 The third and the last module for this course will be on economics and before I enter into the finer details of what I would be handling in this third module I would like to first confess that I am not a trained economist myself as I told you in the beginning of the class the very purpose of this course is to give you a very basic understanding of how much as engineers you should understand you should know what is happening in the business ecosystem outside it is with that perspective that this entire course has been designed and the inputs that I have given so far in accounting in strategy are in my opinion enough for you to survive an interesting conversation with your leadership team and that is the very purpose as I said before that this entire course has been designed in the same perspective the discussions that we are going to have on this third module on economics will be enough for you to traverse the the contours of the economic landscape and a little bit try to delve into some finer details of some concepts. Now while we are attempting to do this at the end of this module you will begin to appreciate the various terminologies that you often hear from economists or you watch people in debates in either in television channels or when you read newspapers financial newspapers like economic times or others you will begin to appreciate the various popularly used terminologies like GDP inflation interest rate macroeconomics and microeconomic variables so with that in mind the remaining classes I will be giving you some inputs on the fundamentals of economics so that you can appreciate various nuances various decision making at the policy level why certain decisions are being taken this in a particular way so that you begin to understand the decision making mind behind the policy makers now with that perspective I will just give you an outline of what I am planning to cover in this particular course first I will try to give you an understanding of some basic economic definitions and then what constitutes a market or what constitutes a society in which a market plays a very crucial role and the economic fundamentals which drive markets some of the economic sectors which are critical in strengthening a nation's output and how is that a nation's output is measured by way of some quantifiable indicators and how that a nation's output can grow or how nation's output contract the consequences of growth as well as contraction and how this is all linked to an academic theory that governs the law of supply and demand and if this law of supply and demand is going to govern the very fundamentals of economics who is responsible for controlling the supply and demand and how is that the supply and demand is being controlled either by a fiscal policy or a monetary policy if it is fiscal policy what are the economic variables that are altered if it is monetary policy what are the economic variables that are altered and in the even that various economic variables are altered what happens into the in the economic ecosystem the inter relationship with between various variables now if we are able to understand this entire spectrum then you will begin to appreciate the nuances of economics for the very limited purpose of understanding various decisions that are taken in the economic realms so let us first begin this discussion by giving you a very very broad definition of what economics is now economics to put it in a very simple form the theoretical definition of economics there are plenty but to put it in a very simple understandable manner economics is a study that understands the behavior of society in its managing the scarce resources that are available in the society so it is a study of how society manages its scarce resources now there are two important terms that you will have to understand here the scarcity and secondly what constitutes the society let us begin with scarcity scarcity I viewed as a tension between the limited resources that are available and the unlimited wants and needs of the end user of such resources now the society constitutes various stakeholders for an individual the resources that are limited is the time the money that is or the skills that the individual possesses and for nations the resources that are limited could be the natural resources that the nation is endowed with the capital the technology the labor that is available in a country so these are various resources either at the individual level or at the nation's level but all of them are available only to a limited extent now when resources are available only within a limited extent then there arises a trade-off it is the willingness of the end user to forego an alternate opportunity that actually forms the basis on which such scarce resources are allocated now different individuals different nations have different priorities and this priority differences is the key for allocation of limited resources suppose I am I have an opportunity to buy two VCDs as against one Blu-ray DVD now I have to take a decision whether I have to forego the opportunity of owning extra one VCD which could be poor quality so that I buy only one Blu-ray DVD for a higher price so that I have one movie of very superior quality now extending this at various levels the willingness of individuals different types of individuals the willingness of nations and different types of nations to forego on alternate opportunities that are available is the one that forms the underlying basis on which various resources are allocated so a society at large behaves in different ways and how the society behaves when it comes to managing these scarce resources that are available what are the variables within a society that determines the behavior of the society as a result of which resources get allocated and if there is a scientific empirical way that can define these relationships then this scientific study is economics as a subject by itself by a society I meant individuals as well as nations if you take the fundamental economic unit I would say that an individual is the fundamental economic unit it is an individual or a group of individuals that constitute a household a group of households constitute a neighborhood a group of neighborhoods constitute a community a group of communities constitute a bigger town a group of towns constitute bigger cities a group of cities to states and a group of states constitute a nation so it is these aggregation of small economic units beginning from an individual and then growing into bigger size economic units and aggregation of these economic units constitute a nation's economy the way in which we would understand the behavior of these economic units constitutes two popular fragments of economics one could be the macroeconomic understanding the other could be understanding economics from a microeconomic point of view now macroeconomics it looks at the total output of a nation and how a nation is able to allocate the resources that it has the limited resources like land labor capital technology whatever it is how a nation is able to allocate such resources constitutes macroeconomics on the other hand microeconomics also looks into the very similar issues of allocation of resources but at a very limited level a level limited to that of an individual or of small business firms within an economy so whether it is macroeconomics or microeconomics it is the understanding of how any of these economic units is able to allocate the limited resources that is available on hand is important the why and how these allocation of scarce resources can be done constitutes the economic theories that have governed the functioning of nations and these theories have a lot of history behind it but fundamentally there are two ways in which a nation puts its economic principles in place one could be driven by market economies the other could be driven by command economies by market economies I mean a nation which is capitalist in its thinking which believes that there is something called a free hand an unseen hand that operates behind the market and it is the market forces left to themselves that govern the law of supply and demand whereas command economies on the other hand believes that an efficient market should not be left to the total should not be left independent of market forces to decide on its functioning but it is the government that actually has to decide on the allocation of these resources so that explains two popular theories whether it is the Adam Smiths capitalist theory or the Marxian communist theory and different countries have embraced these two different options and today you might on hindsight feel that the collapse of Russia or Eastern Europe for that matter or some parts of North Korea which embraced these command economies where the government was supreme it dictated the ways in which resources could be allocated and used and the fall of these economies signaled the success of a capitalist driven society a capitalist driven society that you could see in advanced economies like the USA or UK or Australia which embraces this market economies and after 2008 another alternate theory is emerging as a substitute to these market economies because the feeling is that market economies themselves have not proven to be successful though it is not accepted but this is the general feeling that people have begin to have now my opinion if I am not digressing is whether it is market economies or command economies it is only the nature of ownership that is different both the economies strive hard to allocate capital and in the process add economic value it is only the ownership that actually differs and that is why I always believe that these two economies are two phases of the same coin in a market economy the ownership is diverse whereas in a command economy the government owns the assets other than this both these economies try to achieve economic value by allocating capital so you must understand that different nations have different theories of economies based on which they allocate capital either allowing market forces to determine the allocation or it is the government that actually regulates and allocates these resources now let us begin to understand the fundamentals of economics and I would like to give this understanding by providing a framework or I call a mind map that will describe the various variables in our economic system and try to understand the interrelationships of these variables now I will just begin by giving you a small mind map so that you will be able to understand this better now I will begin describing these interconnected actions by having somebody called the economic man in the middle of the economic ecosystem let us understand the three interrelated actions of the economic man who forms the center of the economic ecosystem so if an economic man forms a center of an economic ecosystem it is this man who actually produces the goods and services the production of goods and services is done by the economic man production of goods and services the economic man creates an economic value from this production the economic man earns income by income I mean the value for which others are willing to pay him so this constitutes the earning power of the economic man so he earns income because of the willingness of others to pay for the economic value that the economic man creates from his income he spends for his needs and wants as a result of which there is an expenditure an expenditure because he spends from the income and it is this expenditure that actually stimulates production so his spending in turn stimulates production so the expenditure stimulates production so beginning from the production that provides income and this income is the one that finances the expenditure and the expenditure stimulate the production quick recap so it is the economic man who produces the goods and services and it is from the production he earns the income and from this income he spends for his needs and this expenditure further stimulates more production so what is this what does this mean for us to understand it means that an economic man has to be more productive and in the process has to create more economic value so that he can earn more and he can spend more in terms of better infrastructure better education better healthcare better food and overall improve his quality of life and at the policy making level we must understand that it is the generation of economic value and in the process creating higher incomes through higher productivity is the key for nations to reduce the poverty levels so at the policy making level we need to understand that we need to generate economic value and also drive higher productivity that gives higher income so any public policy any economic public policy must be to enhance such productivity levels now we will just try to expand the understanding of the economic man by just trying to add some more into this basic economic model that we saw earlier it is a common understanding that local production is insufficient to meet local needs so we actually import to support material goods for production and also to get more goods for conception because the local production is not enough to meet local demand so this total supply can now be split into two parts the local production plus imports because it is this imports that actually expand supply and similarly if suppose the local income that I get is not able to finance the expenditure that is involved then other external financing mechanisms foreign financing mechanisms will supplement local income to finance these expenditures so local income plus foreign finance and just as you have imports to supplement the local production we also have exports that cater to outside demand so you have a local demand and exports so now we understand that imports expand the total supply that is available and then foreign financing supplements local income so that you could finance additional expenditure and then exports expand the demand and when demand is expanded the market for products also gets expanded so this takes the fundamental economic model into the next stage where it is expanded to include imports and exports the other form of expansion that is happening which is very visible nowadays is the effect of globalization now again if we view this from the model that we just saw before it just means that we are trying to globalization means that we are linking a country's economy with that of the entire world as a result of which we create high levels of export high levels of import and free movement of capital since we are talking about supply demand as well as financing it means globally interconnected imports globally interconnected financing and globally interconnected exports now this expansion through globalization results in a supply that is interconnected globally incomes again that are interconnected globally and markets that are interconnected globally so this becomes a global supply source so this expands supply and production because now we are sourcing materials from various countries because we are now viewing world as a market and here greater incomes and better financing capacity due to availability because now a global capital market exists where access to finance actually transgresses national boundaries as a result of which the markets also expand globally markets are global so the expansion of markets through exports the widening of the resource base through imports and the increase in financing through foreign capital outflows inflows allows incomes to grow as well now this economic model which started from a fundamental level to reach to a global level is for the understanding that there are three important ingredients namely the supply which is viewed as production the income and the markets which is viewed as the demand so when markets keep expanding because of this globalization imports increase exports increase and there is movement of capital as well now what creates these markets how do we understand the details of this economic model where is the market created is it in the services is it in the industry or is it in the agriculture or is it just in the imports or just in the exports now to understand these concepts at a finer level we should understand that the production or the supply or the expenditure or the demand or the incomes have amongst themselves different ingredients that constitute the production or supply or the expenditures or the demand or the incomes so if we want to break down the economic model into finer details you will understand that the production or supply is driven by three main sectors the agriculture the industry services as well as imports and the expenditure or demand comes from the consumption or the investments and the government spending and exports and incomes again coming from the savings that we make again consumption driven or the taxes that the government gets its income from and also foreign supplemental incomes if we just begin to split this so as I said the production or the supply will have agriculture will have industry will have services and imports and expenditure or demand and expenditure represents the demand for goods or services and they can be classified as expenditures for they can be classified as expenditures for consumption expenditures for investment government spending or exports exports represents expenditures by foreigners when they buy our products and services and then lastly the incomes which is again through consumption through taxes when domestic incomes are insufficient to finance expenditures then you have foreign financing and domestic savings so when domestic savings are inadequate to finance expenditures you have foreign financing and in the process if you find that the imports are greater than the total exports then the country spending more than what it is earning internationally so that is why you have a trade deficit or a current account deficit when actually the imports is more than the exports so all this put together let us understand the total economic model where again beginning with the economic man the center production or supply which constitutes mainly driven by agriculture industry services as a result of which there is conception there is savings and income derived from taxes not only domestic savings you also have foreign savings which drives expenditure that creates demand which is conception driven or gives rise to investments government spend or exports now we will begin understanding this first you should understand that it is this investment that expands production capacity so it is investment that expands production and countries with high investment rates tend to grow faster and then the savings is the one that finances investments so private savings basically finance private investments and a high savings rate is needed to support a high investment rate but in addition to these domestic savings we also have the foreign savings either through loans equities or grant aids so foreign savings will be needed if domestic savings are not sufficient to finance domestic investments and in addition to this you also have the taxes from government that finance government expenditure when taxes are insufficient to finance the government expenditure the government draws on domestic private savings and when this happens it is crowding out of capital actually it crowds out private borrowers from getting access to capital and or even it draws on foreign savings as well when the taxes are inadequate to fund to finance the government expenditure so if you look at a total economic model that I just draw here drew here you will understand that it is the investments that expand the production capacity and countries with higher investment rate tend to grow faster and the private savings actually constitute the source for private investment and economies that incentivize savings so that there is more savings will have higher investment rates and if that is inadequate there is also access through foreign savings and government expenditure is taken care by taxes that actually finance government expenditure and when taxes are insufficient to meet government expenditure then the government also accesses finance from the domestic savings as a result of which it crowds out private borrowers because it is private borrowers plus government again trying to fight for a capital from the domestic savings so this is the total economic model and all this is done to create a supply to produce output either in the agriculture or the industry or the services or it is also through imports now all of this has to be measured in some form or the other now these measurements the agriculture output or the industry output or the services output they have to be quantified and the extent to which they are quantified determines the strength of a nation's output and it is this nations output that forms the heart of macroeconomics now the total economic model that we saw in itself certain amount of goods and services and the extent to which a country can produce these goods and services constitutes the budget constraints of the country and we need to understand that nation economies must produce volumes of output and that is more important than large quantities of money a layman thinks that you can print more money and make everybody millionaires but without creating additional output mere printing of currency does not serve the economy any good it is the national output that is measured by the large volumes that is being created that characterizes a nation's strength so we need to understand that we need to measure a nation's output how do we measure a nation's output how is that the output that comes from the agriculture or the industry or the services sector can be quantified and these can come in the form of tangible goods or services that the end user uses and all of this needs to be quantified and the extent to which a nation's output is quantified determines the economic strength of a nation nations with higher output will have a higher quantifying indicator nations with lower volumes of output will have a lower measure of this national output then what constitutes the national output is what we will be seeing in next class and this is commonly referred to as the gross domestic produce of a country of a nation and we call this as the GDP so the GDP of a nation is very important because it is that GDP which actually measures the economic strength of a nation and there are different ways of calculating the GDP and we need to understand at the very fundamental level what is GDP why is it important and how is it calculated understanding GDP how it is calculated and what constitutes the economic flow that is used to calculate the GDP these three are very important to understand the national output as measured by its GDP we will see this in the next class thank you.