BCPC 118: Economics for Business 2020/2021 PDF

 COURSE STRUCTURE AND OUTLINE (SYLLABUS) DEPARTMENT: BANKING AND FINANCE A. COURSE DETAILS COURSE CODE BCPC 118 CREDIT HOURS 3 LEVEL 100 COURSE TITLE Economics for Business ACADE...

 COURSE STRUCTURE AND OUTLINE (SYLLABUS) DEPARTMENT: BANKING AND FINANCE A. COURSE DETAILS COURSE CODE BCPC 118 CREDIT HOURS 3 LEVEL 100 COURSE TITLE Economics for Business ACADEMIC YEAR 2020/2021 SEMESTER Second PROGRAMME[S] BSc. Accounting, Banking & Finance, Business Administration, IT, Marketing and Accounting & Finance. COURSE URL: http//: B. COURSE INSTRUCTOR DETAILS NAME DR. ABDALLAH ABDUL-MUMUNI OFFICE LOCATION Rev. J.J. Martey Building TELEPHONE EMAIL [email protected] CONTACT HOURS Monday: 10:00 AM- 2:00 PM OTHER CONTACTS C. COURSE DESCRIPTION This course focuses on introduction to consumer and business behaviour in competitive markets, effects of government policies on market outcomes, and the basic economic concepts used in business analysis and decision-making. It provides students with basic understanding of the economic influences on business. The course introduces students to concepts of scarcity, demand and supply, measures of productivity and cost in the short-run, and market structures. It also exposes students to national income accounting, inflation, unemployment, fiscal and monetary policies. Economics for Business equips students with basic analytical skills to examine the impact of these macroeconomic forces on business conditions. The course will be delivered through class presentation and discussion. D. COURSE OBJECTIVES The objectives of the course are to:  Explain the fundamental problem of Economics in relation to business.  Explain the concepts of demand and supply.  Demonstrate knowledge in measures of productivity and cost in the short-run.  Explain the core principles of market competition and the characteristics of a variety of market structures.  Compute various concepts of Gross Domestic Product (GDP)/National Income.  Introduce students to the concepts, causes and implications of inflation and unemployment with emphasis on Ghanaian economy.  Demonstrate knowledge in the use of fiscal and monetary policies in influencing macroeconomic environment in which consumers and business operate. E. COURSE LEARNING OUTCOMES After completing this course, students will:  Appreciate the fundamental problem of Economics and the need for making rational choice in real life situation.  Apply the understanding of price mechanism in real life situation.  Apply the law of diminishing marginal returns in explaining the stages of production in the short-run.  Analyse market structures and apply the knowledge in price-output decisions of firms.  Describe the various measures of national income and analyse the various problems encountered in national income accounting.  Identify the causes, implications of inflation and unemployment in Ghana, and propose solutions to them.  Analyse fiscal and monetary policies for the management of the Ghanaian economy and their implications on the business environment. F. COURSE OUTLINE IN A WEEKLY FORMAT The course outline shall be prepared in weekly format describing the modules to be thought in each week. WEEK LESSONS/MODULES/ACTIVITIES WEEK 1 Discussion of Course Outline, Outcomes, Expectations, Assessments, Introduction and preliminary concepts in Economics for Business Lecture/Class assignment WEEK 2 Demand, Supply and Market Equilibrium Lecture/Class Discussion/Group assignment WEEK 3 Elasticity and its Application Lecture/Class Discussion/Powerpoint presentation WEEK 4 Application of Demand and Supply model Lecture/Class Discussion/Group assignment WEEK 5 Production Analysis Lecture/Class Discussion WEEK 6 Cost Analysis  Lecture/Class Discussion WEEK 7 Perfect Competitive Market Lecture/Class Discussion WEEK 8 Imperfect Competitive Market Lecture/Class Discussion/Group assignment WEEK 9 National Income Accounting (GDP, Income and Growth) Lecture/Class Discussion WEEK 10 Money, Money Markets, Interest Rate, Exchange Rate and Monetary Policy Group Presentations/ Group Assignment WEEK 11 Fiscal Policy, Unemployment and Inflation Group Presentations/Class Discussion G. COURSE ASSESSMENT Grade in the course would be determined by a student’s performance in a mid-semester and end of semester exams. The mid semester exams would be made up of both assignment and mid-semester exams. The mid-semester exam for mainstream and weekend students is scheduled within the period, 21st – 28th June, 2021. Students will be given a minimum of two assignments – a mixture of group and individual assignments. The breakdown of the marks is as follows: Final Exams - 60% Mid-semester Exams - 20% Group Assignment - 10% Assignments (individual) and/or attendance - 10% Total - 100% Pass mark for this course is 50%.Make-up exams will not be given under any circumstances. However, if a student has a legitimate reason for missing a scheduled exam or assignment and notification is made to the Lecturer at least a week in advance of the exam, the student concern may be considered. H. READING LISTS/REFERENCES Mankiw, N.G., Taylor, M.P., & Ashwin A. (2013). Business economics, (1st ed.). United Kingdom: CENGAGE Learning. Sloman, J., Garratt, D., Guest J. & Jones, E. (2016). Economics for Business, (7th ed.), Pearson Education: Edinburgh, United Kingdom. Abdul-Mumuni, A. (2018). Economics for business, (1st ed.). Sahabia Publications. Supplementary Reading Mankiw, N.G. (2015). Business economics, (7th ed.). United Kingdom: CENGAGE Learning Bamford, C., & Grant, S. (2015). AS and A level economics course book, (3rd ed.), Cambridge University Press. Case, K. E., Fair, R. C. & Oster, S. E. (2013). Principles of microeconomics, (11th ed.). Pearson. Frank, R. & Bernanke, B. (2012). Principles of microeconomics, (5th ed.). McGraw-Hill Education I. COURSE INSTRUCTIONS Teaching Methods The course will be course will be delivered through a combination of both online and face-to-face class presentations - group presentations, class discussions and lectures. Also, tutorials will be organised to solve practical problems. Students will also be given tutorial questions for submission. Student Responsibility: Attendance of each student at lectures will be monitored and checked occasionally. Each student is therefore encouraged to attend lectures and to actively participate in class discussions by asking relevant questions and contributing from their personal knowledge when appropriate. Each class has a wealth of applications-based experience which may add greatly to theclass discussions. No cellular telephones are permitted in class. If you bring one to class, be sure to turn it off or you will be asked to leave. Plagiarism Plagiarism is a form of cheating that undermines academic integrity; it is also a criminal offence and anyone found guilty will be punished severely. Plagiarism means the representation of the work of another person or other persons without due acknowledgement, that is, as if it were one’s own, whether intended or not. This includes published work, material on the internet, and the work of other students or staff. It is still plagiarism even if you re-structure the material or present it in yourown style or words. J. GENERAL INFORMATION – COURSE LECTURERS Dr. Christopher QUAIDOOO ([email protected], Mr. Michael INSAIDOO ([email protected]), Dr. Kofi Osei ADU ([email protected]), Dr. Abdallah ABDUL-MUMUNI ([email protected]), Dr. Richard AGBANYO ([email protected]), Dr. Kwaku Amakye ([email protected]), Dr. ANDARATU ACHULIWOR ([email protected]), Mr. Eric Boachie Yiadom, Mr. Jabir Mohammed, Mr. Michael Ayiney Alpha, and Mr. Dexter Senanu Hewlett BCPC 118: Economics for Business LECTURE ONE Business, The Nature and Scope of Economics 5/5/2023 CHRISTOPHER QUAIDOO, UPSA 1  Learning Outcomes By the end of lecture one you will be able to:  State some of the major decisions facing businesses  Identify the Fundamental Problem of Economics.  Identify Basic Economic Problems facing Societies  Explain the meaning of Economic Resources, Scarcity, Choice and Opportunity Cost  Differentiate between Microeconomics and Macroeconomics  Differentiate between Positive and Normative Economics  Describe the types of Economic Systems and give examples  Explain the Production Possibility Frontier and its importance 5/5/2023 CHRISTOPHER QUAIDOO, UPSA 2  The Role and Decisions of Business  The Role of Businesses in an Economy o Production of goods and services for final consumers. o Creation of job opportunities. o Payment of taxes and duties for development of an economy, etc. Note that businesses depend on households (consumers) and the conducive environment of the State for their growth and survival.  Decisions facing Businesses - A business faces many decisions o It must decide what products to produce; how many people to employ; o How best to manage costs of production. o How to deal with competitors and pricing of products, etc. o In short, business must allocate scarce resources among competing uses, taking into account a range of stakeholder needs and wants. 5/5/2023 CHRISTOPHER QUAIDOO, UPSA 3  Understanding Economic Problem  One major problem facing humanity is the inability of man, business or society to satisfy all his/its wants.  Our wants are unlimited, but the available resources to satisfy them are limited in supply.  Thus, in trying to satisfy our wants the economy is faced with the fundamental economic problem, which is scarcity.  Scarcity, therefore, is the problem of life which requires a solution.  The management of society’s resources is important because resources are scarce.  Economics as a discipline emerged to address the problem of scarcity of resources. It aims at making the best out of the limited resources given our unlimited wants. 5/5/2023 CHRISTOPHER QUAIDOO, UPSA 4  Understanding Economic Problem  Scarcity necessitates choice and in the process some alternatives are forgone.  Thus, the problem of scarcity requires that we make rational choices by satisfying our pressing needs.  Making rational choices demands that we compare the costs and benefits of alternatives or alternative courses of our action(s).  Making choices also involves opportunity cost (real or true cost).  Opportunity cost is the benefit of the next best alternative forgone.  Scarcity therefore imposes on every society three basic questions to be addressed: What to produce; How to produce; For whom to produce. 5/5/2023 CHRISTOPHER QUAIDOO, UPSA 5  Definition of Economics  In the literature, there is no “one-fit-all” definition for economics. Adam Smith in his book the Wealth of Nations defined economics as, “an inquiry into the nature and causes of wealth of nations”. J.S. Mills defined economics as “the practical science of the production and distribution of wealth”. Alfred Marshall defined economics as “the study of mankind in the ordinary business of life”. A.C. Pigou defined economics as “a means of studying how total production could be increased so that the standard of living of people might be improved”. 5/5/2023 CHRISTOPHER QUAIDOO, UPSA 6  Definition of Economics Lionel Robbins defined economics as “the science which studies human behaviour as relationship between ends and scarce meanswhich have alternative uses”. Paul Samuelson defined economics as “the study of how people and society (with or without money) choose to employ scarce productive resources that could have alternative uses in order to produce various commodities and to distribute them for consumption now or in the future among various persons and groups in society”. From the above definitions one can simply define economics as the study of how society allocates its scarce resources, which have competing uses, towards production and distribution of goods services to satisfy human needs/wants. 5/5/2023 CHRISTOPHER QUAIDOO, UPSA 7  Economic Systems What, how and for whom to produce are fundamental and common to all societies.  Under a pure command (socialist) economy decisions are centralized and a delegated authority decides what to produce, how to produce, and for whom to produce. Thus, there is no private participation in solving society’s problem. Close examples are North Korea, Cuba, etc. 1. public ownership of factors of production. 2. economic decision making. 3.equitable distribution of income.  Under a private market (capitalist) economy or free enterprise economy, decisions are decentralized and each individual pursues the self-interest motive which via the ‘invisible hand’ leads to the production of the social good. Close examples are USA, UK, France, Germany etc. Private ownership of factors of production Freedom of choice Economic decision making 5/5/2023 CHRISTOPHER QUAIDOO, UPSA 8  Economic Systems Mixed economic system combines features of both command and market economies. Most capital goods are owned by private individuals but government also owns and controls some key resources and sectors of the economy, especially, where they think producers or investors may exploit consumers (e.g. energy sector). In reality, most countries practice this kind of economic system. Examples are Ghana, Nigeria, South Africa, etc.  What is economic system? What are the features of economic systems? 5/5/2023 CHRISTOPHER QUAIDOO, UPSA 9  Production Possibility Frontier PPF is a curve that shows all the maximum combinations of output that an economy can produce using all its available resources given the state of technology. The PPF is based on the following assumptions:  Only two goods are produced  There is full employment and productive efficiency  Resources are fixed both in quantity and quality, but they have competing uses  Technology is fixed. PPF can be illustrated using both table and graph. 5/5/2023 CHRISTOPHER QUAIDOO, UPSA 10  Table 1: Production Possibility Table Alternatives Labour for Output of Labour for Output of Wine wine cotton cotton A 4 10 0 0 B 3 9 1 1 C 2 7 2 2 D 1 4 3 3 B 0 0 4 4 5/5/2023 CHRISTOPHER QUAIDOO, UPSA 11  Production Possibility Frontier 5/5/2023 CHRISTOPHER QUAIDOO, UPSA 12  Observations from the table The sum of labour at any point is fixed at 4. To increase the production of one good (say Cotton), some resources must be shifted to that particular good – full employment of resources. To increase the production of one good (say cotton), there would be a fall in output/production of the wine. 5/5/2023 CHRISTOPHER QUAIDOO, UPSA 13  Inefficient, Efficient and Unattainable Points inside the PPF are attainable but not desirable because they are inefficient. It indicates unemployment of resources.  Thus, the economy can produce more of at least one good without any trade-off. Points on the PPF are attainable and efficient.  It indicates full employment and productive efficiency. Points outside the PPF are unattainable given the available resources and technology. 5/5/2023 CHRISTOPHER QUAIDOO, UPSA 14  Shape of Production Possibility Frontier The shape of the PPF reflects the law of increasing opportunity cost. The law of increasing opportunity cost: the more of a good which is produced, the greater is its opportunity cost. Thus, as more of one good is produced, larger and larger quantities of the alternative good must be sacrificed. Economic Rationale for the concavity: economic resources are not completely adaptable or suitable to alternative uses. 5/5/2023 CHRISTOPHER QUAIDOO, UPSA 15  Shifts in the PPF Advances in technology: the PPF bodily shifts outward Increase in resource supplies: the PPF shifts outward Discovery of new resources: the PPF shifts outward Note: Advances in technology, increase in resource supplies, and discovery of new resources cause economic growth. Advances in technology that favour production of one commodity may result in a partial shift or growth in favour that particular commodity. 5/5/2023 CHRISTOPHER QUAIDOO, UPSA 16  Microeconomics and Macroeconomics Microeconomics is a detailed study of the behaviour of individual economic agents in the economy such as households, firms and gov’t institutions. How households and firms make decisions and how they interact in specific markets. Microeconomic issues include prices of specific products of firms, employment levels of specific firms, expenditure of specific firms. Macroeconomics is the study of the economy as a whole. Macroeconomics deals with the structure, performance and behaviour of the economy as a whole. Macroeconomic deals with economic aggregates at the national level which include unemployment, GDP, Inflation, exchange rate, interest rate, B.O.P. 5/5/2023 CHRISTOPHER QUAIDOO, UPSA 17  Positive and Normative Economics Positive economics is descriptive and explains how the economy actually works. It is based on facts and devoid of value judgements. Generally about “what is?” E.g. Unemployment is high in Ghana. Normative economics is prescriptive and explains how the economy “ought to be”. It is based on value judgements with no scientific underpinning. E.g. Government should take actions to reduce unemployment. 5/5/2023 CHRISTOPHER QUAIDOO, UPSA 18  Tutorials/Trial Questions 1. In your own words define Economics. 2. What is the importance of Economics in business? 3. Explain the concepts of scarcity, choice, opportunity cost and resources. 4. Describe four characteristics each of the various economic resources 5. What is economic system? State four features each of the three economic systems. 6. Briefly explain how the production possibility frontier illustrates the concepts of scarcity, choice and opportunity cost. 7. Differentiate between the following: a. Microeconomics and macroeconomics. b. Normative and positive economics. 5/5/2023 CHRISTOPHER QUAIDOO, UPSA 19 5/5/2023 CHRISTOPHER QUAIDOO, UPSA 20 BCPC 118: Economics for Business LECTURE TWO DEMAND AND SUPPLY ANALYSIS 5/5/2023 KOFI OSEI ADU, UPSA 1  Learning Outcomes By the end of lecture two, students will:  Identify and explain the factors that influence demand and supply of goods and services.  Distinguish between movement along the demand and supply curves (change in quantity demanded and supply) and shift of the demand and supply curves (change in demand and supply).  Determine the market equilibrium price and quantity of a good or service graphically and mathematically.  Analyse the effect of non-price factors on the equilibrium price and quantities of goods or service. 5/5/2023 KOFI OSEI ADU, UPSA 2  DEMAND Demand refers to the various quantities of a commodity that consumers are willing and able to purchase at various prices during a given period of time. This demand can be represented in the form of a graph (demand curve), algebra (demand function/equation) Table (demand schedule) : Individual demand schedule and market demand schedule. Table 1: Kofi’s DD schedule and Kesewaa’s DD schedule 5/5/2023 KOFI OSEI ADU, UPSA 3  DEMAND 5/5/2023 KOFI OSEI ADU, UPSA 4  DEMAND Types/Forms of Demand 1. Joint demand (complementary demand) 2. Competitive demand 3. Composite demand 4. Derived demand Determinants of Demand( Factors Influencing Demand) 1. Price of the commodity itself 2. Price of related commodity (substitutes and complements) 3. Income of the consumer : Normal good and inferior good 4. Taste and preference 5. Consumer expectation 6. Population (number of buyers) 7. Advertisement 5/5/2023 KOFI OSEI ADU, UPSA 5  Change in Quantity Demanded 5/5/2023 KOFI OSEI ADU, UPSA 6  Change in Demand 5/5/2023 KOFI OSEI ADU, UPSA 7  The Demand Function A general equation representing the demand curve Qxd = f(Px , PY , M, H,) Qxd = quantity demand of good X. Px = price of good X. PY = price of a related good Y. Substitute good. Complement good. M = income. Normal good. Inferior good. H = any other variable affecting demand. 5/5/2023 KOFI OSEI ADU, UPSA 8  The Demand Function Example: Demand Function Qxd = 10 – 2Px – Inverse Demand Function: 2Px = 10 – Qxd Px = 5 – 0.5Qxd 5/5/2023 KOFI OSEI ADU, UPSA 9  SUPPLY Supply refers to the various quantities of a commodity that producers/sellers are willing and able to sell at various prices during a given period of time. This supply can be represented in the form of a graph (supply curve), algebra (supply function/equation) Table (supply schedule) : Individual supply schedule and market supply schedule. Price Table3: market ss schedule S0 price quantity 3 10 2 6 1 2 Quantity 5/5/2023 KOFI OSEI ADU, UPSA 10  SUPPLY DETERMINANTS OF SUPPLY Price of the commodity itself Input prices Technology Government regulations (tax and subsidy) Number of firms – Entry – Exit Producer expectations 5/5/2023 KOFI OSEI ADU, UPSA 11  Change in Quantity Supplied A to B: Increase in quantity supplied 5/5/2023 KOFI OSEI ADU, UPSA 12  Change in Supply 5/5/2023 KOFI OSEI ADU, UPSA 13  The Supply Function An equation representing the supply curve: QxS = f(Px ,W, H,) – QxS = quantity supplied of good X. – Px = price of good X. – W = price of inputs (e.g., wages). – H = other variable affecting supply. 5/5/2023 KOFI OSEI ADU, UPSA 14  The Supply Function Price as a function of quantity supplied. Example: – Supply Function Qxs = 10 + 2Px – Inverse Supply Function: 2Px = 10 + Qxs Px = 5 + 0.5Qxs 5/5/2023 KOFI OSEI ADU, UPSA 15  Market Equilibrium The Price (P) that Balances supply and demand – QxS = Q xd – No shortage or surplus Steady-state 5/5/2023 KOFI OSEI ADU, UPSA 16  Market Equilibrium 5/5/2023 KOFI OSEI ADU, UPSA 17  Market Equilibrium 5/5/2023 KOFI OSEI ADU, UPSA 18  Market Equilibrium T 5/5/2023 KOFI OSEI ADU, UPSA 19  Market Equilibrium Given the demand and supply functions as follows: Qd= a-bP – demand function Qs= -c+ dP - supply function Qd=Qs a-Bp= -c+ dP a+c=bP+ dP a+c= (b+d)P P=a+c/b+d ---- equilibrium price 5/5/2023 KOFI OSEI ADU, UPSA 20  Market Equilibrium Qd= a-bP – demand function Qs= -c+ dP - supply function Q= a-b(a+c/b+d) Q= a(b+d)-b(a+c) b+d Q= ab+ad-ab-bc b+d Q= ad-bc ------ Equilibrium quantity b+d 5/5/2023 KOFI OSEI ADU, UPSA 21  Market Equilibrium Question 1:Demand function for gari is Qd= 10- 2P and supply function is Qs= 2+2P. Determine the competitive equilibrium price and quantity. Question 2: suppose the demand and supply functions for kobi company are given as follows: Qd= 100-4P + 10L Qs = -10+6P + 3W If W=30, L=10, determine equilibrium price and quantity 5/5/2023 KOFI OSEI ADU, UPSA 22  Trial Questions 1. With the aid of relevant diagram(s), explain the difference between change in quantity demanded and change in demand. 2. Analysis the effect of an increase in the price of milo on demand for bournvita. 3. With the help of a appropriate diagram, explain theeffect of an increase in specific tax on equilibrium price and quantity when demand is held constant. 4. Analysis the effect of maximum price legislation on demand for goods and services in an economy. 5/5/2023 KOFI OSEI ADU, UPSA 23 5/5/2023 KOFI OSEI ADU, UPSA 24  THE MARKET FORCES OF DEMAND and SUPPLY REVIEW OF DEMAND and SUPPLY  Markets A market is a group of buyers and sellers of a particular good or service.  The terms supply and demand refer to the behavior of people... as they interact with one another in markets.  Economics, especially Microeconomics is about how supply and demand interact in markets.  Demand Curve Price of Kako GH¢3.00 2.50 2.00 1.50 1.00 0.50 Quantity of 0 1 2 3 4 5 6 7 8 9 10 11 12 Kako  Why does the Demand Curve Slope Downward? Law of Demand – Inverse relationship between price and quantity. Law of Diminishing Marginal Utility. – Utility is the extra satisfaction that one receives from consuming a product. – Marginal means extra. – Diminishing means decreasing.  Market Demand  Market demand refers to the sum of all individual demands for a particular good or service.  Graphically, individual demand curves are summed horizontally to obtain the market demand curve.  Ceteris Paribus Ceteris paribus is a Latin phrase that means all variables other than the ones being studied are assumed to be constant. Literally, ceteris paribus means “other things being equal.” The demand curve slopes downward because, ceteris paribus, decreasing prices imply a greater quantity demanded!  Two Simple Rules for Movements vs. Shifts Rule One – When an independent variable changes and that variable does not appear on the graph, the curve on the graph will shift. Rule Two – When an independent variable does appear on the graph, the curve on the graph will not shift, instead a movement along the existing curve will occur. Let’s apply these rules to the following cases of supply and demand! Change in Quantity Demanded versus Change in Demand Change in Quantity Demanded  Movement along the demand curve.  Caused by a change in the price of the product.  Changes in Quantity Demanded Price of a Mango A tax that raises the price of mango results C in a movement along GH¢2.00 the demand curve. 1.00 A D1 0 12 20 Quantity of Mango Change in Quantity Demanded versus Change in Demand Change in Demand A shift in the demand curve, either to the left or right.  Caused by a change in a determinant of Demand (the independent variables not on the graph).  Determinants of Demand Remember this !!! Rule Two When an independent variable does appear on the graph, the curve on the graph will not shift, instead a movement along the existing curve will occur.  Determinants of Demand  Independent factors  Consumer income  Prices of related goods  Tastes and Preference  Expectations  Number of buyers in the market  Advertisement  Consumer Income Price of Normal Good Ice-Cream GH¢3.00 An increase 2.50 in income... Increase 2.00 in demand 1.50 1.00 0.50 D2 D1  3 4 5 6 7 8 9 10 11 12 Quantity of 0 1 2 Ice-Cream  Consumer Income Price of Inferior Good Ice-Cream GH¢3.00 2.50 An increase in income... 2.00 Decrease 1.50 in demand 1.00 0.50 D2 D1 Quantity of 0 1 2 3 4 5 6 7 8 9 10 11 12 Ice-Cream  Prices of Related Goods Substitutes & Complements  When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes.  When a fall in the price of one good increases the demand for another good, the two goods are called complements.  Change in Quantity Demanded versus Change in Demand Changes in factors that Effects influence Demand Price of the commodity Represents a movement along the demand curve (change in quantity demanded) Income Shifts the demand curve (change in demand) Price of related goods Shifts the demand curve (change in demand) Tastes and preference Shifts the demand curve (change in demand) Expectations Shifts the demand curve(change in demand) Number of Buyers Shifts the demand curve(change in demand)  Supply Curve Price of Ice-Cream S GH¢3.00 2.50 2.00 1.50 1.00 0.50 Quantity of 0 1 2 3 4 5 6 7 8 9 10 11 12 Ice-Cream  Law of Supply The law of supply states that there is a direct (positive) relationship between price and quantity supplied.  Supply Quantity supplied is the amount of a good that sellers are willing and able to offer for sale at a given price.  Change in Quantity Supplied Price of Ice-Cream C GH¢3.00 A rise in the price of ice cream results in a movement along the supply curve. A 1.00 Quantity of 0 1 5 Ice-Cream  Market Supply  Market supply refers to the sum of all individual supplies for all sellers of a particular good or service.  Graphically, individual supply curves are summed horizontally to obtain the market supply curve.  Determinants of Supply Remember this again !!! Rule Two When an independent variable does appear on the graph, the curve on the graph will not shift, instead a movement along the existing curve will occur.  Determinants of Supply  Independent factors  Input prices  Technology  Government policy (Taxes and Subsidies)  Expectations  Number of producers  Change in Supply Price of S3 Ice-Cream S1 S2 Decrease in Supply Increase in Supply Quantity of 0 Ice-Cream  Change in Quantity Supplied versus Change in Supply Changes in factors that Effects influence Supply Price Represents a movement along the supply curve (change in quantity supplied) Taxes and subsidies Shifts the demand curve (change in supply) Input Prices Shifts the demand curve (change in supply) Technology Shifts the demand curve (change in supply) Expectations Shifts the demand curve(change in Supplied) Number of Sellers Shifts the demand curve(change in supply)  Equilibrium of Supply and Demand Price of Ice-Cream Supply GH¢3.00 2.50 Equilibrium 2.00 1.50 0 1 2 3 4 5 6 7 8 9 10 1.00 0.50  Demand Quantity of 11 12 Ice-Cream  Excess Supply Price of Ice-Cream Supply GH¢3.00 Surplus 2.50 2.00 1.50 0 1 2 3 4 5 6 7 8 9 10 1.00 0.50  Demand Quantity of 11 12 Ice-Cream  Excess Demand Price of Ice-Cream Supply GH¢2.00 ¢1.50 Shortage Demand 0 1 2 3 4 5 6 7 8 9 10 11 12 13 Quantity of Ice-Cream  Three Steps To Analyzing Changes in Equilibrium  Decidewhether the event shifts the supply or demand curve (or both).  Decide whether the curve(s) shift(s) to the left or to the right.  Examine how the shift affects equilibrium price and quantity.  How an Increase in Demand Affects the Equilibrium Price of 1. Hot weather increases Ice-Cream the demand for ice cream... Supply GH¢2.50 New equilibrium 2.00 2.resulting Initial in a higher equilibrium price... D2 D1 0 7 10 quantity 3....and a higher sold. Quantity of Ice-Cream  How a Decrease in Supply Affects the Equilibrium Price of Ice-Cream 1. An earthquake reduces the supply of ice cream... S2 S1 New GH¢2.50 equilibrium 2.00 Initial equilibrium 2. resulting in a higher price... Demand 0 1 2 3 4 7 8 9 10 11 12 13 Quantity of 3....and a lower Ice-Cream quantity sold. BCPC 118: Economics for Business LECTURE THREE ELASTICITY OF DEMAND AND SUPPLY 5/5/2023 KOFI OSEI ADU, UPSA 1  Learning Outcomes By the end of lecture two, students will:  Identify the three types of elasticity of demand.  Calculate elasticities of demand and supply.  Explain the uses of elasticities of demand and supply.  Explain the factors that influence price elasticity of demand for a product.  Show the relationship between price elasticity of demand and total revenue.  Demonstrate the applications of elasticity of demand in quantitative demand analysis. 5/5/2023 KOFI OSEI ADU, UPSA 2  Introduction In our previous lecture, we learnt that demand for a commodity (Qdx) depends on its price (Px), the prices of substitutes or complements (Pr ), consumer incomes (I ), and other factors (H) such as advertising, number of buyers/the size of the population, and consumer expectations: Qdx= f(Px, Pr, I, H) There is downward sloping demand curve, which shows an inverse relationship between the price of the good and the quantity demanded by consumers, all else held constant. Firms must lower the price at which they are willing to sell their product if they want to sell more units. Changes in income of consumers have either a positive or negative effect on demand for a product depending on the nature of the product, (normal or inferior). 5/5/2023 KOFI OSEI ADU, UPSA 3  Introduction Changes in the prices of substitutes or complements have positive or negative effect on demand for a commodity. Our analysis of the impact of changes in prices and income on consumer demand has been qualitative rather than quantitative. It only shows the directions of the changes other than their magnitude. – If we cut prices by 6.5 percent, how many more units will we sell? – How much will our sales change if competitors cut their prices by 2 percent? The primary tool used to determine the magnitude of such a change is elasticity analysis. This lecture focuses on how a manager can use price elasticities of demand to quantify the impact of changing conditions on the firm’s sales. 5/5/2023 KOFI OSEI ADU, UPSA 4  Concept of Elasticity of Demand An Elasticity measures the responsiveness of one variable to changes in another variable. In other words, elasticity measures the percentage change in one variable that arises due to a given percentage change in another variable. Elasticity of demand measures the responsiveness of quantity demand to changes in the price of the commodity in question (Px), price of related goods (substitutes or complements) (Pr) and income (I). Generally, there are three main types of elasticity of demand namely: i. Own price elasticity of demand ii. Cross-price elasticity of demand iii. Income elasticity of demand 5/5/2023 KOFI OSEI ADU, UPSA 5  Own Price Elasticity of Demand 5/5/2023 KOFI OSEI ADU, UPSA 6  Own Price Elasticity of Demand Own price elasticity is always negative to reflect the ‘law of demand’. However, the absolute value of the coefficient of the price elasticity is used: it takes values from zero to infinity, i.e. 0≤ ep ≤∞ (Forms/degree of price elasticity of demand and their numerical values) ep>1, demand is elastic ep│1│ 0 Quantity ep>│1│ Unitary inelastic demand Price Quantity ep = │1 │ 5/5/2023 KOFI OSEI ADU, UPSA 8  Own Price Elasticity of Demand 5/5/2023 KOFI OSEI ADU, UPSA 9  Elasticity Along a Straight Line Demand Curve 5/5/2023 KOFI OSEI ADU, UPSA 10  Price Elasticity of Demand and Total Revenue 5/5/2023 KOFI OSEI ADU, UPSA 11 Policy Implications of Own Price Elasticity of Demand to a Business Manager 5/5/2023 KOFI OSEI ADU, UPSA 12  Policy Implications of Own Price Elasticity of Demand to a Business Manager The relationship between price, elasticity and total revenue is known as the Total Revenue Test. If demand is elastic, an increase (decrease) in price will lead to a decrease (increase) in total revenue. If demand is inelastic, an increase (decrease) in price will lead to a increase (decrease) in total revenue. Total revenue is maximized at the point where demand is unitary elastic. By the Total Revenue Test: Decrease in price increases total revenue if demand is elastic. Decrease in price decreases total revenue if demand is inelastic. 5/5/2023 KOFI OSEI ADU, UPSA 13  Determinants of Price Elasticity of Demand Available Substitutes  Goods with close substitutes tend to have more elastic demand. Goods without close substitutes tend to have less elastic demand.  Example: the elasticity of demand for a Ford, Toyota, or a Honda is more elastic there are more and better substitutes for each of them.  The fewer the number of close substitutes, the less elastic the demand curve. Examples: insulin for diabetics. Luxuries Verses Necessities (type of product)  Luxurious commodities tend to be more elastic whilst necessities tend to less inelastic. 5/5/2023 KOFI OSEI ADU, UPSA 14  Determinants of Price Elasticity of Demand Time – Demand tends to be more inelastic in the short term than in the long term. – Time allows consumers to seek out available substitutes. Expenditure Share (proportion of income spent on a good) Goods that comprise a small share of consumer’s budgets tend to be more inelastic than goods for which consumers spend a large portion of their incomes. Habit formation Habit formed → inelastic Habit not formed → elastic 5/5/2023 KOFI OSEI ADU, UPSA 15  Cross-Price Elasticity of Demand 5/5/2023 KOFI OSEI ADU, UPSA 16  Cross-Price Elasticity of Demand  The percentage change in the quantity demanded of a given good, X, relative to a percentage change in the price of good Y, assuming all other factors constant. exy = %ΔQx ÷ %Δpy  Substitutes:  Two goods with a positive cross-price elasticity of demand coefficient are said to be substitute goods.  Milo and Bournvita, exy = 0.28  Complements:  If two goods have a negative cross-price elasticity of demand coefficient, they are called complementary goods.  Bread and egg or rice and stew, exy = - 0.03 5/5/2023 KOFI OSEI ADU, UPSA 17  Income Elasticity of Demand  The percentage change in the quantity demanded of a given good, X, relative to a percentage change in consumer income, assuming all other factors constant. eI = %ΔQx ÷ %ΔI  The income elasticity of demand helps managers todetermine whether the relationship between the two goods is a:  Normal good, then ei > 0  Inferior good, then ei < 0 5/5/2023 KOFI OSEI ADU, UPSA 18  Income Elasticity of Demand If the income elasticity is positive, then the good in question is a normal good because the change in income and the change in quantity demanded move in the same direction. If the income elasticity is negative, then the good in question in an inferior good because the change in income and the change in quantity demanded move in opposite directions. Normal Good: Good X is a normal good if the demand for good X moves in the same direction as a change in income. Cream, eI = 1.72 Apples, eI = 1.32 Inferior Good: Good X is an inferior good if the demand for good X moves in the opposite direction of a change in income. Chicken, ei = - 0.106 5/5/2023 KOFI OSEI ADU, UPSA 19 5/5/2023 KOFI OSEI ADU, UPSA 20 BCPC 118: Economics for Business LECTURE FIVE THEORY OF PRODUCTION 5/5/2023 Christopher Quaidoo, UPSA 1  Learning Outcomes By the end of lecture five, students will:  Explain the types of inputs and concept of production in the short run and long run.  Describe the relationship between inputs and output in the short run.  Derive the total product, marginal product and average product, and show the relationship between them.  Explain the three stages of production in the short run.  Determine the optimal input usage by a firm in the short run. 5/5/2023 Christopher Quaidoo, UPSA 2  Introduction:  What is production?  What is the importance of production?  Which units of input (labour) should a manager of a firm employ to produce a given (optimal) level of output in the short run?  This lecture will help us to know the optimal combination of inputs to be used to produce a given level of output in the short run.  It will also help us to understand the relationships between the various measures of productivity and stages of production in the short run. 5/5/2023 Christopher Quaidoo, UPSA 3  Production  Production involves the process of transforming inputs (factors of production) into outputs (goods and services).  The production of a firm shows the technical relationship between the various units of inputs used and the maximum amount of output that can be produced over a period of time.  A production function shows the technical or functional relationship that exists between the quantity of inputs used and the maximum possible outputs produced per unit of time. It describes the maximum amount of output that can be produced with a given set of inputs. Q = f(L, K, M*) where, Q = quantity of output; L = quantity of labour input K = quantity of capital input; M* = quantity of material input 5/5/2023 Christopher Quaidoo, UPSA 4  Production  In the process of production, managers need to be concerned with the efficiency with which they use inputs.  Efficiency is the act of achieving good result with little waste of efforts: A firm can be: i. Technically efficient ii. Economically efficient  The firm attempts either to minimise the cost of producing a given level of output or maximise output attainable with a given level of cost.  Thus, since inputs are not generally free, firms must ensure that they achieve both technical efficiency and economic efficiency. 5/5/2023 Christopher Quaidoo, UPSA 5  Technical Efficiency Technical efficiency relates to how much output can be obtained from a given input, such as a worker or a machine, or a specific combination of inputs. Maximum technical efficiency occurs when output is maximised from a given quantity of inputs. It is concerned with minimising the amount of inputs to reach an output target, whatever the prices of inputs may be. A producer is considered technically efficient if reducing the quantity of one or more inputs he must increase the others to maintain the same level of production. For example, suppose production takes place with only Capital and Labour units. Also, there are three methods of producing 1000 units of good X. 5/5/2023 Christopher Quaidoo, UPSA 6  Technical Efficiency Alternative Methods of Producing 1000 units of Good X are depicted in the Table 1 below. Table 1 shows three methods of producing 1000 units of Good X. Method A has 3C and 1L. Method B has 2C and 2L and Method C has 1C and 3L. From Method A to C, as the producer reduces the capital units, he increases the labour units. All the three methods are TECHNICALLY EFFICIENT 5/5/2023 Christopher Quaidoo, UPSA 7  Economic Efficiency  Economic efficiency seeks the lowest cost combination of inputs for the production of a given output level.  To be economically efficient, a producer seeks the maximisation of output under a cost constraint, or the minimisation of cost, given an output target.  We assume that the Price of Capital (PC) is GH¢2000 per unit and the Price of Labour (PL) is GH¢1000 per unit 5/5/2023 Christopher Quaidoo, UPSA 8  Economic Efficiency Alternative Methods of Producing 1000 units of Good X are depicted in the Table 2 below. Table 2 shows the cost of using each method assuming PC = GH¢2000 and PL = GH¢1000. What is your observation? 5/5/2023 Christopher Quaidoo, UPSA 9  Types of Inputs Fixed Input: A fixed input is an input whose quantity cannot be changed during a given period of time if demand conditions require an increase or a decrease in production. E.g. factory building, capital equipment, some skilled labour. Variable Input: A variable input is an input whose quantity can be changed during a given period of time if demand conditions warrant a change in production. E.g. labour and raw materials. 5/5/2023 Christopher Quaidoo, UPSA 10 Periods of Production (Time and Production) Two dimensions of time are used to describe production functions: short run and long run. These periods do not refer to specific calendar periods of time, such as month or a year, they are defined in terms of the use of fixed and variable inputs. The short-run is a period of time during which at least one input is fixed, while the long-run is a period of time during which all inputs are variable. The very long run is a period of time during which all inputs and technology can be changed. 5/5/2023 Christopher Quaidoo, UPSA 11  SHORT-RUN PRODUCTION ANALYSIS Short-Run Production Function The short-run production function is essentially only a function of labour since capital is fixed. TP or Q = f(L) = f(L, K* ). Measures of Productivity Total Product (TP): The total quantity of output produced with given quantities of fixed and variable inputs. Average Product (APL): It is total product per unit of the variable factor (L). APL = TP÷L or Q÷L, where APL = average product of labor  Marginal Product - The additional output produced with an additional unit of variable input. MPL = ΔTP÷ΔL or ΔQ÷ΔL where MPL = marginal product of labor 5/5/2023 Christopher Quaidoo, UPSA 12 Total, Average and Marginal Products of Labour 5/5/2023 Christopher Quaidoo, UPSA 13  Law of Diminishing Marginal Returns We have observed from the previous table that as more labour is employed, the marginal product declines. The declining marginal product of an input (labour) represents one of the best-known and most important empirical “laws” of production, the Law of Diminishing Marginal Returns to Variable Proportions. Per the law of Diminishing Marginal Returns, as more units of a variable input are employed, with all other inputs held constant, marginal product initially increases but eventually declines. From the previous table, Table 3, the optimum ratio is (1K, 3L). Diminishing returns set in when the 4th unit of labour was employed 5/5/2023 Christopher Quaidoo, UPSA 14 FIGURE 1: Total Product, Average Product and Marginal Product Curves drawn from the Short-run Input and Output Table of Table 3 Product 66 TPL Increasing Diminishing Returns Returns 0 Labour Units Product 15 Negative Returns APL 0 3 4 7 Labour Units  MPL 5/5/2023 Christopher Quaidoo, UPSA 15  Stages of Production  Stage 1 begins from the origin and ends at the maximum point on the AP curve.  Stage 2 starts from the maximum point on the AP curve and terminates where MPL curve is zero (0).  Stage 3 commences from the point where MPL curve is zero to infinity. These stages can be classified into economic and uneconomic stages of production, depending on the behaviour of MPL and APL curves 5/5/2023 Christopher Quaidoo, UPSA 16 Figure 2: Stages of Production Product TPL Stage 2 Stage 3 Stage 1 APL 0 Labour MPL Units 5/5/2023 Christopher Quaidoo, UPSA 17  Economic and Uneconomic Stages of Production  In stage, MPL rises and starts declining, APL rises and reaches its maximum. This stage is uneconomic, and a rational producer should not produce within this stage.  Stage 3 is also uneconomic because although both APL and MPL are falling, yet MPL turns negative.  The only economic stage is stage 2 where APL and MPL are falling, but both are positive. 5/5/2023 Christopher Quaidoo, UPSA 18  Optimal Use of A Single input (Labour) Operating at the right point on the production function. By using more of a variable input, the firm obtains a direct benefit of increased output in return for incurring an additional input cost. The optimal input to be used is determined by comparing the additional benefit in monetary terms to the additional cost. We will achieve an optimal level where the marginal benefit of the variable input in monetary terms is equal to the marginal cost of the input or where marginal profit is equal to zero. The marginal benefit from an input in monetary terms is termed the Value Marginal Product (VMP). 5/5/2023 Christopher Quaidoo, UPSA 19  Optimal Use of A Single input (Labour) 5/5/2023 Christopher Quaidoo, UPSA 20 5/5/2023 Christopher Quaidoo, UPSA 21  Optimal Use of A Single input (Labour) The cost of an additional labour is $400 while the first unit of labour generates a VMP of $228. The VMP associated with the second unit of labour is $516. – By considering the VMP of only the first unit of labour, the manager would not hire any labour. – However a careful examination of the table shows that the second unit of labour brings in an additional $116 in value above his cost. From the second to the ninth employee, each brings in a VMP greater than the cost of their employment. So long as the VMP is greater than the cost of hiring, it would be profitable to employ that unit of labour. The 10th worker however is associated with a VMP less than $400. Thus the cost of hiring the 10th worker is greater than the benefit. The manager therefore should hire up to 9 employees to maximize profit. 5/5/2023 Christopher Quaidoo, UPSA 22 5/5/2023 Christopher Quaidoo, UPSA 23 BCPC 118: Economics for Business Lecture Six: Cost Analysis  Learning Outcomes By the end of this lecture, students will: Explain cost and how it is measured (implicit and explicit costs). Determine/compute the various costs measures in the Short-run Show the relationship between the short-run cost curves Explain shape of both the short-run average and marginal costs. Define economies and diseconomies of scale State and explain the sources of economies of scale Explain the causes of diseconomies of scale 2  Introduction A firm uses a two-step procedure to determine how to produce an output efficiently. – Determine the production processes which are technologically efficient to produce the desired level of output with least unit of inputs. – Choose from the technologically efficient production processes the one that is economically efficient. We discussed these two issues in our previous lecture. To determine the least cost of production, managers need to understand the relationship between costs of inputs and production. Knowledge about the relationship between costs and output is important in determining the nature of a market – to be discussed later in the course. 3  Meaning of Costs A firm’s costs of production will depend on the factors of production it uses. – The more factors it uses, the greater will its costs be. To run a firm profitably, a manager must think like an economist. Economists measure cost by including all relevant costs. – Explicit costs: Direct, out of pocket payments for inputs for production in a given time period. – Implicit costs: Costs reflecting forgone opportunities 4  Explicit Costs These are direct, out of pocket payments for inputs for production in a given time period. Usually referred to as historical cost. They include rents on land, wages and salaries of labour, interest or dividend earnings on capital and producer's normal profit. The cost of labour, energy, and materials can easily be determined – Multiply the factor’s price by the number of units used. – If workers earn 30 cedis per hour and they work a total of 100 hours per week, then the firm’s cost of labour is 3,000 cedis (30 * 100) Thus calculating explicit cost is straight forward. 5  Implicit Costs These are costs which reflect forgone opportunities. To properly take account of foregone opportunities, one needs to be careful about durable capital goods. – Past expenditures on an input may be irrelevant to current cost calculations if that input has no current use. 6  Short-Run Costs In the short-run, some factors are fixed whilst others are variable. Fixed Costs are costs which do not vary with the amount of output produced. – It is the sum of the explicit and implicit costs on fixed inputs. – They may be incurred even if the firm is producing nothing. Variable costs are costs that vary with the amount of output produced. – Add up the explicit and implicit costs on variable inputs. – The more output produced, the more materials are used and the higher their cost. 7  Short-Run Cost Cont’d Total Cost is the sum of the Total Fixed Costs (TFC) and Total Variable Costs (TVC). 𝑇𝐶 = 𝑇𝐹𝐶 + 𝑇𝑉𝐶 8 Short-Run Costs (Total, fixed and variable) Source: Perloff, J. M. (2015). Microeconomics. 9  Fixed Cost Curve Fixed Cost (F) 60 50 40 Cost 30 20 10 0 0 2 4 6 8 10 12 14 Quantity 10  Variable Cost Curve Variable Cost (VC) 350 300 250 200 Cost 150 100 50 0 0 2 4 6 8 10 12 14 Quantity 11  Total Cost, Fixed Cost and Variable Cost Fixed Cost (F) Variable Cost (VC) Total Cost (C) 400 350 300 Because the total cost differs 250 from the variable cost by the fixed cost, TFC, the total Cost 200 cost curve, TC, is parallel to 150 the variable cost curve, VC. 100 50 0 0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity 12  Average Costs Firms use three average cost measures. – Average Fixed Cost (AFC) – Average Variable Cost (AVC) – Average Total Cost (Average Cost) – ATC (AC) The average fixed cost (AFC) is the fixed cost divided by the units of output produced: 𝑇𝐹𝐶 𝐴𝐹𝐶 = 𝑄 The average fixed cost falls as output rises because the fixed cost is spread over more units. 13  Average Costs Cont’d The average variable cost (AVC) is the variable cost divided by the units of output produced: 𝑇𝑉𝐶 𝐴𝑉𝐶 = 𝑄 Because the variable cost increases with output, the average variable cost may either increase or decrease as output rises. Later in the course, we will show that, a firm uses the average variable cost to determine whether to shut down operationswhen demand is low. 14  Average Cost Cont’d The average cost (AC)—or average total cost—is the total cost divided by the units of output produced 𝑇𝐶 𝐴𝐶 = 𝑄 The average cost is the sum of the average fixed cost and the average variable cost: 𝐴𝐶 = 𝐴𝐹𝐶 + 𝐴𝑉𝐶 𝑇𝐹𝐶 𝑇𝑉𝐶 𝐴𝐶 = + 𝑄 𝑄 15 Computation of Average Costs Source: Perloff, J. M. (2015) 16  Marginal Cost A firm’s marginal cost (MC) is the amount by which a firm’s cost changes if the firm produces one more unit of output. The marginal cost is: ∆𝑇𝐶 𝑀𝐶 = ∆𝑄 Where – ΔTC is the change in total cost – ΔQ is change in output A firm uses marginal cost in deciding whether it pays to change its output level. 17 Marginal Cost Source: Perloff, J. M. (2015) 18 Cost Relationship between Short-Run Costs The MC, cuts the AVC and AC curves at their minimums. AFC falls with quantity produced. What else can you observe from the diagram? Quantity Source: Perloff, J. M. (2015) 19  Why is the Short-run Average Cost curve initially downward slopping? A key reason is that average fixed cost curve is downward sloping: Spreading the fixed cost over more units of output lowers the average fixed cost per unit. Why does the Short-Run Average cost Curve slope upward? A major reason why the short-run average cost curve slopes upward at higher levels of output is the diminishing marginal returns. 20  Explaining the Shape of the Short-Run Marginal Cost curve With a fixed factor of production in the short run, a firm is stuck at its current scale of operation. More output can be produced by hiring more labour (increase variable inputs), but this will eventually lead to diminishing marginal returns. – If each additional unit of labour adds less and less to total output, then more labour is needed to produce each additional unit of output. – Thus, each additional unit of output costs more to produce. – Diminishing marginal returns, or decreasing marginal product, imply increasing marginal cost. 21  Explaining the Shape of the Short-Run Marginal Cost curve Therefore, there is a relationship between marginal product and marginal cost. – As marginal product increases, marginal cost falls (division of labour and specialization) and as marginal product falls, marginal cost increases (diminishing returns). 22  Long-Run Average Cost In the long run, the firm adjusts all its inputs so that its cost of production is as low as possible. The firm can change its plant size, design and build new machines, and otherwise adjust inputs that were fixed in the short run. Our interest in the long-run cost at this level of the course is to understand economies and diseconomies of scale. – This helps to explain why the Long-Run Average cost (LRAC) curve is said to have a “U” shape. 23 Long-Run Average Cost Curve 24  Economies of Scale A firm enjoys Economies of scale if its cost per unit of output falls as the scale of production increases. Sources of Economies of Scale: – Technical Economies – Managerial Economies – Marketing Economies – Financial Economies – Research Economies – Economies of Common Services 25  Sources of Economies of Scale Technical Economies They accrue from the use of large machines with emphasis on full utilisation and efficiency in production. Automobile production, for example, would be more costly per unit if a firm were to produce 100 cars per year by hand. In the early 1900s, Henry Ford introduced standardized production techniques that increased output volume, reduced costs per car, and made the automobile available to almost everyone. The new technology is not very cost-effective at small volumes of cars, but at larger volumes costs are greatly reduced. – Ford’s innovation provided a source of scale economies at the plant level of the auto firm. 26  Managerial Economies More highly qualified managers may be employed, and they may be allowed to specialize in the various branches of the firm. Large firms can also mechanize managerial activities by introducing the usage of improved devices such as computers, cordless phones, faxes, e- mail etc. Opportunities are also made available for the training of young potential career managers for the firm. These economies lead to lower per unit cost of production.  Marketing Economies Cost advantages derived from bulk purchasing of inputs and bulk distribution of outputs. By buying inputs in large quantities (bulk purchases), firms can obtain trade discounts. Sales cost per unit of output sold may fall as the volume of sales increases. These advantages lead to a fall in per unit cost of production for the large firm.  Financial Economies Large firms may enjoy some cost advantages by contracting credit from financial institutions at lower interest rates than smaller firms. They can provide collateral securities for such loans with their sheer size making them look credit-worthy to creditors compared to smaller firms.  Research Economies The industry, within which firms operate or other institutions, may provide research activities with the result being made available to all firms in that industry. This lowers per unit cost of output produced in the industry.  (3) Economies of Common Services: Through the concentration of firms in a particular industry in a given geographical location, the firms may enjoy certain common services. These services include special transport and telecommunication facilities, water, power, publication of trade journals All these lead to a lower per unit cost of output in the industry.  Diseconomies of Scale The disadvantages a firm faces as it grows larger through internal adjustments (internal diseconomies) and or The disadvantages confronting firms as the industry grows beyond the optimal size (external diseconomies). Causes of Diseconomies of Scale – Managerial diseconomies – Increasing raw material Cost – Increasing cost of skilled labour – Excess Marketing Cost  Managerial Diseconomies Managerial ability not only leads to economies of scale but also diseconomies of scale. If the firm's size continues to increase, certain indivisible factors may be duplicated. This increases the average cost of production as well as creates problems of managing and co-ordinating the functions of other productive factors. – For example, red tape/bureaucratic practices, alienating workers from the product and management  Increasing Raw Material Cost As the industry grows, there will be an increase in the demand for raw materials mainly used in the industry. Given supply of raw materials this leads to an increase in the price of raw materials and subsequently an increase in the firms’ unit cost of production within the industry.  Increasing Cost of Skilled Labour Demand for skilled labour increases. To entice such labour to move from one firm to another, one has to bid up the wage rate. This invariably leads to an increase in production costs of the firms in the industry and the resultant rise in unit cost of production.  Excess Marketing Cost With the increase in the number of firms in the industry each firm has to compete for market shares or consumers. Advertising and other marketing strategies therefore become the order of the day. The consequence of these is an increase in unit cost of production of firms in the industry. ECONOMICS FOR BUSINESS LECTURE SEVEN MARKET STRUCTURES SERVICE EXCELLENCE  Learning Outcomes After completing this lecture, students will: Describe the features of perfect competition. Analyse output determination (price-output decisions of firms) of a perfect competitive firm in the short-run. Determine profit maximisation of a perfect competitive firm in the short-run. Differentiate between perfect competition and monopoly. SERVICE EXCELLENCE  Introduction One of the important decisions made by a firm is setting of the price of its product. Factors that influence the pricing decisions of a firm include number of firms in the industry, the nature of the product and the possibility of new firms entering the market. The process by which price and output are determined in the real world is strongly affected by the structure of the market. SERVICE EXCELLENCE  Perfect Competition Perfect competition refers to a market structure characterized by larger number of buyers and sellers of a homogeneous (identical) product.  Characteristics of perfect competition Large number of buyers and sellers (firms). Product Homogeneity. All the sellers sell homogeneous or standardized product. There is free entry of new firms and exit of existing firms. Perfect mobility of factors of production. SERVICE EXCELLENCE  Perfect Competition Firms are price takers – have no control over the price they charge for their products. Consumers and producers have perfect knowledge about the market. Each firm faces a horizontal demand curve. Firms maximize profits when marginal revenue is equal to marginal cost (MR=MC=P). SERVICE EXCELLENCE  Perfect Competition Table1:Revenue Table of a Perfect Competition Firm 1 2 3 4 5 PRICE QUANTITY TR AR MR SOLD (TR= P x Q) (AR =TR/Q) (MR=TR/Q) 100 1 100 100 100 100 2 200 100 100 100 3 300 100 100 100 4 400 100 100 100 5 500 100 100 100 6 600 100 100 SERVICE EXCELLENCE  Figure 1.1: AR, MR and Demand Curves sketched from Table 1 Price/Revenue (in ¢) P = 100 AR = MR = D 0 1 2 3 4 5 6 Quantity Sold SERVICE EXCELLENCE Figure 1.2: Price, Output Determination and Demand Curve under Perfect Competition SERVICE EXCELLENCE  Short-Run Analysis of a Perfectly Competitive Firm Equilibrium of a perfectly competitive firm (Profit Maximisation Condition and Output Determination) There are two main approaches in determining equilibrium of a firm. Hence, profit maximising condition of a firm. MR-MC approach and TR-TC approach. A perfectly competitive firm is said to be in equilibrium when its MR=MC, and MC is rising. For TR-TC approach, TR=TC, and TC must be rising. SERVICE EXCELLENCE Short Run Equilibrium (Profit Maximising Level of Output) TR - TC Approach SERVICE EXCELLENCE Short Run Equilibrium (Profit Maximising Level of Output) MR - MC Approach SERVICE EXCELLENCE  Marginal Revenue The marginal revenue curve for the perfectly competitive firm is horizontal because the firm can sell all units of output at the market price. Cost/Revenue The industry price is determined by the demand and supply of the industry as a whole. The firm is a very small supplier within the industry and has no control over price. They will sell each extra unit for the same price. Price therefore = MR and AR P = MR = AR Output/Sales SERVICE EXCELLENCE  Marginal Cost Curve The MC is the cost of producing additional (marginal) units of output. Cost/Revenue MC It falls at first (due to the law of diminishing returns) then rises as output rises. P = MR = AR Output/Sales SERVICE EXCELLENCE Marginal Cost and Average Cost Curves The average cost curve is the standard ‘U’ – shaped curve. Cost/Revenue MC MC cuts the AC curve at its lowest point. AC P = MR = AR Output/Sales SERVICE EXCELLENCE Does a Firm make Profits or Losses in Equilibrium in the Short-run? MR = MC guarantees two things viz. – either that profits are at a maximum – or that losses are at a minimum for the perfect competitor. To determine whether a profit is made or a loss, we compare price (P) and average cost (AC) corresponding to the equilibrium level of output. SERVICE EXCELLENCE  Does a Firm make Profits or Losses in Equilibrium in the Short-run? Three Possibilities: If (P ≥ AC) the entrepreneur will enjoy a profit in the short-run. If (AVC ≤ P < AC ), firm will incur “acceptable” loses. If (AVC > P), the firm shuts down SERVICE EXCELLENCE  Normal Profit At this output, the firm Cost/Revenue MC is making normal profit. P=AR=AC AC P = MR = AR Q1 Output/Sales SERVICE EXCELLENCE  Supernormal or Abnormal Profit The lower AC compared to a higher price implies that the firm is now Cost/Revenue MC earning abnormal or supernormal profit (P=AR>AC) represented AC by the purple area. P P = MR = AR Abnormal profit AC Q1 Output/Sales  SERVICE EXCELLENC E  Sub-normal Profit or Loss Covering AVC and Part of Fixed Cost Cost/Revenue (PAVC MC ATC AVC AC LOSS P MR=AR=P Output/Sales SERVICE EXCELLENCE  Shutdown Point The price below which it is more profitable for the perfectly competitive firm to shut down than to continue to produce, which equals a firm’s minimum average variable cost. Cost/Revenue ATC AVC MC Shutdown Point AC (P=AVC