model
price level lag 1
world interest rate
IMPORTS
world GDP
inflation lag 1
world price
EXPORTS
EXCHANGE RATE
PRICE LEVEL
NET EXPORTS
money
INTEREST RATE
INFLATION
government
INVESTMENT
REAL GDP
EXPECTED INFLATION
UNEMPLOYMENT
CONSUMPTION
DISPOSABLE INCOME
tax rate
TAX REVENUES
POTENTIAL GDP
capital stock lag 1
investment lag 1
CAPITAL STOCK
labor force
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Typical Macro-Model
price level lag 1
world interest rate
IMPORTS
world GDP
inflation lag 1
world price
EXPORTS
EXCHANGE RATE
PRICE LEVEL
NET EXPORTS
money
INTEREST RATE
INFLATION
government
INVESTMENT
REAL GDP
EXPECTED INFLATION
UNEMPLOYMENT
CONSUMPTION
DISPOSABLE INCOME
tax rate
TAX REVENUES
POTENTIAL GDP
capital stock lag 1
investment lag 1
CAPITAL STOCK
labor force
15
New Economy Macro-Model
price level lag 1
world interest rate
IMPORTS
world GDP
inflation lag 1
world price
EXPORTS
EXCHANGE RATE
PRICE LEVEL
NET EXPORTS
money
INTEREST RATE
INFLATION
government
INVESTMENT
REAL GDP
EXPECTED INFLATION
Tech/Profit Opportunities
STOCK MARKET
UNEMPLOYMENT
CONSUMPTION
CONSUMPTION
DISPOSABLE INCOME
tax rate
TAX REVENUES
POTENTIAL GDP
capital stock lag 1
investment lag 1
CAPITAL STOCK
labor force
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New Economy Macro-Model
price level lag 1
world interest rate
IMPORTS
world GDP
inflation lag 1
world price
EXPORTS
EXCHANGE RATE
PRICE LEVEL
NET EXPORTS
money
INTEREST RATE
INFLATION
government
INVESTMENT
REAL GDP
EXPECTED INFLATION
Tech/Profit Opportunities
STOCK MARKET
UNEMPLOYMENT
CONSUMPTION
EUPHORIA
DISPOSABLE INCOME
tax rate
TAX REVENUES
POTENTIAL GDP
capital stock lag 1
investment lag 1
CAPITAL STOCK
labor force
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New Economy Macro-Model
price level lag 1
world interest rate
IMPORTS
world GDP
inflation lag 1
world price
EXPORTS
EXCHANGE RATE
PRICE LEVEL
NET EXPORTS
money
INTEREST RATE
INFLATION
government
INVESTMENT
REAL GDP
EXPECTED INFLATION
Tech/Profit Opportunities
STOCK MARKET
EUPHORIA
UNEMPLOYMENT
CONSUMPTION
EUPHORIA
DISPOSABLE INCOME
tax rate
TAX REVENUES
POTENTIAL GDP
capital stock lag 1
investment lag 1
CAPITAL STOCK
labor force
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New Economy Macro-Model
price level lag 1
world interest rate
IMPORTS
world GDP
inflation lag 1
world price
EXPORTS
EXCHANGE RATE
PRICE LEVEL
NET EXPORTS
money
INTEREST RATE
INFLATION
government
INVESTMENT
REAL GDP
EXPECTED INFLATION
Tech/Profit Opportunities
STOCK MARKET
EUPHORIA
UNEMPLOYMENT
CONSUMPTION
DISPOSABLE INCOME
tax rate
TAX REVENUES
POTENTIAL GDP
capital stock lag 1
investment lag 1
CAPITAL STOCK
labor force
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Introduction

• The 10 Principles of Economics

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What is Economics?

• Economics is the study of how we use our scarce
  productive resources for consumption, now or in
  future.
• Paul Samuelson
• Resources are scarce
• Society has limited resources and therefore
  cannot produce all the goods and services people
  wish to have
• Example clean air water
• Scarcity is not poverty

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Basic Questions

• What to produce in what quantity?
• How to produce them?
• When and where to produce?
• For whom?
• Who makes economic decisions and by what process?

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Basic Concepts

• Opportunity Cost Things are Scarce
• Next Best Alternative
• Ex Party on Friday night vs. study for exams
• Cost of Time
• Ex 1 hour wait time at the dentist

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Basic Concepts

• Marginal Concept At the Margin

• Utility Level of Satisfaction (here, drunkenness)

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Basic Concepts

• Sunk/Fixed Costs Expenditures Made that Cannot
  be Recovered
• Example
• You bought a computer laptop for 1500
• A newer, upgraded model costs 1200
• The dealer will accept a trade in 400
• What do you do?

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10 Principles of Economics

• People face tradeoffs
• No such thing as free lunch
• Give up one thing to get another Opportunity
  Cost (OC)
• Everything has an OC whatever must be given up
  to get that item
• People make decisions at the margins increments
  matter
• People respond to incentives e.g. cigarette
  laws, communism
• Free Trade is good (for everybody)

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10 Principles of Economics

• Markets organize economic activity
• - Adam Smith Invisible Hand
• Governments can sometimes improve market outcome
• A countrys standard of living depends upon its
  production power (productivity)
• Prices rise when government prints too much money
• Phillips curve short run tradeoff between
  inflation and unemployment

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Branches of Economics

• Micro The Study of One Entity (firm,
  business, people)
• Macro The Study of a Collection of Things
  (national, aggregate)

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How are Theories Developed?

• Decision-Makers
• Firms, governments
• Markets
• Place where exchange takes place

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Winnicks Voyage to the Bottom of the Sea WSJ
by Andy Kessler

• First Mover, FCC regulated fixed costs
• Regulated utility
• Price protection
• You cant lose
• Traffic / use was of low economic value or
  cashless
• Global Crossing couldn't cut prices without
  running the risk of either failing to cover its
  debt or being unable to raise more capital
• Accounting Tricks.

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Who REALLY Owns that Winery TIME Magazine by
Terry McCarthy

• Reshuffling to scarce resources
• He can make lots of money just by shifting more
  of his production - and more of his customers
  from 1.5L jugs of generic red that sell for less
  than 5 retail to smaller bottles of 7 Merlot
• The Future
• The higher end is where the profits and the
  growth are to be found
• The Italians have figured it out how to create
  tastes that suit the American palate

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Chapter 4

• Demand Supply

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Some Basic Definitions

• Market a group of buyers and sellers of a
  particular good or service
• E.g. Warren Buffet has been buying up junk
  bonds
• E.g. Bars, parties informal market
• Stock market organized market

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Example of Supply Demand

• Hong Kong chicken flu scare? Price of chicken ?
• Mad cow disease in US? Price of beef ?
• Oprah bad mouths beef? Price of beef ?
• Amarillo farmers sue her.
• SARS? (Macro issue)

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Demand
Quantity demanded (Q) the amount of a good that
buyers are willing and able to purchase at a
given price (P).

• Pints of Beer
• P QD
• 10.00 0
• 7.00 1
• 5.00 3
• 4.00 6
• 2.00 11
• 0.00 19

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Market Demand versus Individual Demand

• Market demand refers to the sum of all individual
  demands for a particular good or service.
• Graphically, individual demand curves are summed
  horizontally to obtain the market demand curve.

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The Market Demand Curve
The market demand curve is the horizontal sum of
the individual demand curves!
When the price is 5.00, Catherine will demand 3
beers.
The market demand at 5.00 will be 7 beers.
When the price is 5.00, Nicholas will demand 4
beers.


Nicholass Demand
Catherines Demand
Market Demand
Price of Beers
Price of Beers
Price of Beers
5.00
5.00
5.00
4.00
4.00
4.00
13
7
4
7
3
6
Quantity of Beers
Quantity of Beers
Quantity of Beers
When the price is 4.00, Catherine will demand 6
beers.
The market demand at 4.00, will be 13 beers.
When the price is 4.00, Nicholas will demand 7
beers.
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Graph Results

• Demand curve/schedule is downward sloping and
  shows the relationship between price of a good
  and the quantity demanded
• Why downward sloping?
• Law of demand Ceteris Paribus (all other things
  being equal) the quantity demanded falls when
  price rises

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Other Determinants of Demand

• Income (I)
• I ? , D ? ? Normal Goods car, Ferrari
• I ? , D ? ? Inferior goods bus rides, potatoes
• Price of related goods
• Substitutes (inversely correlated)
• Compliments (directly correlated)

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Other Determinants of Demand

• Tastes taken as above
• You get old and prefer Lincoln Town cars to
  sports cars
• Expectations about future
• Income potential with EMBA degree ?
• Loss of jobs, layoffs prospects
• Market Demand
• More players ? Increase in demand
• Buy IPOs in 90s

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Shifts in Demand Curve

• Variables that shift the demand curve

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Shifts in the Demand Curve
Price of
Beer
Quantity of
0
Beer
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Supply
Quantity supplied (Q) the amount of a good that
sellers are willing and able to sell at a given
price (P).
Pints of Beer P QS
10.00 12 7.00 7 5.00 4 4.00 3 2.00 1
0.00 0
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Supply

• Supply graph for another bar

Pints of Beer P QS
10.00 8 7.00 5 5.00 4 4.00 3 2.00 1 0
.00 0
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Determinants of Supply

• Your own Price
• Input Prices
• Cost of bottle of beer labor, capital, rent
• Technology
• Smoking laws ? separation of smoking drinking
• Expectations
• Future outlook

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Shifts in The Supply Curve

• Variables that shift the supply curve

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Shifts In Supply Curve
Price of
Beer
Quantity of
0
Beer
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Equilibrium

• Equilibrium the price where quantity supplied is
  equal to quantity demanded

Equilibrium
6
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Markets Not In Equilibrium
Excess Supply
Price of
Beer
0
Quantity of
Beer
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Markets Not In Equilibrium
Excess Demand
Price of
Beer
0
0
Quantity of
Beer
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Changes in Equilibrium

• Decide whether the event shifts the supply or
  demand curve (or both).
• Decide whether the curve(s) shift(s) to the left
  or to the right.
• Use the supply-and-demand diagram to see how the
  shift affects equilibrium price and quantity.

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Changes in Equilibrium
Price of
Price of
Beer
Beer
Initial equilibrium
Pints of Beer
0
Pints of Beer
0
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One bar closes?
New Equilibrium
5.00
4
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Chapter 5

• Elasticity

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Elasticity Its Application

• Evaluating questions like-
• Banana Republic store manager/headquarters needs
  to decide on sale on jeans vs. sale on shirts
• Rain destroys strawberry crop, prices go ?. Does
  it benefit growers ?
• Why dont you ever see sale or discounts on pure
  milk but see it on orange juice ?
• These can be answered with the concept of
  elasticity (or responsiveness of buyers sellers
  to changes in market conditions)

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Elasticity

• Price elasticity of demand a measure of how much
  the quantity demanded of a good responds to a
  change in the price of that good

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Continued..

• Two types of demand
• Elastic responds a lot e.g. luxury cars (
  luxuries)
• Inelastic not much change e.g. milk, certain
  food items, gasoline ( necessities)
• Preferences Luxuries vs. Necessities
• Availability of close substitutes Elastic
• Butter margarine cars, booze
• Time horizon
• Gasoline necessity in short run
• Substitute long run (electric cars, walk, bike)

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Elasticity

• Inelastic Demand
• Quantity demanded does not respond strongly to
  price changes.
• Price elasticity of demand is lt one.
• Elastic Demand
• Quantity demanded responds strongly to changes in
  price.
• Price elasticity of demand is gt one.

58
Demand Curves

• Question Can I tell from the graphical shape of
  the demand curve what kind of elasticity the
  curve has?
• Answer Yes, but not all the time.

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Perfectly Inelastic Demand
Elasticity 0
Price
Quantity
0
3. . . . revenue goes from 4 x 100 to 5 x 100
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Inelastic Demand
Elasticity lt 1
Price
Quantity
0
3. . . . revenue goes from 4 x 100 to 5 x 90
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Unit Elastic Demand
Elasticity 1
Price
Quantity
0
3. . . . revenue goes from 4 x 100 to 5 x 80
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Elastic Demand
Elasticity gt 1
Price
Quantity
0
3. . . . revenue goes from 4 x 100 to 5 x 50
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Perfectly Elastic Demand
Elasticity Infinity
Price
Quantity
0
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Relationship Between Total Revenue (Sales)
Elasticity

• Total Revenue Price x Qty Sold P x Qty
• If demand is elastic, then a price decrease
  increases revenue
• If demand is inelastic, then a price increase
  increases revenue
• Example ? class to contribute

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Box Shows the 50 Drop of New Paying Customers
for the May August 2004 Conference Caused by
the Latest Price Hike
Conference Date Attendance New Paying of Total
Feb 01 72 6 8
May 01 66 10 15
Aug 01 101 31 31
Nov 01 163 49 30
Feb 02 189 28 15
May 02 160 42 26
Aug 02 195 62 32
Nov 02 169 44 26
Feb 03 260 55 21
May 03 196 37 19
Aug 03 220 43 20
Nov 03 222 40 18
Feb 04 238 48 20
May 04 201 25 12
Aug 04 211 23 11
1st Price Hike
2nd Price Hike
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Applications of Supply, Demand Elasticity

• Can good news for farmers be bad news for
  farmers?
• Wheat is inelastic Bumper crop ? bad news

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Increase In Supply In Market For Wheat
Price of
Wheat

Quantity of
0
Wheat