Managerial Economics Study Set 10
Quiz 1 :
Scarcity : Scarcity is simply a situation where resources are limited and wants are unlimited. It can be defined as a condition in which human wants exceed the available resources necessary to cater to those demands. It means demand is more than the supply, or people want more than is available. As, scarce resources have alternative uses, choice becomes unavoidable. Because of the scarcity of economic resources consumers, producers and government must make choices. Choices must be made regarding the use of these scarce resources in the production, distribution and consumption of goods and services. To make a choice, simply means to trade-off one choice with other. Therefore, Scarcity is a cause of economic problems. Various economic decisions have to be made to allocate the insufficient productive resources efficiently to cater to the unlimited human wants. Opportunity Cost : Opportunity is the outcome of scarcity. An opportunity cost is the value of the second best alternative that is forgone when a choice is made. In other words, opportunity cost can be defined as the benefits that could have been received if other alternative choice was made. As there are alternative uses of scarce economic resources, need arises to select the best way to use these resources (say land, labour and capital). When one alternative is chosen over other, the next best alternative which is forgone is called opportunity cost of making a choice, because we give up the opportunity to have other desirable things. The concepts of scarcity and opportunity cost play a very important role in managerial decision making. Scarcity and opportunity cost are interlinking concepts. Scarcity is the root cause of all economic problems therefore it is central to all economic decisions. Its importance in managerial decision making lies in taking decisions regarding allocation of scarce resources. For example, if a company is in the business of beverages and food. And it has an expansion plan. There are limited resources of capital and labour which can be employed in either of the businesses. As resources are scarce, if the company allocate more resources to beverage business, it will have fewer resources for food business. Therefore, the company need to make a choice and decisions regarding allocation of these scarce resources among the two businesses. This involves trade off among the two choices. If the company makes the choice and decides to allocate resources in beverage business, it will forgo the food business, which will the opportunity cost of the choice the business has made. Or, this trade off is the forgone next best option which represents the opportunity cost. The opportunity cost of the value of opportunity lost is taken into consideration when alternatives are compared. It measures the benefit of opportunity forgone. Therefore, both the concept of scarcity and opportunity cost are helpful in managerial economics in evaluating the various alternatives available when scarce economic resources are employed for various uses.
Economics is the study of how individuals use limited resources to satisfy their unlimited wants. Scarcity of economic resources is the core of all economic problems. Because of scarcity every economic system has to make a choice and face three basic economic questions of What to produce, How to produce, and For whom to produce. All the three economic questions are related to the allocation of scarce resources. Let's elaborate them: What to produce : The very basic economic question is what to produce and how much to produce with the limited available resources. An economy or a society must decide, what should be the combination of various goods and services to be produced to fulfil the unlimited wants of the individuals with the scarce resources of production. There are 3 resources of production i.e. land, labour and capital. Now, what to produce is an allocation question, of how to allocate these limited resources in order to produce various goods and services. As, because of scarcity of resources it is not possible to fulfil the wants of all the individuals, therefore, a nation must decide what combination of goods and services to produce o satisfy the needs of the individuals and society to some extent. We can give example of this question with respect to the use of a country's scarce resources. For example, a nation has to decide how much of the scarce resources should be allocated in the defence sector, and how much should be allocated to domestic sector like hospitals, schools, infrastructure, houses, industry etc. If more resources are devoted to defence sector, there will be less resources for domestic sector, and vice versa. If the nation decides to allocate more resources to domestic sector, it has to further decide what portion of the production will be in the form of capital goods and how much will be in the form of consumer goods. Therefore, the nation has to decide what portion of the limited available resources should be allocated to which sector, in order to satisfy the maximum wants. How to produce : After encountering the first problem, the economy or society is faced with the question of how to produce the goods and services. It is basically an efficiency question. There are number of ways to produce the goods and services. They can be produced with labour intensive techniques or capital intensive techniques. It is a question of how many workers will be employed as compared to usage of machines. Whether the tools are simple or complex, will the methods of production be highly sophisticated involving complex machines with less labour force. It involves decisions regarding the particular mix of inputs to produce a good or service. For example, if a nation decides to produce consumer goods, it must also decide the method of production to produce these consumer goods. Due to the scarcity of the required resources, an economy must decide whether to use labour intensive or capital intensive techniques of production. If the concerned economy lacks skilled labour force, it must rely on capital intensive techniques to produce efficiently. For whom to produce: Once it is decided that what to produce and how to produce, the next question is for whom will it be produced. As, it's not possible for an economy to produce enough goods that will satisfy everyone's wants, there must be some method for distributing the scarce goods and services among the masses. An economy must have some organised set of procedures or economic system which determines how the goods are services are distributed in the economy. Basically there are 3 kinds of economic systems in the world. They are (1) Traditional economies (2) command economies (3) market economies. In traditional economies a family or a tribal unit produces and consumes most of the goods. In command economies, it is the government which decides and answers all the three basic economic questions. However, in market economies, the question of what, how and for whom to produce is decided in freely operating markets by the individuals and businesses. .
a) The first example of economic decision, "Should the company make its own spare parts or buy them from an outside vendor" is an example of how to produce. This is because it involves the purchase of raw material in the form of spare parts. b) The second example of economic decision, "Should the company continue to service the equipment that it sells or ask its customers to use independent repair companies" is an example of what to produce. This is because it involves the company's decision to stop the service it was providing earlier. c) The third example of economic decision, "Should the company extend its business to international market or concentrate on domestic market" is an example of for whom to produce. This is because it involves the decision regarding catering and focussing a particular segment of the market. d) The fourth example of economic decision, "Should the company replace its own communication networks with a virtual private network that is owned and operated by another company" is an example how to produce. This is because it involves the decision of replacing one network with another. e) The fifth example of economic decision, "Should the company buy or lease the fleet of trucks that it uses to transport its products to market is an example of how to produce. This is because it involves the decision of hiring or capital budgeting on the part of the company.