Managerial Economics and

Environment in India for Entrepreneurs

5th April 2022

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Economic Decision Makers

• Market
• Set of arrangements by which buyers and
sellers carry out exchange at mutually
agreeable terms
• Product markets
• Goods and services are bought and sold
• Resource markets
• Resources are bought and sold

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Economy

• An economy is just a group of people interacting with

one another as they go about their lives
• This interaction is invariably through a process of
exchange
• Whether it be an individual buying a morning
newspaper, a business buying several hundred
tonnes of steel for a construction project or a
government funding a higher education institution, the
interaction consists of millions of individuals all
making decisions and together we describe these
interactions as ‘the economy’

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Macroeconomics

• Macroeconomics
• Study of the economic behavior of entire
economies
➖ Performance of the economy as a whole
• Economic fluctuations
• Rise and fall of economic activity
➖ Relative to the long-term growth trend of
the economy
• Also known as business cycles

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A Simple Circular-Flow Model

• Describes flow of resources, products,

income, and revenue among economic
decision makers
• Shows interaction between:
• Households
• Firms

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1 The Simple Circular-Flow Model
for Households and Firms

Households earn income by

supplying resources to resource
markets, as shown in the lower
portion of the model. Firms
demand these resources to
produce goods and services,
which they supply to product
markets, as shown in the upper
portion of the model.
Households spend their income
to demand these goods and
services. This spending flows
through product markets as
revenue to firms.

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The Household

• Demands goods and services

• Determines what gets produced
• Supplies resources to produce output
• Makes choices
• What to buy
• How much to save
• Where to live
• Where to work

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The Evolution of the Household

• Farm households
• Self-sufficient
• Better technology
• Increased productivity
• Factories
• Led to specialization
• Made households less self-sufficient
• Percentage of women in the labor force
increased over time

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Households as Resource Suppliers

• Households with resources

• Supply:
➖ Capital, natural resources, and
entrepreneurial ability to satisfy their
unlimited wants
➖ Labor to earn income
• Households with few resources
• Receive transfer payments
➖ Cash transfers
➖ In-kind transfers
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The Firm

• Is an economic unit
• Formed by profit seeking entrepreneurs
• Combines resources
• Produces goods and services
• Maximizes profit

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The Government

• Role of government
• To intervene in case of market failure
• Market failure
• Arises because of the unregulated operation
of markets
• Yields socially undesirable results

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The Role of Government

• Establishing and enforcing rules of the

game
• Safeguard private property
• Make sure that market participants abide by
the rules of the game
• Promoting competition
• Antitrust laws prohibit:
➖ Collusion (agreement among firms to
divide the market and fix the price)
➖ Unfair business practices
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The Role of Government (continued 5)

• Framing the fiscal policy

• Use of government purchases, transfer
payments, taxes, and borrowing to influence
economy-wide variables
• Framing the monetary policy
• Regulation of the money supply to influence
economy-wide variables

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Sources of Government Revenue

• Taxes
• Federal government—Individual income tax
• State governments—Income tax, sales tax
• Local governments—Property tax
• User charges
• Borrowing
• Monopoly in certain markets

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GDP

• GDP measures two things at once: the

total income of everyone in the
economy and the total expenditure on
the economy’s output of goods and
services

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Do you agree

An economy’s income is the same as its

expenditure because every transaction
has two parties: a buyer and a seller.

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Example

Suppose, for instance, that John Watson, a

local builder, is constructing an extension
for a client and purchases €1000 worth of
bricks, cement and timber from a local
builder’s merchants.
The builder’s merchant earns €1000 and
John spends €1000.Thus, the transaction
contributes equally to the economy’s
income and to its expenditure. GDP,
whether measured as total income or total
expenditure, rises by €1000.
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GDP computation

• We can compute GDP for this economy

in one of two ways: by adding up the
total expenditure by households or by
adding up the total income (wages, rent
and profit) paid by firms
• Because all expenditure in the
economy ends up as someone’s
income, GDP is the same regardless of
how we compute it

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Tell Me

But do households spend all of their

income?

Can we consider GDP to be all what is

earned by Households?

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Household’s Income not equal to GDP

• Households do not spend all of their

income
• They pay some of it to the government in
taxes, and they save some for use in the
future
• In addition, households do not buy all
goods and services produced in the
economy.
• Some goods and services are bought by
governments, and some are bought by
firms that plan to use them in the future to
produce their own output
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Household’s Income not equal to GDP

• Some goods are bought from sellers in

foreign countries and some domestic
products are sold abroad.
• Yet, regardless of whether a household,
government or firm buys a good or service,
the transaction has a buyer and seller.
• Thus, for the economy as a whole,
expenditure and income are always the
same.

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Circular Flow of Income

Try and draw a circular flow of income

with
• Households
• Firms
• Government
• Financial Sector
• Rest of the world – X-M

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Circular Flow of Income - Five sector

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Components of GDP

To understand how the economy is using

its scarce resources and how this use
affects business activity and planning,
economists are often interested in
studying the composition of GDP among
various types of spending.

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AD and AS

Aggregate Demand curve a curve

that shows the quantity of goods and
services that households, firms and the
government want to buy at each price
level

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AD and AS

Aggregate Supply curve a curve

that shows the quantity of goods and
services that firms choose to produce
and sell at each price level

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AD and AS

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AD

The aggregate demand curve tells us the

quantity of all goods and services
demanded in the economy at any given
price level.

This means that, other things equal, a fall

in the economy’ s overall level of prices
(from, say, P to P ) tends to raise the
1 2

quantity of goods and services demanded

(from Y to Y ).
1 2

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AD

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AD

As the price level falls, real wealth rises,

interest rates fall and the exchange rate
depreciates.
These effects stimulate spending on
consumption, investment and net exports.
Increased spending on these components
of output means a larger quantity of goods
and services demanded.

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Shift in AD

Shifts Arising From Consumption

Suppose people suddenly become more

concerned about saving for retirement
and, as a result, reduce their current
consumption. Because the quantity of
goods and services demanded at any
price level is lower, the aggregate demand
curve shifts to the left

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Shift in AD

Shifts Arising From Consumption

Impact of Taxation?

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 Shift in AD

Shifts Arising From Consumption -Impact of

Taxation
• When the government cuts taxes, it
encourages people and businesses
to spend more, so the aggregate demand
curve shifts to the right.
• When the government raises taxes, people
and businesses cut back on their spending
and the aggregate demand curve shifts to
the left.
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 Shift in AD

Shifts Arising From Investment

• Any event that changes how much firms
want to invest at a given price level also
shifts the aggregate demand curve

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 Shift in AD

Shifts Arising From Investment

• Imagine that the telecommunications
industry introduces faster broadband
access, and many firms decide to invest in
this new access. - Impact?

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 Shift in AD

Shifts Arising From Investment

• Imagine that the telecommunications
industry introduces faster broadband
access, and many firms decide to invest in
this new access. Because the quantity of
goods and services demanded at any price
level is higher, the aggregate demand
curve shifts to the right

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 Shift in AD

Shifts Arising From Investment

• If firms become pessimistic about future
business conditions - Impact? Impact on
AD?

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 Shift in AD

Shifts Arising From Investment

• If firms become pessimistic about future
business conditions, they may cut back on
investment spending, shifting the aggregate
demand curve to the left.

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 Shift in AD

Shifts Arising From Investment

• Can Tax policy affect investment?

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 Shift in AD

Shifts Arising From Investment

• A tax rebate tied to a firm’s investment
spending – Investment tax credit
• Increases the quantity of investment goods
that firms demand at any given interest rate
• Preferred Investment tax credit will shift AD
to?

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 Shift in AD

Shifts Arising From Investment

• It therefore shifts the aggregate demand
curve to the right.
• Repeal of investment tax credit will lead to?

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 Shift in AD

Shifts Arising From Investment

• The repeal of an investment tax credit
reduces investment and shifts the
aggregate demand curve to the left

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 Shift in AD

Shifts Arising From Investment

• Impact of Money Supply
• An increase in the money supply lowers the
interest rate in the short run.
• This makes borrowing less costly, which
stimulates investment spending and thereby
shifts the aggregate demand curve to the right.

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 Shift in AD

Shifts Arising From Government Purchases

• Suppose the government decides to
reduce purchases of new weapons
systems.
• The quantity of goods and services
demanded at any price level is lower, the
aggregate demand curve shifts to the ??

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 Shift in AD

Shifts Arising From Government Purchases

• Suppose the government decides to
reduce purchases of new weapons
systems.
• The quantity of goods and services
demanded at any price level is lower, the
aggregate demand curve shifts to the left

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 Shift in AD

Shifts Arising From Net Exports

• When the USA experiences a recession, it
buys fewer goods from Europe

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 Shift in AD

Shifts Arising From Net Exports

• When the USA experiences a recession, it
buys fewer goods from Europe
• This reduces European net exports and
shifts the aggregate demand curve for the
European economy to the left.
• When the USA recovers from its recession,
it starts buying European goods again,
shifting the aggregate demand curve to
the right.
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 The Aggregate Supply Curve

• The aggregate supply curve tells us the

total quantity of goods and services that
firms produce and sell at any given price
level
• In the long run, the aggregate supply
curve is vertical, whereas in the short
run, the aggregate supply curve is
upward sloping

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The Aggregate Supply Curve

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 The Aggregate Supply Curve

• In the long run, an economy’s production of

goods and services (its real GDP) depends
on its supplies of labour, capital and natural
resources, and on the available technology
used to turn these factors of production into
goods and services.
• Because the price level does not affect
these long-run determinants of real GDP,
the long-run aggregate supply curve is
vertical
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 The Aggregate Supply Curve

• One might wonder why supply curves for

specific goods and services can be upward
sloping if the long-run aggregate supply
curve is vertical.

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 The Aggregate Supply Curve

• One might wonder why supply curves for

specific goods and services can be upward
sloping if the long-run aggregate supply
curve is vertical.
• The reason is that the supply of specific
goods and services depends on relative
prices – the prices of those goods and
services compared to other prices in the
economy.

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 The Aggregate Supply Curve

• When the price of ice cream rises, holding

other prices in the economy constant, there
is an incentive for suppliers of ice cream to
increase their production by taking labour,
milk, chocolate and other inputs away from
the production of other goods, such as
frozen yoghurt.

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 The Aggregate Supply Curve

• By contrast, the economy’s overall

production of goods and services is limited
by its labour, capital, natural resources and
technology.
• Thus, when all prices in the economy rise
together, there is no change in the overall
quantity of goods and services supplied
because relative prices and thus incentives
have not changed.

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 The Aggregate Supply Curve

• The natural rate of output is the level of

production towards which the economy
gravitates in the long run
• Draw the following impacts on LRAS
• immigration from abroad
• if the government were to raise the minimum
wage substantially

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 The Aggregate Supply Curve

• Imagine that an economy experiences an

increase in immigration from abroad.
Because there would be a greater number
of workers, the quantity of goods and
services supplied would increase. As a
result, the long-run aggregate supply curve
would shift to the right.

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 The Aggregate Supply Curve

• If the government were to raise the

minimum wage substantially, the natural
rate of unemployment would rise, and the
economy would produce a smaller quantity
of goods and services.
• As a result, the long-run aggregate supply
curve would shift to the left

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 The Aggregate Supply Curve

• Draw the following impacts on LRAS

• Effect of increase in the economy’s capital
stock
• A discovery of a new mineral deposit

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 The Aggregate Supply Curve

• An increase in the economy’s capital stock

increases productivity and, thereby, the
quantity of goods and services supplied. As
a result, the long-run aggregate supply
curve shifts to the right.
• A discovery of a new mineral deposit shifts
the long-run aggregate supply curve to the
right.

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The Aggregate Supply Curve

• Upward Sloping SRAS

• In the short run, the aggregate supply curve is
upward sloping
• That is, over a period of a year or two, an
increase in the overall level of prices in the
economy tends to raise the quantity of goods
and services supplied, and a decrease in the
level of prices tends to reduce the quantity of
goods and services supplied

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The Aggregate Supply Curve

• Upward Sloping SRAS

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