Key economic principles that are relevant to managerial decisions are
discussed in the foil owing sub-sections.
1.4.1
Division
of Labour
I put the division of labor first mainly because Adam Smith did argue
that division of labor is the key cause of improving standards of living.
Modern economics doesn’t do much with the concept of division of labor, but two
closely related concepts are important:
1.
Returns
to Scale: Returns to scale may be increasing, constant or decreasing. Increasing
returns to scale is the case that leads to special results, and division of
labor is one cause (arguably the main cause) of increasing returns to scale.
2.
Virtuous
Circles in Economic Growth: For Smith, a major consequence of division of
labor and resulting increasing productivity wasa" virtuoustirde” of
continuing growth. Modern “virtuous arde” theories have more dimensions, but
division of labor and increasing returns to scale are among them.
1.4.2
Opportunity
Cost
The idea is that anything you must give up in order to carry out a
particular decision is a cost of that decision. This concept |s applied again
and again throughout modern economics.
1.
Scarcity: According to modern economics, scarcity
exists whenever there is an opportunity cost, that is, where-ever a meaningful
choice has to be made.
2.
Production Possibility Frontier: The production
possibility frontier is the diagrammatic representation of scarcity in
production.
3.
Comparative Advantage: A very important principle in
itself and a key to understanding of international trade the principle of
comparative advantage is at the same time an application of the opportunity
cost principle to trade.
4.
Discounting of Investment Returns: Another
application of the opportunity cost principle
that is very important in itself, this one tells us how to handle
opportunities that come at different times. .
1.4.3
Equimarginal Principle
This is the diagnostic principle for economic efficiency. It has wide
applications in modern economics. Two of the most important are key principles
of economics in themselves
1
The Fundamental Principle of Microeconomics This
principle describes the circumstances under which market outcomes are
efficient.
2
The Externality Principle It describes some
important circumstances in which the markets are not efficient
3.
Marginal
Analysis: It is also an important principle in itself and very widely applied in
modern eoonomics. There is no major topic in microeconomics that does not
apply marginal analysis and opportunity cost.
Market Equilibrium
The market equilibrium model could be broken down into several principles
— the definitions of supply, demand, quantity supplied and demanded and
equilibrium, at least — but these all complement one another so strongly that
there is not much profit in taking them separately.
However, there are many applications and at least four important
subsidiary principles;
1.
Elasticity and Revenue: These ideas are a key to understanding how market
changes transform society
2. The Entry Principle:
This tells us that, when entry into a field of activity is free, profits
(beyond opportunity costs) will be eliminated by increasing competition. This
has a somewhat different significance depending on whether competition is
"perfect" or monopolistic
3. Cobweb Adjustment:
This might give the explanations when the market does not move smoothly to
equilibrium, but overshoots.
1. Competition vs.
Monopoly: Why economists tend to think highly of competition, and lowly of
monopoly.
2. Diminishing Returns t
Perhaps the best-known of major economic principles, the Principle of
Diminishing Returns is much more
reliable in short-run than in long-run applications, so the Long Run Short
Run dichotomy is an important subsidiary
principle. Modern economists think of diminishing returns mainly in marginal
terms, so marginal analysis and the equimarginal principle are cosely
associated
3. Game Equilibrium
Game theory allows strategy to be part of the story. One result is that
we have to allow for several kinds of equilibriums.
3
Non-cooperative equilibrium
(a)
Prisoners’ Dilemma (dominant strategy) equilibrium
(b)
Nash (best response) equilibrium, (but not all Nash
equilibrium are dominant strategy equilibrium),
4
Cooperative equilibrium
5
Oligopoly (few seller)
1.4.7 Measurement Principles
Economics is multidimensional, and that creates some difficulties in
measuring things like production, incomes, and price levels. Some of the
problems can be solved more or lees fully
1. Value Added and Double Counting One for which we
have a pretty complete solution is the problem of double
counting, the solution is, use value added.
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