economics for business chris mulhearn and howard r. vane

Lecture 1: What is economics? Not done economics before? Don’t worry, it’s all here & you’ll probably do better than those that have So what’s it about? Inflation, profit, markets, fiscal policy, quantitative easing? Well, yes, these are part of it But economics is really about how societies organize the production and consumption of goods and services – like mobile phones, insurance, education, medicine & health services and so on.

The basic economic questions We can distil the essence of this task into three memorable phrases: What goods and services should a society produce? How should it produce them? For whom should they be produced? Every society, rich or poor, has to answer these questions in deciding how to use – allocate – the scarce resources it has at its disposal. We’ll come back to scarcity later. Let’s start with the what? question– how does this work for industrial economies like our own and the rest of the G7? G7 = US, Japan, Germany, UK, France, Italy, Canada

Fewer goods More services What do industrial countries produce? Produced in some industrial countries Produced in most industrial countries but in uneven quantities Produced in industrial countries in declining quantities Produced in all industrial countries in large quantities Cars Tourist services Footwear and clothing Education services Computers Books, magazines Sports goods Health care Mobile phones Feature films Toys Mobile phone services Fewer goods More services Countries like China and India produce more of almost everything; they’re developing, maturing…working out what they’re good at

How are goods & services produced? There are two main issues here: 1. First the technicalities of production } technology changes In 2002 there were 44 million physical singles sold in the UK & no digital sales In 2009 there were 1.5 million physical singles & 116 million downloaded sales Other examples of threats & opportunities in production – newspapers, communication, shopping As technology changes, markets change

How are goods & services produced? (cont.) 2. The extent to which governments involve themselves in production When UK citizens fall ill most use the NHS How are health services in the UK predominantly organized? Via the state – collective provision The US spends a bigger proportion of GDP on health care than we do & may offer the most cutting edge treatments for those that can afford it But 15 per cent of Americans have no health insurance to cover the cost of care should they fall ill – some undoubtedly suffer and even die as a consequence So – where should the boundaries between the market and the state lie in health care, education, banking, car making, etc.?

For whom are goods & services produced? This is often closely linked to the How question In the US, President Obama is controversially trying to change the How question in US healthcare; he’s trying to partly collectivize healthcare to make it fairer But in changing the How question he’s really after the For whom question Where the free market provides goods & services, access depends on ability to pay When the state gets involved, access is decided by other criteria such as, in the case of medicine, clinical need

Positive & normative economics So which is better, private health care or collective provision? This is a normative issue You may think fairness is important so argue for equality of access This is a positive response (positive meaning factually-based) to your normative preference Or, you might think that maximising incentives in medicine is more important because it raises efficiency, so the positive solution to your normative preference might be private health care If you think fairness & incentives are important your positive solution might be a mixed system

What, how, for whom: understanding roles of firms, consumers & government Firms, consumers and government interact through markets A market is simply a nexus for these three groups Virtually everything we produce and consume is delivered through some kind of market process.

What, how, for whom: understanding the role of firms The firm’s purpose is to generate profit Firms need to ask themselves, what, how & for whom in the market they serve EXAMPLE: Until about 10 years ago Tesco was a large traditional UK grocer What – food How – in large UK superstores (just 2 abroad) For whom – British consumers But to an extent this was a saturated & over-competitive market; what could Tesco do to better its medium-term prospects?

Tesco’s plan Sell clothing, computers & electrical goods, not just food Review its UK retail outlets Become much more internationally-orientated Develop a new online business Its answers to our three questions began to look radically different What – food & non-food items How – in different kinds of store & location in the UK and overseas, & over the Internet For whom – a wider & more differentiated UK market and an increasingly global customer base.

Did Tesco’s plan work out? Its 450 traditional superstores are complemented by 170 Tesco Metro city centre stores & 1,000 Tesco Express shops - Tesco has carved out an entirely new ‘local’ market It has 2,200 stores in Europe, North America & the Far East More than 1 million active online customers & has extended its online activities into financial services, insurance & mobile phone services Tesco has made effective decisions about resource allocation in a competitive market environment What happens when firms don’t do this? They go bust!

What, how, for whom: understanding the role of consumers A key concept here is consumer sovereignty It places consumers as the drivers of what, how & for whom Consumer sovereignty indicates that consumer preferences are dominant in markets When consumers express a preference for a good or service by buying it in big quantities, more of it is produced, and firms deliver improvements to cement their place in the consumer’s mind Positive examples? Branded coffee shops; portable communications; green credentials Negative examples? Newspapers; some traditional retailers

What, how, for whom: understanding the role of government Few markets are wholly free in that the government absences itself from them entirely We live in a mixed economy There are 2 kinds of state intervention in markets: The state may directly produce goods & services itself e.g. the UK’s NHS; social housing provision in the Netherlands The state may regulate markets in some way. e.g. subsidies paid to European farmers; fines imposed on firms that pollute; the provision of health inspectors to keep restaurants up to standard

The mixed economy: some examples Does the government have any say over your choice of shoes? Actually, yes Since 2006 the EU has protected European shoe producers by imposing tariffs on shoes imported from China and Vietnam Chinese shoes have a tax of 16.5%; those from Vietnam are taxed at 10% This pushes up the price of imported shoes & warps your freedom of choice But it saves shoe industry jobs in Italy, Portugal and Eastern Europe

The mixed economy: some examples (cont.) What about mobile phone services? More than 80 million prepay & contract mobile subscriptions in the UK – a quarter of these are 3G In 2000 the government arranged the largest ever auction in the UK What was it selling? Air! Actually, licenses to operate 3G technology in the UK It made £22.5 billion from the 5 successful bidders The government got a ton of cash & put technology in the hands of firms that had a huge incentive to use it well

Scarcity, choice and opportunity cost Economics concerns itself with how societies allocate their scarce resources between competing uses What is scarcity? In poorest countries there are unmet needs for food, shelter, clean water, medical care & education. This sounds like scarcity But in US, which has a quarter of the world’s income, there is under-provision of health care & acute poverty and even comparatively rich Americans want better houses or cars So, all resources must be considered scarce – given the vast range of competing uses to which they can be put All societies have to address the what, how & for whom questions

Scarcity, choice and opportunity cost (cont.) Opportunity cost: cost of a resource commitment expressed in terms of the best foregone alternative Environmental protection provides an example In the West we’re increasingly focused on the environment but in poorer countries there is less regulation. Why; don’t they care? We could increase our GDP by allowing firms to pollute – they could produce things more cheaply. Result – a little more output but a lot more pollution In poorer societies more pollution may mean more output which is very highly valued as it provides the dollars to pay for food, medicine and technology; the decision to pollute can be understood in opportunity cost terms

Microeconomics Macroeconomics Microeconomics, macroeconomics & business Microeconomics Macroeconomics Economic issues as they apply to individuals Individual firms, consumers, industries, workers & markets Why are there multinational car firms but no multinational barbers? Why are teachers paid a lot less than X Factor judges? Micro questions Considers the behaviour & performance of the economy as a whole Why does inflation matter? What causes unemployment? Why are interest rates presently set at their lowest ever level? Macro questions

Interest rates Interest rates are a key tool of macroeconomic policy Presently they’re set at a record low of 0.5 per cent Why? As a response to the worst recession since the Great Depression of the 1930s Lower interest rates are intended to encourage economic activity – how? In the past rates have been much higher – 17 per cent in the early 1980s

Interest rates (cont.)

Interest rates (cont.) Why set interest rates higher? Wouldn’t this discourage firms from borrowing to invest & encourage consumers to save rather than spend? Well, yes, but rates may need to be set higher to confront the problem of high and rising inflation Markets are coordinated by price signals; inflation makes them less reliable Inflation in UK – recently far above government’s target of 2% Raising rates might be necessary to curb inflationary pressures but potentially disastrous for growth

Interest rates (cont.)

Exchange rates Two simple points about exchange rates: 1. Value of the pound is important to firms selling in foreign markets If the £ depreciates it’s easier for UK firms to sell abroad Foreign residents give up less of their currency to buy pounds, so price of UK goods abroad falls At the rate £1 = $2 a British computer would cost $2,000 in New York. If the pound depreciates to £1 = $1.50 the computer’s price falls to $1,500 2. This leads to our second point – why has the £ fallen in recent years? Lower interest rates – there’s a short-run connection here

Confronting the 08-09 recession What was the credit crunch? Failings in US housing market Bad debts in property & black holes in some banks All financial institutions borrow heavily from each other Raised concerns – were some banks insolvent? Banking essentially a micro concern BUT it posed systemic risk to the economy Governments stepped in to shore up the banks What did the government do? Interest rate cuts A falling £ VAT cut Quantitative easing Car scrappage scheme Bank nationalizations & liquidity support

Confronting the 08-09 recession (cont.) Another issue… If we excuse bad behaviour what’s the likely consequence? More of the same: Moral hazard What’s since changed in the banking sector? Not much? Are banks too big to fail? Should we demand that they be allowed to fail? UK government provided cash & guarantees to the banks – worth a 1/3 of national income Govt. nationalised Northern Rock, Bradford & Bingley, etc. Why aid the banks which behaved recklessly & not least in development of a bonus culture that rewarded excessive risk-taking? Right, systemic risk.

Conclusion To understand business issues and the environments in which business operates you need to know about micro and macroeconomics.