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Economics for Business Summary

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    Oil, gas, base metals, wood etc. ). – Labor is the ability to work. Capital is composed by all the elements Which take part in the production process (e. G. Machinery, computers, offices. Buildings etc. ). – Enterprise is what brings land, labor and capital together and organizes them into business units that produce goods and services with the objective of making a profit. The production possibility frontier (APP) is an important illustrative tool, showing the maximum number of products that can be produced by an economy with a given amount of resources.

    Figure 1 cars A C 50 25 x Come utters The APP shows how resources are finite. The maximum production possibility or a give country is limited, and choices have to be made in order to decide what and how much to produce (How many cars and how many computers tort example). At any point on the APP curve, the country is employing all to its resources to produce the best mix of goods and services to fit its needs. At point X not all the 1 resources are employed, thus there is a margin of improvement in terms of total output.

    Point Y represents a level of output which is not available yet but which might be achieved in the future (when more resources will be available). Opportunity costs are the benefits foregone from choosing the next best alternative. As noticeable in figure I, the country Will have to choose whether to produce more computers or cars. In case it produces more cars, the opportunity cost Will consist in the foregone benefit Of producing more computers instead. Ideally we try, when making decisions, to make the opportunity cost as low as possible.

    Macroeconomics is the study Of how the Whole economy works (e. G. At national level or the whole market for one product/service), while microeconomics is the study of how individuals make economic decisions within an economy, Macroeconomics deals with the performance, structure, behavior and decision making of the whole economy. Microeconomics is concerned with how households and firms make decisions to allocate their limited resources. In a planned economy the government is the major owner of all the factors of production and decides how resources are allocated.

    In a market economy private individuals own the majority tooth economic factors of production and the government plays no role in allocating the resources, which is done by the market itself without regulation. Most of the times is a mix of both (for example the healthcare system might be government based while the reduction of groceries will be decided by the firms in the groceries industry). In a mixed economy, the government and the private sector jointly solve economic problems. Market economies rely on a very quick and efficient communication of information that occurs through prices.

    Therefore the price system solves the problem of what should be produced and what not and the quantities. Gross domestic product (GAP) is a measure Of overall economic activity Within an economy. A way of measuring the planned side of an economy is to examine the size Of government expenditure as 3 percentage Of GAP- 1. 2; Why study economics for business? The focus of economics is on the functioning of markets, and markets are very important for firms. First Of all because the marketplace is where businesses sell their products and therefore where they make profits.

    Second, the market influences the costs of businesses: land, labor, capital and enterprise are all purchased through markets. Governments can also intervene in the markets, usually in order to benefit the whole society. Governments can either seek to boost revenues when the firms operate in the interest of the public or reduce them (increase costs) when the firms operates against the interests of society, Firms don’t only operate within their regional or national environment, but rather in a very complex and massive global macroeconomic system.

    It’s therefore important that businesses, in order to be 2 successful, understand how macroeconomic events and global change will impact on their current and future operations. 1. 3; Appendix: the economists approach. Economists think about the world in terms of models or theories, striping out the complexity of the real world in favor of a simple analysis of the central issues. Models or theories are frameworks for organizing how eve think bout an economic problem Positive economics studies objective or scientific explanations of how the economy works.

    Normative economics offers recommendations based on personal value judgments. Thus positive economics statements rely upon data and facts, while normative economics statements are people’s opinion, and thus subjective Statements. Diagrams provide a visual indication of the relationship been two variables. Variables can have either a positive or a negative relationship, the former meaning their values increase and decrease together, while with the latter the two variables move in opposite erections (With an increase in one there Will be a decrease in the Other one).

    The equation of a straight line is Y = a 4 box. A quadratic is generally specified as Y – a CZ The gradient is a measure of the slope of a line. One method of measuring the gradient of a line is to calculate the ratio between AY LAX (the change of Y divided by the change of X). Another method involves the use of a simple mathematical function called differentiation. Differentiation is a means of understanding the gradient. The rule consist in CNN n,CNN-l. For example: 4 * X’ EX. (all the constants become 0).

    It’s important to business because if we want to covers the level to production that leads to minimum costs per unit, then we need a mathematical equation which links production and costs, differentiate, set to zero and solve to tint the ideal level to production. Economists use two different types of data: time series and cross-sectional, Time series data are the measurements of one variable at different points in time. Cross-sectional data are the measurements of one variable at the same point in time but across different individuals. Panel data combines cross-sectional and time series data.

    A percentage measures the change in a variable as a fraction of 100. Since percentages measure the rate Of change in a variable, we need both the original and the new value of the variable to do so, with the help of the following formula: [(New value – Original value) / Original value] x 100 For example, a company’s share price was 2$ in 2008 and 6$ in 2010. The percentage change will be 200, thus the share price increased by 200%. Index numbers are used to transform a data series into a series with a base value of 100. Why do we use index numbers?

    First because having a base value of 100, it is very easy to calculate the percentage change in the variable over time. Also, its very easy o make averages. The Retail Price Index is, for example, the average of many individual product price indices, Economists use two different ways to calculate averages: the arithmetic and the geometric means. Arithmetic means sum all the values and divides them by the number of values, creating an error when measuring growth since when doing so the base value changes all the time. This error can be avoided using the geometric mean, For example: Observations 23. 4 Arithmetic mean (2+2)/2 = 2 (2. +4)/3 = 3 Geometric mean (ex.)'” = 2 (xx)l” – 2,88 The percentage increase between 3 and 4 is not the same as the percentage increase between 2 and 3, therefore arithmetic mean shows an error when calculating growth. Chapter 2: Consumers in the marketplace. 2. 1: Business problem: what is the best price? The best price is determined by the firm’s Objectives, usually one Of the following: ; ; ; Maximize profits Maximize market share Maximize total revenues Though also non-commercial objectives are possible, such as improving the environment or being a socially responsible employer, these are the most common ones.

    It is generally not possible to for a firm to choose more than one of these objectives (thefts often in conflict with each other). . 2; Introducing demand curves, In attempting to understand consumers behavior, economists use a very simple construct known as the demand curve. The demand curve illustrates the relationship between price and quantity demanded off particular product. The slope tooth demand curve Q is negative (downward sloping). Figure I – Demand curve p ?10 As the price falls, consumers are Willing to demand greater amounts of the good and vice versa.

    Quo 10 1520 Q SQL Q 2. 3; Factors influencing demand. The demand curve shows a negative relationship between price and quantity demanded, but the willingness of nonusers to purchase a certain product is affected by more factors than just price. These alternative factors are divided by economists in four broad categories: ; ; ; ; Price of substitutes and complements Consumer income Tastes and preferences Price expectations Substitutes are rival products competing in the same marketplace (e. G. , rice and pasta).

    Complements are products that purchased jointly (e. G. , cars and petrol). To understand the effect of income upon demand, distinction between normal and inferior goods has to be made. Normal goods are demanded more when consumers income increases and less when income falls. Inferior goods are demanded more when income level fall and demanded less when income rises. Tastes and preferences reflect consumers attitudes towards a particular product. Over time these tastes and preferences are likely to change Advertising plays a very important role in demand theory.

    First, it provides consumers with information about the products, making them aware that a new product is on the market, with special features. Demand usually increases only just because buyers know the nature and availability of the product. Second, advertising is also about trying to change consumers tastes and preferences. Accordingly, advertising is also about informing the consumer about What they should buy. Whether advertising is providing information or developing consumers’ tastes and preferences (desires), the overriding aim is to shift the demand curve from Q to Quo (as in figure 1).

    In terms of demand curves, if we expect to prices to fall in the future, then demand today will be reduced as people is willing to delay the purchase in order to save money, This will shift demand back to Quo (as in figure 1). Also opposite price expectations are possible, with prices believed to rise in the future leading to anticipated purchase (moving the demand curve o the right). Price expectations are beliefs about how prices in the future will differ from prices today. The law of demand states that, setters Paramus (all other things being equal), it the price to a product falls, more will be demanded.

    Some consumers prefer products that have an element of exclusivity, and high prices ensure exclusivity along with signaling that the product is special. Therefore high prices sometimes attract a special group of consumers, shifting the demand curve to the right These product are usually said to be status symbols. But everyone has limited resources, so the curve will be still downwards sloping, . 4; Measuring the responsiveness of demand. Businesses need to know the impact of price changes on the quantity demanded. Elasticity is a measure of the responsiveness of demand to a change price.

    The elasticity of a product is determined by a number Of factors: ; ; Number Of substitutes Time Definition of the market As the number of substitutes increases, the more elastic will be demand. In the early periods off new market, demand tends to he inelastic (due to fewer competitors and substitutes), but in the long term, as more products enter the market, demand is likely to become more elastic, In markets where the similarity teen products is higher than in others, demand will be more elastic (it’s easier for consumers to switch to another and similar product).

    Mathematically economists can measure elasticity using the following formulae: ; ; (percentage change in quantity demanded / percentage change in price) (AD/ (P/D) The value of E for elasticity will lie between zero and infinity (O < E < AD/ AP Elasticity value (E) 01 - Type of demand Perfectly inelastic Inelastic unit elastic Elastic Perfectly elastic O O. S 1 2 Infinitely large When demand is perfectly inelastic, quantity demanded Will not be affected by any change in price. When demand is perfectly elastic, any change in price Will hugely affect quantity demanded.

    When demand is unit elastic, quantity demanded will change equally to the change in price. Figure 2 Figure 3 Figure 2 perfectly inelastic demand [E-0] Figure 3 perfectly elastic demand 2. 5; Income and cross-price elasticity. Income elasticity measures the responsiveness of demand to a change in income. Cross-price elasticity measures the responsiveness of demand to a change in the price of a substitute or complement. Income elasticity (YE) = If YE < 1 the product is described as income inelastic, demand will change slower that the ncome does, while if I then the product is income elastic, and demand will change at a faster rate than income.

    Cross-price elasticity (EX.) = If products X and Y are substitutes or rivals, then, as the price of Y increases the demand for X will increase, so EX. lies between zero and If X and Y are complements, then, as the price Of Y increases, quantity demanded for X will decrease. EX. lies between zero and 2. 6; Business application: Pricing strategies – exploiting elasticity’s. A rather simple approach to pricing is to simply take the cost of producing the product and add a mark-up. This system s called cost-plus pricing.

    The benefits Of this approach lie in it being simple, you only need to know how much profit you want to add on the production expenses. Though, it fails to take into account the consumer’s willingness or unwillingness to buy the product. The best pricing method comprehends the understanding and utilization of price elasticity of demand. Total revenue is price multiplied by number of units sold, If demand is elastic, then dropping prices will raise total revenues; if demand is inelastic, price should be raised in order to increase total revenues.

    Changing the price involves the development of new rising plans and the communication to price changes to retailers tooth product. As a result, change can be costly and not always offset by improvements in revenues. Change can also represent a risk, since competitors could react to your price changes. Furthermore you may not fully understand the price elasticity of your product and therefore make a mistake when reprising it. If we wish to target unit elasticity (that’s where revenues can be maximizes), we need a measure of how far our current pricing is from this best price.

    To find the best price we need to gather data that will enable the demand curve for our product to be plotted ND mathematically modeled. Once eve have a demand curve, we can see the relationship between price and quantity and measure the elasticity of demand at various prices. Data is difficult to find and retailers are not willing to change prices just for the sake of experimenting and gathering data, therefore the job is usually given to market research companies. These will scanner data from large selections Of retailers such as supermarkets across vast areas. Or each price at which the product is sold, the market researchers also note down how many units Of the product are sold at the tills. By using econometrics, trend lines can be drew and analyses, providing information about the price elasticity of demand. Knowing that unit elasticity is what we are looking for, we will be able to move in that direction from the actual position along the curve, Successful products go through four phases of the product life cycle: introduction, growth, maturity and decline.

    Unsuccessful products usually don’t pass the introduction phase, At each stage there is a different competitive environment and thus elasticity to demand. In the introduction stage an innovative product is likely to be unique and face few, if any, competitors. Therefore demand will be price inelastic, as the early adopters aren’t able to switch to another company or product easily. Firms could therefore set higher prices. In the growth phase competition increases, as companies that witnessed the success of the product in the introduction stage want to enter the market as well.

    Elasticity of demand rises and therefore prices start to decrease. To gain a dominant position in the marker prices should be cut, giving preference to increased market share rather than to maximize profits. At the maturity stage of the market competition is usually fierce, leading to higher price elasticity Of emend. This is a reasonable base for aiming at sales mastication strategies. High price elasticity means having little control over pricing as competitive pressures force the price down. As the product enters the decline part of its life cycle, competition becomes lighter as companies exit a market where consumers are doing the same.

    Elasticity of demand will become more inelastic, which along with greater price stability will allow higher prices to be set. Therefore, throughout the product life cycle the pricing strategy has to be reactive to the changing competitive nature of the market. 2. 7; Business application: Pricing strategies II – extracting consumer surplus. Consumer surplus is the difference between the price charged for a product and the maximum price that the consumer would have been willing to pay, Consumer surpluses represent a benefit for consumers, but also missed profits for businesses.

    Price discrimination is the act of charging different prices to different consumers for an identical good or service. For price discrimination to be successful three elements must exist: ; The firer must have control over prices, thus an inelastic demand (having price-setting power) The firm must be able to distinguish the different ropes of consumers that are willing to pay different prices The resale of the good must be prohibited There are three different types/degrees of price discrimination. Ender first-degree price discrimination each consumer is charged exactly What they are willing to pay for the good/service. It is very unlikely to happen because none is ever going to pay What he would be able to. Also quite complicated to manage. The most used application of this method is selling through biddings. The second-degree price discrimination consists instead in charging consumers different prices based on the amount of quantity purchased. Usually there is a iced cost plus a variable cost that will depend on the amount purchased. For example telephone subscriptions.

    Consumers that are willing to spend more will buy at a higher fixed cost but receiving lower variable costs, while people that is not willing to pay as much will get the cheaper base cost but with higher variable costs. Third-degree price discrimination is when different groups of consumers are charged different prices. For example business class seats in flights. Another example could be the pay per view television subscriptions. Starting trot a basis package of certain channels, the more channels you want the more you pay e. G. , sport channels, movie channels etcetera).

    This technique is called product debugging. Chapter 3: Firms in the marketplace 3. 1; Business problem; managing fixed and variable costs. Fixed costs are constant, they remain the same whatever the level of output. Variable costs change or vary with the amount of production or demand. The biggest problem Of fixed costs is not that they cost huge amounts Of money, but that the nature of the cost does not change with the output and revenues. Variable costs have the advantage that they can easily be changed in relation to the revenues/ production/demand. 3. ; The short and long run.

    The short run is a period of time of production is fixed, we tend to assume that capital is fixed and labor is variable. If demand changes in the short run, a company can easily employ or fire people to manage that demand, but if they need to expand because of the growing demand they cannot easily build a new office, therefore capital is fixed in the short run. But labor could also be fixed in the short run if a company works with contracts, like professional football players; they signed a 5-year contract so their labor is rather fixed than variable. The long run is a period of time when all actors of production are variable.

    We cannot really give a definition of how long the long run is, because it depends very much on the industry. In the internet industry the long run may be a week, while in the airplane manufacturing industry the long run may be ten years. 3. 3; The nature of productivity and costs in the short run. Productivity in the short run. In assessing productivity, we need to distinguish between total product and marginal product. Total product is the total output produced by a firm’s workers. Marginal product is the addition to total product after employing one more unit of factor input (labor).

    Marginal always means ‘one more’. See table 3. 1 on page 55 to get good understanding of total product and marginal product. Task specialization helps to raise productivity because the total process is broken down into separate components, each worker then specializes in one task and becomes an expert in that task. The law of diminishing returns states that, as more of a variable factor Of production, usually labor, is added to a fixed factor Of production, usually capital, then at some point the returns to the variable factor will diminish.

    In Other words; over-resounding Of capital (putting four people behind one cash ask) does not raise productivity/marginal product. Costs in the short run. In the short run, we have three types of costs; variable costs, fixed costs and total costs. Variable costs are costs associated with the use of variable factors of production, such as labor. Fixed costs are associated with the employment of fixed factors of production, like capital. Total costs are simply fixed costs plus variable costs. Average costs.

    We measure the costs per unit using average costs. To calculate the average costs we have to divide 11 the total costs by the number of units produced. You can subcategories this y doing it for the variable and fixed costs. To calculate the marginal costs we have to divide the change in total costs by the change in output. If we make graphs with the lines of average costs and marginal costs, it should be noted that the marginal cost curve cuts through the minimum points of the average total and average variable cost curves.

    This is a mathematical relationship which is difficult to explain. 3. 4; Output decisions in the short run. The price you sell your products for should always be related to your fixed and variable costs. If your price is lower than the average fixed costs but higher than the average variable sots you could still produce and sell and try to cover as much as possible of your fixed costs With the ‘profit’ you made on the average variable costs. But if your price is lower than both average costs you shouldn’t produce.

    If a company produces one more unit and the firm can receive a price that is equal to or greater than the marginal cost, then it can break even or earn a profit on the last unit. 3. 5; Cost inefficiency. We only looked at the cost curve this far, but this does not give a clear view on how firms operate because one firm may be way more efficient than another firm. Cost inefficiencies lead to competitive disadvantages, so operating as near to the cost curve as possible is the best thing to do for companies. 3. 6; The nature of productivity and costs in the long run.

    In the long run, both capital and labor are variable. Therefore, the law of diminishing returns does not determine the productivity of a firm in the long run. This is simply because there is no fixed capital in the long run to constrain productivity groom. So, in the long rill, productivity and capital must be driven by something else; returns to scale. Increasing returns to scale exist when output grows at a aster rate than inputs. And the other way Roland of course. Constant returns to scale exist when inputs and outputs grow at the same rate, Economies of scale: production techniques.

    Economies of scale exist for a number of reasons. The greater the scale of operations/production, the more specialization is needed by workers, and the production uses mass-production techniques. Therefore, as firms change their level of scale, they also change their production process and longhorn costs tall. Indivisibility’s. This is about not being able to separate your fixed costs. E. G. If you hue a jumbo jet that can carry 400 passengers, but you only find 300 passengers you cannot chop off the back of the plane to cut your costs.

    Increasing your scale by buying another plane which flies from the end point to a new point may give you the 100 passengers because they want to fly from the Start point to the end point via the middle point. This is nothing more than spreading fixed costs. Geometric relationships. Volume is a measure of storage capacity. So, if you decide to create a tank to brew beer, and eve 12 decide to double the volume of the tank, the material needed will not double in size, It becomes proportionately cheaper to build larger tanks than it does to lid smaller tanks. Discomposes of scale.

    Long-run average costs will eventually begin to rise because, as companies increase in size, they become more difficult to control and co-ordinate. More managerial input is required to run the business. Competitive issues. The lowest point on the long-run average total cost curve is defined as the minimum efficient scale. This is the output level at which long-run costs are at a minimum. The closer you are to the point of minimum efficient scale, the more competitive your operation is. In order to take advantage of this sort of economies of scale, a company might merge with another many.

    The new company will be bigger than the two separate parts and economies of scale can be realized, 3 7; Business application; linking pricing with cost structures. In every example given so far, fixed costs are a major component of total costs. We know that volume is crucial when fixed costs are high, because additional volume helps to spread the fixed costs over additional units of output. This louvers cost per unit sold, Which ultimately louvers prices. Prom the demand theory we know that we can generate higher demand at lower prices. 3. 8; Business application: footballers as sweaty assets.

    A common business term for making your fixed inputs work harder is ‘to sweat the assets’ Chapter 4: Markets in action 4. 1: Business problem: picking a winner. Volatility (fluctuations) in prices makes financial planning very difficult for business owners, they never know whether it is the right time to invest because of the changing environment. This problem is not just limited to investing, the wage or price at which you hire employees also depends on the market (demand and supply). Greater supply will increase competition and prices will fall, while higher demand by firms will lead to higher ages.

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