Learning outcome 1: Apply basic principles of economics to manufacturing

activities

1.1Introduction to engineering economics:

What are the 4 main principles of engineering economics?

Principle 1: A dollar earned today is worth more than a dollar earned in the future.
Principle 2: The only thing that matters is the difference between alternatives.
Principle 3: Marginal revenue must exceed marginal cost.
Principle 4: Additional risk is not taken without the expected additional return.
What are the types of engineering economics?
The five main types of engineering economic decisions are
(1) service improvement,
(2) equipment and process selection,
(3) equipment replacement,
(4) new product and product expansion
(5) cost reduction.
Elements of engineering economics
An engineering economy study involves many elements:
• problem identification,
• definition of the objective,
• cash flow estimation,
• financial analysis, and
• decision making.
Applying basic concepts of microeconomics and macroeconomics
Distinction between microeconomics and macroeconomics
Microeconomics is concerned with the actions of individuals and businesses, while
macroeconomics is focused on the actions that governments and countries take to influence
broader economies.
2 Economic good, free good, consumer’s want/need
The relationship between economic goods, free goods, and consumer wants/needs is a complex
and fascinating one.
Economic goods: These are goods and services that are scarce and have a positive price.
Free goods: These are goods and services that are readily available in abundance and have no
price.
Consumer wants/needs: These are the desires and necessities of individuals that motivate them
to consume goods and services.
Demand of goods and services.
Economists use the term demand to refer to the amount of some good or service consumers are
willing and able to purchase at each price.
Relationship between Demand and Market Prices
Demand can be defined as the consumer’s willingness to pay for a certain product at a certain
price.

What are factors affecting demand?

quantity demanded: the total number of units of a good or service consumers wish to purchase
at a given price
Supply of Goods and Services
When economists talk about supply, they mean the amount of some good or service a producer
is willing to supply at each price.
When economists refer to quantity supplied, they mean only a certain point on the supply curve,
or one quantity on the supply schedule.
Prices of substitute goods
Substitute goods are goods that can be used in place of one another, which means that they
provide similar utility for the consumer.
Prices of complementary goods
Complementary goods are goods that are used together to satisfy a want.
Relationship between Supply and Market Prices
Supply refers to the quantity of a commodity that a producer offers for sale at a given price at
a given point of time.
Supply depends on the following factors:
 • Prices of substitute goods
• Prices of input factors
• Taxes on production
• Market Price for Financial Markets

Understanding National Income

Definition of National Income
The definition of National Income if of two types:

✓ Traditional Definition of National Income

✓ Modern Definition
National Income
defines a country's wealth.
National income is the sum total of the value of all the goods and services manufactured by the
residents of the country, in a year., within its domestic boundaries or outside.
Modern Definition
This definition has two subparts

✓ GDP

✓ GNP
Gross Domestic Product
Gross Domestic Product, abbreviated as GDP, is the aggregate value of goods and services
produced in a country.
The Formula for Calculation of GDP:
GDP = consumption + investment + government spending + exports - imports.
Gross National Product
Gross National Product (GNP) is an estimated value of all goods and services produced by a
country’s residents and businesses.
Components of GNP

✓ Consumer goods and services

✓ Gross private domestic income

✓ Goods produced or services rendered

✓ Income arising from abroad.
Formula to Calculate GNP

✓ GNP = GDP + NR (Net income from assets abroad or Net Income Receipts) - NP
(Net payment outflow to foreign assets).

✓ GDP = C + G + I + NX
where:
• C = consumption;
• G = government spending;
• I = Investment
• NX = net exports (exports - imports)
1.2.7 Savings, investment and financial system
The term savings refers to the dollars made available due to individuals foregoing some of
their consumption.
A financial system refers to a set of institutions such as banks, insurance companies, etc., that
enable the efficient channeling of funds from savers to investors. The financial system refers
group of institutions that helps match the saving of one person with the investment of another.
Non-bank financial institutions, also known as non-depository institutions since they do not
hold deposits, are an additional significant type of financial intermediaries that also transfer
savings to borrowers. Non-bank financial institutions include organizations such as finance
businesses, life insurance companies, and pension funds, amongst others.
The Market for Loanable Funds
The demand for loanable funds comes from investment:
Firms borrow the funds they need to pay for new equipment, factories, etc.
Households borrow the funds they need to purchase new houses.
The Financial System, Saving and Investment Relationship
Saving and investment have a positive relationship in the financial system. It's easy to become
confused between the concepts of saving and investing. Most individuals use both of these
phrases interchangeably. However, in economics, they are not always the same thing.
Example:
Moe takes out a loan from the bank to pay for the construction of his new home, he contributes
to the nation's overall investment. It is important to remember that purchasing a new home is
the only household expenditure considered an investment rather than consumption.
Note: As both saving and investment are equal in an economy, they have a positive
relationship with one another. If the amount of savings was to increase, it would also lead to
an increase in investment.
1.2.7 Money and Inflation
I) Definition of Money
It is defined as anything that the public readily accepts in payment for goods and services and
other assets and in the discharge of debt.
ii. INFLATION
Inflation is defined as an increase in the average level of prices. When the supply of output is
less, the rise in prices is described as inflationary.
Causes of Inflation
a) Increase in demand and decrease in supply of goods cause inflation.
b) Inflation occurs during the war when the government creates additional money and
circulates the same into the economy to meet war expenditures.\

b) Types of Inflation
The classification of inflation is based on the speed with which the price increases in
the
economy.
a) Creeping inflation: It is the mildest type of inflation, under which prices rise slowly,
say,
one per cent per annum.
b) Walking inflation: When the rise in prices is more pronounced as compared to a
creeping
inflation, it is called walking inflation. Roughly, the prices rise five per cent annually
under
this situation.
c) When the movement of price accelerates rapidly, “Running inflation” emerges.
Under this,
prices rise by more than ten per cent per annum.
d) Hyperinflation: This is an alternative term for run away or galloping inflation.
There is such
a tremendous expansion in the supply of money and eventually it becomes worthless.

c) Deflation
It is the opposite of inflation. It means a fall in the general price level associated with
a contraction of the supply of money and credit.

1.2.7 Full-employment and unemployment

Full-employment

Full employment is seen as the ideal employment rate within an economy at which no
workers are involuntarily unemployed. Full employment of labor is one component of
an economy that is operating at its full productive potential and producing at a point
along its production possibilities frontier.

Types of Unemployment
Unemployment can result from cyclical, structural, frictional, or institutional causes.
Policymakers can focus on reducing the underlying causes of each of these types of
unemployment, but in doing so they may face trade-offs against other policy goals.
Structural
The desire to encourage technological progress can cause structural unemployment.
For example, when workers find themselves obsolete due to the automation of factories
or the use of artificial intelligence.
Institutional
Institutional unemployment arises from institutional policies that affect the economy.
These can include governmental programs promoting social equity and offering
generous safety net benefits, and labor market phenomena, such as unionization and
discriminatory hiring.
Frictional
Some unemployment may be unavoidable by policymakers entirely, such as frictional
unemployment, which is caused by workers voluntarily changing jobs or first entering
theworkforce. Searching for a new job, recruiting new employees, and matching the
right worker to the right job are all a part of it.
Cyclical
Cyclical unemployment is the fluctuating type of unemployment that rises and falls
within the normal course of the business cycle. This unemployment rises when an
economy is in recession and falls when an economy is growing. Therefore, for an
economy to be at full employment, it cannot be in a recession that’s causing cyclical
unemployment.
Other types

Underemployment
occurs when people are employed, but would like and are available to
work more hours.
Hidden unemployment
occurs when people are not counted as unemployed in the formal ABS labor market
statistics, but would probably work if they had the chance. For example, someone might
have looked for work for a long time, given up hope and stopped looking, but still wish
to work. (These people are sometimes referred to as ‘discouraged workers.)
Seasonal unemployment
occurs at different points over the year because of seasonal patterns that affect jobs.
Some examples include ski instructors, fruit pickers and holiday-related jobs.
Three broad categories:
• Employed – includes people who are in a paid job for one hour or more in a week.
• Unemployed – includes people who are not in a paid job, but who are actively looking
for work.
• Not in the labor force – includes people not in a paid job, and who are not looking
for work.

This can include people who are studying, caring for children or family members on a
voluntary basis, retired, or who are permanently unable to work. Once the number of
people in each of these categories has been estimated, the following labor market
indicators can be calculated:
• Labor force – the sum of employed and unemployed people.
• Unemployment rate – the percentage of people in the labor force that are
unemployed.
• Participation rate – the percentage of people in the working-age population that are
in the labor force.
Calculation
In this example 12.6 million people are employed and 0.7 million people are
unemployed. The size of the labor force is calculated as the sum of these groups. There
are 13.3 million people in the labor force and, if the working-age population is 20.0
million people, the participation rate.
Calculating the Unemployment Rate
 Answer: The size of labor force is 13.3

What Is a Simple Explanation of the Law of Supply and Demand?

If you've ever wondered how the supply of a product matches demand or how market prices are
set, the law of supply and demand holds the answers. Higher prices cause supply to increase
while demand drops. Lower prices boost demand while limiting supply. The market-clearing
price is one at which supply and demand are balanced.
Why Is the Law of Supply and Demand Important?
The Law of Supply and Demand is essential because it helps investors, entrepreneurs, and
economists understand and predict market conditions. For example, a company considering a
price hike on a product will typically expect demand for it to decline as a result, and will attempt
to estimate the price elasticity and substitution effect to determine whether to proceed regardless.
Major Market Forces
There are four major factors that cause both long-term trends and short-term fluctuations.
Government holds much sway over the free markets. The fiscal and monetary policies
that governments and their central banks put in place have a profound effect on the
financial marketplace.
By increasing and decreasing interest rates, the Federal Reserve can effectively slow or attempt
to speed up growth within the country. This is called monetary policy. If government spending
increases or contracts, this is known as fiscal policy and can be used to help ease unemployment
and/or stabilize prices.
By raising or lowering taxes, altering interest rates, and influencing the amount of dollars
available on the open market, governments can change how much investment flows into and out
of the country.
International Transactions
The flow of funds between countries affects the strength of a country's economy and its
currency. The more money that is leaving a country, the weaker the country's economy and
currency.
Speculation and Expectation
Speculation and expectation are integral parts of the financial system. Consumers, investors, and
politicians all hold different views about where they think the economy will go in the future, and
that affects how they act today.
Supply and Demand
The International Effect
High demand for a currency means that currency will rise relative to other currencies.
The value of a country's currency can also play a role in how other markets will do within that
country. If a country's currency is weak, this will deter investment into that country, as potential
profits will be eroded by the weak currency.
The Participant Effect
The analysis and resultant positions taken by traders and investors based on the information they
receive about government policy and international transactions create speculation as to where
prices will move. When enough people agree on one direction, the market enters into a trend that
could sustain itself for many years.
1.3.2 Elasticity and its applications
Elasticity is an important economic measure, particularly for the sellers of goods or services,
because it indicates how much of a good or service buyers consume when the price changes.
When a product is elastic, a change in price quickly results in a change in the quantity demanded.

1< means elastic

= 0 means perfect inelastic
1> means inelastic
When a good is inelastic, there is little change in the quantity of demand even with the change of
the good's price.
1.3.3 Substitutes and complements
Substitute goods are products that consumers use for the same purpose as other similar
products.
Complementary goods are products that are consumed together to enhance the value or utility
of each other.
Independent goods are two goods whose price changes do not influence the consumption of
each other.
1.4 Identifying consumer and producer choices for manufacturing product
Consumers make choices based on their preferences, income, and the prices of goods and
services. Producers, on the other hand, make decisions based on the costs of production, potential
profits, and the prices that consumers are willing to pay.
1.4.1 Consumer’s preferences and budget constraint
The budget constraint is the all possible combinations of consumption that someone can afford
given the prices of goods and the individual’s income.
Opportunity cost measures cost in terms of what must be given up in exchange.
Marginal analysis is the process of comparing the benefits and costs of choosing a little more or
a little less of a certain good.
The law of diminishing marginal utility indicates that as a person receives more of a good, the
additional—or marginal—utility from each additional unit of the good declines.
Sunk costs are costs that occurred in the past and cannot be recovered; they should be
disregarded in making current decisions.
Utility is the satisfaction, usefulness, or value one obtains from consuming goods and services.

1.4.2 Producer’s preferences and production cost

Producers prefer price instability in production, but prefer price stability in consumption.
Production costs refer to all of the direct and indirect costs businesses face from manufacturing a
product or providing a service.
Types of production costs
1. Direct costs
Direct costs are the expenses a company incurs directly to produce a product or service or to
purchase a wholesale product for resale. Direct costs are often variable, which means they may
fluctuate depending on different factors.
2. Indirect costs
Indirect costs are expenses you can't directly associate with a produced product. Some indirect
costs are impossible to factor into a specific product's cost of production. Instead, companies
often consider those costs a part of production overhead.
Factors affecting cost of production
Demand
As a company's success grows, the demand for certain products also increases
Technology
Automated machines have replaced some jobs that human laborers performed traditionally.

Exchange rate
If a company imports materials from overseas, exchange rates can greatly affect the cost of
production.
Cost of materials
The costs of raw materials that are necessary for manufacturing can vary depending on the year,
the economy and availability.
Tax rates
Taxes are an indirect production cost that can contribute significantly to a company's annual
overhead.
Interest rates
Another indirect cost for companies is their loans. If a company borrows funds from a bank or
other entity to pay expenses, the loan's interest rates can rise or fall.
How to calculate cost of production
Cost per unit = (total fixed costs + total variable costs) / total units produced
1.4.3 Consumer’s and producer’s surplus
Consumer surplus can be positive or negative. It will be positive if the market price of a good is
less than the price the customer is ready to pay. In contrast, it will be negative if the market price
is greater than the customer’s willingness to pay. Producer Surplus can be negative in some
situations. Sellers often charge higher prices for products than the minimum amount they are
willing to accept. It results in producer surplus. A producer surplus combined with a consumer
surplus equals overall economic surplus or the benefit provided by producers and consumers
interacting in a free market as opposed to one with price controls or quotas.
Assumptions of the Consumer Surplus Theory
1. Utility is a measurable entity
Under Marshallian economics, utility can be expressed as a number. For example, the utility
derived from an apple is 15 units.
2. No substitutes available
There are no available substitutes for any commodity under consideration.
3. Ceteris Paribus
It states that customers’ tastes, preferences, and income do not change.
4. Marginal utility of money remains constant
It states that the utility derived from the income of a consumer is constant.
5. Law of diminishing marginal utility
It states that the more a product or service is consumed, the lower the marginal utility is derived
from consuming each extra unit. According to economist Alfred Marshall, the more you
consume a certain commodity, the lower the satisfaction derived from each additional unit of
consumption.
Consumer Surplus = Total Utility – (Price x Quantity)
6. Independent marginal utility
The marginal utility derived from the product being consumed is not affected by the marginal
utility derived from consuming similar goods or services.
Total revenue - marginal cost = producer surplus

Consumer Surplus and the Price Elasticity of Demand

Consumer surplus for a product is zero when the demand for the product is perfectly elastic. This
is because consumers are willing to match the price of the product.

1.4.4 Markets efficiency and welfare

Market efficiency refers to the ability possessed by markets to include information that offers
maximum possible opportunities for traders to buy and sell securities without incurring
additional transaction costs. The goal that the government has in mind is to help increase
consumer welfare by lowering prices.
What are the factors of market efficiency?
Market Participants
Information availability and financial disclosure
Limits to trading – Limitations on arbitrage and short selling decrease efficiency.
There are three degrees of market efficiency.
The weak form of market efficiency is that past price movements are not useful for
predicting future prices. Therefore, future price changes can only be the result of new
information becoming available.
The semi-strong form of market efficiency assumes that stocks adjust quickly to absorb
new public information so that an investor cannot benefit over and above the market by
trading on that new information.
The strong form of market efficiency says that market prices reflect all information both
public and private, building on and incorporating the weak form and the semi-strong
form.
Markets Welfare
Welfare economics is a field of economics that applies microeconomic techniques to evaluate
the overall well-being (welfare) of a society. This evaluation is typically done at the economy-
wide level and attempts to assess the distribution of resources and opportunities among members
of society.
There are three core concepts used in welfare analysis: total surplus, allocative efficiency, and
the social welfare function.
Total Surplus and Allocative Efficiency
Consumer and producer surplus together represent the total surplus, or total welfare in a
market. Total welfare is the total extra benefit or happiness enjoyed by producers and consumers
who feel they got a good price for the product being exchanged (paid less than they were willing
to pay or received more than they were willing to accept).
The total welfare in a market is the combined areas of consumer surplus and producer surplus.
1.4.4 Effect of taxation and international trade on welfare
National welfare in the importing country falls when a large exporting country implements an
export tax.
Environmental taxation affects the competitiveness of a small country without power in the
global market.
The model presented in this article focuses on this issue. In particular, it uses a general
equilibrium perspective to analyze the impact of an environmental tax by capturing the
interactions with the existing tax system.
Environmental regulation in the context of an open economy involves a more complex process of
welfare consequences than previous contributions, based on closed economies.

1.5 Applying market structure specifications in manufacturing

In economics, market structures can be understood well by closely examining an array of factors
or features exhibited by different players. It is common to differentiate these markets across the
following seven distinct features.

• The industry’s buyer structure

• The turnover of customers
• The extent of product differentiation
• The nature of costs of inputs
• The number of players in the market
• The largest player’s market share
1.5.1 Firms in competitive market
A competitive firm can keep increasing its output without affecting the market price. So, each
one-unit increase in Q causes revenue to rise by P.A competitive market, sometimes called a
perfectly competitive market has two characteristics:
1. There are many buyers and many sellers in the market
2. The goods offered by the various sellers are largely the same
1.5.2 Firms Competition and Market Structure
1. Perfect Competition
Perfect competition occurs when there is a large number of small companies competing against
each other. They sell similar products (homogeneous), lack price influence over the
commodities, and are free to enter or exit the market.
No incentive for innovation: In the real world, if competition exists and a company holds a
dominant market share, there is a tendency to increase innovation to beat the competitors and
maintain the status quo.
There are very few barriers to entry: Any company can enter the market and start selling the
product. Therefore, incumbents must stay proactive to maintain market share.

2. Monopolistic Competition
Monopolistic competition refers to an imperfectly competitive market with the traits of both the
monopoly and competitive market. Sellers compete among themselves and can differentiate their
goods in terms of quality and branding to look different.
3. Oligopoly
An oligopoly market consists of a small number of large companies that sell differentiated or
identical products. Since there are few players in the market, their competitive strategies are
dependent on each other.
4. Monopoly
In a monopoly market, a single company represents the whole industry. It has no competitor, and
it is the sole seller of products in the entire market.