MODULE -1 Introduction to Managerial Economics

What is economics?
Economics is essentially about scarcity and choice. This section covers an
introduction to some of the fundamental concepts of IB Economics, as well as the
study of the subject of Economics in general. The fundamental problem of
economics is that there is scarcity and that choices must be made. We cannot have
everything we want as a result of scarcity, every choice that must be made
between two or more options has an opportunity cost.
WHAT is economics?
Economics is a social science:
 Explain that Economics is social in nature
 Explain that microeconomics and macroeconomics are the basis of
economics
 Outline the central concepts of IB Economics: scarcity, choice, well-being,
efficiency, change, interdependence, intervention, equity, and economic
sustainability

The problem of choice:

Explain that land, labour, capital and entrepreneurship are the factors of
production
 Explain scarcity
 Explain that the problem of limited resources being met with unlimited
human needs and wants
 Explain that the problem of sustainability and scarcity
 Explain that opportunity cost is a cost of choice
 Explain free goods
Essential economic questions:
 Explain that Economics focusses on what/how much to produce, how to
produce and for whom to produce
 Explain how we can go about answering these economic questions
 Explain market solutions versus government intervention
 Explain the different economic systems: planned economies, free market
economies, and mixed economies
THE STUDY OF ECONOMICS
Economics is the social science that studies how people use scarce
resources to satisfy unlimited needs and wants. You will notice it is a social
science because it is about how people interact and why they behave in
certain ways. In some respects, it is a lot like psychology because we talk
and make decisions based on our understandings of why people do what
they do.

Social science, which includes economics, psychology, sociology,

anthropology and political science, consists of the disciplined and
systematic study of society and its institutions, and of how and why people
behave as they do, both as individuals and in groups within society. The
world's resources are limited and already overstretched. Economics is the
study of scarcity and decision-making.

Economics as a social science

Economics is the scientific study of the ownership, use, and exchange of
scarce resources – often shortened to the science of scarcity.

Economics is regarded as a social science because it uses scientific

methods to build theories that can help explain the behaviour of
individuals, groups and organisations. Economics attempts to explain
economic behaviour, which arises when scarce resources are exchanged.

In terms of methodology, economists, like other social scientists, are not

able to undertake controlled experiments in the way that chemists and
biologists are. Hence, economists have to employ different methods, based
primarily on observation and deduction and the construction of abstract
models.

As the social sciences have evolved over the last 100 years or so, they have
 become increasingly specialised. This is true for economics, as witnessed
by the development of many different strands of investigation including
microeconomics and macroeconomics, pure and applied economics,
international economics, development economics and industrial and
financial economics. What links them all is the attempt to understand how
and why exchange takes place, and how exchange creates benefits and
costs for the participants.

Social science:
The scientific study of society – of human behaviour and of social
interactions. Economics is one of several social sciences. Others are
sociology, political science, and anthropology. Economics is considered a
social science because it seeks to explain how society deals with the
problemof scarcity.

Scarcity is the situation in which available resources, or factors of

production, are finite, whereas wants are infinite. There are not enough
resources to produce everything that we need and want. The basic
economic problem that arises because people have unlimited wants but
resources are limited. Because of scarcity, various economic decisions
must be made to allocate resources efficiently.

The basis of economics: microeconomics and macroeconomics-

Microeconomics analyses basic elements in the economy, including individual
agents and markets, their interactions, and the outcomes of interactions.
Individual agents may include, for example, households, firms, buyers, and
sellers. For example, firms sell goods to households, and households provide
labour.
Macroeconomics analyses the economy as a system where production,
consumption, saving, and investment interact, and factors affecting it:
employment of the resources of labour, capital, and land, currency inflation,
economic growth, and public policies that have impact on these elements.
Central Concepts in Economics

Economic Well-Being
Equality is not the same as equity. Equality refers to the same or similar economic
outcomes for different groups or individuals. Equity relates to fairness, a
normative concept. A normative statement is one that makes a value judgment.
Such a judgment is the opinion of the speaker; no one can “prove” that the
statement is or is not correct. Inequity (unfair) is often referred to as inequality,
in economics, and may refer how income, wealth or even opportunity is
distributed in society. Irrespective of society or economic system, inequity and
inequality are significant issues, both between societies (e.g., Zimbabwe and
Denmark) and within societies (e.g., men and women in Saudi Arabia). An area
of economic debate is whether markets or governments can, or even should,
create more equity and reduce inequality in societies.
Interdependence
Interdependence: Individuals, communities and countries are interdependent, not
self-sufficient. Economic groups such as consumers, households, businesses, and
governments all interact together within and across national borders to achieve
their economic goals. The more these groups interact, the more they are
interdependent. The economic world is highly interdependent, and decisions
made by economic actors can cause many unintended consequences for other
economic actors. When conducting an economic analysis, it is important to
consider interdependencies.
Scarcity
Scarcity: Scarcity is a central concept in economics. Scarcity is the situation in
which available resources, or factors of production, are finite, whereas wants are
infinite. There are not enough resources to produce everything that we need and
want. The basic economic problem that arises because people have unlimited
wants but resources are limited. Because of scarcity, various economic decisions
must be made to allocate resources efficiently.
Choice
Economics is the study of choice because resources are scarce and many needs
and wants cannot be satisfied. As such, choices must be made, and whenever a
choice is made an opportunity arises. Households, businesses and governments
are always making choices between alternatives competing with each other. The
consequences of such choices, present and future, is studied in economics.
Change:
Change is an essential concept in economics. As economists, we need to be aware
that the economic world is in a state of constant change and adjust our thinking
accordingly. Change is an important concept in economic theory and in empirical
evidence from the real world. Change is relevant to economic variables (e.g., a
change in the unemployment numbers) and from one situation to another (e.g., a
Russian invasion of a sovereign nation). Our economic world is subject to
profound and continuous economic change that occurs in technologies,
institutions, and societies, as well as structural change (a dramatic shift in the way
an industry or market functions).
Sustainability:
Sustainability focuses on meeting the needs of the present without compromising
the ability of future generations to meet their needs. Sustainability refers to limits
on current economic activities that harm our environment by depleting and
degrading resources, negatively impacting future generations (e.g., climate
change won’t impact boomers as severely as Gen Zs or Gen Alphas). Good
economic analysis considers sustainability as our world’s resources, boundaries
and capacities are pushed to their limits.
Efficiency:
Efficiency is quantifiable – a ratio of inputs to outputs. Efficiency could be using
less inputs to achieve the same quantity of output or using the same amount of
inputs to achieve greater output. Allocative efficiency is where scarce resources
are put to their best possible use in producing goods and services in optimal
combinations for society, minimising the waste of resources.
Intervention:
In economics, intervention means governments getting involved to rectify
perceived failure in markets (e.g., taxation and redistribution). Markets may be
the most efficient at organising scarce resources, but they often fail to achieve
many of the goals of societies such as economic well-being, equity, or
sustainability. Such failures may be considered just cause for government
intervention, however, there is considerable disagreement between policy makers
and economists as to the need for intervention, the type of intervention to be used,
and the extent of any such intervention. There is much debate about the merits of
the free market and the merits of intervention.

Equity:
Equity, being different to equality (sameness), refers to the normative concept of
fairness. Fairness has a different meaning from one person to the next. Inequity
(unfair) is often referred to as inequality, in economics, and may refer how
income, wealth or even opportunity is distributed in society. Irrespective of
society or economic system, inequity and inequality are significant issues, both
between societies (e.g., Zimbabwe and Denmark) and within societies (e.g., men
and women in Saudi Arabia). An area of economic debate is whether markets or
governments can, or even should, create more equity and inequality in societies.
SCARCITY – FACTORS OF PRODUCTION ARE FINITE AND WANTS
INFINITE
Needs, wants and resources.

Our needs and wants are very different. We need some things just to stay alive –
including water, food and warmth. But our wants are never-ending (infinite). We
may want a PlayStation 4 for Christmas. Do we actually need it to stay alive?
Most people would say no – it is simply a luxury that would be nice to have.
Imagine you get a PlayStation for Christmas – what will you want for your
birthday? An iPhone, perhaps. The cycle of wants continues, once you get one
thing, you move straight on to wanting another.
In contrast, the resources used to produce these goods and services are in limited
supply (finite). Collectively, resources are called factors of production. Resources
can be divided into four groups:
 Land. Land is the natural resources available for production. Some nations
have a large amount of a particular natural resource, and so are able to
specialise in the extraction and production of it – for example North Sea
oil and gas in Britain and Norway.
 Labour. Labour is the human input into the production process. Not all
labour is of the same quality. Every person has different skills and
qualifications – we call this human capital. When people have more human
capital, they are likely to be more productive. This means they can produce
more in the same period of time.
 Capital. The term capital means investment in goods that are used to
produce other goods in the future. Examples include machinery, plant and
equipment, new technology, factories and buildings.
 Enterprise. Enterprise is the idea of having ideas and taking risks in setting
up or running a business. An entrepreneur is someone involved in taking
those risks, perhaps by putting in their money, or having the ideas and the
drive to set up or run the business. The reward for being an entrepreneur is
profit.
The main purpose of economic activity is to produce goods and services to satisfy
consumers’ needs and wants. This means that firms produce to satisfy people’s
need for consumption, both as a means of survival, and also to meet their growing
demands for an improved lifestyle or standard of living.

Production of goods and services.

Goods are items that you can touch (tangible) – you can take them home and use
them. An example of a good is a pen or a packet of crisps. A service is something
that someone provides for you; you cannot touch it (intangible). Examples
include tourism and banking.

The production of nearly all goods and services uses up scarce resources.
Production takes place in one of three sectors, as shown in the table.
Types of Sectors
The basic economic problem: as a result of scarcity choices must be made.

The basic economic problem occurs because resources are scarce – but our wants
are infinite. As resources are scarce and our wants are never-ending, we have to
allocate resources. When we allocate resources, we ask the following questions:
 What goods and services should we produce?
 How should the economy use its resources to operate schools or hospitals?
 What mix of goods will it produce?
 What is the best way to produce goods and services?
 What is the best use of scarce resources?
 Who is to receive goods and services?

When allocating resources, individuals, firms and governments must all make
decisions about what, how, and for whom.
EVERY ECONOMIC CHOICE HAS AN ASSOCIATED OPPORTUNITY
COST
Opportunity costs and choices.

We already know that resources are scarce and we have infinite wants. This
creates a problem; if we cannot have everything we want, we have to make
choices. I really want to go on holiday and I would like a new car. I do not have
the money to do both, so I must decide which I would like to do the most. If I
choose to go on holiday, it means I cannot buy a new car. I can therefore say that
the opportunity cost of going on holiday is buying a car. This means that when I
have chosen the holiday, the next best alternative is the car.

Thus, because we cannot have everything we want as a result of scarcity, every

choice that must be made between two or more options has an opportunity cost.
Opportunity cost – the next best alternative foregone when making a choice –
what we give up when we make a choice.
A free good is a good that is not scarce, and therefore is available without limit.
A free good is available in as great a quantity as desired with zero opportunity
cost to society. A good that is made available at zero price is not necessarily a
freegood.
Examples of free goods:
 Air. Oxygen is something we need and we can simply breathe it in. There
is no element of rivalry (e.g. if I breathe, there is still enough air for you to
breath too).
 Sunlight. Sunlight is available to all. Unless your neighbour grows a tall
tree that shade your garden.
ECONOMIC QUESTIONS THAT MUST BE ANSWERED BY ANY
ECONOMIC SYSTEM

Scarcity makes every economy in the world, regardless of how it is organised, to

answer three basic questions – What to produce? How to produce? For whom to
produce? The first two questions are about resource allocation.

 What to produce? All economies must choose the combinations and

quantities of the particular goods and services that they produce.
 How to produce? All economies must choose how to use the resources
they have to produce goods and services. Different combinations of the
factors of production can be used to produce goods and services (for
example, relatively more human labour with fewer machines, or relatively
more machines with less labour), by using different skill levels of labour,
and by using different technologies.

Resource allocation refers to assigning an economy’s available resources, i.e., the

factors of production, to certain uses which have to be chosen among the many
possible alternatives available.

For example, if ‘a what to produce?’ choice involves choosing a certain amount

of education services (schools, universities, etc.) and a certain amount of health
care (medical centres, hospitals, etc.), this means a decision is made to allocate
some resources to the production of education and some to the production of
health services. At the same time, a choice needs to be made about how to produce
these services. Which factors of production (e.g., labour – doctors, nurses,
dentists, teachers, professors, and capital – buildings, information systems,
equipment) and in what quantities (for example, how much labour, how much
capital equipment and what type of capital equipment, etc.) should be used to
deliver health care and how much to deliver education services.
Bearing in mind that resources are scare relative to needs and wants, if a decision
is made to change the amounts of services produced, such as more education and
less health care, this involves a reallocation of resources. Sometimes, economies
do not produce the best amount of goods and services relative to what is socially
desirable. For example, if too many cigarettes or alcohol are being produced, then
there is an over allocation of resources in production of cigarettes or alcohol. If
too few socially desirable goods or services are being produced, such as health
care or education, then there is an under allocation of resources in producing
these services.
The third and final question, ‘for whom to produce’ is about the distribution of
output, i.e., how much output different individuals or different groups in the
economy receive.

For whom to produce? All economies must choose how goods and services are
to be distributed among the population. Some may argue that everyone get an
equal amount of these, while others would argue that some people should get
more than others (equality versus inequality versus equity). Further arguments
can be made that some goods and services such as healthcare and education
should be distributed more equally among the population than other goods and
services such as handguns and assault rifles.

Here the distribution of income among individuals and groups in an economy

becomes an important consideration. To a large extent the amount of output
different people receive depends on how much of it they can buy, which is
dependent on how much income they receive. When the distribution of income
or output changes so that different social groups now receive more, or less,
income and output than previously (e.g., taxing the rich to provide education for
the poor), this is referred to as redistribution of income.
ECONOMICS EXAMINES HOW RESOURCES ARE ALLOCATED
The economic problem – sometimes called the basic, central, or fundamental
economic problem – is one of the fundamental economic theoretical principles
in the operation of any economy. It states that there is scarcity; that is, that the
finite resources available are insufficient to satisfy all human wants and needs.
The question then becomes how to determine what is to be produced, and how
the factors of production (such as capital and labour) are to be allocated.
Economics revolves around methods and possibilities of solving this
fundamental economic problem.
The economic problem can be divided into different parts:

1. Problem of allocation of resources

The problem of allocation of resources arises due to the scarcity of resources,

and refers to the question of which wants should be satisfied and which should
be left unsatisfied; in other words, what to produce and how much to produce.
More production of a good implies more resources required for the production
of that good, and resources are scarce. These two facts together mean that, if a
society decides to increase production of some good, it has to withdraw some
resources from the production of other goods; in other words, more production
of a desired commodity can be made possible only by reducing the quantity of
resources used in the production of other goods.

The problem of allocation deals with the question of whether to produce capital
goods or consumer goods. If the community decides to produce capital goods,
resources will have to be withdrawn from the production of consumer goods.
However, in the long run, the investment on capital goods will increase the
ability to produce consumer goods. Thus, both capital and consumer goods are
important. The problem is determining what the optimal ratio of production
between the two types of goods [Link] is a social science that studies human
behaviour as a relationship between end and scarce means that have alternative
uses.

2. The problem of economic efficiency

Resources are scarce and it is important to use them as efficiently as possible.

Thus, it is essential to know if the production and distribution of national
product made by an economy is maximally efficient. The production becomes
efficient only if the productive resources are used in such a way that any
reallocation does not produce more of one good without reducing the output of
any other good; in other words, ‘efficient distribution’ means that any
redistribution of goods cannot make anyone better off without making someone
else worse off. The inefficiencies of production and distribution exist in all
types of economies. The welfare of the people can be increased if these
inefficiencies are ruled out.
3. The problem of full-employment of resources

In view of the scarce resources, the question of whether all available resources
are being fully employed is an important one. An economy should achieve
maximum satisfaction by using the scarce resources in the best possible manner;
resources should not be wasted or used inefficiently. However, in capitalist
economies, the available resources are not fully employed. In times of
recession, there are many people willing and wanting to work who go without
employment. It supposes that the scarce resources are not fully being used in a
capitalist economy.

4. The problem of economic growth

If the productive capacity of the economy grows, it will be able to produce

progressively more goods, which will result in a rise in the standard of living of
the people in that economy. The increase in productive capacity of an economy
is called economic growth. There are various factors affecting economic growth
including the allocation of resources to capital goods, investment in technology
and skills and education training to raise the productivity of labour. This part of
economic problem is studied in the economies of development.
The existence of scarcity creates the basic economic problem faced by every
society, rich or poor: how to make the best use of limited productive resources
to satisfy human needs and wants.

To solve this basic problem, every society must answer these three basic
questions:
1. What goods and services will be produced? For example, an economy must
decide whether they should produce kitchen appliances or weapons, build
and fix roads or buy textbooks for schools.
2. How will goods and services be produced? For example, should we use
copper or plastic to make pipes? Should machines be used to make clothing
or should workers make it by hand? Should the power plant be built close
to the ocean or inland? Which fertilizer is best for growing strawberries?
There are millions of decisions that need to be made to figure out how to
produce goods and services.
3. Who will consume the goods and services? Once the goods and services
are produced, who will get to consume them? Will people consume them
on a first-come, first-served basis? Should goods be allocated or given out
 by height, weight, religion, age, gender race, looks, strength, health or
wealth? How should the goods and services be distributed among the
people?

Economic Goals and Societal Values. Societies or communities answer the

economic questions in different ways. Societies look at economic goals and
make decisions based on what is most valued.

Some economic goals that are considered are:

 Economic Efficiency: Making the most of resources without waste is an
economic goal.
 Economic Freedom: Being able to make choices about which goods and
services to produce and distribute without government interference or
intervention is an economic goal. This freedom allows entrepreneurs to
take risks and make choices to start various businesses.
 Economic security: Knowing that goods and services will be available
when needed. Having a safety net that protects individuals in a time of
economic disaster.
 Economic Equity: A fair distribution of wealth.
 Economic Growth and innovation: Using new ideas and ways of creating
goods and services leads to growth and a higher standard of living or way
of life for all.

TYPES OF ECONOMIC SYSTEMS

Economic Systems. An economic system is the method used by a society to

produce and distribute goods and services. Several fundamental types of
economic systems exist to answer the three questions of what, how, and for whom
to produce: traditional, command, market, and mixed.

Traditional Economies: In a traditional economy, economic decisions are based

on custom and historical precedent. For example, in tribal cultures or in cultures
characterized by a caste system, people in particular social strata or holding
certain positions often perform the same type of work as their parents and
grandparents, regardless of ability or potential.

Command Economies: In a command economy, governmental planning groups

make the basic economic decisions. They determine such things as which goods
and services to produce, their prices, and wage rates. Cuba and North Korea are
examples of command economies.

Market Economies: In a market economy, economic decisions are guided by the

changes in prices that occur as individual buyers and sellers interact in the market
place. As such, this type of economy is often referred to as a price system. Other
names for the market system are free enterprise, capitalism, and laissez-faire. The
economies of the United States, Singapore, and Japan are identified as market
economies since prices play a significant role in guiding economic activity.

Mixed Economies: There are no pure command or market economies. To some

degree, all modern economies exhibit characteristics of both systems and are,
therefore, often referred to as mixed economies. For example, in the United States
the government makes many important economic decisions, even though the
price system is still predominant. Even in strict command economies, private
individuals frequently engage in market activities, particularly in small towns and
villages.

The key point to remember is that every individual and every society must
contend with the problem of scarcity. Every society, regardless of its political
structure, must develop an economic system to determine how to use its limited
productive resources to answer the three basic economic questions of what, how,
and for whom to produce.
Market vs government

Market versus government intervention. One of the main issues in economics

is the extent to which the government should intervene in the economy. Free
market economists argue that government intervention should be strictly limited
as government intervention tends to cause an inefficient allocation of resources.
However, others argue there is a strong case for government intervention in
different fields, such as externalities (e.g., pollution caused by factories), public
goods (e.g., policing and firefighting) and monopoly power (e.g., pharmaceutical
companies that can set their own prices for crucial drugs).

Arguments for government intervention:

 Greater equality – redistribute income and wealth to improve equality of
opportunity and equality of outcome.
 Overcome market failure – Markets fail to take into account externalities
and are likely to under-produce public/merit goods. For example,
governments can subsidise or provide goods with positive externalities.
  Macroeconomic intervention – intervention to overcome prolonged
recessions and reduce unemployment.
 Disaster relief – only government can solve major health crisis such as
pandemics.

Arguments against government intervention:

 Governments liable to make the wrong decisions – influenced by
political pressure groups, they spend on inefficient projects which lead to
an inefficient outcome.
 Personal freedom – Government intervention is taking away individuals
decision on how to spend and act. Economic intervention takes some
personal freedom away.
 The market is most efficient at deciding how and when to produce.