AB - The Business Organisation,

Stakeholders and the External Environment

Microeconomic Factors

DEFINITION:

Whereas macroeconomics is the study of the wider economy and how all the participants interact, microeconomics
is concerned just with the immediate world surrounding a participant, including how it deals with:

1. Customers;
2. Pricing;
3. Manufacturing;
4. Supply;
5. Cost management; and
6. Competition.

Note: The environment that macroeconomics is concerned with can include any entity or matter that the
organisation itself does, or may have to, deal with in the course of its activities.

A key element in the study of microeconomics is concerned with the economics underpinning the demand for an
organisation’s product and services from its customers, and the supply by an organisation of those goods and
services to the customers.

DEMAND AND THE DEMAND CURVE:

The demand curve is a graph which shows how many of an organisation’s goods or services its customers are
willing to buy - Q, for a given price - P.

Note: Each company will have a different demand curve for different products. They may be curved, steeper or
flatter in parts, and will be determined by deep technical analysis.
Imagine that at we know that at €1.50 the entire stock of 100 units is sold out. So, from demand curve analysis we
would be able how many we would actually sell at €1.50 before customers lost interests at that price. Let’s say its
500 units.

If we lower the price to €1.25, we would get all those 500 customers plus another 200 customers who are ready
to pay that price, but who would deem €1.50 too expensive:

SUPPLY AND THE SUPPLY CURVE:

The supply curve examines what an organisation is prepared to supply at different prices.

An analysis tells us that at price of €1.00 the company will supply at least 100 units and at a price of €2.50 it will
supply 1000 units. This information forms the basis of the supply curve:

Note: There will be a price below which the company will not supply any goods if it is losing money on the supply.
Similarly, there may be a maximum possible supply that the company can deliver regardless of the price.

DEMAND AND SUPPLY EQUILIBRIUM:

Demand and supply equilibrium is where the demand and supply curves cross. This is the point where the
customers are prepared to demand a certain volume - Qx, at a certain price - Px, and where the company is
prepared to supply that same quantity - Qx, at that same price - Px. This is the volume that the company should
produce and the price it should set.
Note: There may be reasons why a company might not produce Qx or sell at Px, for example:

● It might charge a much lower price and accept lower profits, or even no profits, if it is trying to gain market
share in the short term; or

● It may have decided that by retaining a higher price at the expense of volume it might enable perception
of its goods as a luxury item and shift the demand curve out.

ELASTICITY OF DEMAND:

Elasticity of demand refers to the change in demand in response to changes in other economic variables,
particularly the price.

The price elasticity of demand informs us about what would be the unit or percentage change in sales given the
price per unit, or percentage change.

Percentage change in Q (the quantity demanded)

PED =
Percentage change in P (the price offered)

Example:

From our analysis, we know that for our product the higher the price, the fewer we sell and the lower the price, the
more we sell.

(700 - 500) / 500 40%

PED = = = 2.4
(€1.5-€1.25) / €1.5 16.7%

Note: This means that for every 1% increase in price quantity decreases by 2.4% and vice versa.

SUBSTITUTE AND COMPLEMENTARY GOODS:

Substitute goods are alternative goods which consumers can switch to as substitutes for the goods the
organisation is producing.
Complementary goods “go with” other goods, often sold together. A change in demand for one changes the
demand for the other.

Note: Even if we do nothing on price, quantity sold could fall if the price of substitute goods in the marketplace is
reduced.

CROSS ELASTICITY OF DEMAND:

Cross elasticity of demand is an economic concept that measures the responsiveness in the quantity demand
of one type of goods when a change in price takes place in another type of goods.

Percentage change in Product A quantity

CED =
Percentage change in Product B price

THE BEHAVIOUR OF COSTS:

A fixed cost is a cost that does not vary in the short term, irrespective of changes in production or sales levels, or
other measures of activity. A fixed cost is a basic operating expense of a business that cannot be avoided, such
as a rent payment.

Variable costs are those costs that vary depending on a company's production volume. They rise as production
increases and fall as production decreases.

Total cost = Fixed cost + Variable cost

The marginal cost of production is the change in total cost that comes from making or producing one additional
item.

Costs behaviour in the short run:

Example:

Let’s say that the cost of the factory is fixed at €1000 per annum and we have 10 members of staff who can
produce 1000 of widgets at the variable cost of €1.50 each. In this case our costs are €2,500. This represents an
average cost of €2.50 per unit produced.

Let's say our staff can produce more units per person than they currently are. Say, from 100 widgets per person
to a 150 widgets per person. We have now produced 1,500 widgets and in this case our labour costs have not
increased but we have had to still spend on raw materials. So our variable average cost per unit has dropped to,
say, €1.25. Therefore, our total variable costs are now €1,875 (1,500 units x €1.25). Total costs are thus €2,875
meaning average total cost per unit has dropped to €1.92 (€2,875 / 1,500 units).
If we were to start to plot the cost numbers from the table above, we would begin to see an interesting charts:

From the chart above we can see that the marginal cost (MC) falls as the variable resources in the business
become used more and more to fill the capacity at MC1, where the marginal cost is the lowest. However, as more
resources are added, marginal costs start to go up.

For example, additional resources added that are not fully used, and marginal returns from the resources begin to
diminish as the factory fills up. We can see that the average fixed costs (AFC) decline continually as the single
fixed cost is spread across more and more units. The average variable cost (AVC) and the average total cost
(ATC) will drop as the marginal costs fall, but will begin to go up again as the marginal costs begin to increase
beyond MC1.

Costs behaviour in the long run (all costs are variable):

We can see that the long run average cost curve (LRAC1) is made from a series of short run curves. When output
grows beyond a certain level, costs become inefficient, so the short run costs flip from SR1 to SR2 and so on.
LRAC1 falls at an earlier level of outputs due to economies of scale and then rises beyond LRAC1 due to
diseconomies of scale. There comes a point where further efficiencies cannot be reached, and further output
cannot be done more cheaply on average than the previous output (LRAC1).

COMPETITION:

There are four main types of competitive environments:

1. Perfect competition: There are many competitors operating in a marketplace with equal power, selling a
homogenous product. None of the participants is big enough to control the market;
2. Oligopoly: There are just a small number of large players in the market;
3. Monopolistic competition: There are a lot of participants, but each participant produces a slightly
different product differentiated in areas other than price; and
4. Monopoly: There is only a single participant, or single supplier, of a particular product and there is no real
competitive market.