1. B200 TUTORIAL WEEK SIX

2. By the end of the Markets module you should be able to: Describe the role of markets and market economies as social institutions that co-ordinate economic activity. Describe the role and behaviour of various socio- economic agents such as households, firms and governments. Use the various models of the nature of market competition and of market power. Recognise the existence and nature of market competition and of market power. Describe the ways in which Governments may try to remedy market failures and the limitations of this process of state intervention. Deemonstrate the importance of the international dimension of economic activity in both current and historical contexts. Describe the diversity of market economics.

3. Economic Agents This area of markets is covered by your study of Chapters 3, 4 and 5 of the markets module. Chapters 3 and 4 will be studied this week, and Chapter 5 (alongside chapter 6) will be studied next week. In a market economy, there are three important agents or decision makers whose behaviour we need to understand if we wish to understand how the economy functions: households, organisations, and government. In this section, we concentrate on the behaviour of households (chapters 3 & 4) and households (chapter 5). The role of behaviour of government is covered later in the module.

4. Chapter 3 Household by Jane Wheelock

5. Household, The term refers to all individuals who live in the same house, without regard to whether they are related to each other. and is the basic unit of analysis in many microeconomic and government models Households take three sets of economic decisions: –Production –Consumption (spending) –Distribution This chapter discusses the key factors that influence the consumption decisions of households.

6. The structure of this chapter looks at the (macro) behaviour of people and household in the economy as a whole to gain an understanding of the relationship between income, expenditure and savings. Also we will cover the factors that affect these decisions and behaviour; mainly income and price.

7. Diagram 3.1 p 59 It shows us the relationship between Household and Firms. Households supply factors of production to firms and are paid from firms for doing so. The firms produce goods and services and sell them to households. Firms decide what to produce, how much and for whom? And this is according to household needs and demands.

8. The personal sector of the economy: income expenditure and savings Income and expenditure account tracks where household income comes from and what they are spent on (see table 3.1 on page 61) – the focus is on consumption. There are 3 main ways in which households use their income: consumer expenditure for day to day living, savings and tax.

9. Consumer expenditure, uses about two thirds of income. Economically this is very important because it ensures that people are in a fit state to produce what the economy needs. Consumption behaviour is affected by the level of income. Savings, households put savings to provide security for the family in the future (financial assets) or they save to provide shelter ( house). Tax, is used by government to pay for social consumption such as education, health, … and to redistribute purchasing power between households.

10. Food and housing represents the largest part of consumer expenditures. Consumer expenditures can also be considered an investment in people. How? In the process of consuming, the people are also consuming the environment and cause pollution, like waste and car pollution. Unfortunately, this consumption of the environment is not accounted for in economics.

11. Household demand for particular commodities Demand and Income Income is unequally distributed between households in all countries. Income distribution means a hierarchy of patterns of consumption between poor and rich. A hierarchy of income distribution means a hierarchy of patterns of consumption between poor and reach. Rules of the relationship between level of income and demand: 1.Those with higher income will buy more of most commodities. If a country’s national income goes up, households have more purchasing power and more commodities will be bought. Ex, cars. 2.In the case of so-called inferior goods, those with higher incomes actually buy less of them. Also, when income rises, the household will buy different things. Ex, buy fish, meat, … instead of wheat or rice.

12. Socio economic influences Example of these influences : -Influence of technology: technology is mediated between psychological need and economic demand. Socio technical innovation like video recorder provide entertainment, lead to change in the structure of household demand, families watch video instead of going to the cinema. -Social influences, like when people feel social pressure to purchase what other have which is called ‘Demonstration effect’. Veblen makes a distinction between instrumental consumption and ceremonial or wasteful consumption. - Price influence, is considered one of the most important variables. ( lower income …avoiding expensive goods)

13. Relationship between price and demand ‘ Law of demand’ quantity demanded of a good in inversely related to that good’s price, other things constant. As the price goes up (P), the quantity demanded goes down (Q). When price goes down, quantity demanded goes up. There are exceptions to the general rule above: 1.Veblen goods: refers to luxury items, may be in greater demand at higher prices. 2.Giffen goods: consumers spend less on these goods when their price goes down because their spending power is released to purchase a greater variety.

14. A shift of demand curve The relationship between quantity of demand (D) and price ( P) influenced by factors change! If the salary falls, every one will buy less quantity of products. The curve will shift from D to D1 Fixed price … change in factors.

15. Movement along the demand curve Change in price …all other factors constant.

16. Movements along the demand curve and shifts of the demand curve Turn to page 69 of the markets reader. Use the strawberry example to understand the difference between shifts of the demand curve and movements along the demand curve.

17. Chapter 4 More on Consumer Demand by Atkinson and Miller

18. The concept of elasticity Your tutor will explain the following concepts with reference to pages 73-82 of the Markets reader: Elasticity of demand Price elasticity of demand Measurement of price elasticity of demand Factors influencing price elasticity of demand The relationship between price elasticity of demand and revenue Income elasticity of demand Cross-elasticity of demand

19. The concept of elasticity Elasticity is is a measure of the responsiveness of one variable to another. It tells you: If you change this variable a little bit, how much will another variable change? elasticity is a general concept that describes the proportional change in quantity relative to a proportional change in the price of a good, or the proportional change in a shift factor such as income or price of another good. Ex Ex, The price of CDs goes up 10 percent and you decide: No more CDs for you – they are too expensive; and you stop buying any. Your demand for CDs is very price elastic – you respond a lot in terms of quantity demanded to a change in price. change in price causes change in quantity demanded.

20. There are numerous factors which can affect the level of demand: Price elasticity of demand Income elasticity of demand Cross elasticity of demand

21. Price elasticity of demand This is the most common elasticity concept. It’s measure the general responsiveness of quantity to change in price. Can be measured through this formula : Percentage change in quantity demand _________________________________________________________________ where, Percentage change in price If the value for price elasticity greater that 1, the demand is price elastic. If the value is less than 1, the demand is price inelastic. The higher the value of price elasticity, the more elastic demand is said to be. Figure 4.1 – 4.2 – 4.3 – 4.4 p 75,76

22. Relationship between price elasticity of demand and revenue The effect on firm’s revenue of a change in price depends on the price elasticity of demand for its product. Knowledge of the price elasticity of demand for products is important for firms when considering their pricing policy. When demand is elastic (for product we can replace it like chocolate) …… increase in price will lead to fall in firms revenue, while reduction in price will lead to an increase in revenue. When demand is inelastic (for important product like salt, milk, bread) ….. increase in price results in an increase in the firms revenue, while decrease in price results in a fall in revenue. Figure 4.5 – 4.6 – 4.7 – 4.8 p 78, 79

23. Factors influencing price elasticity of demand Availability of substitute, if there are many close substitutes or alternative Product available, then the demand is likely to be price elastic. But if there few Alternative products then demand is likely to be price inelastic. Ex, the demand for petrol is price inelastic, but the demand for petrol products Is elastic. Necessity or luxury product, also have an influence on price elasticity of Demand. If product is luxury consumer may decide to forgo the product as Increase in price. But if the product is necessity still continue to demand For the product even if the price increase. Time, time give consumers with time to search for alternative products. The passing of time has made demand more price elastic. Ex, if the price of petrol rises, the people still buy it and use it because they need It, but over time the people are looking for alternative products. In this example

24. Income elasticity of demand Is defined as the percentage change in demand divided by the percentage change in income. It tell us how much demand will change with a change in income. The measurement formulas as following: = % Change in Demand % Change in Income If the value is more than 1, the demand will be income elastic. If the value between Zero and 1 demand will be income inelastic. Luxury products have high income inelasticity, while necessities Have low income inelasticity. Knowledge of the income elasticity of demand is important as it can help Us to predict what will happen to demand as income level change.

25. Cross-elasticity of demand Is defined as the percentage change in demand divided by the percentage change in the price of another good. It tell us the responsiveness of demand to change in prices of other goods. ___% Change in Demand for X % Change in Price of a related good Y Ex, if the price of Toyota rises ! What will happen to the demand of Honda? Of course it will rises, so the cross-elasticity between the two is positive. Positive cross-elasticity of demand mean the goods are substitutes. A good that can be place of another. When the price of a substitutes goes up, the demand for other good goes up.

26. Another example, if the price of burger sandwich rises, what will happen to the quantity of ketchup demand? If you always add ketchup to your sandwich …. Cut consumption of burger will also cut consumption of ketchup. Ketchup and burger sandwich are complements. Complements are goods that are used in conjunction with other goods. A fall in price of a good will increase the demand for its complement. The cross-price elasticity of complement is negative.

27. Small Group Work based on chapters 3 and 4 In small groups, consider what other things besides price may not remain equal in the market for the following goods: Luggage Ice cream Dates Chicken Use the material on pages 70-71 to help you. What causes shifts in the demand curve? What causes movements along the demand curve? Use the material on pages 69-70 to help you.

28. Activities Activity 1 (page 14 of the Markets Study Guide) Skills (page 16 of the Markets Study Guide) Activity 2 (page 19 of the Markets Study Guide) Activity 3 (page 20 of the Markets Study Guide)

29. Chapter 5 Organisations by Costello.

30. we discussed the households sector. We mentioned that households supply factors of production to business and are paid by business for doing so. The market where this interaction takes place is called a factor market. Business produces goods and services and sells them to households and government. The market where this interaction takes place is called the goods market. In this chapter we analyse the role of another important economic agent – the organisation (firms).

31. Firms and productive activity The objective of this chapter is to develop several models of firms as producing organizations to try to understand how firms operate in the economy. It should be emphasized that not all production takes place in private firms. E.g.; The Open University, parks, mosques,…. Most of the chapter concentrates on private firms. They have been extraordinarily successful at creating wealth and a range of products undreamt of in our grandparents’ generation. In terms of size: firms can start from 1 to thousands of employees.

32. Firms are among the important institutions in the economy which organise productive activity. No firm carries out all productive activity internally, it also chooses to buy certain inputs from the market rather than produce them itself. This “make or buy” decision is influenced by the fact that the costs of producing a good or service internally may be different from buying it on the market. Also, the availability of knowledge and security of supply affect this decision. Businesses decide what to produce based on what they believe will sell. A key question a person should ask about starting a business is: Can I make a profit from it? Profit is what is left over from total revenues after all the appropriate costs have been subtracted.

33. Firms and Finance The model that is most commonly used to explain firms’ behavior is that based on accounting conventions. The primary focus of this model is the firm as a money processor. Balance sheet: which is a picture of financial conditions on a given date. This statement records what a firm, person, or nation is worth at a given point in time. Assets = Liabilities + Stockholders’ Equity Profit Statement: measures a flow concept (the amount of income and expenses passing through a company during a particular period of time). Funds flow statement: shows where and how funds have come into an organization during a period, and what has happened to those funds.

34. Production, Costs, & Profits The Production Function Production is name the given to the transformation of factors into goods. The Production Function specifies the maximum output that can be produced with a given quantity of inputs. It is defined for a given state of engineering knowledge and technology. But if you have a fixed amount of inputs, the amount of output will depends on the state of technology and engineering knowledge.

35. The Production Function can be expressed in an algebraic form as: Q = f (F1, F2, F3, ….., Fn) Q is the function of F1,F2, …Fn where Q is the quantity of meals required and F refer to the factors of production, and the size will vary. In other word is the number of meals of a given quality that a restaurant can produce depend on the different factors of production that the restaurant have. If we have more skilled chefs we might need fewer raw materials and less waste, or may be require different kinds of equipments. Regarding technology, If we have microwave the productivity will be more, and chef skills will focus on something else, or we will use less number of staff.

36. The short and the long run Production requires not only labor and land but also time. Pipelines cannot be built overnight, and once built they last for decades. Farmers cannot change crops in midseason. It often takes a decade to plan, construct, test, and commission a large power plant. To account for the role of time in production and costs, we distinguish between two different time periods. We define:

37. Short and Long Run Short run: is a period in which firms can adjust production by changing variable factors such as materials and labor but cannot change fixed factors such as capital (variable factors of production/variable costs). Long run: is a period sufficiently long that all factors including capital can be adjusted (fixed factors of production/fixed costs). As we mentioned short run is a time period in which some inputs are fixed. In the long run, firms have many more options than they do in the short run. They can change any input they want.

38. Marginal Cost Marginal Cost, denotes the extra or additional cost of producing 1 extra unit of output. Say a firm is producing 100 compact discs for a total cost of $100. If the total cost of producing 101 discs is $106, then the marginal cost of production is $6 for the 101st disc. The Marginal Cost of production is the additional cost incurred in producing 1 extra unit of output. Economies of scale: are the reductions in costs associated with expansion in output in the long run.

39. Organizational Structures, cultures, and goals Organization Structure/configurations the systems it uses, the people it hires, the fit between jobs and people, the results it recognizes and rewards, and what it defines as problems and opportunities and how it deals with them. Organizational Culture is the system of shared values, beliefs, and habits within an organization that interacts with the formal structure to produce behavioral norms. values and standards that guide people’s behavior. It determines the organization’s overall direction Organization goals An objective or goal is an organizational desired end point in development. It is usually endeavored to be reached in finite time by setting deadlines.

40. Case Study The chapter looks at the case study of an entrepreneurial high-tech firm. This helps you to understand the complexity of the activities a firm undertakes.

41. Key points If a firm faces a competitive environment, it may try to organise production in an efficient or least cost fashion. In the short run, a firm can vary the use of some inputs such as labour and raw materials, but cannot vary others such as capital and land which are fixed costs. In the long run, all costs are variable. As a firm produces more, it uses more inputs and the total costs increase however the costs of production may change – when the firm reaps economies of scale.

42. Activity in your section See Exercise 5.2 on page 107 of the reader. Carry this out in a tutor led activity in your section. Be prepared to share your answers in a discussion.

43. How Markets Work In the last chapter we looked at what we mean by firms, and some aspects of how they work. We now carry out study of firm behaviour forward by considering the interdependence of firms within markets. This is covered by Chapter 6.