ECONOMICS AS AN ACADEMIC DISCIPLINE

Economics is as old as the human race: it is probably the first art which man
acquired. When some cavemen went out to hunt and others remained to defend the
fire; or when skins were traded for flint axes - we had economics. But economics
as an academic discipline is relatively new: the first major book on economics
Adam Smith's The Wealth of Nations was published in 1776. Since that time the
subject has developed rapidly and there are now many branches of the subjects
such as microeconomics, international economics and econometrics as well as
many competing schools of thought.
There is an economic aspect to almost any topic we care to mention of education.
Economics is a comprehensive theory of how society works. But as such it is
difficult to define. The great classical economist Alfred Marshall defined
economics as the study of I man in the everyday business of life.
This is rather too vague a definition. Any definition should take account of the
guiding idea in economics which is scarcity. Virtually everything is scarce; not just
diamonds or oil but also bread and water. How can we say this? The answer is that
one only has to look around the world to realize that there are not enough resources
to give people all they want. It is not only the very poor who feel deprived; even
the relatively well-off seem to want more. Thus when we use the word 'scarcity' we
mean that: All resources are scarce in the sense that there are not enough to fill
everyone's wants to the point of satiety.
We therefore have limited resources both in rich countries and poor countries. The
economist's job is to evaluate the choices that exist for the use of these resources.
Thus we have another characteristic of economics: it is concerned with choice.
Another aspect of the problem is people themselves; they do not just want more
food or clothing, but specific items of clothing and so on.
We have now assembled the three vital ingredients in our definition, people,
scarcity and choice. Thus we could define economics as: The human science
which studies the relationship between scarce resources and the various uses
which compete for these resources.
The great American economist Paul said that every economic society has to answer
three fundamental questions, What, How, and For whom?
What? What goods are to be produced with the scarce resource: clothes, food, cars,
submarines, television sets?
How? Given that we have basic resources of labor, land, how should we combine
them to produce the goods and services which we want?
For whom? Once we have produced goods and services we then have to decide
how to distribute them among the people in the economy.
One alternative definition of economics is that it is the study of wealth. By wealth
the economist means all the real physical assets which make up our standard of
living: clothes, houses, food, roads, schools, hospitals, cars, oil tankers, etc. One of
the primary concerns of economics is to increase the wealth of a society, i.e. to
increase the stock of economic goods. However, in addition to wealth we must also
consider welfare. The concept of welfare is concerned with the whole state of well-

being. Thus it is not only concerned with more economic goods but also with
public health, hours of work, with law and order, and soon.
Modern economics has tried to take account not only of the output of economic
goods but also of economic such as pollution. The wealth welfare connotation is
thus a complex aspect of the subject.
.
1. .
1) What are the early examples of economic activity?
2) Why is economics difficult to define?
3) What is the main problem of economics?
4) How should we understand the term scarcity?
5) What are the three questions of economics?
6) Why is the definition of economics complicated?
7) How can you define economics?
2. 1-3 .
3. C , .
4. .
5. .
6. .
PROLOGUE TO ECONOMICS

There is almost universal agreement that economies are becoming more complex
every year and that an understanding of how an economy works is more important
than ever before. For someone who is just beginning to study economics, the task
indeed appears to be a difficult one. Economics is the study of the way in which
mankind organizes itself to solve the basic problem of scarcity. All societies have
more wants than resources, so that a system must be devised to allocate these
resources between competing ends. In a very real sense, the complexity of the
economy makes it difficult to decide exactly where to start. Simultaneously,
production is taking place, goods and services are being allocated, and a great
number of market participants are being motivated by a diverse set of goals. In
addition, there is the complex financial system in which individuals, firms, and
governments borrow and lend funds.
Economics is divided into two major branches: macroeconomics and
microeconomics. Macroeconomics is the study of behavior of the economy as a
whole with emphasis on the factors that determine growth and fluctuations in
output, employment, and the level of prices. Macroeconomics studies broad
economic events that are largely beyond the control of individual decision makers
and vet affect nearly all firms, households, and other institutions in the economy.
Specialists in macroeconomics are particularly interested in understanding those
factors that determine inflation, unemployment, and growth in the production of
goods and services. Such an understanding is necessary in order to develop
policies that encourage production and employment while controlling i n fl at i o n.
The other major branch of economics is microeconomics. Microeconomics is the
study of behavior of individual units within the economy. The di vi si on of

economics has resulted from the growing complexity and sophistication of

economic research.
These two approaches and the topics they include are in fact interdependent.
Individuals and firms make their decisions in the context of the economic
environment, which has an impact on the constraints the decision makers face as
well as their expectations about the future. At the same time, when taken as a
whole, their decisions determine the condition of the overall economy. A good
understanding of economic events and an ability to forecast them require
knowledge of both individual decision making and the way in which individuals
react to chances in the economic environment.
.
1. .
1) Why is it difficult nowadays to understand how an economy works?
2) Do you think that definition of economics given in this text is better/ worse
compared to the others from the previous text? Why?
3) What makes macroeconomics different from microeconomics?
4) What led to the division of economics?
5) What do you think about the relations between the two branches of
economics and their role for a deep insight into economic events?
2. 1-3 .
3. C , .
4. .
5. .
THE ECONOMIC ENVIRONMENT
The economy comprises millions of people and thousands of firms as well as the
government and local authorities, all taking decisions about prices and wages,
what to buy, sell, produce, export, import and many other matters. All these
organizations and the decisions they take play a prominent part in shaping the
business environment in which firms exist and operate.
The economy is complicated and difficult to control and predict, but it is certainly
important to all businesses. You should be aware that there are times when
businesses and individuals have plenty of funds to spend and there are times when
they have to cut back on their spending. This can have enormous implications for
business as a whole.
When the economy is enjoying a boom, firms experience high sales and general
prosperity. At such times, unemployment is low and many firms will be investing
funds to enable them to produce more. They do this because consumers have plenty of
money to spend and firms expect high sales. It naturally follows that the state of the
economy is a major factor in the success of firms.
However, during periods when people have less to spend many firms face hard
times as their sales fall. Thus, the economic environment alters as the economy
moves into a recession. At that time, total spending declines as income falls and

unemployment rises. Consumers will purchase cheaper items and cut expenditure
on luxury items such as televisions and cars.
Changes in the state of the economy affect all types of business, though the extent
to which they are affected varies. In the recession of the early 1990s the high street
banks suffered badly. Profits declined and, in some cases, losses were incurred. This
was because fewer people borrowed money from banks, thus denying them the
opportunity to earn interest on loans, and a rising proportion of those who did
borrow defaulted on repayment. These so-called "bad debts" cut profit margins
substantially. Various forecasters reckoned that the National Westminster Bank's
losses in the case of Robert Maxwell's collapsing business empire amounted to over
100 million.
No individual firm has the ability to control this aspect of its environment. Rather, it
is the outcome of the actions of all the groups who make up society as well as being
influenced by the actions of foreigners with whom the nation has dealings.
.
1. .
1) What elements does an economy consist of?
2) What influences the business environment?
3) Why is the economy difficult to control?
4) What are the signs of economic booms and recessions?
5) How is the state of the economy connected with the businesses within the
economy?
6) What can influence business environment?
2. 1-3 .
3. C , .
4. .
5. .
WHY FINANCE
One of the primary considerations when going into business is money. Without
sufficient funds a company cannot begin operations. The money needed to start
and continue operating a business is known as capital. A new business needs
capital not only for ongoing expenses but also for purchasing necessary assets.
These assets inventories, equipment, buildings, and property represent an
investment of capital in the new business.
How this new company obtains and uses money will, in large measure, determine
its success. The process of managing this acquired capital is known as financial
management. In general, finance is securing and utilizing capital to start up,
operate, and expand a company.
To start up or begin business, a company needs funds to purchase essential assets,
support research and development, and buy materials for production. Capital is
also needed for salaries, credit extension to customers, advertising, insurance, and
many other day-to-day operations. In addition, financing is essential for growth
and expansion of a company. Because of competition in the market, capital needs

to be invested in developing new product lines and production techniques and in

acquiring assets for future expansion.
In financing business operations and expansion, a business uses both short-term
and long-term capital. A company, much like an individual, utilizes short-term
capital to pay for items that last a relatively short period of time. An individual
uses credit cards or charge accounts for items such as clothing or food, while a
company seeks short-term financing for salaries and office expenses. On the other
hand, an individual uses long-term capital such as a bank loan to pay for a home or
car goods that will last a long time. Similarly, a company seeks long-term
financing to pay for new assets that are expected to last many years.
When a company obtains capital from external sources, the financing can be either
on a short-term or a long-term arrangement. Generally, short-term financing must
be repaid in less than one year, while long-term financing can be repaid over a
longer period of time.
Finance involves the securing of funds for all phases of business operations. In
obtaining and using this capital, the decisions made by managers affect the overall
financial success of a company.
.
1. .
1) What is necessary to have to start up a business?
2) What can be referred to assets?
3) What determines a new company success and why?
4) Why do companies invest in developing new products and techniques?
5) What is the difference between short- and long-term capital?
6) What role does financial management play in the general success of a
company?
2. 1-3 .
3. C , .
4. .
5. .
MACROENVIRONMENT
Macro environment is the network of systems composed of culture, political and
economic forces, technology, skill mixes, and consumer groups; a source of
opportunities and constraints for the organization. Once the organization has built
its product or defined its service, it must distribute it to consumer client groups
who have wants and needs that they attempt to satisfy through the consumption of
such products and services.
Every organization exists within an extensive and complex environmental network.
Organizational environment refers to all groups, norms, and conditions with which
an organization must deal. It includes such things as the political, cultural,
economic, religious, educational, and like systems that affect an organization and
which in turn are affected by it.
Culture, composed of values, norms, artifacts, and accepted behavior patterns,
affects the way the organization is formed and how it operates once in existence.

Indeed, one must recognize that all of the decisions made in an organization are
culture bound; i.e., they are a reflection of all these components of culture. Societal
norms are those standards that mold behavior, attitudes, and values of those
members who constitute a society. They come from laws, customs, religious
teachings, and common practice. They are standards because members take them
into account in their decisions and behavior. Dress, speech, what is considered to
be in good taste, and the general understanding of what is right and wrong are all
affected by societal norms. At the same time, almost every institution in a society
is capable of transfusing some of its values, norms, and behavior patterns into its
environment. Organizations can hardly afford to ignore such a vital ingredient in
its macro environment.
Political forces are classified as the form and role of government in a society. The
source of law and other regulations that restrict or at least affect the organization,
the political system also is the source of a rich variety of services for the
organization. These services range from fire and police protection to the provision
of recreational areas. When one thinks of the governmental sector, one might be
likely to think of its negative connotation and red tape. Although there is an
element of restriction originating from the political sector, it is by no means
dominant. Even though the presence of the political system has served to
complicate managements job, it has also made it easier at the same time. By
knowing that all similar organizations must observe the same rules and regulations,
managers can experience an element of certainty in their activity. They know that
they have a source of protection and redress when violations do occur.
The political system is coupled with the economic system. The type of economy a
society has can range from private enterprise to planned economy. Whatever its
form, the economic system is concerned with the allocation of scarce resources and
the provision of some form of distribution. It is, in practice, quite difficult to
separate the political and economic systems from each other.
The macro environment is also the source of technologythe machines,
techniques, and methods required for production and distribution. To be able to
compete successfully, organizations must have access to modern technology. It is
simply not feasible for an organization to compete unless an adequate level of
technology is available to it. It can be safely stated that organization success is
measured by the ability of the organization to adjust to and to employ
technological innovations. Among their responsibilities, managers today must
count the obligation to maintain a spirit of creativity and ingenuity among
members so that continued progress on the technological front can be made. The
ever-growing shortages of resources of all types are but one indication of the
seriousness of this obligation.
Skill mix in the labor force is likewise an important facet of an organizations
macro environment. All organizations depend to some extent on a supply of labor
that possesses the skill and ability to perform the work necessary to attain
objectives. Consequently, labor market conditions and skill mixes are crucial to
success.

The consumers are the ultimate arbiters of the organizations success, for it is they
who make the critical choices to consume or not to consume an organizations
output. Without the income (in whatever form) that results from this consumption,
the organization is doomed to a relatively short life. This means that managers
must be more aware of and sensitive to the total environmental complex of their
organization in order to develop and implement plans for successfully coping with
it. Otherwise, there is little chance for success, for no longer will yesterdays
methods based on a placid environment serve in todays turbulent outside world.
.
1. .
1) What are the elements of macro environment?
2) What tasks does an organization offering a product or service face?
3) What is an organizational environment?
4) What is culture according to the text?
5) How can political forces be classified?
6) What is the essence of the economic system?
7) Why is technology so important for the success of an organization?
8) How can skill mix influence a companys success?
9) What part do consumers play in the success or failure of a business?
2. 1-3 .
3. C , .
4. .
5. .
,
, .

MACROECONOMICS
On September 29, 2008, the United States experienced one of the largest economic
shocks in its history; the stock market plunged by over 777 points, wiping out over
$1 trillion in stock value. The market continued to plummet over the following
week, setting off a deep recession. Home prices fell, foreclosures rose, and
unemployment soared. Toxic financial products flooded the international
marketplace, pushing many of the worlds largest financial companies to the brink
of bankruptcy.
Almost immediately, political leaders took action to limit the severity of the
recession. They provided government funds to save large banks and connected
institutions from default. They created a program to buy up the toxic assets that
were dragging down the market. The Federal Reserve expanded the nations
money supply to cover public debts and loosen credit markets. The president

enacted a stimulus plan to get money to consumers in hopes of revitalizing the

economy by increasing demand for goods and services.
Today, with the economy functioning but sluggish, U.S. politicians battle over the
next course of action. Would another stimulus plan get consumers buying again?
Should Congress pass a jobs bill to reduce unemployment? Would printing more
money for debts help, or cause out-of-control inflation? Could new trade
agreements provide an answer to the nations economic woes?
Whatever the solution, all of these measures, both implemented and debated,
involve macroeconomics. The prefix macro-, meaning big, in the word
macroeconomics refers to how economists in this field analyze the structure and
function of large-scale economies as a whole, whether regional, national or global.
Macroeconomics examines the complex interplay between factors such as national
income and savings, gross domestic product, gross national product, consumer and
producer price indexes, consumption, unemployment, foreign trade, inflation,
investment and international finance. Economists in this field seek to understand
fluctuations in business cycles and the elements that contribute to long-term
economic growth, which are vital to the creation of sound economic policies by
governments and businesses.
The underpinnings of macroeconomic theory emerged in the early 1800s with the
work of Swiss writer Jean Charles Lonard de Sismondi. Sismondi proposed that
markets experienced natural economic fluctuations apart from those caused by
external events, such as war. It was a radical theory at the time, but a major
peacetime recession in 1825 proved it valid. Later, in 1860, French economist
Clement Juglar took Sismondis idea further by identifying specific cycles
occurring with fixed investments. These 7-to-11-year cycles became known as
Juglar Cycles.
Soon other cycles were observed, such as the lag in feedback on business
production (Kitchin Cycle), increased infrastructural investment resulting from
demographic expansion (Kuznets wave) and prolonged periods of technological
growth (Kondratiev wave). Around 1930, Austrian-American economist Joseph
Schumpeter described the four stages of a business cycle: expansion, crisis,
recession and recovery.
The concept of business cycles became the basis of macroeconomic theory
established by British economist John Maynard Keynes in 1936. Keynes found that
classical economics failed to explain prolonged unemployment and recessions, so

he proposed examining the economy as a whole to find the answer. What he

discovered was that businesses and individuals hoard cash during tough times,
restricting the supply of cash available to satisfy demand through consumption.
This causes a surplus of goods and labor and slows economic recovery.
Before, economists assumed that markets naturally tended toward satisfying
demand, eventually resolving product surpluses and unemployment. Keynes not
only challenged such beliefs, he suggested that government intervention could be
used to counteract disruptive economic fluctuations through deficit spending,
reduced taxes, expansion of the money supply, lower interest rates and other
monetary policies.
Unemployment is a major concern of macroeconomists, as it is detrimental to a
countrys productivity and prosperity. While classical economists in Keyness day
blamed unemployment on high labor costs, Keynes argued that chronic
unemployment results from underconsumptionmeaning that individuals and
businesses are not spending enough to fuel demand for labor.
Keynes proposed that money moves in cycles: the payment for a product goes to
pay the wages of an employee. In an economy burdened by underconsumption,
businesses simply reduce production instead of lowering prices, giving consumers
no incentive to buy, increasing unemployment further and causing recession
through decreased national output. If prices remain high during recession, then
workers have little incentive to settle for reduced wages since they would still lack
the purchasing power needed to jump-start demand. Keynes believed the
government could counteract underconsumption, prevent recession and encourage
rapid economic growth by getting more money into the hands of consumers when
markets failed to adequately redistribute wealth.
Keyness theory was revolutionary not just because it offered a more valid
explanation of why recessions and unemployment occur, but also because it
suggested that such events could be controlled through strategic monetary policy.
Economists who supported traditional laissez-faire capitalism found Keyness
notion of policy-driven economic growth distasteful, to say the least. Nevertheless,
Keynesian macroeconomics rose to become the dominant economic theory among
capitalist nations for nearly 40 years, especially in the U.S. It was most famously
used during World War II to keep unemployment at historically low levels.
Macroeconomics also led to the creation of the International Monetary Fund and
the World Bank in the 1940s.

In 1956, U.S. economist Milton Friedman modified macroeconomic theory to

include an equilibrium approach to regulating the money supply, citing Keyness
disregard for inflation caused by printing too much money. Then, in the 1970s,
Keynesian macroeconomics was largely abandoned when it failed to prevent
stagflation. It was replaced by supply-side macroeconomics, which seeks to
augment demand by cutting taxes, reducing regulations on businesses and lowering
prices through increased production. With the recent global economic crisis,
however, Keynesian macroeconomics is experiencing resurgence in popularity.
Modern macroeconomic theory has enjoyed some success in the past, though
exactly how much remains the subject of much debate. Critics of macroeconomic
policies say that government intervention in markets exacerbates, rather than
corrects, economic fluctuations through unforeseen consequences. Some point out
that Keynesian macroeconomics assumes irrational behavior from economic
actors, putting itself in direct conflict with microeconomic theory. Others claim
that macroeconomic policies have little effect on market performance.
Of course, macroeconomics is not just employed at the federal level. Banks,
industries and local governments look to macroeconomists for data to guide their
economic activities. For instance, central bankers, who are responsible for
controlling inflation, rely heavily on macroeconomic analyses to determine
whether to release more currency into the marketplace or remove some of it.
Industries or businesses struggling to find skilled employees likewise turn to
macroeconomists to solve the problem.
Macroeconomists perform analyses by constructing models to simulate or predict
market behavior. Such models are usually mathematical in nature, but they can also
be logical or computational. Generally, models show the relationship between
various economic components, such as a countrys exchange rate, interest rate and
output, or inflation and unemployment. Economists may draw diagrams based on
models to illustrate market dynamics or the flow of money in an economy. Such
aids can be useful for those who create and modify monetary policies.
However, macroeconomic models are far from infallible. Models that only
examine a few aspects of an economy when testing the potential effects of a new
monetary policy may be excluding dozens of mitigating factors. Random, irrational
behavior that seems insignificant at the microeconomic stage may be highly
magnified at the national or global scene. Though macroeconomics is largely an
extension of microeconomic activity, the aggregation of microeconomic forces
creates an other-worldly level of complexity thats tough for even brilliant

economists to untangle. Inventing a macroeconomic model that takes all economic

factors into account would be impossible.
Where macroeconomics fails at predicting future economic outcomes, though, it
often does quite well at describing past and current market situations. It has, for
example, been particularly useful in helping U.S. leaders and historians understand
the factors that contributed to the start and severity of the Great Depression in the
1930s. It has also been used to create strategies to deal with chronic unemployment
and increase GDP. Despite the controversy surrounding macroeconomic policies,
they likely wont be abandoned anytime soon.

MICROECONOMICS
Meet Employees A, B and C. A year ago, they were hired at the same wage to work
for XYZ Electronics. They typically work about 50 hours a week, and all are due
for a raise. Employee A receives a 5 percent wage increase and immediately feels
energized by the boost in pay. He decides to commit an additional 10 hours a week
to the company to increase his income even further. Employee B receives the same
raise, but decides her original 50-hour workweek suits her just fine. Shell make
more money for the same work. For Employee C, however, the pay raise means he
wont have to work as many hours to make his starting income, which is adequate
to pay his bills. Therefore, he opts to work only 45 hours a week.
How will the decisions of Employees A, B and C affect the company? Cost-wise,
who is the most desirable employee for the company? Do the cost savings offered
by Employee Cs reduced hours outweigh the potential profit generated by
Employee As additional work, or vice-versa? Why is Employee A motivated to
work more hours, but Employee C motivated to work fewer? How will this affect
their purchasing power as consumers?
Microeconomics seeks to answer questions such as these. The prefix micro-,
meaning small, in the word microeconomics refers to the basic, small-scale
economic behaviors and decisions that economists in this field study.
Microeconomics examines the impact that economic choices made by individuals,
businesses and industries have on resource allocation and the supply and demand
of goods and services in market economies. Because supply and demand determine
the price of goods and services, microeconomics also studies how prices factor into
economic decisions, and how those decisions, in turn, affect prices.

Microeconomics emerged as a branch of study when economists began analyzing

consumer decision-making processes and their economic outcomes in the early
18th century. The first in-depth explanation of consumer thought came from a
Swiss mathematician named Nicholas Bernoulli, who laid the groundwork for
microeconomic theory by suggesting that consumer choices are always rational.
However, it wasnt until the late 19th century, when London economist Alfred
Marshall proposed examining individual markets and firms as a way to understand
the broader economy, that microeconomics became formally established as a field
of study.
In the mid 20th century, other economists rose up to modify the theories proposed
by Bernoulli and Marshall. Although Marshall first described the concept of utility,
or the satisfaction a consumer receives from a purchased product or service,
economists John von Neumann and Oskar Morgenstern are credited with
introducing modern utility theory, based on Marshalls work, in 1944.
Its the concept of market failure, however, that really defined microeconomics in
the mid 20th century. Market failure, a term coined in 1958, refers to when markets
operate in ways that prevent resources from being allocated in the most efficient
manner. Today, micro economists are primarily concerned with analyzing market
failure and suggesting ways to correct or prevent it, often through public policy or
government intervention.
Monopoly power is one such market failure. Monopolies can form in several ways.
A natural monopoly occurs when one business produces a good at a far cheaper
cost than its competitors, causing them to go out of business. In an oligopoly, a few
businesses that dominate a particular industry may get together and set prices and
competition rules for that industry. A strong business may monopolize by buying
up industry resources or controlling means of production and shut competitors out
of the market by denying them access. Some governments may simply grant
monopoly rights to certain businesses.
Micro economists see monopolies and other market failures as undesirable and
highly inefficient ways to allocate resources in an economy. For instance, a
monopoly can choose to charge a higher-than-market-value price for its product
because no competition exists that can force it to do otherwise. Consumers who are
charged an unfair price are unable to maximize their utility and satisfy demand,
either because the product is too expensive for most to afford, or consumers must
forgo purchasing other products. If the monopolys product is a necessary one, like
water or gasoline, consumers may be forced to negatively alter their spending

habits to buy it, putting strain on other areas of the economy. Furthermore, a
business that has a monopoly on a limited resource may misuse or deplete the
resource, damaging both the environment and the economy. Other kinds of market
failure include information asymmetry, missing markets and externalities.
Micro economists believe supply and demand can only be balanced through
perfect competition, where no one individual or entity possesses the power to
influence the price of a particular good or service. In a perfectly competitive
economy, the complete cost of a product is factored into its price, and the product
is sold for maximum profit based on its demand. In theory, perfect competition
maximizes both consumer utility and company profits while ensuring resources are
used in the most efficient manner. Since micro economists generally arent
concerned with promoting any sort of political philosophy, they tend to
recommend whatever they think will most likely achieve perfect competition.
Suggestions may range from anti-trust and right-to-know laws to governmentcreated markets and social welfare expansion.
Unfortunately, such recommendations are rarely foolproof. Because economics
involves many complex interactions between various market forces, accurately
predicting the outcome of an economic policy is tricky at best, impossible at worst.
For example, expanding social welfare may create a safety net that protects
workers from economic hard times and promotes upward mobility. The result is a
wealthier population that will drive economic growth. However, the same welfare
expansion may give some workers an incentive to stop working, which will reduce
the governments income tax revenue and slow economic growth.
Of course, the outcome may not be simply either/or. When offered welfare
benefits, some people find incentive to work harder, while others find incentive to
work less. The micro economists task is to propose solutions to market failures
that will result in the best possible outcomes despite unintended consequences.
To determine the best policies, micro economists attempt to predict how people
will respond to the incentives, or disincentives, such policies will create. For
example, an economist sees that a paper company has been clear-cutting too many
trees in one area to make paper. For the company, cutting a large number of trees
makes sense because it can produce its product quickly at a cheap price that
consumers love. However, the economist estimates that if the unrestrained cutting
continues, the trees will disappear and the company will go out of business within
five years, leaving hundreds of workers unemployed. Construction prices in the
area will also skyrocket due to lumber scarcity, and tourism will decline from the

destruction of the lands natural beauty. To prevent these outcomes, the economist
suggests the local government should regulate the number of trees that can be
harvested at one time.
However, the new regulation means the company wont be able to produce paper
as quickly or cheaply as before, causing its product price to rise. The rise in price
means some consumers may not be able to afford the product, or they may choose
to buy from another supplier, shrinking the companys profits. If the company finds
the regulation too punitive, it may choose to relocate to another state, resulting in
the local unemployment the economist was trying to avoid. The economist can
prevent such an outcome by recommending the government provide the company
with an incentive to support the regulation, like a tax break.
Of course, such an incentive may not even be necessary. Consumers may happily
pay the higher prices and even increase their patronage because they see the
company treating the environment responsibly. The company may discover that
sticking to cutting quotas protects it from fluctuations in resource availability,
leading to greater price stability and steadier profits over time. These outcomes
may not become obvious until after the regulation is implemented.
Micro economists also examine opportunity cost when evaluating consumer and
corporate behavior. Opportunity cost refers to the next best alternative a consumer
or company passes up to purchase or produces a product. In other words, buying or
producing one thing is done at the expense of buying or producing something else.
A consumer who chooses to rent an apartment over buying a house, for instance,
misses out on building equity and taking advantage of the homeowners tax credit
provided by the government. Likewise, a homeowner must provide maintenance
for his propertys upkeep, while a renter usually does not.
Examining opportunity costs reveals much about what people value, which guides
micro economists in making policy recommendations. The tricky part comes when
such costs involve items whose monetary value is unclear. For instance, some
people value preserving the integrity of an Alaskan wildlife refuge over drilling for
oil that could be used to lower gasoline prices. Economists must work to establish
the refuges value so it can be accurately compared to the cost benefit of drilling
for oil. Cost-benefit analyses play a major role in microeconomics.
For micro economists, however, economic behavior always comes back to one
concept: utility. Consumers purchase products to increase their satisfaction, and
businesses produce to maximize their profits. Its utility that drives demand and

keeps prices reasonable through market competition. Utility can be used to explain
why a consumer chooses to take a tropical vacation over enrolling in college, or
why a business chooses to make childrens toys instead of rifle ammunition. The
benefit of such a theory is that its simple to understand and apply. Indeed,
microeconomics provides the foundation for nearly all economic theory and has
applications in the fields of health, law, psychology, history, urban development,
politics and sociology.

Macroeconomics Microeconomics
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ENVIRONMENTAL ECONOMICS
For centuries, traditional economics has been used to explain how people can
create wealth and improve their lives through the supply and demand of goods and
services. Starting in the 1960s, however, people began to realize that traditional
economics failed to take into account other factors that greatly influenced quality
of life, such as social welfare and the environment. Thus, environmental
economics was born.
Environmental economics seeks to measure the external environmental effects, or
costs, of economic decisions and propose solutions to mitigate or eliminate those
costs to better manage natural resources and promote social well-being. Unlike
traditional economics, which focuses on private ownership of property,
environmental economics primarily concerns itself with the management of
common or public property, such as lakes, rivers, game and parks.
Environmental economics functions on the theory of market failure. Simply
stated, market failure occurs when markets fail to efficiently allocate limited
resources in a way that benefits society most. For example, assume that a town has
a large, freshwater lake. A parts manufacturing facility, responding to a market
demand for car parts, moves into the town and begins using the lake water to
process the parts. Without pollution controls in place, the water is soon
contaminated, becoming unsafe to drink and killing all the fish. Since the lake was
the towns main source of food, recreation and drinking water, its citizens are
forced to move away to find a new water sourceleaving the manufacturing facility
without a ready labor pool or a nearby consumer base. As a result, the companys
labor and shipping costs increase dramatically. Though the company simply

responded to market forces by using the lake, its actions resulted in massive
inefficiency caused by environmental degradation. Environmental economists seek
to remedy such inefficiency by establishing environmental regulations, pollution
quotas and property rights so that market suppliers can become wealthy without
negatively impacting others.
Types of market failure include externality, non-exclusion and non-rivalry.
Externality refers to the effect of an economic choice that is not factored into a
products price. Non-exclusion exists when restricting someones access to a
resource would be too costly. Non-rivalry means that a benefit provided to one
individual, business or country can be enjoyed by others, reducing the incentive for
economic actors to contribute to the public good. Some aspects of all of these can
be seen in the example above. Because the lake was common property, the
manufacturing facility was able to use it freely (non-exclusion). With unlimited use
of the resource and no pollution controls in place, the facility could cheaply
produce many parts to meet demand (externality). The townspeople had up until
then kept the lake clean and properly managed, from which the company benefited
without ever contributing to it (non-rivalry).
In order to address these market failures, environmental economists must first
assess the value of environmental resources and assets. This can be quite tricky,
since environmental resources are often viewed as having value beyond their
economic use. People may want to preserve resources for undiscovered future use,
to bequeath to future generations, or to simply enjoy their existence. Economists
can calculate a resources non-use value by researching nearby land values,
surveying the public, or examining what people are willing to pay to access or
protect the resource. Once the value of the environmental asset is determined,
economists can then establish policies that will preserve the long-term viability of
the resource while still allowing it to be used for economic gain. Thus,
environmental economics plays an important role in managing and allocating
scarce natural resources.
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BEHAVIORAL ECONOMICS
Meet Consumer A. Consumer A needs a new computer so she can work from
home. The computer must be reliable and have a large processor since Consumer A
will be using it daily to do several complex tasks. However, Consumer A only has
a limited amount of money to spend, so she must ensure that she gets the best
computer possible for her money.

Before going to the store, Consumer A carefully researches her options, comparing
prices and reading consumer reviews of different computers. Finally, being fully
informed, she selects one that will best meet her needs. In this way, Consumer A is
a textbook example of the economic man in neoclassical economic theory: the
always rational and informed consumer who drives all economic activity.
Now, meet Consumer B. Consumer B just had a bad day at work. Hes depressed,
bored and craving some excitement. He goes to the mall to do some browsing and
sees a stylish new fishing pole on display. Consumer B hasnt been fishing in six
months and already owns two other fishing poles, but this particular fishing pole
arrests his attention. Consumer B starts thinking about how much he would like to
own this fishing pole and how exciting it would be to buy it.
Like Consumer A, Consumer B has a limited amount of money to spend, and the
fishing pole is very expensive. However, Consumer B quickly rationalizes his
purchase by arguing that it will make him happy. Without even knowing how well
the fishing pole will work or when he will use it, Consumer B purchases it on the
spotwith his credit card. This type of economic behavior is commonly referred
to as retail therapy: shopping to improve ones mood.
The concept of retail therapy, however, is surprisingly absent from neoclassical
economics, despite being prevalent enough to warrant a phrase in the modern
vernacular. For centuries, economists have assumed that peoples economic
choices are always rational since they are motivated by need and limited by
scarcity. But as retail therapy proves, that is not always the case. So where is the
theory that takes into account irrational economic behavior like retail therapy?
That theory is called behavioral economics. Behavioral economics seeks to unite
the basic principles of neoclassical economics with the realities posed by human
psychology. The theory grew out of neoclassical economics in the early 20th
century when neoclassical theory fell short of explaining the anomalies that occur
within market economies.
Although behavioral economics arose from the writings of several notable
economists, one of the theorys leading principles came from economist Herbert
Simon in the 1950s. Simon postulated that man could not always act logically
because he possessed a bounded rationality. In other words, human minds are
finite; they do not have unlimited information to solve problems, nor do they have
all the time in the world to think about them. Humans also struggle to analyze
problems objectively when the outcomes directly affect themselves, especially

when viewing problems through a frame of personal experience warped by

social or cultural bias.
To cope with these realities, humans apply their own rules of thumb, or
heuristics, when making quick decisions. While it is inherently rational to do so,
the rules themselves and the behavior they lead to may not be. In fact, heuristics, as
described by leading behavioral economist Daniel Kahneman, are inherently
irrational.
For example, in a common heuristic known as gamblers fallacy, consumers take
risks on what appears to be a future outcome in an instance of random chance, like
a coin toss. Their logic is based on seeing the same outcome occur several times in
a row and assuming a different outcome is due. The logic is, of course, faulty, since
the odds for either outcome remain the same in every instance.
From Simons concept of bounded rationality sprang the idea that other aspects of
humanity may be bounded as well, such as the self-interest that motivates the
neoclassical economic man. Behavioral economists accept that other factors may
drive consumers economic choices, like altruism or self-control.
Of course, an economic theory that allows for such variance in consumer logic and
behavior poses a problem: how can economists rely on it to accurately predict
economic outcomes? After all, pure neoclassical theory is much tidier by
comparison, basing its mathematical models on a few basic, if convenient,
assumptions.
Obviously, behavioral economists cannot rely as heavily on mathematical models
to predict outcomes. Instead, they collect real world data on past consumer
behavior and conduct experiments involving real transactions to gauge how
consumers might behave in future situations. The goal in collecting such data is to
eliminate unlikely outcomes so that likely ones come into focus. Although not as
exact of a science compared to using mathematical equations, behavioral
economists often manage to make startlingly accurate economic predictions.
Economists have found that making realistic assumptions about human nature
generally leads to a more precise result.
However, some economists still find reason to reject behavioral economics. Those
who cling to pure neoclassical theory insist that the economic man is more rational
than the natural man because market competition forces consumers to make
rational choices. They claim that behavioral models based on data gleaned from

experiments, mostly illustrates one-time choices, not complex economic behavior

exhibited over time. Also, economists who prefer the stark, impartial rigidity of
neoclassical mathematical models view behavioral economics experimental
approach with distrust. They say experiments and surveys can be skewed by
participants biases. They see little application for behavioral models in real
markets.
Nevertheless, behavioral economics has succeeded in explaining market anomalies
where neoclassical economics could not. For instance, it has been used to examine
the roles played by human greed and fear in the 2008 financial crisis. The promise
of windfall profits lead financial companies to create and sell highly complex
credit default swaps without fully understanding their risk. When the stock market
crashed, fear drove usually adventurous hedge fund investors to withdraw their
money from the market, even when they could have bought good stocks at recordlow prices. Behavioral economics can explain other phenomena as well, such as
why some prices or wages refuse to change with market forces (price stickiness),
why stock markets perform worse on Mondays (calendar effect) and why some
investors choose to hold onto poorly performing stocks while selling highperforming ones (disposition effect).
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DEVELOPMENT ECONOMICS
Development economics is a branch of economics that focuses on how to improve
the economies of developing countries. Its major concern is the development of
third world economies. Development in such countries is met by improving the
basic amenities to promote the welfare of its citizen and to maintain a certain set
standard of living for all its citizens. The sectors that should be improved
according to the development economists are Health sector, education,
employment, inflation, domestic and international economic policies. This branch
of economics is specially tailored to the developing country to help them transform
into a prosperous nation through progressive economics.
Development economics concepts might differ from one nation to the other
because of the existence of unique features for different countries like political and

social background. The concepts of macro and micro economics is greatly

borrowed in the development economics on structures of developing economy and
efficient domestic and international growth.
The economic development field looks at both the traditional measures of
economics like the GDP and more modern measures of the Economy like the
standard of living and equal rights opportunities. Development economics can also
be seen as the only branch of economics that is concerned more on political
processes. It is very keen on the economics agenda that have been passed by the
political class in each economy. The most fundamental features of development
economics became very clear after the world war two. Although some primitive
form of this economy were still practiced by some countries, especially the major
empires. The need to expand the concept of development economics came after the
war-ravaged nations started the process of economic building. The world war two
had left major economies especially in Europe in shambles.
Development economics is surrounded by many theories. The earliest being the
linear stages of growth model. The basic ideas in this theory is that economy
development and steady growth is to be achieved through the pooling and holding
of huge capital from domestic and international savings. The theory failed
immediately after being advanced because it did not recognized the necessary
preconditions for takeoff. The other development theory that was advanced by
developing economy was the international dependency theory. This theory
suggests most of the economics problems facing the developing economy were
from external forces beyond their control. There was a huge outcry on this theory
and this gave birth to the neoclassical theory of development economics. The
neoclassical theory suggests that economic development can only be achieved if
government removed all the controls and regulations to make the market free and
allow demand and supply to play the important roles in economics equilibrium and
controls. The theory has been adopted by many institutions such as the World Bank
with some few differing points on the degree to which the market should be free. A
market friendly approach is adopted by the World Bank and allows for some
government regulation. The market free schools of thought suggest a free economy
that is not influenced by external factors rather than the market forces.
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MANAGERIAL ECONOMICS
Managerial economics is a social science discipline that combines the economics
theory, concepts and known business practices in order to make the process of
decision making easy. It is a very useful concept for every manager that is planning
for the future. This is so because it assists the managers to make rational decisions
on various obstacles facing the firm. Most of the complex management decision
facing a firm can be broken down in a series of logical solutions. A key area of
managerial economics is the theory of a firm that entails the best mix of the scarce
resources to maximize profits within the firm. Marginal benefits and cost analysis
is also another broad area in managerial economics. Managerial economics can be
viewed by most modern economists as a practical application of economics theory
in using effectively the firms scarce resources.
Managerial economics as a science is useful to managers in making decisions
relating to a firms customers base, competitors and strategic future decisions. A
lot of mathematical concepts especially statistics and analytical tools are required
because of the probabilistic nature of future decisions that the firm wants to make.
Most people might ask the questions why study managerial economics while one
can make decisions based on past data. It is a genuine question but it is not
possible to make a conclusion merely on the bases of prior data because of the
dynamic nature of the current market. We have seen a lot of unexpected events that
have happened in the past that we never expected. One is the crash of major banks
in the US and the current crisis in Greece. Based on these examples it is now clear
that we need an approach like managerial economics which will not only take into
consideration the prior data but will allow us to include future risks in the posterior
data.
Managerial economics helps the manager or the group/ groups of people making
the decisions to increase their problem analytics skills as well as formulation
solution to probabilistic problems. The main differences between managerial
economics and the other branches of economics such as macro and micro
economics is that. Micro economics involves the allocation of scarce resources on
household level. Macro economics involve the study of economics as a whole.
While managerial economics applies the tools learnt in these branches to come up
with viable business ideas. Managerial economics is very broad and is not only
used in decisions making for profit making organization but also useful to nonprofit making organizations in the proper utilization of their scarce resources. The
concept of management economics is also very useful in price determination, long
term capital budgeting, and insights into the demands of a commodity.
Different schools of thought have suggested that managerial economics use the
concepts of economics theory that differ from the fact that managerial economics
is a combination of both economics theory and econometrics in making decisions.
Econometrics is the use of statistical tools such as statistical packages and theories
to experimentally measure the relationship that exist between economics variables.
Its main advantage is that it uses factual data to model different scenarios.

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