The Art and Science

of Economic
Analysis
Sunil Ashra, Chairperson
Economics Department

References
Krugman and Wells, Microeconomics*
Krugman and Wells, Economics*
Salvatore, 2005, Managerial Economics in a Global
Economy*
H Varian Intermediate Microeconomics
Samuelson & Nordhus, Economics
Rubinfield and Pindayak, Microeconomics
Browning and Browning, Microeconomics
Lipsey, RG, An intro to Positive Economics
Habbard, 2009, Microeconomics
Tim Harford (2006) Undercover Economist
Partha Dasgupta A short introduction to Economics

What is Economics?

Economics is the study of

how people choose to use
their scarce resources in
an attempt to satisfy
unlimited wants
A resource is scarce if the
amount people desire
exceeds the amount that is
available
Without scarcity there
would be no economic
problem

Resources

Land
used

Labor
The

in the production of goods and services

physical and mental effort of humans

Capital
Skills,

and Buildings & equipment

Entrepreneurial Ability
Managerial,

skills

organizational, and risk-taking

Resources - Payments
Land or Natural Resources
Rent (for land)
Labor or Human Resources
Wages (for labor)
Capital (Physical and Human)
Interest (for capital)
Entrepreneurial Ability
Profit (for entrepreneurial ability)

Markets

A market is a set of
arrangements through
which buyers and sellers
carry out exchange at
mutually agreeable terms
Product Market
A

market in which goods and

services are exchanged

Resource/Input Market
A

market in which
resources/input are
exchanged

Economic Actors

Households
Firms
Financial

Intermediaries
Government
Rest of the World

The circular flow of income

INJECTIONS

Investment (I)

Factor
payments

Consumption of
domestically
produced goods
and services (Cd)

Export
expenditure (X)

Government
expenditure (G)
BANKS, etc

Net
saving (S)

GOV.

ABROAD

Import
Net
expenditure (M)
taxes (T)

WITHDRAWALS

Distinction between
Microeconomics &
Macroeconomics
Microeconomics is the study of the
economic behavior of individual
decision makers, e.g. Firm, Household
etc. & how they interact with one
another in markets.
Macroeconomics is the study of the
behavior of entire economies. Its goal is
to explain the economic changes that
affect many households, firms, and
markets at once.

Rational Self-Interest

Individuals
rationally select
alternatives
they perceive to
be in their best
interests

Marginal Effects
A term meaning
incremental or
decremental,
used to describe a
change in an
economic variable
Marginal benefits
and marginal costs

Economic Models
A model is a simplified
representation of a real
situation that is used to
better understand reallife situations.
A model is usually a
graph or a set of
mathematical equations

Clearly, the Wright

brothers believed
in their model.

Ceteris Paribus
(other things constant)
When focusing on key economic
variables, other variables are held
constant
This is important for model building

As

economic models become more

complex, fewer and fewer variables
will be held constant

Behavioral Assumptions

A behavioral
assumption describes
the expected
behavior of economic
actors
Most behavioral
assumptions are
applied to the most
sophisticated
decision makers:
households and firms

Positive Versus Normative Economic Analysis

The Glass
is half full

half
empty

Positive Vs Normative Economic Analysis

A positive economic statement can be

proved or disproved by reference to facts
"A

ceiling on rents (or rent- control) reduces

the quantity and quality of housing
available"

A normative economic statement

represents an opinion, which cannot be
proved or disproved
"The

government should be the employer of

last resort"

Some Tools
of
Economic Analysis

Opportunity Cost

When an activity is
chosen, the opportunity
cost is the benefit
expected from the best
alternative forgone

Example: If you choose

to attend B-School this
year, your opportunity
cost is the salary you
would have received
from the best available
full-time job.

Impact of Interaction

Gains from trade

Case

1: Boss better than secretary at

decision making, secretary better at typing,
boss focuses on decision making alone and
lets secretary focus on typing alone
Case 2: Boss better than secretary at both
typing and decision making but more
better in decision making, so focuses on
decision making alone and lets secretary
focus on typing alone
This would suggest that trade would take
place between heterogeneous countries
Data shows trade between similar countries
which exchange similar products, eg. Cars
Krugmans theory of economies of scale

Law of Comparative Advantage

The individual (or

country) with the
lowest opportunity
cost of producing a
particular good
should specialize in
producing that
good

Global Corporations
Company
Nestle

Revenue
(USD Billion)
48.3

Unilever

46.4

Exxon

120.3

Walmart

245.4

Sony

51.1

Shell

128

IBM

78.5

Volkswagen
UN World Investment Report, 2010

65

And the world's biggest companies are...

1.Wal-Mart Stores
2.Royal Dutch Shell
3.Exxon Mobil
4.BP
5.Sinopec Group

Fortune 2012

6.China National
Petroleum
7.State Grid
8.Toyota Motor
9.Japan Post Holdings
10.Chevron

Nominal GDP in 2011

55

countries had GDP above USD

120 billion
US,

China, Germany

110

countries had GDP below

USD 45 billion
Bulgaria,

Bhutan,

Sri Lanka, Ethiopia,

Barter

Barter is the direct

exchange of one
good for another
without the use of
money
Modern economies
moved beyond
barter by using
money to facilitate
exchange

Division of Labor: Adam Smith (1776)

The organization of
production of goods
into separate tasks
in which workers
specialize
The specialization of
labor takes
advantage of the
individual
preferences and
natural abilities of

Trade-offs: The Production Possibility Frontier

What to do?
Even a castaway faces trade-offs.

The Economys Production

Possibilities Frontier

Fish

30

Coconut

20

The production
possibilities
frontier is a
curve showing all
alternative
combinations of
goods that can
be produced
when available
resources are
used fully and

Consumer Goods

The Economys Production

Possibilities Frontier
The
Thelaw
lawof
ofincreasing
increasing
opportunity
opportunitycost
cost
makes
makesthe
theproduction
production
possibilities
possibilitiesfrontier
frontier
concave
concave(bowed-out)
(bowed-out)

Capital Goods

Efficiency & Production Possibilities

Frontier
Efficiency exists when there is
no way resources can be
reallocated to increase the
production of one good without
decreasing the production of
another good

Efficiency & Production Possibilities

Frontier
Consumer
Goods

Unattainable

Inefficient

Capital Goods

An Increase in Resources (growth)

Consumer
Goods

An
Anincrease
increaseininresources
resources
will
willcause
causethe
theproduction
production
possibilities
possibilitiesfrontier
frontiertotoshift
shift

Capital Goods

A Technological Change
Consumer
Goods

Technological
Technologicalimprovement
improvementin
in
the
theproduction
productionof
ofone
onegood
goodwill
will
cause
causethe
theproduction
productionpossibilities
possibilities
frontier
frontierto
torotate
rotate

Capital Goods

The business cycle

The Business cycle is the rise and fall of economic activity relative to the long-term
growth trend of the economy

4
2
The boom

The upturn

Depression & Recession

-

A recession is a decline in an economys total

production lasting 6 months or longer
A depression is a severe reduction in an
economys total production accompanied by
high unemployment lasting several years

When your neighbour looses his job it

is slow down when you loose your
job it is a recession when an
economist looses her job it is

Economic Expansion
-

An expansion is an
increase in the
economys total
production lasting six
months or longer

Boom
Overheating

Whos responsible for the mess

Nitin Gupta Video on 2G, CWG, KG & Madam G

https://www.youtube.com/watch?v=HIudxeqFuz8

Hans Rosling
http://www.ted.com/talks/hans_rosling_asia_s_rise_ho
w_and_when?language=en

Leading Economic Indicators

Leading economic indicators are these
economic statistics,
housing starts,
stock prices,
demand for consumer durables, and
consumer expectations,
that foreshadow future
changes in economic
activity

The Changing Business Cycle?

1991-2015

3- Important Economic Questions

1.What goods will be produced

what markets to serve

how differentiated should the products be
what price to charge
How goods will be produced

2.What mix of inputs to use in the

process of production
3.Who gets the goods that are
produced

Economic Systems

An economic
system is a set of
mechanisms and
institutions that
resolve the what,
how and for whom
questions

Types of Economic Systems

Pure capitalism (or Free Market

Economy)

A system with private ownership of

resources and the use of prices to
coordinate economic activity in free,
competitive markets

Planned (or Command) Economy

A system with centralized economic
planning and public ownership of
resources

Mixed economy

Classifying economic syste

syst
Early 1980s

Totally
planned
economy

Poland
N. Korea China
India
Cuba

UK
France

USA

Hong
Kong

Totally
free-market
economy

Classifying economic syst

Early 1980s

Totally
planned
economy

Poland
N. Korea China
India
Cuba

N. Korea

UK
France

USA

Hong
Kong

Totally
free-market
economy

Cuba China
USA Hong Kong
India France
UK
Poland
Singapore

Early 2000s

N. Korea

Cuba

China
Poland

late 2000s

China
UK
Singapore
(Hong
FranceUSA
Kong)

India

Understanding
Graphs
Please revise
Your Math esp
Differentiation

The Slope of a Line

y

change
changein
in yy
slope
slope change in x
change in x
change in y
change in x

A Line with Positive Slope

y

change in y >0
change in x

A Line with Negative Slope

y

change in y < 0
change in x

The Slope of a Curve

y

change
in y
change in x