Concepts. To introduce certain terms and concepts, revisit To provide a background Concepts: 1.Firms, consumers, government 2.Demand, supply 3.Price-elasticity,

Concepts

To introduce certain terms and concepts, revisit

To provide a background Concepts:

1.Firms, consumers, government2.Demand, supply3.Price-elasticity, makers, takers4.Joint costs, allocation5.Profit maximization, perfect competition6.Business and government

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

Business economics

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

Business is exchange of goods or services for a consideration

Firms)

Consumers) ………Market-framework for buyers and sellers

Government)

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

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

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!

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 interference-

what , how and for whom decided by market forces

State intervention:1.State may be a producer- with or instead of

firms2.State may not produce but regulate e.g.

empowerment of health inspectors for hotels

Firms Free market Consumer

Firms

Market Consumer

Govt

Business firm Market Consumers

Govt as regulator

Definitions Price Costs

◦ Fixed costs◦ Variable costs◦ Marginal costs◦ Average costs◦ Long term costs◦ Short term costs◦ Joint costs

Definitions Revenues

◦ Total revenues◦ Marginal revenue

Profits

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)

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.

PRICE (PER

CALL)

QUANTITY DEMANDED (CALLS PER

MONTH)$ 0 30

0.50 253.50 77.00 3

10.00 115.00 0

ANNA'S DEMAND SCHEDULE FOR

TELEPHONE CALLS

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 slopeThis means that demand curves slopedownwarddownward

• Changes in determinants of demand, Changes in determinants of demand, other than price, cause a change in other than price, cause a change in demanddemand, or a , or a shiftshift of the entire demand of the entire demand curve, from curve, from DDAA to to DDBB..

• Summarize:Summarize:• 1.Change in price leads to movement 1.Change in price leads to movement

along curvealong curve• 2.Change in income, tastes, substitutes 2.Change in income, tastes, substitutes

leads to shift of curveleads to shift of curve

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)

0

1

2

3

4

5

6

0 10 20 30 40 50Thousands of bushels of soybeans

produced per year

Pri

ce o

f so

ybea

ns

per

bu

shel

($)

PRICE (PER

BUSHEL)

QUANTITY SUPPLIED

(THOUSANDS OF BUSHELS

PER YEAR)$ 2 0

1.75 102.25 203.00 304.00 455.00 45

CLARENCE BROWN'S SUPPLY SCHEDULE

FOR SOYBEANS

• 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.

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

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

“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

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

Elastic demand

Demand is elastic if a specific percentage change in price results in a larger percentage change in quantity demanded

Ed = 0.4/0.2 = 2Ed > 1

Examples include luxuries

P

O

Q

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 < 1Examples include

Necessities

Perfectly Elastic◦ Ed = infinity

◦ Quantity demanded changes without any change in price

Perfectly inelastic◦ Ed = 0

◦ Change in price brings no change in Quantity demanded

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)

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.

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.

f. All sellers and buyers have perfect information about the market conditions.

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.

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.Monopoly2.Public Goods3.Externalities

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

Characteristics:1.Non rival in consumption ( use does not

diminish supply)2.Non excludable Other e.gs. National defence, justice

system, roads

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

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 transactions2.Some may choose not to do itRationale for govt intervention

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 benefits2.Risk of catching disease3.Some cant afford4.Wider benefit-vaccinated person cannot be

a carrier

Framework in which buyers and sellers interact

How demand and supply behave How price reacts and why Cost allocation Role of government and why?