Concepts and Theories

Module 2.1c to Module 5

Module 2.1c- Market Equilibrium
Market Equilibrium

❑ Market equilibrium
▪ Situation in which at the prevailing
market price, consumers can buy all the
good they wish and producers can sell
all of the good they wish.

▪ A situation in which supply and demand

have been brought into balance.
❑ Equilibrium price
▪ The price that balances supply and
demand.

❑ Equilibrium quantity
▪ The quantity supplied and the quantity
demanded when the price has adjusted to
balance supply and demand.
 Excess supply or Surplus

▪ Exists when the quantity supplied exceeds the

quantity demanded.

Excess demand or Shortage

▪ A situation in which quantity demanded exceeds

quantity supplied
Shortage vs Surplus
Measuring the value of market
exchange
• Buyers bring money to market to exchange for the
commodities that sellers bring to market to trade for
money.
• In free-market exchange between buyers and sellers,
no government agency or labor union forces
consumers to pay for the goods they want or coerces
producers to sell their goods.
❑ Changes in Equilibrium
▪ Suppose that one summer, the weather is
very hot. How does this event affect the
market for ice cream?
❑ Changes in Equilibrium
▪ Suppose that during another summer, an
earthquake destroys several ice-cream
factories. How does this event affect the
market for ice cream?
❑ Price ceiling
▪ Maximum price government permits sellers
to charge for good.
▪ When ceiling price is below equilibrium , a
shortage occurs.

❑ Price floor
▪ Minimum price government permits sellers
to charge for a good.
▪ When floor price is above equilibrium, a
surplus occurs.
Module 2.2- Elasticity
Elastic
• capable of being easily stretched or expanded and
resuming former shape

• https://www.merriam-webster.com/dictionary/elastic

Old state to a new state

Most managers
agree that the
toughest
decision they
face is the
decision to
raise or lower
the price of
their firm’s
products.
• Walt Disney- decided to raise ticket prices at its theme
parks.
• The price hike cause attendance at Disney parks to fall.
• The price increase was a success because it boosted
Disney’s revenue.

• However, price increases do not always increase the firm’s

revenue.
Elasticity of demand

❑Elasticity
▪ We indicated, ceteris paribus, the
quantity of a product demanded will
vary inversely to the price of a
product.

▪ What is known is the extent by which

quantity demanded will respond to
changes in variables.
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 Elasticity of demand
❑ Own price elasticity of demand
▪ A measure of the responsiveness of quantity
demanded to a price change.
▪ The percentage change in the quantity
demanded relative to a percentage change in
its own price.

∆𝑄 ∆𝑃 ∆𝑄 𝑃 𝜕𝑄 𝑃 %𝝏𝑸
𝐸𝐷 = ÷ = × = × =
𝑄 𝑃 ∆𝑃 𝑄 𝜕𝑃 𝑄 %𝝏𝑷
▪ Price and quantity are inversely related by the
law of demand so elasticity is always negative.
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 Elasticity of demand
❑ Own price elasticity of demand
▪ The larger the absolute value of elasticity, the
more sensitive buyers are to a change in
price.

Elasticity Responsiveness E

Elastic %Q%P E 1
Unitary Elastic %Q=%P E= 1
Inelastic %Q%P E 1
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 Elastic
E>1
Demand
Inelastic E < 1
Demand
 Elasticity of demand
❑ Price elasticity and total revenue

Elastic Unitary elastic Inelastic

%Q%P %Q=%P %Q%P
Quantity-effect No dominant effect Price-effect
dominates dominates

Price TR falls No change in TR TR rises

rises
Price TR rises No change in TR TR falls
falls

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 Other Demand Elasticity
❑ Income elasticity
▪ Measures the responsiveness of quantity
demanded to changes in income, holding
other determinants of demand constant.
%∆𝑄𝑑 ∆𝑄𝑑 𝑀
𝐸𝑀 = = ×
%∆𝑀 ∆𝑀 𝑄𝑑
Quantity Demanded Income EM
100 $1200
150 $1600 (50/400)x(1200/100) = 1.5
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 Other Demand Elasticity

❑ Income elasticity
• Interpretation:
• If EI = 2.27: A one percent increase income results in a 2.27%
increase in quantity demanded of beer
• Classification:
• If EI > 0, then the good is considered a normal good (ex. beef).
• If EI < 0, then the good is considered an inferior good (ex. ramen
noodles)
• High income elasticity of demand for luxury goods
• Low income elasticity of demand for necessary goods

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 Other Demand Elasticity
❑ Cross-price elasticity
▪ Measures the responsiveness of
quantity demanded of good X to changes
in the price of related good Y, cet. Par.

%∆𝑄𝑋 ∆𝑄𝑋 𝑃𝑌
𝐸𝑋𝑌 = = ×
%∆𝑃𝑌 ∆𝑃𝑌 𝑄𝑋

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 Other Demand Elasticity

❑ Cross-price elasticity
• Interpretation:
• If Edyx = - 0.36: A one percent increase in price of chips results in a 0.36%
decrease in quantity demanded of beer

• Classification:
• If (Edyx > 0): implies that as the price of good X increases, the quantity
demanded of Good Y also increases. Thus, Y and X are substitutes in
consumption (ex. chicken and pork).
• If (Edyx < 0): implies that as the price of good X increases, the quantity
demanded of Good Y decreases. Thus Y & X are Complements in consumption
(ex. beer and chips).
• If (Edyx = 0): implies that the price of good X has no effect on quantity demanded
of Good Y. Thus, Y & X are Independent in consumption (ex. bread and coke)
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Module 3- Theory of Consumer
Behaviour
Basic assumptions…

❑Consumer’s Optimization Problem

▪ Individual consumption decisions are made with
the goal of maximizing total satisfaction from
consuming various goods and services.

▪ Subject to the constraint that spending on goods

exactly equals the individual’s money income.

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 Basic model of consumer theory
• Seeks to explain how consumers make their
purchasing decisions when they are completely
informed about all things that matter.
• Consumption
bundles for two goods,
X and Y
❑ Utility function
▪ An equation that shows an individual’s perception of the
level of utility that would be attained from consuming
from each conceivable bundle of goods.

▪ Example:
𝑼 = 𝒇(𝑿, 𝒀)

Utility- the name economists give to the benefits consumers

obtain from goods and services they consume.
• In class, units of utility (utils)- to measure utility
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Hello! I’m Baymax! On a scale of 1 to
10, are you satisfied with my care?
• Consumption
bundles for two goods,
X and Y
 The Indifference Curves

❑ Indifference Curves
▪ Set of points representing Y
different bundles of goods and
services, each of which yields
the same level of utility.
B
I3
▪ Indifference map A I2
• A collection of I1
indifference curves.
X

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❑ Marginal Rate of Substitution (MRS) 𝑄𝑦
▪ The rate at which a consumer is
A
willing to trade one good for
6
another.
1
▪ The MRS is the amount of 𝑄𝑥 we B
2
would substitute for another 𝑄𝑦 . 1 I1
𝑄𝑥
▪ MRS falls as we move down along
an indifference curve.
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 The Consumer’s Budget Constraint

❑ Budget Line
▪ The line showing all
bundles of goods that can
be purchased at given
prices where the entire
income will be
consumed.
Module 4- Theory and empirical
analysis of supply
 • Importance of short and long run production theories:
Reason Details
Decision making helps managers make informed decisions. For example, in
the short run, they might need to decide on the optimal
quantity of labor to hire given fixed capital.
Cost management managers can identify cost-saving opportunities. In the
short run, they might focus on reducing variable costs,
while in the long run, they can consider changes in their
scale of operations.
Market Knowledge of short run and long run production helps
competition firms understand their competitiveness. They can adjust
production levels to respond to market changes
effectively.
• Vary by industry
Industries

• Technology
• Hardware: Companies that produce computers,
smartphones, tablets, and other electronic devices.
• Software: Development of applications, operating
systems, and other digital products.
• IT Services: Consulting, cybersecurity, cloud computing,
and data management.
• Retail
• Brick-and-Mortar Stores: Physical retail locations for
clothing, electronics, home goods, etc.
• E-commerce: Online retailers such as Amazon, Alibaba,
and eBay.
• Fast-Moving Consumer Goods (FMCG): Everyday products
like food, beverages, toiletries, etc.
• Manufacturing
• Automotive: Production of cars, trucks, and other vehicles.
• Aerospace: Manufacturing of aircraft, spacecraft, and
related components.
• Consumer Goods: Manufacturing of products for personal
use, like appliances, furniture, and clothing.
Basic concepts of production
theory
• Short run
- at least one input is fixed
- all changes in output
achieved by changing
usage of variable inputs
• Long run
- all inputs are variable
- output changed by
varying usage of all
inputs
Marginal revenue Marginal cost

• refers to the • the additional cost

additional revenue incurred by producing
earned by a firm from one more unit of a
selling one more unit product or service.
of a product or
service.
The bakery owner can use this marginal analysis to
determine the optimal level of production where marginal
revenue equals marginal cost, maximizing profit. This might
involve producing cupcakes until the point where MR = MC,
or until other factors such as market demand or capacity
constraints come into play.
 Economies of scale

• are cost advantages

reaped by companies
when production
becomes efficient.
Companies can
achieve economies of
scale by increasing
production and
lowering costs.
Break-even Point

• The break-even point represents the level of

sales at which a company's total revenues
equal its total expenses, resulting in neither
profit nor loss.

• In other words, it's the point where a

company is "breaking even."
 are expenses that remain constant
Fixed costs regardless of the level of production or
output.

Employees not directly

involved in production
 are expenses that remain constant
Variable costs regardless of the level of production or
output.
Contribution margin

• Contribution is what the business needs to achieve to

cover its fixed costs

• Every additional unit will be profit.

Module 5- Market structures
 Perfect competition
Description
•Many small firms.
•Homogeneous products.
•Price takers (individual firms
cannot influence the market
price).
Pricing strategy
No ability to set prices above
market equilibrium
Cost- based pricing
Non-price competition:
quality, service or branding
 Monopoly

Description Pricing strategy

•Single seller or dominant Monopolies can set prices since
firm. they have market power.
•Unique product with no Profit maximization
close substitutes.
•Significant barriers to They may engage in price
entry. discrimination (charging different
prices to different customers based
on willingness to pay).
 Monopolistic competition
Description
•Many firms.
•Differentiated products
(similar but not identical).
•Some control over prices
due to product
differentiation.
Pricing strategy
Firms set prices based on
perceived product differentiation.
Price discrimination
Promotional pricing- using sales,
discounts or special offers.
Advertising
Oligopoly
Description Pricing strategy
•Few large firms dominate Price leadership- one dominant
the market. firm sets the prices
•Interdependence among Strategic pricing- adjust pricing
firms' pricing decisions. depending on competitor
responses and market changes
•High barriers to entry. Non-price competition: Focus on
advertising, product
differentiation, and customer
service.
 Common pricing strategies across
Market structures
Pricing Description
strategies
Cost-Plus Adding a markup to the cost of
Pricing production.
Penetration Setting a low price to gain market share.
Pricing
Price Skimming Setting a high initial price to "skim"
revenues from the market.
Dynamic Adjusting prices based on demand, time
Pricing of day, season, etc.
Bundle Pricing Selling multiple products or services
together for a lower combined price.
Discount Offering discounts to encourage buying in
Pricing bulk or during promotions.