THE ECONOMIC ENVIRONMENT OF BUSINESS

I. Markets and Microeconomics

A.  Introduction and Supply and Demand

1.  Introduction

a.  Microeconomics

• Deals with the actions of individual consumers, firms, and industries

• Concerned with prices and quantities of inputs and outputs - deals with strategic and tactical decisions by firms and individuals

• Issues:

(1)  Consumer behavior and the impact on revenues

(2)  Production technology and the impact on costs

(3)  Market structure and competition

(4)  Pricing practices and strategy

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b.  Macroeconomics

• Deals with larger economic environment

• Concerned with overall level of economic activity, interest rates, unemployment, inflation, exchange rates - deals with the setting in which business occurs

• Impacts microeconomic factors - demand, productions costs, profitability

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2.  Supply and demand

a. Demand

• Relationship between the price of a good or service and the quantity demanded, all else held constant

• Concerned with buyers or consumers of a product

(1) Representing demand

(a)  Demand function

Q_D = f (P_X, T, I, P_Y, P_Z, EXC, NC . . .)

P_X = price of product

T = tastes and preferences

I = income

P_Y, P_Z = prices of related goods

EXC = consumer expectations of future prices

NC = number of consumers

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(b)  Demand curve

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(2)  Changes

(a)  Change in quantity demanded

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(b)  Change in demand

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(3)  Nonprice factors affecting demand

(a)  Tastes and preferences

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(b)  Income

i) Normal good - more of the good is demanded as income or wealth increases

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ii) Inferior good - less of the good is demanded as income or wealth increases

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(c)  Prices of related goods

i) Substitutes - use one good instead of another

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ii) Complements - use goods together

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(d)  Future expectations

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(e)  Number of consumers

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b. Supply

• Relationship between the price of a good or service and the quantity supplied

• Concerned with sellers or the producers of a product

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(1) Representing supply

(a)  Supply function

Q_S = f (P, TX, P_I, P_A, P_B, EXP, NP . . .)

P = price of product

TX = technology

P_I = prices of inputs

P_A, P_B = prices of related goods

EXP = producer expectations of future prices

NP = number of producers

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(b)  Supply curve

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(2)  Changes

(a)  Change in quantity supplied

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(b)  Change in supply

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(3)  Nonprice factors affecting supply

(a)  Technology

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(b)  Input prices

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(c)  Prices of related goods

i) Substitute production - produce one good instead of another

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ii) Complementary production - produce goods together

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(d)  Future expectations

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(e)  Number of producers

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c. Equilibrium

• Combine supply and demand

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• Disequilibrium

(1) Shortage

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(2) Surplus

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d. Market changes

(1) Changes in demand

(a) Increase in demand

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(b) Decrease in demand

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(2) Changes in supply

(a) Increase in supply

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(b) Decrease in supply

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(3) Changes in demand and supply

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