Business Economics

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Business Economics
Elisabeth Oltheten January 24, 2001
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Why Economics?

• Economic Theory helps us understand how and why
  business models work or dont work.
• Example of the Harvard student
• He didnt understand why the model didnt work
  anymore.
• Robust results depend on robust assumptions.

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Ten Principles of Economic
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How People Make Decisions

• People face tradeoffs
• The cost of something is what you give up to get
  it
• Opportunity Cost
• Rational People think at the margin
• Marginal Changes
• People respond to incentives

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How People Interact

• Trade can make everyone better off
• Markets are usually a good way to organize
  economic activity
• Governments can sometimes improve market outcomes
• Market failure
• Externality
• Market Power

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How the Economy Works

• A Countrys standard of living depends on its
  ability to produce goods and services
• ?Key Economic Data
• Prices rise when the government prints too much
  money
• ? The Aegean Gap Widens
• Society faces a short run tradeoff between
  inflation and unemployment

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Economic Models

• An Economist is someone who,
• having observed that something works in reality,
• wonders if it works in theory.

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Economic Models

• Observation
• Assumptions
• Models

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Model 1The Circular Flow Diagram
Markets (goods and services)
Firms
Households
Capital Markets Labour Markets
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Model 2Production Possibilities
0 tomatoes, 30 sheep
The opportunity costof 3 extra sheepis 80
tomato plants
550 tomatoes, 18 sheep is impossible
470 tomatoes, 15 sheep is inefficient
800 tomatoes, 0 sheep
Tradeoffs
Opportunity Cost
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Micro and Macro

• Microeconomics how households and firms make
  decisions and interact in markets
• Macroeconomics how economies behave
  (production, growth, inflation, unemployment)

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Positive and Normative

• Positive minimum wage laws cause unemployment
• Normative the government should eliminate
  minimum wage laws

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Graphing Techniques

• Review in the text pp. 34 to 43

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Gains from Trade

• George and Tasos are both farmers
• Tasos has a bigger better piece of land and can
  produce
• more tomatoes (5 bushels instead of 4)
• more lamb (40 kilos instead of 3)
• Tasos has an absolute advantage in both lamb and
  tomatoes

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Absolute Advantage
1 kilo lamb 2 bushels of tomatoes
20 kilos lamb 2.5 bushels of tomatoes
Total Production 21 kilos lamb 4.5 bushels of
tomatoes
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Comparative Advantage
TRADE 3 kilos lamb for 1 bushel of tomatoes
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Gains from Trade
Consumption 3 kilo lamb 3 bushels of tomatoes
TRADE get 3 kilos lamb for 1 bushel tomatoes
Production4 bushels tomatoes
Note that the consumption is beyond the
production possibility curve
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Gains from Trade
TRADE get 1 bushel tomatoes for 3 kilos lamb
Production24 kilos lamb 2 bushels tomatoes
Consumption 21 kilos lamb 3 bushels of tomatoes
Note that the consumption is beyond the
production possibility curve
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Total Production 24 kilos lamb (up from 21) 6
bushels of tomatoes (up from 4.5)
Production 24 kilos lamb 2 bushels of tomatoes
Production 4 bushels of tomatoes