Basic Economics and Market Structures

economics

• The study of how individuals and societies allocate their limited resources in attempts to satisfy their unlimited wants.

• Tries to answer three questions:

  • What shall we produce with society’s limited resources?

  • How shall they (resources) be used in production?

  • Who shall receive the resulting goods and services?

supply and demand

interact to determine the market prices for commodities (goods and services)

utility

• The economic term for satisfaction obtained from consumption of a good (or service).

• It is assumed that people want to maximize their utility within resource constraints

3 basic resources

1. Natural resources (e.g., land)

2. Labor

3. Capital (e.g., money, physical resources)

cost

proportional to constraints

value

determined by marginal utility, the satisfaction obtained from receiving one more of a good or service

marginal utility

depends on the personal desire for one more unit of the good or service

law of diminishing marginal utility

the satisfaction received by obtaining one more unit of a good declines as one consumes more of it

law of demand

• The quantity demanded of a commodity is inversely proportional to its price

  • (i.e., the higher the price, the less of it one wants).

demand schedule

shows the relationship between amounts of a commodity that consumers are willing to purchase and the possible prices over a specified period of time

demand curve

• The graphical representation of a demand schedule with price (P) plotted on the y-axis and the quantity demanded (Q) on the x-axis

  • As prices go down, the quantity demanded goes up

  • As prices go up, the quantity demanded goes down

factors that change demand environment

1. Prices of related goods

2. Financial income of the consumer

3. Number of consumers in the market

4. Attitudes, tastes, and preferences of the consumer

5. Consumer expectations with respect to future prices and incomes

substitutes

• Price of one good is directly related to the demand for another

• Example: beef and chicken, coffee and tea

complements

• Price of one good is inversely related to the demand for another.

• Example: laser printers and toner cartridges

superior goods

• Demand increases for a good as consumer income rises.

• Examples: luxury cars, second homes

inferior goods

• Demand decreases for a good as consumer income rises.

• Examples: used cars, store brand-name products

number of consumers

• Attracting new customers to the same product

• Examples: direct-to-consumer advertising

• Rebranded Loniten (for hypertension) as Minoxidil (for baldness)

attitudes, tastes, and preferences

• As attitudes, tastes, and preferences change, products are changed or remarketed to fit, or lose market share.

• Example: NyQuil® takes advantage of drowsiness side effect to market as cold medicine for bedtime sleep

• Multiple examples based on advertising...

consumer expectations

• If consumers expect prices to go (up) (down), they buy (now) (later).

• If consumers expect their income to go (up) (down), they buy (more) (less).

law of supply

as the price that individuals are willing to pay for a product increases, more of the product will be supplied to the market

supply schedule

shows the quantity of a commodity that sellers are willing to supply at a given price

factors that change supply environment

1. Techniques of production, including technology

2. Number of sellers in the market

3. Resource costs (material and wages)

4. Prices for related goods

5. Sellers’ expectations

techniques of production

• As technology advances, cost of production usually decreases

• Examples: equipment, supplies, methods of production, or management techniques

number of sellers

• More producers create more output

• As the number of sellers increases, supply increases

resource costs

• As costs (increase) (decrease), sellers make (less) (more) profit, and therefore, have (less) (more) incentive to produce

• Example: Lower fertilizer costs allow farmers to plant more land to produce more crops

substitute products

• Products that can be produced with the same or similar inputs

• If there are two products made with essentially the same inputs, one will produce more of that which will create more profit

• Ex: whole steaks versus ground beef patties.....

joint products

• Goods that are almost always produced together

• Example: Beef and leather; an increase in the price of beef will induce more production, and hence, more leather will be produced as well

sellers’ expectations

• If sellers expect selling prices to (increase) (decrease) in the near future, they will (increase) (decrease) production...

• Example: Farmers timing sales to obtain favorable prices, hence maximizing profit.

market equilibrium price

the price where the demand curve and supply curve intersect

elasticity

• Measures the responsiveness of the consumer demands to a change in price

• Producers try to maximize their revenue:

  • Unit Price x Quantity Sold = Revenue

• Depending on the elasticity of a product, sellers can maximize revenue by either increasing or decreasing prices.

• Three types:

  • Elastic: ￪ Price = ￬ Revenue

  • Inelastic: ￪ Price = ￪ Revenue

  • Unitary: (rarely found in any markets)

factors that affect elasticity of demand

• Availability of substitutes

  • The more substitutes for a product, the more elastic the demand

  • Example: Brands of sugar (or generic brands of ibuprofen - Motrin©)

• Price relative to income

  • A purchase that accounts for a large portion of a person’s income will be more elastic than the demand of relatively inexpensive one

  • Example: Luxury SUVs vs. paper clips

• Number of alternatives

  • The fewer alternatives a product has, the more likely its demand will be inelastic

  • Example: Gasoline

4 basic market structures

1. perfect competition

2. monopolistic competition

3. oligopoly

4. monopoly

perfect competition

• Many buyers and sellers

• Freedom of entry and exit

• Standardized products

• Full and free information

• No collusion

• In reality, very few market situation meets this definition... !

barriers to entry

patents, regulation, capital, training, technology, etc.

barriers to exit

fixed assets not transferable

collusion

firms get together to set prices instead of competing against one another; more likely to happen if there are fewer sellers so that they can influence one another

monopoly

• One seller of a product with no close substitutes.

• Maximize revenue by restricting supply & increasing price.

• Patents grant temporary monopolies to encourage innovation.

• Some monopolies exist because more sellers would actually increase prices because of barriers to entry (i.e., public utilities).

monopsony

one buyer (e.g., federal government for military equipment)

monopolistic competition

• Similar to perfect competition, except no standardized and interchangeable products.

• Firms rely on product differentiation – promoting differences.

• Example: Auto industry

oligopoly

• Few sellers and many buyers.

• Firms are frequently interdependent, and the dominant firm influences the market through price leadership – “price-setters” – either increases or decreases.

• Example: Breakfast cereal

health care market

• Numbers of buyers and sellers

• Entry to and exit from market

• Variations in products, services, and quality

• Full and free information

• Inelastic demand

• Universal demand

• Unpredictability of illness

• Health care as a “right” – not a product

• Supplier-induced demand

• Third-party insurance and patient-induced demand

moral hazard

by decreasing patients’ out-of-pocket expenses (i.e.: health insurance), demand and consumption are increased

revenue

utilization x unit price

value

(quality/cost) x quantity

indemnity insurance

• Reimbursement of a percentage of expenses to subscribers rather than direct payment to providers

  • The predominant form of health insurance for decades

• Drawbacks: Patients had to save receipts, fill out forms, and it was expensive for insurance companies to process

• Because of this and reimbursement on a retrospective, fee-for-service basis, costs (and premiums) rapidly increased, and companies had little ability to control it

  • Now, providers are paid directly, which allows for cost controls (i.e., standardization, automation, negotiation of discounts)

fee-for-service reimbursements

results: more utilization = more $$$ revenue