Concepts
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To introduce certain terms and concepts,
revisit
To provide a background
Concepts:
1.Firms, consumers, government
2.Demand, supply
3.Price-elasticity, makers, takers
4.Joint costs, allocation
5.Profit maximization, perfect competition
6.Business and government
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Is business +economics
What is economics: deals with-privatization,
unemployment, exchange rates, profitability,
competition……..
Concerned with production and consumption
of goods and services
Goods ( tangible products) e.g. cars, books,
food
Services( intangible products) e.g. banking,
transportation
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More precisely it deals with
◦ What goods and services societies produce
( type-cars, wine, housing, health)
◦ How they produce them
( by firms, govt assistance, govt ownership)
◦ For whom they are produced
( available for all or to those who can pay)
and
◦ How resources are allocated to do the above
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Business is exchange of goods or services for a
consideration
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Firms)
Consumers) ………Market-framework for
buyers and sellers
Government)
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A firm/business/enterprise-legally
recognized organization designed to make
goods and services
Objective-generation and receipt of financial
return for work and acceptance of risk
Different forms of business ownership-sole
proprietorship, partnership, corporation
What a firm must ask itself
◦ What it should produce
◦ How should it organize production
◦ At which segment should the output be aimed e.g.
the growth of a supermarket from a grocery shop
to a global retailer
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Issues for the firm:
◦ Source of raw materials and costs
◦ Competition
 Players
 substitutes
◦ Demand and Supply
◦ Pricing
◦ Consumers
◦ Resource allocation in a competitive market
environment
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Why are consumers important?
◦ Have the needs for which firms compete to satisfy
◦ Determine the consideration for satisfaction of
need-- price
◦ They determine way markets behave
◦ How they grow or decline
◦ How fast they change
◦ E.g. Levi Jeans blues blamed for 700 job losses!
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Consumer sovereignty –’consumption choices
of individuals in competitive markets
condition production patterns’.
Producers must follow lead given by
purchasing pattern of consumers
Hence consumers exercise sovereignty over
producers. E.g. environmentally friendly
products, vegan, cosmetics without animal
testing
Free market:
One in which there is no govt interferencewhat , how and for whom decided by market
forces
State intervention:
1. State may be a producer- with or instead of
firms
2. State may not produce but regulate e.g.
empowerment of health inspectors for
hotels
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Firms
Free market
Consumer
Firms
Market
Govt
Consumer
Business firm
Market
Govt as regulator
Consumers
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Price
Costs
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Fixed costs
Variable costs
Marginal costs
Average costs
Long term costs
Short term costs
Joint costs
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Revenues
◦ Total revenues
◦ Marginal revenue
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Profits
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Quantity demanded: The amount of a good or
service that consumers wish to purchase at a
particular price. ( assuming all other
influences are constant)
Factors influencing demand-substitutes,
consumer preferences, complements ( CD
and player)
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The price of the product in question.
The income available to the household.
The household’s amount of accumulated
wealth.
The prices of related products available to
the household.
The household’s tastes and preferences.
The household’s expectations about future
income, wealth, and prices.
ANNA'S DEMAND
SCHEDULE FOR
TELEPHONE CALLS
PRICE
(PER
CALL)
$
0
0.50
3.50
7.00
10.00
15.00
QUANTITY
DEMANDED
(CALLS PER
MONTH)
30
25
7
3
1
0
The law of demand states that there is a
negative, or inverse, relationship between
price and the quantity of a good demanded
and its price
This means that demand curves slope
downward
• Changes in determinants of demand,
other than price, cause a change in
demand, or a shift of the entire demand
curve, from DA to DB.
• Summarize:
• 1.Change in price leads to movement
along curve
• 2.Change in income, tastes, substitutes
leads to shift of curve
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Quantity supplied is the amount that firms
wish to sell at a particular price
Factors influencing supply: price, Input costs
( decrease in cost of beans, tins etc will
increase supply of baked beans ) technology
( Henry Ford’s introduction of mechanized
assembly line reduced cost of car production)
PRICE
(PER
BUSHEL)
$
2
1.75
2.25
3.00
4.00
5.00
QUANTITY
SUPPLIED
(THOUSANDS
OF BUSHELS
PER YEAR)
0
10
20
30
45
45
Price of soybeans per bushel ($)
CLARENCE BROWN'S
SUPPLY SCHEDULE
FOR SOYBEANS
6
5
4
3
2
1
0
0
10
20
30
40
Thousands of bushels of soybeans
produced per year
50
• When supply shifts to the right, supply
increases. This causes quantity
supplied to be greater than it was prior
to the shift, for each and every price
level.
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The operation of the market depends on the
interaction between buyers and sellers.
An equilibrium is the condition that exists
when quantity supplied and quantity
demanded are equal.
At equilibrium, there is no tendency for the
market price to change.
• At Po the wishes of buyers
and sellers coincide.
• In equilibrium the quantity
demanded and quantity
supplied are equal
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Price takers are firms that are forced to
accept the market price when selling goods
and service. Accept prices set by demand and
supply. E.g. firms small wrt market size
Price makers determine their own price. E.g. a
monopoly
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“Elasticity of demand may be defined as the ratio of the
percentage change in demand to the percentage change in
price.”
We measure the degree of price elasticity with
the coefficient Ed
Ed = Percentage change in Quantity demanded /
Percentage change in price
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Demand is elastic if a specific percentage
change in price results in a larger
percentage
change
in
quantity
demanded.e.g luxury goods. Ed>1
If a specific percentage change in price
produces a smaller percentage change in
quantity demanded, demand is inelastic.
Ed<1e.g. necessities
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Elastic demand
Demand is elastic if a
specific percentage change
in price results in a larger
percentage change in
quantity demanded
P
Ed = 0.4/0.2 = 2
Ed > 1
Examples include luxuries
O
Q
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Inelastic Demand
If a specific percentage
change in price produces a
smaller percentage change
in quantity demanded,
demand is inelastic
Ed = 0.1/0.2 = 0.5
Ed < 1
Examples include Necessities
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Perfectly Elastic
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Perfectly inelastic
◦ Ed = infinity
◦ Ed = 0
◦ Quantity demanded
changes without any
change in price
◦ Change in price brings no
change in Quantity
demanded
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Number of substitutes-Larger the number of substitutes,
higher the price elasticity of demand and vice versa
Proportion of income
Higher the price of good relative to consumers’ income
greater the price elasticity of demand and vice versa
Luxuries and Necessities
The more a good is considered to be a “luxury” rather
than a “Necessity” the greater is the price elasticity of demand
Time
Product demand is more elastic the longer the time
period under consideration e.g newspapers
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Characteristics: A common manufacturing
process produces simultaneously two or more
products from common input
Joint costs-costs of the common
manufacturing process
Joint Products-products from a common –
input and manufacturing process
Split –off point-the stage in manufacturing
where joint products are separated
Cost allocation
Firms maximize profit when:
Cost of producing last unit (MC) is equal to
revenue generated by sale of last unit (MR)
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Many (small) firms, producing a homogeneous (identical)
product, none of which having an impact on the price; each
firm's product is non-distinguishable from other firms'
product.
b. Many buyers none of whom having any effect on the
price.
c. No barriers to entry and exit: in the long run firms can
shut down and leave the industry or new firms can come
into the industry freely.
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d. No interference in the market process: No price control or
restrictions on production
e. All firms have equal and complete access to the available
inputs (input markets) and production technology; all firms
have the same production and cost functions.
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f. All sellers and buyers have perfect information about the
market conditions.
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g. Making above-normal profits by existing firms will result
in new entries into the industry. Firms that have losses shut
down and leave the industry in the long run.
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In real markets, monopoly & oligopoly
undermine consumer sovereignty
Inimical to consumer interests
Rationale for govt intervention in markets
Business therefore has various relationships
with govt
Arises when the market either fails to provide
certain goods or fails to provide them at their
optimum or most desirable level
 As per economic theory 3 kinds of market
failures:
1. Monopoly
2. Public Goods
3. Externalities
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May distort functioning of market
Government may limit commercial freedom
E.g. The case of Walls and competition
commission
Assume ownership by nationalization
Defined as one that once produced can be
consumed by everyone e.g. street lighting
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Characteristics:
1. Non rival in consumption ( use does not
diminish supply)
2. Non excludable
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Other e.gs. National defence, justice
system, roads
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Private Good-One that is wholly consumed by
an individual e.g. a can of beer, a seat in a
theatre
The goods/service are comprehensively and
exclusively used up
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Costs incurred or benefits received by other
members of society not taken into account by
producers and consumers
Third –party effects
Negative externalities e.g. environmental
pollution, animal testing for cosmetics,
development control ( Case of Manchester
Airport)
Arises when a private transaction produces
unintended benefits for economic agents who
are not party to it
 Problem?
1. Occur at the discretion of individuals as
private transactions
2. Some may choose not to do it
Rationale for govt intervention
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E.g. Case of Small pox eradication in 1977
 Achieved by a vaccination program of WHO
and funded by most govts
 If vaccination left to market then:
1. Balancing of costs vs benefits
2. Risk of catching disease
3. Some cant afford
4. Wider benefit-vaccinated person cannot be
a carrier
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Framework in which buyers and sellers
interact
How demand and supply behave
How price reacts and why
Cost allocation
Role of government and why?