ASSESSMENT TOPICS. TOPIC 1: Market & Resource Allocation PEC 4123: ECONOMIC ENVIRONMENT FOR BUSINESS 10/13/2016

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1 ASSESSMENT PEC 4123: ECONOMIC ENVIRONMENT FOR BUSINESS Course Work: 60% - Time Constrained Assessment 20% - Case Analysis & Presentation 30% - Participation 10% Examination: 40% TOTAL: 100% TOPICS 1. Markets & Resource Allocation 2. Demand, Revenue & Consumer Behaviour 3. Supply, Production & Cost 4. Business Organisation, Objectives & Behaviour 5. Firm Size, Mergers & The Public Interest 6. Market Structures 7. Labour & Other Factor Markets 8. Market Failure, Regulation & Competition 9. National Income Determination 10. Government Policies: Instrument & Objectives 11. International Business Environment TOPIC 1: Market & Resource Allocation 1

2 Content - Wants, limited resources & choices - Demand curves & functions - Supply curves & functions - Price determination - Changes in market price & quantity - Resources allocation in different economic systems Wants, Limited Resources & Choice The Economic Problem: Unlimited Wants Scarce Resources Land, Labour, Capital Resource Use Choices Opportunity Cost Definition the cost expressed in terms of the next best alternative sacrificed Helps us view the true cost of decision making Implies valuing different choices The determinants of demand for goods and services The demand curve shows the relationship between price and quantity demanded Generally the higher the price of a product the smaller the quantity demanded As price decreases quantity demanded increases Therefore the demand curve has a negative slope 2

3 Demand Curve Shifts in the demand curve The demand curve shows an inverse relationship between price and quantity demanded If price changes then you would move along the demand curve to calculate any change in quantity demanded Changes the following factors causes a shift in the demand curve: Prices of other goods either substitutes or compliments Incomes Tastes and fashions Consumer expectations Advertising Population level and structure These factors can enable the demand curve to shift to the: Left (less demanded at each price) Right (more demanded at each price) Shifts in the demand curve These graphs show what would happen if Demand increased Demand decreased Price elasticity of demand Elasticity looks at the responsiveness of one variable to a change in another Price elasticity: The responsiveness of demand to a change in price %change in quantity demanded / % change in price If PED > 1 it is elastic (flat demand curve) If PED < 1 it is inelastic (steep demand curve) 3

4 Price elasticity of demand, revenue and profit If a product is elastic to increase revenue you reduce price The reduction in price increases quantity demanded by a greater amount therefore increasing revenue If a product is inelastic to increase revenue you increase price The increase in price reduces quantity demanded by a smaller amount therefore increasing revenue If costs stay the same then these actions will result in greater levels of profit for the firm Income elasticity of demand Measures the responsiveness of demand to changes in income % change in quantity demanded / % change in income YED > 0 (positive sign) = Normal goods as income rises demand rises YED < 0 (negative sign) = Inferior goods as income rises demand falls Cross elasticity of demand Measures the responsiveness of demand of one good to changes in the price of another good % change in quantity of good 1 / % change in price of good 2 Cross elasticity < 0 (negative sign) The goods are compliments Cross elasticity < 0 (positive sign) The goods are substitutes Factors that influence elasticity of demand Number of substitutes the greater the number of substitutes the more elastic a product is The % of income spent on the product the smaller the % the more inelastic the good The time period the longer this is the more elastic the good is Luxury or necessity Luxuries tend to be more elastic and necessities more inelastic 4

5 The determinants of the supply of goods and services The supply curve shows the relationship between price and quantity demanded The supply curve generally slopes upwards at higher prices more is supplied There is a positive relationship between price and quantity supplied As price increases revenues would increase for the supplier If revenues increase then profits would be likely to increase encouraging producers to increase production levels The Supply Curve If price changes the quantity demanded will change this will indicate a movement along the supply curve Determinants of Supply The following factors influence supply: Profitability of other goods in production Technology Costs of production Natural shocks Social factors Expectations of producers Changes to any of these factors will cause the supply curve to shift: Supply curve shifts to the left less will be supplied at every price Supply curve shifts to the right more will be supplied at every price Shifts in the supply curve These graphs show the consequences of: An increase in supply A decrease in supply 5

6 Price elasticity of supply This measures the responsiveness of supply to changes in price % change in quantity supplied / % change in price If PES > 1 it is elastic this means it is easy for suppliers to respond quickly to price changes If PES < 1 it is inelastic this means it is hard for suppliers to respond quickly to changes in price Factors influencing Price Elasticity of Supply Spare capacity if there is lots of spare capacity the business should be able to increase output quite quickly therefore supply will be elastic Ease of factor substitution -If capital and labour resources can easily be switched then the production process is more flexible and elasticity of supply for a product is likely to be higher Stocks If stock levels are high then supply will be elastic Time period the longer the time period the more likely supply is likely to elastic as the firm has time to alter production levels The determination of market equilibrium prices The interaction of the demand and supply curves sets the equilibrium price in a market The equilibrium point is where the supply and demand curves cross Equilibrium price is p* Equilibrium quantity is q* Unless the demand or supply curve shift p* and q* stay the same Cause of changes in equilibrium price Shifts in the demand or supply curve will cause the equilibrium price to change The extent to which the price changes is dependent on the elasticity of demand / supply 6

7 Demand and supply analysis in specific markets Demand and supply may work differently in different markets Governments may pay subsidies to producers in certain markets These reduce producers costs of production and encourage them to produce more therefore the firms supply curve shifts to the right Subsidies are often common in agricultural markets, where industries are struggling e.g. shipbuilding and where goods are perceived as merit goods Consumer surplus A consumer surplus arises is where consumers are willing to pay more for a good / service than they actually do As the government provides health care free on the NHS this represents a consumer surplus Different Markets In commodity markets such as coffee and oil demand and supply interact to create an equilibrium price In the housing market prices have risen as demand has outstripped supply causing a shift in the demand curve Interrelationships Between Markets Changes in one market are likely to influence other markets Composite demand is the demand for a product that has more than one use Derived demand is where demand for one good or service is due to demand of another This may be due to the production process E.g. demand for trainers will increase demand for rubber 7

8 Joint demand Joint demand is where the demand of one product is tied to the demand of another Joint demand occurs when products are complements in production or consumption Because the products are used together the demand for one good is tied to the demand for the other good E.g. tea and milk if there is no milk demand for tea would decline How markets and prices allocate resources Markets allocate resources as they allow all consumers who are willing and able to purchase goods at a set price to receive them Prices allow a good to be rationed if the product is in short supply the price of the good will increase so only those willing to pay the highest prices will be allocated the resources How markets and prices allocate resources Incentives are any factor (financial or non-financial) that provide a motive for a course of action Incentive pricing aims to encourage consumers to purchase a particular product increasing its demand Prices can also be used as a signaling tool Often high prices are seen to reflect high quality The effectiveness of the market system The allocation of resources in the market system is not always efficient Governments may use taxes and subsidies to try and correct market failure The market system only allocates resources to those who are able to pay 8