Consumers and Businesses

The Role of Consumers in the Economy

Consumer sovereignty is the idea that consumers have the ultimate power in determining what goods and services are produced. Firms adjust the quantity and types of products they produce based on consumer spending and saving trends.

Patterns of Consumer Spending and Saving/Dissaving

  • Individual consumers either spend or save their income.
  • As income rises, the level of saving increases.
  • Variations occur with income and age.
  • Life cycle theory of consumption: As people age, they work more and increase savings for retirement. After retirement, they stop earning and start spending their savings.
  • Business Cycle Impact:
    • During a downturn, consumer confidence falls, leading to less spending and more saving.
    • During a boom, rising incomes increase consumer confidence, resulting in more spending and less saving.

Calculating APC and MPC:

  • APC (Average Propensity to Consume): Percentage of income spent on goods and services.
  • APS (Average Propensity to Save): Percentage of income saved on goods and services.
    • Higher income earners tend to have a higher APS.
  • To measure how much more individuals will spend or save for every additional dollar of income they earn, we find an individuals MPC and MPS.

The Multiplier Effect

The multiplier effect explains how an initial injection of spending into the economy can lead to a larger increase in overall GDP.

  • The higher the economy’s marginal propensity to consume, the greater the impact of an injection on total aggregate demand.
  • The multiplier (k) is the factor by which an injection raises total aggregate demand.

k = 1 / MPS

Example of Multiplier

GDP in an economy is 500. The Government injects an additional 10 into the economy.

An injection increases aggregate demand by more than the value of the injection itself because a proportion of the injection will be re-spent by whoever earns that income. The multiplier (k) measures how many times more the increase in GDP is than the injection. E.g. if an injection of 100 will increase total GDP by 300, the multiplier is 3

Factors Influencing Individual Consumer Choice

  • Income
  • Price
  • Price of substitutes
  • Price of complements
  • Preferences/tastes
  • Advertising

An increase in demand is when people would buy more of a particular product than before even if the price stayed the same.

Sources of Income

  • The return for resources: wages, rent, interest, and profits.
  • Social welfare.
  • Top sources of income in Australia are wages and welfare.
  • Common types of welfare are aged pension, disability pension, and family payments.

Comparative Advantage and the Division of Labour

The division of labor involves specializing in producing one thing and then selling it to be able to buy everything you need.

  • Comparative Advantage: If you have a lower opportunity cost of producing a product than other people, you have a comparative advantage in that product.
  • When individuals specialize in their comparative advantage they are able to trade their surplus production for what they don’t specialize in. Similarly countries are able to specialise in their comparative advantage and trade their surplus production with other countries. This increases AS and GDP both domestically and internationally.

The Role of Business in the Economy

Definition of a Firm and an Industry

  • Firm: An organization that produces goods or services to generate revenue.
  • Industry: A group of firms that produce similar goods or services that usually compete with each other.

A Firm's Production Decisions

  • What to produce
  • What quantities to produce
  • How to produce

Business as a Source of Economic Growth

Firms improve productivity to maximize profit, which is a key source of economic growth.
The goal to maximize profits by firms provides an incentive for firms to increase efficiency and productivity. Therefore increasing productive capacity (total output of a business), increasing aggregate supply and GDP growth. Therefore firms act as a source of economic growth.

Goals of the Firm

  • Maximizing profits
  • Maximizing growth
  • Increasing market share
  • Meeting shareholder expectations
  • Satisficing

Efficiency and the Production Process

Productivity

Firms consistently find ways to improve productivity in order to lower production costs, compete with rivals, and maximise profit.

Economies and Diseconomies of Scale

Internal Economies of Scale

As the volume of production increases, the total cost rises, but the cost per unit falls. There are many ways to achieve economies of scale as volume increases:

  • Spread the cost of capital across a greater volume of production
  • Spread the cost of research and development across production
  • Bulk buy inputs
  • Use an assembly line with specialized labor
    By increasing production volume, firms can take advantage of task specialization on an assembly line, which leads to faster production and a decrease in costs per unit.
Internal Diseconomies of Scale

If a firm produces too much, management may lose control, reducing efficiency and increasing costs. When an increase in the volume of production causes costs per unit of production to rise, it is called a diseconomy of scale.

External Economies of Scale

External Economies of scale: advantages a firm experiences due to growth in the industry of which the firm is operating in

Costs are also affected by the size of the industry, not just of the business itself. Growth in the industry can lead to external economies of scale due to:

  • Support services are likely to set up nearby
  • Skilled labour is likely to move to the area
  • The government may invest to support the industry
External Diseconomies of Scale

External Diseconomies of scale: disadvantages a firm experiences due to growth in the industry of which they operate in

BUT growth in the industry can also lead to external diseconomies of scale due to:

  • Transport congestion on roads and ports resulting in transport bottlenecks
  • Increased prices for land and labour

Impact of Investment, Technological Change, and Ethical Decision-Making on a Firm

Through:

  • Production methods
  • Prices
  • Employment
  • Output
  • Profits
  • Types of products
  • Globalization
  • Environmental sustainability

Globalisation

Globalisation is the process of increased economic integration between countries, including trade, technological change, and investment.

  • Increased trade occurs when countries choose to specialize in their comparative advantage and trade their surplus production with other countries for what they don’t produce.
    This is beneficial where:

    • Countries productive capacity increases because they are producing what they have the lowest opportunity cost in. Increasing total output, increasing GDP.
    • Prices in the country drop because businesses can import cheaper inputs from efficient foreign firms and individuals can import cheaper products from foreign firms.
      With increased trade domestic business are now exposed to foreign efficient firms. This pushes domestic firms to find ways to become more competitive, increasing efficiency, reducing their prices. Therefore decreases domestic inflation.

  • Improvements in technology allow for faster and greater transportation of goods across countries.

  • Freight ships can transport 20 times as much as 60 years ago, and are 90% cheaper. The internet has also increased global communication.
    This has effects such as:

    • Faster to order imports
    • Faster and safer to invest overseas
    • Easier to manage international businesses
      Firms get funds for investment from loans (debt) or selling shares (equity). They increasingly get this debt and equity from overseas - we call this foreign investment.
      Foreign investment allows firms to get the funds they need to expand and increase production.
      But when borrowing from overseas there is a risk that the country will be unable to repay all of its foreign investment.