MANAGERIAL ECONOMICS MODULE 1 Scarcity

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. When we talk of scarcity within an economic context, it refers to limited resources, not a lack of riches. These resources are the inputs of production: land, labour and capital. People must make choices between different items because the resources necessary to full fill their wants are limited. These decisions are made by giving up (trading off) one want to satisfy another. Scarcity occurs when people want more of something than is readily available. In economics, scarcity forces people to make choices, as everyone cannot have everything. Without scarcity, an economy cannot exist.

Choice and allocation problem in business

The economic problem, sometimes called the basic, central or fundamental economic problem, is one of the fundamental economic theories in the operation of any economy. It asserts that there is scarcity, or that the finite resources available are insufficient to satisfy all human wants and needs. The problem 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 the economic problem. In short, the economic problem is the choice one must make, arising out of limited means and unlimited wants. The economic problem, sometimes called the basic, central or fundamental economic problem, is one of the fundamental economic theories in the operation of any economy. It asserts that there is scarcity, or that the finite resources available are insufficient to satisfy all human wants and needs. The problem 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 the economic problem. In short, the economic problem is the choice one must make, arising out of limited means and unlimited wants.

Overview
The economic problem is most simply explained by the question "how do we satisfy unlimited wants with limited resources?" The premise of the economic problem model is that human wants are constant and infinite due to constantly changing demands (often closely related to changing demographics) of the population. However, resources in the world to satisfy human wants are always limited to the amount of natural or human resources available. The economic problem, and methods to curb it, revolve around the idea of choice in prioritizing which wants can be fulfilled.. and how do we know what to produce for economy

Concepts in the economic problem

Needs
Human needs are material items people need for survival, such as food, clothing, housing and ware. Until the Industrial Revolution, the vast majority of the worlds population struggled for access to basic human needs.

Wants
While the basic needs of human survival are important in the function of the economy, human wants are the driving force which stimulates demand for goods and services. In order to curb the economic problem, economists must classify the nature and different wants of consumers, as well as prioritize wants and organize production to satisfy as many wants as possible. One assumption often made in mainstream neoclassical economics (and the methods which attempt to solve the economic problem) is that humans inherently pursue their self-interest and the market mechanism best satisfies the various wants different individuals might have. These wants are often classified into individual wants, which depend on the individual's preferences and purchasing power parity, and collective wants, those of entire groups of people. Things such as food and clothing can be classified as either wants or needs, depending on what type and how often a good is asked for. Wants are effective desires for a particular product, or something which can only be obtained by working for it.

Choice
The economic problem fundamentally revolves around the idea of choice, which ultimately must answer the problem. Due to the limited resources available, businesses must determine what to produce first to satisfy demand. Consumers are considered the biggest influences of this choice, and the goods which they want must also fit within their budgets and purchasing power parity. Different economic models place choice in different hands. Socialism asserts that producers (workers) should have some control over the decisions that effect their welfare in the workplace and on the governmental level, which cooperatively formulates

economic plans for economic decisions regarding the allocation and use of capital goods. Socialist systems that utilize the market for this role are termedmarket socialism. The idea of State socialism argues that most or all major economic choices (regarding production, allocation of inputs and distribution of output) should be made through central planning by the government. Only by constructing a cohesive plan that takes the good of everyone into account, so the idea states, can the best allocation of resources be achieved. (Also see Planned economy.) Communism refers to a stage of development where the productive forces are advanced to such a degree that it solves the economic problem, insofar as needs are concerned. A communist system is a highly developed form of socialism where productive property is held in common, individual autonomy from coercive social relations is abolished and the state no longer exists. (Also see Marxism.) Capitalism argues for a system where private businesses (and some state-owned enterprises, in the case of mixed economies) make economic decisions regarding investment decisions, production levels and distribution of output, wherein the role of the government is to protect the property rights of individuals and companies, provide the institutional and infrastructural framework for the development of a market economy and the provision of some government social programs. In a free-market economy, which exists without the constraints of government wage and price controls, proponents of market capitalism argue that resources are automatically allocated toward the things that society collectively values the most. This form of capitalism argues for a laissezfaire approach, wherein the role of the government is to protect the property rights of individuals and companies so that they can have the confidence to undertake the economic activity (and risks) that will create the most value. If a good or service is overvalued (i.e., the price is too high), the surplus will force providers of the good or service to lower their prices or to re-allocate their capacity to produce something more worthwhile. If the supply of a good or service is inadequate, rising prices increase the value and so cause more production capacity to be directed toward the item. Adam Smith's The Wealth of Nations has been an extremely influential book for this school of thought.

. Basic
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factors in business decision making

Businesses make economic decisions everyday. Entrepreneurs have to make decisions on how to run their business so as to make a profit. They have to make choices on matters such as what they will produce, how they will produce it and how to finance the production. Economic theory assumes a rational approach to decision-making that may not always be borne out in the real world.

What to Produce
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In order to start running a business, an entrepreneur must decide on what he is going to produce. Maybe he is going to offer a service rather than a manufactured product. In deciding this, economic decision-making involves weighing the costs of the different choices and deciding which will generate the most earnings. In the real world though, there could be other factors that influence this decision. For instance, a nonprofit may be influenced more by its mission than by the need to generate earnings.

How to Produce
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Once an entrepreneur decides what to produce, she will have to make a decision about how to actually go about the production. What sort of production method should she employ? What parts of the production should the entrepreneur undertake in-house and what parts should she outsource? Again, the economic decision-making boils the decision process down to the costs of the different solutions and what sort of profit they will generate. For example, if you have to choose between setting up a manufacturing plant in the United States and outsourcing your production to a plant in China, due to economic differences between the countries, you may find that outsourcing is more economically beneficial.

How to Finance the Production

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How to raise the financing to fund the business is another aspect of economic decision-making. The entrepreneur will have to choose between using his savings and getting financing from others. For instance, he could apply for funding from banks, through a credit card line-of-credit, private investors or from friends and family. Each of these options carries a different cost. If the entrepreneur uses his own funds, he will not have to pay any interest, but he should set a goal to achieve a certain return on the money. This rate should compensate him for the risk involved and offer an investment return on the 'loan.' On the other hand, he may decide that he doesn't want to risk his money and approach outside sources for financing.

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Marginalism

What Does Marginalism Mean? The study of marginal theories and relationships within economics. The key focus of marginalism is how much extra use is gained from incremental increases in the quantity of goods created, sold, etc. and how those measures relate to consumer choice and demand. Marginalism covers such topics as marginal utility, marginal gain, marginal rates of substitution, and opportunity costs, within the context of consumers making rational choices in a market with known prices.

Explains Marginalism The idea of marginalism, and its value in establishing market prices as well as supply and demand patterns, was popularized by British economist Alfred Marshall in a publication dating back to 1890. Marginalism is sometimes criticized as one of the "fuzzier" areas of economics, as much of what is proposed is hard to accurately measure, such as an individual consumers' marginal utility. Also, marginalism relies on the assumption of (near) perfect markets, which do not exist in the practical world. Still, the core ideas of marginalism are generally accepted by most economic schools of thought, and are still used by businesses and consumers to make choices and substitute goods.

In economics, marginalism is the belief that economic value is set by the consumer's marginal utility. Its one of the basic economic approaches. This approach seeks a level of operation of some activity that will maximize the net gain from that activity (which is the difference between its benefits and costs). During any activity, the benefits and costs increase, but because of diminishing returns, costs will generally rise faster than benefits. At its maximum level, marginal costs (the cost of increasing the activity) equal marginal benefit (the benefit of increasing the activity) so the activity is said to be optimized, or maximized. In other words, further expansions will cost more than it is worth, and further reductions will reduce benefits more than it will save costs. The marginal theory of value was first broached in the 1870s, and it revolutionized economics. An earlier theory holds that the value of an item is a reflection of the work and resources devoted to making it, or the cost-of-production theory of value. Some economists, particularly many classical economists still believe this. Most Marxist economists also accept a version of the earlier theory, the labor theory of value. Neo-classical economists accepted the marginal utility explanation for value and grafted this insight on to classical economics. Although the factors of production were still thought to be important, customer demand and the marginal benefits that they would obtain from a good is seen as the driver of the whole process and the ultimate source of economic value. The law of diminishing marginal utility is said to explain the paradox of water and diamonds. Human beings cannot even survive without water, whereas diamonds were mere ornamentation or engraving bits. Yet water had a very small price, and diamonds a very large

price, by any normal measure. Marginalists explained that it is the marginalusefulness of any given quantity that matters, rather than the usefulness of a class or of a totality. For most people, water was sufficiently abundant that the loss or gain of a gallon would withdraw or add only some very minor use if any; whereas diamonds were in much more restricted supply, so that the lost or gained use were much greater. That is not to say that the price of any good or service is simply a function of the marginal utility that it has for any one individual nor for some ostensibly typical individual. Rather, individuals are willing to trade based upon the respective marginal utilities of the goods that they have or desire (with these marginal utilities being distinct for each potential trader), and prices thus develop constrained by these marginal utilities. The Austrian School accepted marginalism more completely. They made a clear break from the factor input theories of value. They used marginal utility as a starting point in breaking away from the stress that other economic schools put on analysis of economic data. Karl Marx died before the marginalism theory came about. Thus the task of critiquing this theory fell to his followers, who still hold to the labor theory of value.
Equi-marginalism

We will use the utility theory to explain consumer demand and to understand the nature of demand curves. For this purpose, we need to know the condition under which I, as a consumer, am most satisfied with my market basket of consumption goods. We say that a consumer attempts to maximize his or her utility, which means that the consumer chooses the most preferred of goods from what is available. Can we see what a rule for such an optimal decision would be? Certainly I would not expect that the last egg I am buying bring exactly the same marginal utility as the last pair of shoes I am buying, for shoes cost much more per unit than eggs. A more sensible rule would be: If good A costs twice as much as good B, then buy good A only when its marginal utility is at least twice as great as good B's marginal utility. This leads to the equimarginal principle that I should arrange my consumption so that every single good is bringing me the same marginal utility per dollar of expenditure. In such a situation, I am attaining maximum satisfaction or utility from my purchases. This is clear concept of equimarginal principle. Read more: http://wiki.answers.com/Q/What_is_the_equi-marginal_principle#ixzz1agQ3GUlS