Microeconomics PDF

Micro economics looks at the behaviour of individuals and organisations that make up the economy. Resources are limited for both individuals and organisations, so how people decide to allocate their resources has a direct impact on the economy. In addition, an organisation’s competitors also hav...

Micro economics looks at the behaviour of individuals and organisations that make up the economy. Resources are limited for both individuals and organisations, so how people decide to allocate their resources has a direct impact on the economy. In addition, an organisation’s competitors also have limited resources and the way they choose to use their resources has its own impact on the marketplace. Sustainability considers individuals and organisations attitudes towards the resources they do have. This is particularly important as the availability of resources reduces across the globe. The use of resources has historically been aimed at returning a profit to shareholders, but globally, attitudes are changing towards considering the needs of all stakeholders. The law of supply and demand is a theory that explains a relationship between: 1)the buyers of a resource, and how much they are willing to pay for it 2)the sellers of a resource, and the price they set for it. Equilibrium is the term for the point where supply and demand meet. The theory says that over time, the market for any given product will move towards equilibrium as at this point both buyers and sellers are happy with the price point. Supply, demand, and equilibrium Summary of the below graph, shows that 1. At a price of P1, supply is at Q1, but demand is at Q3. There is an excess of demand over supply. This will increase the price of goods until the market reaches equilibrium. 2. At a price of P3, supply is at Q3, but demand is at Q1. There is an excess of supply over demand. This will reduce the price of goods until the market reaches equilibrium. 3. At a price of P2, supply is at Q2 and demand is also at Q2. This is equilibrium. The law of demand refers to how much consumers are willing to purchase using their limited resources. Law of Demand As the price falls, demand for the product increases. Gaining Insight The law of supply states that as the price of a product increases, the quantity of the product in the marketplace will also increase. Generally, as the price increases organisations are willing to supply more. Shifts in the supply and demand curves Shifts in the supply and demand curves occur when the whole supply and demand curves moves to either the left or the right. This causes an imbalance in the market that is corrected by prices and demand changing. Let’s look at what factors will cause a shift in the supply or demand curve. Supply Curves A shift in the supply curve to the left occurs when there is a decrease in supply. When there is an increase in supply the supply curve shifts to the right. The price of the supply moves accordingly. This isn’t a change in the quantity supplied, as this would cause movement along the existing supply curves, rather it’s a shift in the whole price-quantity relationship that defines the supply curve. Primary factors that shift the supply curve: the price of raw materials the technology used in the market improved efficiency. A change in supply is an increase or decrease in the quantity supplied that is paired with a higher or lower supply price. For example, a farmer produces apples. In year one, the conditions are perfect for growing apples , and there is a plentiful supply. The farmer reduces the price of the apples in order to sell them all. In year two, a batch of the apples is spoiled due to an insect infestation. The farmer increases the price of the apples as the demand hasn’t changed, but the quantity of the supply is reduced. Demand Curves A shift in the demand curve to the left occurs when there is a decrease in demand. When there’s an increase in demand the demand curve shifts to the right. A change in demand represents the consumers desire to purchase a product, even when the price remains constant. This shift could be for a number of reasons: Primary factors that shift the demand curve: how much consumers have to spend trends and attitudes – what products are popular buyer expectations – does the consumer expect the price to change price of substitute goods population growth. For example, a new brand of trainers is introduced to the market. They are endorsed by a celebrity and are in very high demand. In year one, the price of the product can increase due to the increase in demand. In year two, the trainers are no longer in demand due to a change in attitudes. The price of the product decreases due to the decrease in demand. Impact of price changes When the price of products changes, the impact on an organisation’s profits will be different depending on the specific product and how elastic it is. Inelastic products are products that people want to buy, but they generally want to buy fixed amounts of. They tend to be necessities. Elastic products tend to be luxuries, such as designer clothing or eating out at restaurants. If prices increase for elastic products consumers tend to stop buying as much of the product. As well as whether an item is a luxury or a necessity, other factors that impact elasticity are: bullet how many substitutes there are in the market bullet how much as a proportion of income the product costs bullet how addictive the product is. If supply outstrips demand, an organisation may reduce the price to encourage more sales. However, the price may fall to an unsustainable level. When this happens some companies withdraw from the market either because they fail entirely or they refocus on products that make more profit. This rebalances the supply/demand levels as there are now fewer suppliers in the market. Equilibrium refers to the point where supply and demand meet At this point there is sufficient supply to meet the demand and both buyer and seller are happy with the price point. An increase in population growth can affect the demand curve. For many products and services, the more people there are in the population the more demand there is for their products. Prices are driven by many factors. Sometimes an increase in price may result in a decrease in revenue as consumers look elsewhere for substitute products, or may choose not to purchase the product at all. Perfect competition Perfect competition describes a marketplace where there are no barriers to entry into the market, equal market share for all suppliers, and ultimately an environment where all prices are set by supply and demand. In this environment, there would be many small organisations all providing identical products as they would all have access to the same industry knowledge. Equilibrium rules the pricing in a perfect competition marketplace. There’s no point in a supplier raising their prices, as there are other suppliers providing the exact product in the marketplace. There’s no point in a supplier lowering their prices, because the demand is already being met. Perfect competition is a theoretical concept, and it’s difficult to find real world examples of perfect competition. Imperfect competition Imperfect competition is very common. The primary features of a marketplace with imperfect competition include: a marketplace with products and services that have different features a number of sellers competing for market share barriers to entry preventing sellers from entering the market place, such as regulatory requirements, high start-up costs, industry expertise required buyers and sellers that don’t have readily available information. In a monopoly there’s only one main supplier, and they can set their price at any level they want. Profitability isn’t guaranteed however, as there is no certainty that consumers will want the product they are selling. In an oligopoly there are a small number of suppliers and the prices they set impact on each other. If a supplier increases their prices, the other suppliers can gain market share if they don’t follow suit. If a supplier reduces their prices the other suppliers have to do the same if they want to maintain market share. Examples of oligopolies: supermarkets, soft drinks companies, petrol providers, high street banks. Monopolistic Competition In this marketplace, suppliers compete with each other on something other than price. They all offer similar products but will use things like their brand and expertise to increase demand for their products. Car manufacturers, airlines, and the restaurant industry are all examples of monopolistic competition. They typically compete with each other on brand or features rather than on price. Perfect competition requires there to be few or minimal barriers to entry so many suppliers can participate. Sustainability is concerned with how individuals and organisations use the resources they have available to them, and at what rate. Definition: Sustainability means taking a long-term view and allowing the needs of present generations to be met without compromising the ability of future generations to meet their own needs. Sustainable performance There are three aspects to sustainable performance Environmental Environmental sustainability is a concept that organisations are familiar with as it has historically received the most attention. Organisations have been asked by their governments to commit to reducing their carbon footprints, reducing the waste they produce, and implementing policies within their organisations to reduce waste produced at an individual level. Social Social sustainability (the people aspect) is focused on considering the needs of the organisation’s wider stakeholders, which includes the community it operates in. Their needs include having access to local businesses to work at, having businesses in their community that don’t pollute the environment, and having organisations that support the needs of individuals through charitable acts such as donations or volunteering their expertise. Economic Economic, or financial, sustainability is intuitive to many organisations. In order to be sustainable, an organisation must make a profit and many organisations will focus on securing profits in order to grow. Economic sustainability includes the concept that the profit being made should not be at the cost of the other two aspects. Informally, these are referred to as planet, people, and profit. In order to be able to produce goods or services, an organisation needs to manage its resources optimally. Materials Raw materials and resources that are processed. Money Capital used to finance the organisation’s activities. Human Resources People and the labour they provide. Machines Tools and equipment used by the organisation Management How these resources are managed. Applying a sustainable development approach means that the management of resources is focused on the long-term rather than the short term. This could result in making decisions that provide less profit in the short term, so can represent a shift in strategic thinking for a lot of organisations. It isn’t just about inputs and resources. A sustainable organisation should consider how to maintain sustainability across all of its activities. This includes the products and services it provides, but it extends to the supply chain and whether the organisations in its supply chain are sustainable. Workforce policies that affect employees and the environment they work in should be focused on ensuring they are sustainable. Recruitment and retention policies, along with flexible working policies, flexible maternity and paternity policies, and other policies that help support employees balance their roles, are designed to provide sustainability to a workforce. This contrasts with short term policies where employees can be dismissed and replaced with very little notice. The role of the professional accountant has always included protecting organisational value for the long term; for example, an auditor is looking for indicators that might suggest that an organisation is not a going concern. The preparation of accurate financial statements is a key aspect of attracting confidence from investors and allowing organisations to continue in the long-term. As the focus shifts towards organisations considering the needs of all stakeholders, professional accountants have a key role to play in building confidence that organisations are acting in the wider public interest. Professional accountants have a key role to play in building confidence that organisations are acting in the wider public interest. How individuals and organisations use their resources is the subject of much study as there are many human, behavioural factors that go into a purchasing decision. Understanding some of these factors and how they impact supply and demand in the short term and sustainable organisational development in the long term are both skills that a professional accountant needs to have.