السبت، 14 مايو 2011

INTRODUCTION AND MICROECONOMICS


INTRODUCTION AND MICROECONOMICS


A. Adam Smith Resource Allocations

The Scottish economist, Adam Smith, in his 1776 masterpiece, The Wealth of Nations, founded the modem economic theory known as economic liberalism. Smith's basic assumptions of economic analysis included that there are unlimited economic needs and wants among consumers, as well as limited resources (land, labor and capital) available. Aggregate economy wide demand exceeds resource supply. The most efficient allocation of scarce resources to achieve the largest amount of goods and services becomes the ultimate goal. Smith's analysis concludes that a system of competitive free markets ("the invisible guiding hand") best achieves this result. Individuals pursuing their own selfish best interests facilitate efficiency through the division of labor; this specialization creates national and individual wealth and maximizes efficiency in resource allocation.

B. Basic Economic Systems and Decisions

Conventional economic study recognizes three elementary economic systems.

1. Conventional System: Historically, economics was built upon land and agriculture. It was common to adopt Barter economy, but was limited to transactions between people who wanted the same item. To overcome this restriction, rare metals started serving as an exchange medium. Medium examples include the European Middle Ages' feudal systems and some nowadays underdeveloped countries.

.2. Command System: The economic system is centrally manipulated/planned and resources are often publicly owned. This includes a variety of democratic, socialist, or communist political systems with centrally-controlled resources. Such centralized systems lack the efficiency of the free-market and are losing favor as a means for organizing economic activity. Many countries are privatizing businesses previously owned by the Government. Russia plans to privatize 3/4 of the Soviet State businesses before the year 2005. But the exchange to a free-market economy has proven difficult in Eastern Europe; in order to cover deficits, the government has printed money. Yet, it has produced high inflation and a fall of real incomes by 40% since 1992. There is political uncertainty following.

3. Capitalism: Individuals and firms seek for their personal private interests in the free market system of' private ownership. More is determined by the market and less by the government. Consumer demands are contented by free-enterprise firms running for profit.

a. Consumer Votes: Consumers show their preferences in the global marketplace on a basis of one vote, one dollar. They seek to get the best-quality product at the cheapest price. This price mechanism determines resource allocation.

b. Production Costs: Businesses fight for consumers' money in an egocentric search for profits. Competition compulses producers to innovate and specialize. This promotes efficiency and costs reduction per unit. Costs of production, mixture of inputs and control are equally important as revenue.

c. Efficiency and GDP: The free market economy is more efficient than a command system. This efficiency creates a maximum Gross Domestic Product (GDP) for the economy given a pre-existing income level. Therefore, the highest standard of living for the people is created.

4. Mixed Systems: Nowadays, most systems are mixed; partially capitalistic and partially command. Japan is an instance where resources are privately owned, but the government organizes the economic climate through an industrial policy.

C. Free Market Decisions

The five basic free-market economic decisions include:

1. What to Produce? Consumers vote for their preferences with dollars in the marketplace and hence, determine the production of demanded goods. Suppliers produce to meet the market demand.

2. How to Produce It? The production procedure is to be accomplished by the most efficient, least cost per unit, method possible.

3. How Much to Produce? The market determines the quantity demanded. An individual firm can sell all the quantity it wants at the market price in a truly competitive environment.

4. What Price to Charge? This decision as to the exchange price may not be available in a truly competitive environment. In other economic contexts, the firm may enjoy price elasticity.

5. Ownership Structure: This decision determines who shall receive tile profit or bear tile loss caused by the sale of the goods or services. In the free market economy private individuals own the business entities and resources.

D. Production Possibilities Curve

The production possibilities curve is illustrated by Figure 1-1 below.

1. Purpose: This curve indicates all possible combinations of two goods that a society can produce, employing its available level of resources at greatest efficiency. The gradient of the curve represents the rising opportunity cost of producing each successive unit of one good in terms of units of the other good for which production is foregone.

2. Variable Points: Due to scarcity of resources, points to the right of the curve are not obtainable. Points to the inside of the curve represent underemployment of resources are available. Growth in productive resource capacity or the productivity of workers (output per labor hour) causes the curve to shift outward. This allows the society to produce more of both goods. In 1990s and early 2000 decade, U.S. productivity increased about 3% per year.



II.            DEMAND CURVE ANALYSIS

A. Utility and Consumer Demand

1. Dollar Votes: Dollar votes in the marketplace indicate the perception of consumers towards a good's utility. Utility measures the satisfaction or benefit derived from consuming a unit of the good. Total utility (TU) is the cumulative satisfaction or benefit derived from all units consumed. Marginal utility (MU) shows the satisfaction or benefit derived from the last unit consumed.

2.   Savings Utility: Utility is provided through earning the security and interest from savings.

B. Marginal Utility Theory

Marginal utility theory is one approach used to explain how the consumer with a given level of income behaves to maximize the utility provided by various goods. This theory assumes that the quantification of utility.

1. The Law of Diminishing Marginal Utility: Each successive unit of the same good consumed provides declining additional, or marginal, satisfaction. The more you buy an item, the less you want the next unit. This results in a downward-sloping demand curve. Graphically, it can be shown that as increased quantities of a good are consumed, the total utility curve rises at a decreasing rate, and the marginal utility curve declines.

2. Utility Maximization: Maximization of utility for a given consumer's level of income is where the marginal consumption utility (MU) per dollar price of all goods equals savings. If a, b, and c are different goods available to the consumer and s equals savings, the formula to maximize utility for a given consumer's income is:

MUa =                   MUb =                MUc =                    MUs
Pa                           Pb                        Pc                            Ps

C. Indifference Curve Analysis

Indifference curve analysis is an another approach to explain consumption behavior. This approach does not measure utility quantitatively. An indifference curve shows all combinations of two goods which yield the same level of satisfaction to the consumer, who is indifferent between combinations represented by points on the curve.

1. The Marginal Rate of Substitution: The slope of an indifference curve is the Marginal Rate of Substitution (MRS), or the amount of one commodity that the consumer is willing to forego to obtain an extra unit of the other goods. The MRS diminishes along the curve due to the consumer's increasing unwillingness to give up successive units of a commodity to continue to increasingly more of the other. A set of indifference curves is referred to as an indifference map. Convex curves further from the origin represent higher levels of consumption successively and satisfaction correspondingly.

2. The Budget Line: The linear budget line indicates all possible matchings of the two commodities that the consumer can buy given the prices of the commodities and the level of income available to buy them. A change in money income results in a parallel shift of the budget line -outward if income is increased, toward the origin if decreased. Whenever there is a change in the relative prices, the slope of the budget line changes correspondingly.


3. Maximization of Consumer Satisfaction: When the budget line is superimposed upon the indifference map, at the point of tangency of the budget line to an indifference curve, the consumer's satisfaction is maximized. Figure 1-2 is an illustration.


D. Basic Demand Curve Features

1. General Considerations: A demand schedule indicates the quantity consumers will purchase at a given price. The law of demand states that as unit price decreases, consumers will purchase an increasing number of goods. As unit price rises, quantity demanded will fall. This produces a demand curve that is downward sloping to the right and normally convex to the origin.


2. Demand Curve Shift: A shift of the demand curve (a change in demand - see below) is different from a movement on the same demand schedule. The above movement from P2/Q2 to P1/Q1 is an example which indicates a change in quantity demanded.

a. Cause of Change in Quantity Demanded: A change in quantity demanded results from a change in price, with all other factors remaining the same. This is a movement along the demand curve from one price-quantity combination to another.
b. Causes of Change in Demand: Changes in consumers' tastes, prices of complementary or substitute items, money income, expectations as to price or income changes, the range of available products, and the number of buyers may all result in a change in demand.

c. Direction of Shift: An increase in income or the elimination of a substitute good can result in a shift of the curve to the right, an increase in demand. While a decrease in income or an increase in substitute goods can result in a shift to the left, a decrease in demand.





E. Demand Elasticity

Demand Elasticity measures the responsiveness of quantity to a change in the product's price. For most goods, the basic determinant of the demand elasticity is the amount of substitutes available. The more close substitutes a good has, the greater its elasticity of demand. A longer period of time or when a larger portion of the consumer's income is required to purchase the commodity may also facilitate greater elasticity. The impact of the change on total revenue becomes the eventual question.

1. Elastic Demand: Total Revenue rises from a fall in price if the percentage change in quantity (Q) is larger than the percentage change in price (P). This occurs in tile lower right section of a traditional concave demand schedule and the coefficient of elasticity is greater than one. If the elasticity of demand is 1.3, a 5% decrease in price will increase quantity demanded by 6.5%. In this portion, the demand curve is more horizontal (remember the elastic or rubber band). Luxury and expensive goods usually enjoy more elastic demand than necessary products. If the demand curve is horizontal at a given price, demand is perfectly elastic (the coefficient is infinite).

2. Inelastic Demand: Total Revenue decreases from a decrease in price if the percentage change in Q is less than the percentage change in P. This is in the upper left section of a traditional concave demand schedule and the coefficient of elasticity is less than one. In this portion, the curve is more vertical. Inelasticity in the demand curve allows a seller to more easily pass supplementary costs, new taxes, etc. through to the buyer. The demand will be more inelastic in case there are fewer substitutes for a good. If the demand curve is vertical at a given quantity, such as a diabetic's requirement for insulin, demand is perfectly inelastic (the coefficient is zero).

3. Unitary Demand: This is the point on the demand curve where a decrease in price is exactly eliminated by an increase in quantity. The coefficient is exactly one. At this point, total revenue remains static.

4. Price Elasticity of Demand: This is a measure to evaluate and quantify the elasticity relationship of elasticity. The formula for the coefficient of elasticity indicates the impact on quantity purchased caused by a price change. To get a positive number, the result is negative multiplied by (-1).



Example:      The unit price of a good fell from $15 to $12 and the unit quantity increased from 22 to 28. What was the elasticity
                      principle of the demand curve and calculate the elasticity coefficient?


Answer:

The demand curve was in the elastic portion of the schedule. A total revenue increase caused by the change. ($12 x 28 = $336 > $15 x 22 = $330). The Coefficient is calculated as:




  28-22     =   6          12-15
28+22         25         12+15
     2                              2
-3         (For simplify, offset the decimal, the
13.5      price change fraction can be changedto-6/27)


5. Income Elasticity of Demand: A measurement of the impact on quantity purchased from income change.


Formula =

% change in Quantity % change in Income



a. Normal Good: A normal good indicates a positive elasticity coefficient. Quantity demanded rises with an increase in income, such as lobster.

b. Inferior Good: An inferior good indicates a negative elasticity coefficient. As income rises, quantity demanded falls, such as beans.

6. Cross Elasticity of Demand: Measures the relationships of changes in two products. A typical exam question includes a manufacturer adding a product line or changing the unit price. The question is whether such an action will retard or arouse the purchase of the other product.

Formula =            % change in Quantity of Y
                             % change in Price of X

a. Substitute Goods: Substitutes bears a positive coefficient index. They are alternatives. Consumers purchase one good or the other, such as Coke - Pepsi or butter - margarine. The greater number of substitute products, more elastic the demand schedule for any one. If substitute goods increase their prices, the demand curve for a firm's product will shift to the right.




b. Complementary Goods: Complements indicates a negative coefficient. One facilitates the other. The purchase of one good stimulates the purchase of another, such as beer -pizza or baseballs - baseball bats. A decline in the price of a complementary good will shift the demand curve of the joint commodity to the right.

7. Increase in Price or Income: An increase in price or income would have the counter effect. For instance, if the demand curve is inelastic, a rise in price (say from a sales tax increase) will be more easily shifted ahead to consumers. Similarly, an inelastic demand is required for a crop reduction program to increase farmers' incomes.

III.          AN ANALYSIS OF SUPPLY CURVE

A. Basic Supply Curve Characteristics

1. General Considerations: The supply schedule shows the various quantities producers will bring to market at various prices. The law of supply states that sellers will provide more quantity at a higher price and less quantity at a lower price. The supply curve schedule is, therefore, downward sloping to the left.

               

2. Supply Curve Shift: A shift in the supply curve (a change in supply) should be compared with a movement on the same schedule (a change in quantity supplied).

a. Cause of Change in Quantity Supplied: A change in quantity supplied is originated from a change in price, with other factors remaining static.

b. Causes of Change in Supply: A change in supply (a shift to the right of the supply curve) results from a change in one of the following: input prices, technology, prices of other commodities, the amount of suppliers, and suppliers' expectations.

c.     Shift Direction:

1.) Right: A fall in the cost of the required inputs or a technological improvement are examples of changes that will shift the supply curve to the right; this will increase the quantity provided by a supplier at all price levels. The price would be reduced if there was no quantity change.

2.) Left: A fall in the amount of suppliers or increase in input prices will shift the supply curve to the left, causing from a decrease in supply.


B. Elasticity of Supply

Elasticity of supply indicates the measurement of the responsiveness of quantity supplied to a change in the price of the product.

Formula -- % change in Quantity
% change in Price

1. Elasticity Measurement: When the coefficient is greater than one; supply is elastic (percentage change in quantity exceeds percentage change in price). When the coefficient is less than one, supply becomes inelastic. A positive number signifies the elasticity of supply. There are two exceptional cases: the coefficient is zero with a vertical supply curve and infinite with a horizontal supply curve.

2. Determinants: The ease of input substitution, length of time, and behavior of costs as output levels change are all basic elasticity determinants. Supply is more elastic for a given commodity when it is relatively easy to shift the production factors to another commodity, if the buyer can provide a variety of input usage, when a longer time frame is involved, and when production costs show no tendency to rise sharply as output increases.

IV.          INTERACTION OF DEMAND AND SUPPLY

With no government interventions, the consumers demand and producers supply for a good proceed the transactions in the free market.

A. Equilibrium

The equilibrium market price and quantity, as shown by Figure 1-8 below is produced under the circumstance that there is an intersection of the supply and demand curve. An equal increase in both supply and demand will rise market-clearing quantity.



B. Government Price Support Programs

The political process may think that some industries or resource input cannot  receive an equitable income allocation under the free market system operation. To remedy, government price support programs dictate a certain price which is usually above the market equilibrium price. At this support price, the quantity supplied will be greater than the quantity demanded. Minimum wage is an instance. The government purchased he surplus in quantity supplied. Milk and wheat surplus programs are instances of these free market restrictions (and may result in milk lakes and wheat gifts to foreign countries). Since consumers pay higher prices, the affected producers of the surplus enjoy the benefit.



C. Government Price Ceiling Programs

The government may impose a maximum or ceiling price on a good that is lower than the market equilibrium price. Rent control is a typical instance. The quantity demanded exceeds the quantity supplied at the governed price. The government may need to ration the product. Such a free market restriction, the long-term result is that the quality of good subject to price ceiling will fall.




V.            PRODUCTION FUNCTION AND FACTORS OF COST


A. Production Efficiency

The production function requires figuring out the quantity demanded by the market. This includes combining resource variable inputs (labor and raw materials) and fixed inputs (managerial capability, equipment and space). The objective is the most efficient utilization and combination of inputs. The state of technological efficiency (technical and engineering know-how) eventually determines the maximum quantity of physical output a firm can produce with a specific combination of resource inputs. The following is the graphical representation of the production function:




1. Increasing Returns to Scale: The short-run marginal output transcends the marginal input. This is often called economies of scale and the short-run average cost of production is declining.

a. Marginal Product Increasing: In segment AB, the marginal product curve is rising and is above the average product curve resulting in the rise of both the average product and the total product to rise. The increased quantity produced has resulted in labor specialization. Specialization facilitates efficiency, as well as marketing advantages, by-product utilization. Volume purchase discounts may lead to additional economic efficiency.

b. Marginal Product Declining: In segment BC, marginal product starts declining per additional unit of input. Average product continues to rise since marginal product curve is above the average product curve. Total product continues to rise but at a diminishing rate.

2. Constant Returns to Scale: This condition assumes all resource inputs are variable. The additional output is constant to the input. No economies or diseconomies of scale can be observed. This is at point C. This refers to the quantity location of maximum average productivity.

3. Decreasing Returns to Scale: The Law of Diminishing Returns states that the marginal output (increase in total units) decreases eventually as more variable inputs are added to a given number of fixed inputs. Inefficiency has set in. This may also be named diseconomies of scale.

a. Positive Marginal Product: In segment CD, marginal product continues to decline but remains positive. Because the marginal product curve is below the average product curve, average product will decline in this range. Total product continues to increase, at a declining rate.

b. Maximum Output: At point D, output is at a maximum. The ideal output range is Segment BD since the marginal product for a unit of input resource is greater than zero and total product is still rising.

c. Negative Marginal Output: Beyond D, the marginal output of product from a unit of variable resource input is negative; total product is ,hence, decreasing. Because the marginal product curve is below the average product curve, average product is falling as well. Bottlenecks, transportation problems as well as the management difficulties that result from coordinating large enterprises may cause diseconomies.

4. Management's Decision: In making management decisions, priority will be given to produce in some location within segment BD. The optimal point is at C where average productivity is maximized. Management would regard production unacceptable in the segments of AB and DE. In segment AB the firm's capital is not being utilized efficiently. In segment DE marginal output is negative and extra units of variable resource inputs will result in decrease in total output.

B. Family of Costs

Total Costs -- Total Fixed Costs + Total Variable Costs

1.     Fixed Costs: These costs remain fixed in total over the relevant production range.

2.     Variable Costs: Variable costs vary directly with the production level.


C. Short-Term Marginal Costs

Marginal costs (MC) are the change in Total Variable Costs in the short-run as a supplementary unit is produced. Fixed or sunk costs are not paid attention. Increasing returns to scale usually mean the cost curve will decrease at first. But ultimately diminishing returns and/or increasing costs will result from each variable input unit in the short-term. Therefore marginal costs tend to increase as production expands. The entrepreneur should be sensitive to the relationship. The short-term marginal cost curve is upward sloping to the right.





D. Marginal Revenue Analysis

Marginal revenue (MR) is the change in total revenue derived from the sale of one additional unit. In a pure competitive market environment, one additional unit will not effect the per unit revenue from previous units' sales. But in most imperfect competitive markets there is a point where marginal revenue will start decreasing.

E. MR-MC Relationship

An entrepreneur looks closely at the MR and MC relationships facing his firm. As long as marginal revenue transcends marginal cost (MR > MC), production should be expanded in a firm since the additional gross margin contributes to fixed costs. This will result in a higher net profit or lower net loss. A firm's marginal cost curve in pure competition is, therefore, its short-term supply curve.

F. Long-Term Cost Analysis

In the long term, all input costs become variable in principle. A firm can diversify its physical plant size, method of production labor, and other resource inputs. Economies of scale is almost always a factor in lower output ranges as fixed costs are allocated over more units of output; this reduces average cost per unit. Even so, at some point diseconomies turn up the long-term average cost (LRAC) curve. Graphically, the long-run average cost curve equals the low point of all short-run average cost (SRAC) curves and is usually U-shaped.



G. Profit Measurement

The following three profit measures are recognized. They include:

1.Accounting Profit: This is the GAAP measurement. Revenues are recognized when all exchange events have occurred. Explicit expenses are paired with the period of the associated revenue



2. Normal Profit: This is the return on the firm's investment which is required to keep the venture capital from going elsewhere. This opportunity cost represents the implicit or imputed costs capital and risk taking. This is regard as a "cost" of resources from an economic point of view. Economic cost, hence, includes the total of all explicit and implicit costs of the firm.


Example:
A firm produces 50 units of output during a month in which its total variable production costs are $500, its total fixed production costs are $200, and its normal profits arc $100. The firm's average total cost per unit of production
in economic terms is $500 + 200 + 100            =        800          =           $16 per unit
50                      50

3. Economic Profit: Economic or pure profits are the surplus of the normal opportunity rate. If the actual return transcends the return available from other opportunities, production will be expanded in a firm and new entrepreneurs will enter the market. This will raise the supply available and eventually push the market price down. Yet, when the increase in quantity lowers the price, firms will begin making lower profits (or perhaps incurring losses). Marginally efficient firms will be excluded from business operation, and investment capital will flee the industry. This will lower the amount brought to market by suppliers and push prices back up. Eventually an equilibrium will be reached at the normal profit level. This will be at the rate of the firm's opportunity cost.

VI.          RESOURCE PRICING AND EMPLOYMENT


Apart from the decisions that individual business firms make about the pricing and quantity of output, they must produce the goods. How well firms do in the production process determines their cost and hence their profits. If the firm scarcely manipulates the market price, costs censorship will be required.

A. Resource Returns

1. Various Input Resources: Land input returns rent; labor returns wages; capital returns interest or dividends. The real return to capital is the nominal return minus the inflation rate. Economic rent is the total price paid for land and other natural resources when there is a totally fixed cumulative supply. Since economic rent is higher, then it is necessary to induce supply of the resource, which is sometimes referred to as "surplus" rent.

2. Resource Price: Industry demand and supply curves for a certain input operate under the same principles we previously mentioned. These factors determine the price equilibrium and used quantity in the process of production.

3. Labor Demand: Factors influencing the demand for labor include the total level of economic activity, the production function mentioned above and the skill level of the labor force. The supply of labor is influenced by demographic factors, the financial and personal rewards of working as well as the training, education and skill level required for certain positions. The labor productivity is vital because if it is high, it may raise wages and lower per-unit costs of ouput at the same time.

4. Supply Elasticity.: The supply input curve for an individual firm is horizontal for most inputs in the short-run. As shortages begin to occur, the supply curve becomes upward sloping. The aeronautical engineers in Seattle when the Boeing Company is expanding would be an instance.

5. Time Resource: Time which refers to all inputs has become a precious resource. The lead-time required between product initiation and market delivery (conception, design, production, marketing) is increasingly significant. Coordinating time properly minimizes the production cost cycle and lowers non-value added costs such as storage or scrap. Quicker inventory turnover will cause in lower levels of necessary working capital.

6. Opportunity Cost: This is the return on investment foregone that could have been obtained by picking the second best alternative activity or product.

B. Input Denmnd Factors

A number of general factors influence a firm's input demand for a certain resource.

1. Derived Demand: Consumer demand for the firm's finished products or services result in an expectation. Entrepreneurs analyze this factor and bid up the price of the necessary input resources. If demand for the output rises, there will be a shift to the right of the resource input demand curve. The greater the elasticity of product demand, the greater the elasticity of demand for the required resource inputs. Hence, the output demand derives the input demand.



2. Technology and Productivity: Higher technology may promote more efficient input. This situation could urge a demand for a more technologically advanced resource. Productivity of labor is influenced by the education level, skill level and good health of the labor force. This is now at a 20 year high and allows wage rises without inflation.

3. Substitution: Input prices relative to input price of substitute resources influences the demand for acertain resources. The principle of substitution states entrepreneurs will opt for the less expensive substitute. The larger number of resource substitutes available, will enlarge the elasticity of demand for any particular resource.

4. Relative Profitability: This pays attention to the magnitude of potential marginal revenue derived from extra sales. Higher marginal revenue and related profit will require a larger demand for the resources.

5. Materiality: This focuses on the attributable percent of total costs to that particular input. The entrepreneur is concerned less about the cost of that particular resource in a lower the relative percent. Labor-intensive firms are especially sensitive to this factor.

6. Other Influences: Outside influences may also influence the input demands for certain resources. Examples include strong labor unions or license-operating requirements. Governmental interference in the free market such as minimum wages, price controls, rationing, etc. may all determine the resource's input demand.

C. Optimum Usage Quantity

This analysis is similar to the Marginal Revenue (MR) and the Marginal Cost (MC) decisions in pricing output mentioned above. Management makes decisions about the quantity, and price of resources it purchases from employees and material retailers. Notice that the impact on previous units revenue and cost may affect the total revenue and total cost.

1. Marginal Physical Product: Marginal physical product (MPP) is the change in cumulative physical output resulting from an extra unit of variable input while other production factors remain constant.

2. Marginal Revenue Product: Marginal Revenue Product (MRP) is the corresponding change in total revenue. A firm's MRP curve equals its resource demand curve.

3. Marginal Resource Cost: Marginal Resource Cost (MRC) is the change in total costs causing by increasing one unit of input.

4. Decision Factors: As long as the MRP transcends the MRC a firm should expand its production. But as more units are added, the marginal revenue will tend to fall and the marginal costs will tend to rise. Where these two measures are equal (MRP=MRC) is the optimum production quantity and maximum resource usage efficiency.

D. Resource Imperfections

Imperfections exist in supply and demand forces.

1. Minimum Wage: A minimum wage guarantees marginal firms don't compensate for their weakness by paying substandard wages. However, it may also promote firms to use less labor, disturb uneconomical product lines and increase the use of labor-savings devices; this may hurt minorities and unskilled worker~. Real wage increases are nominal wage increases minus inflation. Minimum wage indexing links the wage rate to a price level index; this and cost-of-living-adjustments (COLAs) may cause inflationary pressure on the economy.

2. Wage-Employment Preference Path: Wage-Employment Preference Path examines the impact of organized labor on the free market. The theory is that if there is an increase in labor input demand curve, a rise in quantity should result. However, if demand decreases labor unions will opt for quantity decrease to try and keep the higher price. This results in a supply curve that is similar to a backward kinked curve.

3. Conditions Favoring Labor Unions: Labor unions will win above-average wage gains under particular favorable conditions. This includes where industry is highly unionized; industry-wide bargaining is in effect; profits are high; work stoppages affect the whole economy; unions control trade entry through apprentice programs. A fertile area for unionization is where the existing wage is less than the marginal value product. Since 1975 overall membership in unions as a proportion of the total labor force has declined since manufacturing jobs have been replaced by service industry jobs. To remain competitive in the world markets, increasingly labor and management are finding they must form mutual interest partnerships.

4. Wage and Price Controls: It is often effective for government to impose wage and price controls to break an inflationary wage-price spiral. But, such controls are inherently unstable, may create shortages, black markets and dislocations of the market. If the situation continues, rationing may become necessary.

5. Energy Resource Pricing: At present, energy expenditures occupy a large portion of GDP. There are limited petroleum, coal, solar and hydro-generation sources. Transportation, heating, appliance and industrial use keeps growing. Imported oil from the Organization of Petroleum Exporting Countries (OPEC) cartel provides most of the U.S. non-hydro energy. Market prices will eventually increase and domestic producers may reactivate alternative energy sources development. Consumption will reduce and high mileage vehicles may again become popular.

VII.         MARKET STRUCTURE


A. Perfect or Pure Competition

1.     Characteristics

a. Large Number of Players: Various amount of independent buyers and sellers compete in the market. Each competitor's actions are assumed to be independent of the other players.

b. Access Free: Mobility of resources is free and flexible. New suppliers can easily enter (and leave) the market and the required capital investment is not large. Such an industry may encourage entrepreneurs to commit venture capital.

c. Price Takers: No individual seller (or buyer) is large enough to manipulate the price; each must therefore take the market price. Consumer demand is perfectly elastic at the market price; each seller decides the quantity. There is, hence, no logical reason to advertise.

d. Perfect Knowledge: All players are assumed to have perfect knowledge about all relevant information and make rational decisions. Since buyers have perfect information about prices and products, they maximize the utility derived from their limited income. Firms know exactly what their revenue and costs are. It is not necessary to launch significant research and development.

e. Identical Products: A homogeneous, standardized product and no differentiation in quality perception are assumed in this market model; buyers, therefore, pick the cheapest brand. Instances include sugar, farm products and Douglas fir lumber.

2. Short-Run Determinants: The interaction of supply and demand curves' determines price and output. Figure 1-15 shows short-run equilibrium.

a. Horizontal Demand Curve: The individual firm faces a horizontal (perfectly elastic) demand curve at the market price. Hence, the firm is capable of selling all it produces.

b. Profit Maximization: Profit maximization for an individual firm is at that quantity where Marginal Revenue (MR) = Marginal Cost (MC). In the short run, the firm may realize extra profits (or incur losses).


c. Graph:




1) In pure competition, MR = Market Price; MC = Unit Variable Cost. Changes in input prices may affect MC. The firm will sell Q1 quantity of goods at a price of P1.

2) If MR transcends MC, more units will contribute to fixed costs and increase profits
or decrease losses.

3) If MC transcends MR, the firm should close down, because variable costs are not
included.

d. Short-Run Supply Curve: A firm's short-run supply curve is therefore the same as the marginal cost curve. Notice that in perfect competition, the MR is the same as the market price, in all other types of market structure the MR curve is below the price axis. Because the MC curve is upward sloping to the right, MR and MC curve will intersect at a higher quantity. Therefore perfect competition produces the greatest rate of output at the lowest cost so there is optimal resource allocation.

e. Industry Supply Curve: Accumulate all the firms' individual supply curves to equal the industry supply curve.

f. Government Intervention: The Government supports perfect competition through the Sherman and Clayton Acts which hinder business combinations or collusion which substantially lessen competition. On the other hand, patent and copyright laws build a barrier to entering an industry and price supports and ceilings for agricultural products override the free market forces.

3.     Long-Run Consequences:

a. Profits Attract Competitors: If the industry is highly profitable, there will be an expansion of existing firms and an entry of new entrepreneurs in the market. This will increase the supply available and put downward pressure on lowering price.

b. Profits Decrease: If the resulting rise in supply is excessive, the market price may be driven down below that necessary to earn a normal profit. Firms will begin making lower profits (or perhaps incurring losses). Marginally efficient firms will reduce production or leave the industry. This will lower the quantity brought to market by suppliers and push prices back up.

c. Stabilization: Eventually, price will become stable at an equilibrium point. This will equal long-run average cost and there will be no economic (excess) profits. Figure 1-16 illustrates long-run equilibrium. Perfect competition hence sustains a lower price and a higher (larger) quantity than other market structures.



B. Monopolistic Competition

                      1.      Characteristics

a. Price Manipulations: Isolated firms have some ability to control the market price. Sellers are price searchers. There is some downward slope to the demand curve.

b. Easy Entry: Since there is no enormous amount of capital required, and no government restrictions on entrance, new suppliers may easily get into (and leave) the market. Required capital is not large and there are no government restrictions on entrance.

c. Differentiated Products: Among very similar products, there are still perceived differences. Instances include breakfast cereal, computers, men's suits and the fast food industry. This generates a broad range of products and imposes some degree of price control on the firms.

d. Advertising: Non-price competition is a usual phenomenon in the market. Instances include advertising designed to encourage trade name distinctions, quality of service.

e. Large Number of Firms: There are many players in the industry so that each seller’s actions are not affected by the others.

2. Elasticity of Demand: Highly elastic demand curve locates near the horizon. The degree of product differentiation as well as the number of rival firms will influence price elasticity of demand.

3. Short-Run Determinants: There is profit maximization when MR = MC. The firm may realize extra profits (or losses) in the short run.

4. Long-Run Consequences: In the long-run, there may be fewer quantities of production than necessary to coordinate with the lowest average unit cost. Hence, fewer firms could produce total output in lower cost (or higher efficiency). Excess profits (losses) are eliminated in the long run.

C. Oligopoly

1.     Characteristics

a. Few Large Firms: A small number (usually 5 or less) of large players who supply the major portion of the output. Instances include the OPEC cartel or the airline industry. This produces a high degree of interdependence between competitors. When there are only two sellers in a given market, duopoly is generated.

b. Rigid Prices: Prices are less flexible than the one dominates the industry supply. It is common to recognize price leadership and covert cooperation. There is cyclical and seasonal consumer demand. This leads to sticky price changes.

c. Entrance is Difficult: These are barriers to entry. High start-up costs are necessary required. In order to operate profitably, economies of scale become a must.

d. Either Differentiated or Standardized Product: The good may be either pure or different from others in the industry.

1.) Pure Oligopoly: A pure oligopoly is a homogeneous standardized product, such as gasoline or steel.

2.) Differentiated Oligopoly: A differentiated oligopoly includes automobiles and

airlines.

3.) Advertising: When the players find price competition undesirable, advertising is adopted to distinguish good from another and facilitate brand or name recognition; this offers an established firm an advantage over new market entrants.

e. Kinked Demand Curve: This is a phenomena that is exclusive to oligopoly. If the price is raised above the market price, it addresses the slope of the demand curve.

2. Mutual Interdependence: If there are only a few players in the industry, and they all expect all their competitors' next move, For instance, oligopolistic firms will consider the anticipated responses of their rivals before making a decision to change price. To avoid "price wars", it is usual to witness the collaboration on prices through price leadership and ~'conscious parallelism". Output may be restricted. Firms in an oligopoly industry can , hence, results in free-market failures in the same manner as a monopoly.

3. Kinked Demand Curve Diagram: Above the market price, the curve is highly elastic. Competitors usually go down to meet a price cut but may ignore a price increase. The segment on the demand curve above the "kink" is highly elastic and quantity very, responsive to price alternations.





D. Pure Monopoly

1.     Characteristics

a. Blocked Entry: Industry entrance is closed due to natural conditions or governmental directive. Hence, there is only one supplier in a given market.

b. Unique Product Without Substitute: There are no close options that are viable for most consumers. Instances include a city's electrical supply.

c. Tying Ability: There are significant marketing advantages for the monopolist. This includes the power to tie new or less desirable goods to the intended monopoly good. This may be illegal under the anti-trust laws- see next chapter.

d. Single Firm in Industry. Only one single player is at the table in a given market. This high market concentration may indicate little incentive for a business to develope innovations, introduce new products, or find and implement new cost-savings technologies; hardly is efficiency is maximized. Advertising may also used to convert buyers from a substitute good (electricity vs. natural gas vs. coal).

e. Important Ability to Set Prices. By altering prices a monopolist can implement various business plans. The demand curve may be highly inelastic. As compared to pure competition, there is often a higher price, but a lower rate of output. This generates the power to extract extra profits from the market.

                      2.      Graphical Depiction: Figure 1 – 18 shows Pricing, Quantity and Profit of a monopoly.

a. Demand Curve: The monopolist's demand curve is the industry's demand curve. The marginal revenue curve is below the demand curve.

b. Profit Maximization: Profit maximization locates in the spot where MR = MC. It is not necessary the highest price. The output level for a monopolist is where total revenue transcends total costs by the greatest amount. There is extra profit, less quantity is produced, and an inefficient allocation of resources. The monopolist's profit is the rectangular area of P1 to P2 x 0 to Q I.

c. Higher Price: As compared to pure competition, consumers will be forced to pay a higher price under the restriction on output.



Graph:


3. Governmental Regulation Justifications: A natural monopoly exists since technical circumstances and/or economic efficiency facilitate only one supplier serving a market.

a. Efficiencies Present: Thanks to economies of scale, a natural monopolist may be capable of producing at a lower average cost than two or more firms over the same relevant range of output. Instances include a neighborhood's water, electricity services, and cable television franchises. There are usually highly inelastic demand curves and a public interest in a stable market in regulated monopolies.

b. Regulation Necessary: It is necessary to regulate the monopolist from exploiting his/her position. In such circumstance, a government agency may set the price and quantity decisions which are originally made by the free market forces. Rates are often set at a level allowing the monopoly a reasonable return on investment based upon the cost of capital. (See also the Sherman and Clayton Acts restraining provisions discussed below for controls placed upon monopolists).

VIII.       STRUCTURAL INTEGRATION


Thanks to a more relaxed federal anti-trust policy and the availability of debt to finance mergers and acquisitions, there is a radical increase in the number of combination in the 1980s and 1990s. There are three types of corporate merger combinations recognized in conventional economic analysis.

A. Conglomerate Expansion: A firm purchases or merges with a firm share no obvious overlap in products within its current marketing mix.

1. Advantages: Sales and earnings may indicate cyclical stability in this diversification. It is less expensive to engage in such investment opportunities than starting a new business in the industry. Furthermore, a conglomerate merger may provide instant availability of productive facilities, skilled management and established vendor sources and distribution channels of greater financial strength and easier acquisition of capital for expansion followed.

2. Disadvantages: Yet, at present, there is a growing perspective that productivity may increase in de-diversification as management under focuse on their field of expertise~

B. Horizontal Expansion: A firm merges with a competitor who produces or sells comparable products.

1. Advantages: This may promote economies of scale and the fuller use of excess production and distribution capacity. Furthermore, it may allow increased market share and hence more manipulation over pricing decisions.

2. Anti-Trust Consideration: Since it is common to see restrictions on competition under the influence of horizontal expansion, there may also be anti-trust implications. (See Chapter 2 for federal statutes controlling this area.)

C. Vertical Expansion: A firm expands its power within its own industry. This may involve a purchase of an upstream supplier or a downstream distribution outlet.

1. Upstream Advantages: Vertical integration can ensure more certainty and reliability in the input decisions and supply is less likely to be disturbed.

2. Downstream Advantages: Quality standards may be manipulated more easily and imposed upon a distributor if it is a part of the company.

3. Competitive Advantages: Such expansion may also generate a potential barrier to the entry of competitors into the industry. Overall, a more efficient operation is found after vertical expansion has been proceeded.

D. Synergies: Synergies refers to the positive benefits from acquisition. This is essentially that the new combined entity will share more value than the sum of the old. It should be noted that it is difficult to measure synergies quantitatively since they are in the future and may have a high qualitative content. There are six basic synergies:

1. Greater Revenues: Stronger distribution networks and a more balanced product mix may result in marketing power gains. Cross-technologies may facilitate strategic gains. Market or monopoly power may allow price increases.

2. Costs Decrease: Economies of scale drive many horizontal mergers in that duplicate elimination of operating functions is common.  Furthermore, there is spreading of overheads over more units.

3. Quality Increases: An integrated vertical distribution chain may be able to increase quality. Processes are easier to change if a part of the enterprise.

4. Tax Advantages: Net Operating Losses may be more comprehensively adopted. Surplus funds in one corporation can be utilized to purchase the stock of another. This saves the tax the shareholder would have paid had they received a dividend and invested it in the same stock. Furthermore, a corporation is allowed at least a 70% dividend received deduction not directly available to individual shareholders.


5. Cost of Capital Reduced: The cost of issuing securities are subject to the influence of economies of' scale. As a percentage of the net issue proceeds, underwriter and placement fees of larger offerings may cost less. Furthermore, there may be a decline in the cost of debt instruments..

6. Capitalization Advantages: If the price-to-earnings ratio of the acquirer transcends that of the acquired target, there may be an instant market gain.

ليست هناك تعليقات:

إرسال تعليق