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Preliminaries
Learning Objectives
1) Gain a basic understanding of economic ways of thinking and approaching questions. 2) Be able to use simple theory to analyze real world issues. 3) Understand and be able to use the terminology of economics. 4) Understand how microeconomic principles relate to the daily decisions and activities of individuals, groups of people, businesses, and government. 5) Appreciate how economics can provide a basis for understanding how economic forces condense information used to make choices.
Microeconomic Goal
One of the goals of microeconomics is to analyze market mechanisms that establish relative prices amongst goods and services and allocation of limited resources amongst many alternative uses. Microeconomics analyzes market failure, where markets fail to produce efficient results, as well as describing the theoretical conditions needed for perfect competition. Significant fields of study in microeconomics include general equilibrium, markets under asymmetric information, choice under uncertainty and economic applications of game theory. Also considered is the elasticity of products within the market system.
17 INFORMATION SHARING
Accuracy Timeliness Reliability Decision support Control measures Motivational impact 18 INNOVATION PROCESS Problem solving styles Sources of innovation Product/service life-cycles Time-to-market
ECONOMIC CLIMATE
15
GOVERNMENT REGULATIONS Regulation/deregulation Local requirements CUSTOMER & COMPETITIVE DEMANDS Price Quality Delivery Variety Service BUSINESS ASSOCIATES Type of relationship Stability Values Risk/reward strategies TECHNOLOGY
14
PLANNING & SCHEDULING Strategic planning Operational planning Budgetting Work scheduling
19
BUSINESS PLAN Maturity of Industry Key industry trends Bases of competition Strategic thrusts
13
Departmental/Interdepartmental procedures Personnel policies Pay structure Work ethics Complaint procedures
Institutional Goals
6 9
MANAGEMENT Style, Beliefs & Attitudes Technical competence Continuity Fairness
12
EMPLOYEES/INDUSTRIALRELATIO NS
Climate/history Involvement Collective Agreement Informal practices Union Leadership EMPLOYEES Union policies Number & types Age & job tenure Knowledge & skills Supply & demand Attitude & morals Expectations Group norms Training & Development
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Microeconomics
Microeconomics is a branch of economics that studies how individuals, households and firms and some states make decisions to allocate limited resources, typically in markets where goods or services are being bought and sold. Microeconomics examines how these decisions and behaviours affect the supply and demand for goods and services, which determines prices; and how prices, in turn , determine the supply and demand of goods and services.
Preliminaries
When Consuming
When Producing
Markets:
The interaction of consumers and producers
Preliminaries
Macroeconomics, which involves the "sum total of economic activity, dealing with the issues of growth, inflation and unemployment, and with national economic policies
Preliminaries
Unemployment
Microeconomic Analysis
Theories are used to explain observed phenomena in terms of a set of basic rules and assumptions. For example
What is a Market?
Markets
A geographically defined area where buyers and sellers interact to determine the price of a product or a set of products. Industries are the supply side of the market.
What is a Market?
Competitive Markets
Because of the large number of buyers and sellers, no individual buyer or seller can influence the price. Example: Most agricultural markets
Noncompetitive Markets
Markets where individual producers can influence the price. Example: OPEC
What is a Market?
Market Price
Competitive markets establish one price. Noncompetitive markets may set many prices for the same product.
What is a Market?
Market Definition
Market Extent
What is a Market?
Examples
Gasoline: US vs California Housing: Chicago vs a Chicago neighborhood Gasoline: regular, super, & diesel Cameras: SLRs, point & shoot, digital
Nominal price is the absolute or current dollar price of a good or service when it is sold. Real price is the price relative to an aggregate measure of prices or constant dollar price.
Real Price
(base year = 100)
1975 1980
53.8 82.4
1985 1990
107.6 130.7
1998
163.0
Nominal Prices
Grade A Large Eggs $0.61 $0.77 $0.84 College Education $2,530 $3,403 $4,912 $0.80 $0.98 $1.04 $8,156 $12,800 $19,213 $0.29 $0.30 $2,941 $3,800 $0.25 $4,573
Observations
1. The minimum wage has been increasing in nominal terms since 1940. 2. The 1999 real minimum wage was no higher in 1999 than 1950.
What are the positive and normative issues of raising the minimum wage?
Microeconomic concepts are used by everyone to assist them in making choices as consumers and producers.
Questions
Consumer acceptance and demand Production cost Pricing strategy Risk analysis Organizational decisions Government regulation
Questions
Impact on consumers Impact on producers How to enforce the standards What are the benefits and costs?
Summary
Microeconomics is concerned with the decisions made by small economic units. Microeconomics relies heavily on the use of theory and models.
Summary
Microeconomics is concerned with positive questions and normative analysis. A market refers to a collection of buyers and sellers who interact and to the possibility for sales and purchases that results from that interaction.
Summary
The market price is established by the interaction of buyers and sellers. A markets geographic boundaries and range of products must be defined. To eliminate the effects of inflation we measure real prices, rather than nominal prices.
The Marketplace
Any place where buyers and sellers come together and freely decide what goods and services to buy and sell.
Demandhow people in the marketplace decide what to buy and at what price. Supplyhow producers in the marketplace decide what to sell and at what price. Voluntary Exchangetogether the decisions on what to sell, what to buy, when to buy, and how much to buy of an item.
Demandrepresents all of the different quantities of a good or service that consumers will purchase at various prices. Law of Demand
As prices go up, quantity demanded goes down. As prices go down, quantity demanded goes up.
Real Income EffectThe consumer cant keep buying something when the price goes up and income stays the same.
The lesson of the income effect is that there is nominal income (what you're paid), and real income (the basket of goods and services that you can buy with what you're paid). And a corollary is that when prices of different items in your real income change, this constitutes a change in income. This is because you must now choose (opportunity cost here) how to adjust your basket of goods and services. If the price of one item in the basket goes up, you have some basic options:
1) Buy less of the item in question this is because you can now get fewer units for the same amount of nominal income. 2) Buy the same amount, but because you must spend more nominal income to get the same quantity of the good in question, you will have to buy less of something else. 3) Buy the same amount of everything, but borrow against future spending/consumption to pay for current consumption (go into debt). 4) Some combination of above.
Substitution Effect
Substitution EffectThe concept that if two items are comparable in satisfying the same need and one price goes up, consumers will buy the other.
Example:
Going to and renting movies are priced the same. The price of going to a movie goes up. The demand for renting a movie will now go up
while the demand for going to movies will go down.
Based on utility consumers decide what to buy and how much to pay for it.
Marginal Utilitydefines the additional amount of satisfaction that a consumer receives upon additional use of a good or service. Law of Diminishing Marginal UtilityThis rule states that the additional satisfaction a consumer gets from purchasing one more unit of a product will lessen with each additional unit purchased.
For example, say you go to a buffet and the first plate of food you eat is very good. On a scale of ten you would give it a ten. Now your hunger has been somewhat tamed, but you get another full plate of food. Since you're not as hungry, your enjoyment rates at a seven at best. Most people would stop before their utility drops even more, but say you go back to eat a third full plate of food and your utility drops even more to a three. If you kept eating, you would eventually reach a point at which your eating makes you sick, providing dissatisfaction, or 'disutility'.
Demand Schedule
Economists track the quantities demanded at different prices by forming a demand schedule
Demand Curve
A graph that is formed using the data from the demand schedule
Changes in Population when population increases, opportunities to buy and sell increase. Changes in Income Changes in taste and preferenceswhat people like and prefer to choose. Substitutes Complementary Goodsa product often used with another product. (Film and Cameras)
Elasticity
Elastic Demandsituation in which the rise or fall in a products price greatly impacts the willingness to buy. Inelastic Demandsituation in which the rise or fall of a products price has little impact on the willingness to buy.
Supply
The willingness and ability of producers to provide goods and services at different prices in the marketplace.
As the price rises for a good, the quantity supplied generally rises. As the price falls, the quantity supplied also falls.
Like the demand schedule and demand curve, there is also a supply schedule that charts the data of supplies and a supply curve that graphs these supply findings.
Price of inputsraw materials and wages mainly Number of firms in the industrymore firms, more quantity supplied. Taxesbusinesses are normally taxed on the amount of supply they produce Technologycreating new methods to produce supply.
As more units of a factor of production (labor) are added to other factors (equipment), the total output continues to increase at a diminishing rate.
What do Cabbage Patch Kids, Tickle Me Elmo, Beanie Babies, and Furbys all have in common?
were all in short supply. Shortages occur when quantity demanded exceeds quantity supplied at the current price.
What is the perfect price to charge for an item and yet keep it in supply?
Equilibrium Price
The price where the quantity demanded and the quantity supplied are equal and intersect on a graph. The price will shift constantly depending on the amount of demand
Demand goes up, price generally goes up. Demand goes down, price generally goes down.
Shortages (demand is greater than supply) and surpluses (supply is greater than demand) are attempted to be controlled by businesses in order to stabilize the price.
Equilibrium Price
The government may have to resort to rationing (distributing) goods. Finally, the government has laws to try to control the black market.
The illegal underground activity of selling a good for far above its designed price. A legal minimum price that can be charged for a good.
Chapter 3
Market Structures
Market Structure
The number of firms in the industry The nature of the product produced The degree of monopoly power each firm has The degree to which the firm can influence price Profit levels Firms behaviour pricing strategies, non-price competition, output levels The extent of barriers to entry The impact on efficiency
Market Structure
Perfect Competition Pure Monopoly
Market Structure
Perfect Competition Pure Monopoly
Market Structure
Perfect Competition Pure Monopoly
Monopolistic Competition
Oligopoly
Duopoly Monopoly
The further right on the scale, the greater the degree of monopoly power exercised by the firm.
Market Structure
Importance: Degree of competition affects the consumer will it benefit the consumer or not? Impacts on the performance and behaviour of the company/companies involved
Market Structure
Market structure deals with a number of economic models These models are a representation of reality to help us to understand what may be happening in real life There are extremes to the model that are unlikely to occur in reality They still have value as they enable us to draw comparisons and contrasts with what is observed in reality Models help therefore in analysing and evaluating they offer a benchmark
Market Structure
Number and size of firms that make up the industry Control over price or output Freedom of entry and exit from the industry Nature of the product degree of homogeneity (similarity) of the products in the industry (extent to which products can be regarded as substitutes for each other) Diagrammatic representation the shape of the demand curve, etc.
Market Structure
Characteristics: Look at these everyday products what type of market structure are the producers of these products operating in?
Electric Remember to Guitar think about the Jazz Body nature of the
product, entry and exit, behaviour of the firms, number and size of the firms in the industry. You might even have to ask what the industry is??
Bananas
Perfect Competition
Large number of firms Products are homogenous (identical) consumer has no reason to express a preference for any firm Freedom of entry and exit into and out of the industry Firms are price takers have no control over the price they charge for their product Each producer supplies a very small proportion of total industry output Consumers and producers have perfect knowledge about the market
Diagrammatic representation
Cost/Revenue
Perfect Competition
MC AC
Given The average The the MC industry assumption is the cost cost price curve of of is profit is the AtThe this output the firm maximisation, standard producing determined U additional the shaped by firm the produces curve. demand is making normal profit. at MC an (marginal) cuts output and supply the where AC units of curve MC of the output. industry = at MR its It This is a long run (Q1). lowest falls as This at point a first whole. output because (due level The to firm the of is a the law is a of fraction mathematical diminishing very of the small total relationship returns) supplier industry then within equilibrium position. rises supply. between asthe output industry marginal rises. and and has average no values. control over price. They will sell each extra unit for the same price. Price therefore = MR and AR
P = MR = AR
Q1
Output/Sales
Perfect Competition
Diagrammatic representation
Cost/Revenue
MC MC1 AC AC1
Because the model assumes perfect knowledge, the firm Nowlower The Average assume and ACMarginal a and firm MC makes costs would gains the advantage for some that imply could be form expected the of modification firm is tonow be only lower to a short time before others copy its product earning but price, abnormal in or the gains short profit some run, form the idea or are attracted the of cost advantage (AR>AC) remains the represented same.(sayby ato new the industry by method). the existence of production grey area. What abnormal profit. If new firms would happen? enter the industry, supply will increase, price will fall and the firm will be left making normal profit once again.
AC1
Abnormal profit
P = MR = AR P1 = MR1 = AR1
Q1
Q2
Output/Sales
Where the conditions of perfect competition do not hold, imperfect competition will exist Varying degrees of imperfection give rise to varying market structures Monopolistic competition is one of these not to be confused with monopoly!
Characteristics:
Large number of firms in the industry May have some element of control over price due to the fact that they are able to differentiate their product in some way from their rivals products are therefore close, but not perfect, substitutes Entry and exit from the industry is relatively easy few barriers to entry and exit Consumer and producer knowledge imperfect
MC AC
1.00
Abnormal Profit
0.60
We Marginal assume Cost that and the firm This IfSince The the is demand firm a the short produces additional run curve equilibrium Q1 facing and produces Average where Cost will MR be = MC the position sells the firm revenue each for will received a unit firm be for downward in1.00 from a on (profit same maximising shape. However, output). monopolistic average sloping each unit with and sold market represents the falls, costthe (on the At because this output the level, products AR>AC structure. average) AR MR earned curve for lies from each under sales. unit the being and are the differentiated firm in 40p x 60p, AR curve. the firmmakes will make abnormal some way, profit the (the firm grey will Q1 in abnormal profit. shaded only be area). able to sell extra output by lowering price.
MR
Q1
D (AR)
Output / Sales
MC AC
Because there is relative freedom of entry and exit into the market, new firms will enter encouraged by the existence of abnormal profits. New entrants will increase supply causing price to fall. As price falls, the AR and MR curves shift inwards as revenue from each sale is now less.
MR1
Q1
MR
AR1
D (AR)
Output / Sales
MC AC
AR = AC
Notice that the existence of more substitutes makes the new AR (D) curve more price elastic. The firm reduces output to a point where MC = MR (Q2). At this output AR = AC and the firm will make normal profit.
MR1
Q2 Q1
MR
AR1
D (AR)
Output / Sales
MC AC
AR = AC
MR1
Q2
AR1
Output / Sales
Some important points about monopolistic competition: May reflect a wide range of markets Not just one point on a scale reflects many degrees of imperfection Examples?
Restaurants Plumbers/electricians/local builders Solicitors Private schools Plant hire firms Insurance brokers Health clubs Hairdressers Funeral directors Estate agents Damp proofing control firms
In each case there are many firms in the industry Each can try to differentiate its product in some way Entry and exit to the industry is relatively free Consumers and producers do not have perfect knowledge of the market the market may indeed be relatively localised. Can you imagine trying to search out the details, prices, reliability, quality of service, etc for every plumber in the UK in the event of an emergency??
Oligopoly
May be a large number of firms in the industry but the industry is dominated by a small number of very large producers
Concentration Ratio the proportion of total market sales (share) held by the top 3,4,5, etc firms:
A 4 firm concentration ratio of 75% means the top 4 firms account for 75% of all the sales in the industry
Oligopoly
The music industry has a 5-firm concentration ratio of 75%. Independents make up 25% of the market but there could be many thousands of firms that make up this independents group. An oligopolistic market structure therefore may have many firms in the industry but it is dominated by a few large sellers.
Oligopoly
Price
Oligopoly
The kinked demand curve - an explanation for price stability? The Assume If The the firm principle firm the therefore, seeks firm ofto is the lower charging effectively kinked its price demand a faces price to of 5 gain a kinked and a curve competitive producing demand rests on an curve advantage, the output principle forcing of 100. its it rivals to will follow maintain that: asuit. stable Any orgains rigid pricing it makes will If it chose to raise price above 5, its quickly beOligopolistic structure. lost and the firms % change may in rivals a. would If a firm not raises follow its suit price, andits the firm demand will overcome this beby smaller engaging thanin the non% effectively rivals faces will not an follow elasticsuit demand reduction price competition. in price total revenue curve for its product (consumers would would b. If again a firm fall lowers as the its firm price, now its faces buy from the cheaper rivals). The % a relatively rivalsinelastic will all do demand the same curve. change in demand would be greater than the % change in price and TR would fall.
Total Revenue B
Total Revenue A
Total Revenue B
100
Kinked D Curve
D = elastic
D = Inelastic
Quantity
Duopoly
Collusion may be a possible feature Price leadership by the larger of the two firms may exist the smaller firm follows the price lead of the larger one Highly interdependent High barriers to entry Cournot Model French economist analysed duopoly suggested long run equilibrium would see equal market share and normal profit made In reality, local duopolies may exist
Monopoly
Pure monopoly where only one producer exists in the industry In reality, rarely exists always some form of substitute available! Monopoly exists, therefore, where one firm dominates the market Firms may be investigated for examples of monopoly power when market share exceeds 25% Use term monopoly power with care!
Monopoly
Monopoly power refers to cases where firms influence the market in some way through their behaviour determined by the degree of concentration in the industry
Influencing prices Influencing output Erecting barriers to entry Pricing strategies to prevent or stifle competition May not pursue profit maximisation encourages unwanted entrants to the market Sometimes seen as a case of market failure
Monopoly
Origins of monopoly:
Monopoly
Price could be deemed too high, may be set to destroy competition (destroyer or predatory pricing), price discrimination possible. Efficiency could be inefficient due to lack of competition (X- inefficiency) or
Monopoly
Innovation - could be high because of the promise of high profits, Possibly encourages high investment in research and development (R&D) Collusion possible to maintain monopoly power of key firms in industry High levels of branding, advertising and non-price competition
Monopoly
Often difficult to distinguish between a monopoly and an oligopoly both may exhibit behaviour that reflects monopoly power Monopolies and oligopolies do not necessarily aim for traditional assumption of profit maximisation Degree of contestability of the market may influence behaviour Monopolies not always bad may be desirable in some cases but may need strong regulation Monopolies do not have to be big could exist locally
Monopoly
Costs / Revenue
MC
7.00
Monopoly Profit
3.00
AC
This AR Given (D) isthe both curve barriers the forshort a to monopolist entry, run and likely the long monopolist run to be equilibrium relatively will be position price able to inelastic. exploit for a monopoly abnormal Output assumed profits in the to be atrun long profit as maximising entry to the output (note caution market is restricted. here not all monopolists may aim for profit maximisation!)
MR
Q1
AR
Output / Sales
Monopoly
Costs / Revenue
MR
Q2 Q1
AR
Output / Sales
Contestable Markets
Theory developed by William J. Baumol, John Panzar and Robert Willig (1982) Helped to fill important gaps in market structure theory Perfectly contestable market the pure form not common in reality but a benchmark to explain firms behaviours
Contestable Markets
Key characteristics:
Firms behaviour influenced by the threat of new entrants to the industry No barriers to entry or exit No sunk costs Firms may deliberately limit profits made to discourage new entrants entry limit pricing Firms may attempt to erect artificial barriers to entry e.g
Contestable Markets
Over capacity provides the opportunity to flood the market and drive down price in the event of a threat of entry Aggressive marketing and branding strategies to tighten up the market Potential for predatory or destroyer pricing Find ways of reducing costs and increasing efficiency to gain competitive advantage
Contestable Markets
Hit and Run tactics enter the industry, take the profit and get out quickly (possible because of the freedom of entry and exit) Cream-skimming identifying parts of the market that are high in value added and exploiting those markets
PMA
Make a study of market structures in Malaysia with any company of your interest.