Business Economics

1. Business Economics Concepts

2. Objectives • To introduce certain terms and concepts, revisit • To provide a background • Concepts: • Firms, consumers, government • Demand, supply • Price-elasticity, makers, takers • Joint costs, allocation • Profit maximization, perfect competition • Business and government

3. Business economics • 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

4. 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

5. Influences on resource allocation • Firms) • Consumers) ………Market-framework for buyers and sellers • Government)

6. Role of firms • 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

7. Role of firms 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

8. Role of firms • 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

9. Role of consumers • 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!

10. Role of consumers • 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

11. Role of government in markets • Free market: One in which there is no govt interference-what , how and for whom decided by market forces State intervention: • State may be a producer- with or instead of firms • State may not produce but regulate e.g. empowerment of health inspectors for hotels

12. Role of govt in markets Firms Free market Consumer Firms Market Consumer Govt

13. Role of govt…… Business firm Market Consumers Govt as regulator

14. Definitions • Price • Costs • Fixed costs • Variable costs • Marginal costs • Average costs • Long term costs • Short term costs • Joint costs

15. Definitions • Revenues • Total revenues • Marginal revenue • Profits

16. Demand and Supply • 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)

17. Determinants of Household Demand • 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.

18. The Demand Curve

19. The Law of Demand 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

20. Shift of Demand Versus Movement Along a Demand Curve • 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

21. Firms and Supply • 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)

22. The supply curve

23. A Change in Supply Versusa Change in Quantity Supplied • 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.

24. TheMarket Equilibrium • 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.

25. Market Equilibrium • At Po the wishes of buyers • and sellers coincide. • In equilibrium the quantity demanded and quantity supplied are equal

26. Price takers & Price makers • 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

27. Price Elasticity of demand • “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

28. Price Elasticity • 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

29. 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 = 2 Ed > 1 Examples include luxuries P O Q Interpretation of Ed

30. 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 Interpretation of Ed

31. 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 Extreme cases

32. Determinants of Price Elasticity of Demand • 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

33. Joint Cost Allocation • 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

34. Profit Maximization • Firms maximize profit when: Cost of producing last unit (MC) is equal to revenue generated by sale of last unit (MR)

35. Perfect Competition • 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.

36. Perfect Competition • 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.

37. Business and Government • 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

38. Market Failure • 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: • Monopoly • Public Goods • Externalities

39. Monopoly • May distort functioning of market • Government may limit commercial freedom E.g. The case of Walls and competition commission • Assume ownership by nationalization

40. Public Goods • Defined as one that once produced can be consumed by everyone e.g. street lighting • Characteristics: • Non rival in consumption ( use does not diminish supply) • Non excludable • Other e.gs. National defence, justice system, roads

41. Private Goods • 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

42. Externalities • 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)

43. Positive Externalities • Arises when a private transaction produces unintended benefits for economic agents who are not party to it • Problem? • Occur at the discretion of individuals as private transactions • Some may choose not to do it Rationale for govt intervention

44. Externality • 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: • Balancing of costs vs benefits • Risk of catching disease • Some cant afford • Wider benefit-vaccinated person cannot be a carrier

45. Summary • Framework in which buyers and sellers interact • How demand and supply behave • How price reacts and why • Cost allocation • Role of government and why?