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TOPICS:

Consumer Behavior

Analysis of Demand

Analysis of Supply

Market Equilibrium

Production and Cost Theories

Market Structure and

Price-Output Determination

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CONSUMER BEHAVIORNeeds vs. WantsAnalysis of Consumer Behavior

o Marginal Utility Approacha. Consumer Equilibrium

o Indifference Curve Approacha. Indifference Curveb. Family of Indifference Curvesc. Budget Lined. Consumer Equilibrium

Patterns of Filipino ConsumptionThe Responsible Consumer

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Needs – have to be satisfied for an individual to live.

Wants – have to be satisfied in order to live comfortably. Marginal Utility - means the additional

satisfaction or utility one gets from consuming an additional unit of a good.Utils – unit of measure to quantify utility or satisfaction.Law of Diminishing Marginal Utility - It asserts that as more and more of a commodity is concerned, his additional utility from every unit consumed tend to become less and less.

Important Terms

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Law of Diminishing Marginal Utility

Change in TU

MU =

Change in Q

Where;

MU – Marginal Utility

TU – Total Utility

Q - Quantity

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Relationship between Total Utility and Marginal Utility

Table 1

TOTAL UTILITYTOTAL UTILITY MARGINAL MARGINAL UTILITYUTILITY

IMPLICATIONSIMPLICATIONS

increasiincreasingng

positivepositive satisfiedsatisfied

constanconstantt

zerozero satiatedsatiated

decreasdecreasinging

negativnegativee

dissatisfdissatisfiedied

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Equimarginal Principle – states that consumers maximize their utility or satisfaction when the marginal utility they get per price of a certain good is the same as the marginal utility achieved per price of any other good.

MU for Milk MU for Bread =

Price of Milk Price of Bread

Marginal Rate of Substitution (MRS) - It measures the maximum amount of one good given up in order to consumer more units of the other good. It is also the slope of indifference curve.

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Law of Diminishing Marginal Rate of Substitution –It indicates that consumer gives up less and less amount of cookies in favor of additional units of candies.

Budget/Income – It is the amount allocated for buying the goods.

Consumer Equilibrium – It is attained at the point of tangency (the point where the budget line touches but does not cross the indifference curve) between the budget line and the highest possible indifference curve.

The Responsible Consumer

AwarenessSocial Concern

ActionSolidarity

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CONSUMER RIGHTSBasic Needs

Safety

Information

Choice

Representation

Redress

Consumer Education

Healthy Environment

P15.00

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ANALYSIS OF DEMANDPrice and Quantity Demanded

o Demand Functiono Demand Schedule and Demand Curveo Other Factors Affecting Demand

Change in Quantity Demanded and Change in Demand

Price Elasticity of Demanda. Elasticb. Inelastic

c. Unit-Elastic d. Perfectly Elastic and Perfectly Inelastic

o Price Elasticity of Demand and Total Revenueo Factors Affecting Demand Elasticity

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Market exists if there is interaction between buyers and sellers.

Buyers - are the ones who exert demand

Sellers - are the ones who bring about supply.

Price and Quantity Demanded

Demand – refers to the various quantities of a good that a consumer is willing and able to buy.

Ceteris Paribus (remain constant) – income of the consumers, the prices of related goods, and the number of consumers.

Demand Function –It specifies the relationship between the price of the good and the various quantities that a consumer is willing and able to buy.

Important Terms

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Demand Schedule - assumption of price levels and for the corresponding quantities demanded.

a. Individual Demand Schedule – prices and quantities demanded by one buyer.

b. Collective Demand Schedule– prices and quantities demanded by several buyers.

Demand Curve– graphical illustration of demand schedule.

DOWN SLOPING DEMANDCURVE

When the price of the good increases, the demand for that good decreases, keeping other things constant conversely, when the price decreases, the demand increases, keeping everything else constant.

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OTHER FACTORS AFFECTING THE DEMAND

A. Consumers’ Tastes and PreferencesB. Consumers’ IncomeC. Number of ConsumersD. Prices of Substitutes and ComplementsE. Price ExpectationsF. Traditions

CHANGE IN QUANTITY DEMANDED AND CHANGE IN DEMAND

Shift of the demand curve may be upward to the right, which means an increase in demand; or downward to the left, which means there is a decrease in demand.

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PRICE ELASTICITY OF DEMAND

It measures how the quantity demanded changes when the price changes. It measures the degree of the responsiveness of quantity demanded to the change in the product price.

∆ Qd / Q

ED =

∆ P/ P

Where;

∆ Qd – new quantity demanded – old quantity demanded

Q – new quantity demanded + old quantity demanded

2

∆ P – new price-old price

P – new price + old price

2

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Types of Demand ElasticityA. ELASTIC DEMAND – Coefficient is less than 1, demand is said to be

price –elastic. This means that the percentage change in price results in a greater percentage change in quantity demanded. Goods with many close substitutes are price-elastic.

B. INELASTIC DEMAND – Coefficient is greater than 1.Percentage change in quantity demand is smaller than the percentage change in price. Goods that consume a smaller portion of the consumer’s income are price-inelastic.

C. UNIT-ELASTIC DEMAND – Coefficient elasticity is equal to 1. Percentage change in quantity demand is equal to the percentage change in price. Goods that are semi-luxury or semi-essential goods.

D. PEFECTLY ELASTIC DEMAND & PERFECTLY INELASTIC DEMAND A. Elastic Demand – price elasticity is infinite. Even a slight

change in price can result in an infinitely large change in quantity demanded. This implies that consumers face several choices and that a slight increase in the price of one good can result in a large decrease in demand for that good, and an increase in demand for other goods.

B. Inelastic Demand – zero price elasticity (Quantity Demanded stays the same, no matter what the change in price is.)

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The Relationship between Product Price and Total Revenue at various elasticity

Table 2Value of Demand Elasticity

Definition Price Total Revenue

<1 (inelastic)

Percent change in quantity

demanded is less than percent

change in price

If price increasesTotal Revenue

increases

If price decreasesTotal Revenue

decreases

= 1 (unit-elastic)

Percent change in quantity

demanded is equal to percent change

in price

If price increasesTotal Revenue is

constant

If price decreasesTotal Revenue is

constant

1 (elastic)

Percent change in quantity

demanded is greater than

percent change in price

If price increasesTotal Revenue

decreases

If price decreasesTotal Revenue

increases

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PRICE ELASTICITY OF DEMAND AND TOTAL REVENUE

TOTAL REVENUE (TR = P x Q) refers to the total expenditure on the product by a consumer or to the total sales by the producer. Revenue depends on price elasticity of demand.

Factors affecting Price Elasticity of Demand

1. Availability of Close Substitutes

2. Importance of the goods to consumer

3. Proportion of Income Spent on the Good

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ANALYSIS OF SUPPLYPrice and Quantity Supplied

o Supply Function

o Supply Schedule and Supply Curve

o Law of Supply

o Other Factors Affecting Supply

Change in Quantity Supplied and

Change in Supply

Price Elasticity of Supply

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LAW OF SUPPLY

As price increases, the quantity supplied also increases, all other things remaining constant.

PRICE AND QUANTITY SUPPLIED

Supply – refers to the various quantities of a good that a seller is willing and able to sell at all possible alternative prices over a given period of time.

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Supply Function - The relationship between the price of the good and the various quantities that a seller is willing and able to sell can be expressed in mathematical form which is called the supply function.

QSx = f (Px)

Where;

QSx - Quantity supplied of Good x

Px – price of Good x

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Supply Schedule - It is made up of a listing of prices and quantities. The higher the price, the more incentives for the seller to supply more for a higher profit.

Supply Curve - It is a graphical representation of the supply function.

1. Sellers are encouraged to sell more at a high price than at a low price since this means more profit. More profits create more goods.

2. At a higher price, even inefficient firms can stay in the industry. But as price declines, efficient firms displace the inefficient ones, triggering their withdrawal from the industry.

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Other Factors Affecting Supply

a. Technology b. Prices of Resources/Inputs

c. Taxes and Subsidiesd. No. of Sellerse. Price Expectationsf. Natural Calamities

Change In Quantity Supplied – it refers to the movements of points along the give supply curve. It happens when the price of a good under consideration changes.

Change in Supply – it refers to either a downward to the right or upward to the left movement or shift of the entire supply curve.

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Factors that Cause Supply to Increase1. Improvement in technology

2. Decrease in the price of resources/inputs used3. Decrease in taxes imposed on producers4. Increase in government subsidy5. Increase in the number of sellers6. Decrease in the future prices expected by

producers

PRICE ELASTICITY OF SUPPLY

It measures the responsiveness or sensitivity of producers to changes in the price of a good. This refers to the degree to which the quantity supplied responds to changes in price.

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Various Types of Elasticity

A. Elastic Supply – a slight change in price results in a large change in quantity supplied, implying elastic supply.

B. Inelastic Supply – the percent change in price is higher than the percent change in quantity supplied.

C. Unit-elastic Supply – the percent change in price is the same as the percent change in quantity supplied.

D. Perfectly Elastic and Inelastic Supply

a. Perfectly Elastic - the price is fixed but the quantity varies infinitely.

b. Perfectly Inelastic – whatever the price is, then supply is fixed.

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MARKET EQUILIBRIUMMarketo Market Equilibriumo Market Surplus and Shortageo Effects of Change in Demand

on Equilibrium Price and Quantity

o Effects of Change in Supply on Equilibrium Price and Quantity

o Effects of Simultaneous Change in Demand and Supply on Equilibrium Price and Quantity

Price setting by the governmento Price Flooro Price Ceiling

Tax Incidence

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Market - It refers to the medium in which buyers and sellers interact.

Market Equilibrium - It refers to the balance between all quantity demand and quantity supply. When buyers and sellers transact at an agreed price, there is market equilibrium.

Equilibrium Price – It is the price at which consumers will be willing to take exactly the amount that sellers want to place in the market. This is also called the “market-clearing price”.

Mathematical Solution to Equilibrium

Qd = 18 – 2P (demand for cookies)Qs = 2 + 6P (supply of cookies)

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In solving for equilibrium price and quantity, we equate the demand and supply function :

Qd = Qs 18 - 2P = 2 + 6P -2P-6P = 2 – 18

-8P = -16 -8 = -8 Pe = P2.00

We can substitute the equilibrium price P = P2.00 for the demand and supply function, to get the equilibrium quantity (Qe)

18-2(2) = 2 + 6(2) 18-4 = 2+12 14 = 14 Qe = 14 units

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Table 3

Table 3 shows the demand and supply schedules for cookies. At P2.00, the demand for cookies at 14 units is equivalent to the supply of cookies.

PriceQuantity

DemandedQde

Quantity Supplied

Qse

0 18 2

1 16 8

2 14 14

3 12 20

4 10 26

5 8 32

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Market Equilibrium

0123456

0 10 20 30 40

Quantity

Pri

ce

Supply

Demand

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Price setting by the GovernmentPrice Floor - It is the price set by the government that

is higher than the equilibrium level.

Price Ceiling - It is the price set below the equilibrium price.

Tax Incidence - It refers to the final resting of a tax burden. It crucially depends on how the demand and supply curves are drawn. It is largely dependent on price elasticity of demand and supply; the flatter the demand curve (more elastic) is than the supply curve, the lesser will be the burden on consumers.

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PRODUCTION AND

COST THEORIESProduction Theoryo Production Functiono Production Periodso Short-run Production

a. Total produce and Average Product

o Marginal product and Law of Diminishing Returns

Cost Theoryo Cost Conceptso Short-run Costs

a. Total Cost : Fixed and Variable

b. Average Cost : Fixed and Variable

c. Marginal Cost

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The goal of a producers is to maximize profits (sales minus costs) and, at the same times, minimize costs.

Production - It refers to the process of creating goods and services with the use of productive resources or factors of production.

Production Function - It refers to the relationship between inputs that are required and outputs that are obtained.

Inputs – refer to the different ingredients used to produce goods and services.

Outputs – refer to the goods and services that result from the production process.

“How many units of input must be combined to produce so much of an output?”

Important Terms

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Production Period - It is the length of time within which the firm can vary the amount of production inputs to be used.

3 Classifications of Production Period

1. Immediate period – the time is too short for the firm to vary the quantity of its inputs. This is why it is sometimes called the very short run, or the market period.

2. Short-run period – the time is long enough for the firm to vary some – but not – all of its inputs. Thus, some inputs are variable while others are fixed. Land, buildings, machinery, and heavy equipment are usually held fixed in the short-run period; raw materials, laborers, and power supply are available.

3. Long-run period – is extensive enough for the firm to vary the quantity of all inputs used. Therefore, in the long run, all inputs are variable. No fixed inputs exist.

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SHORT RUN PRODUCTIONFor the production of children’s dresses (output), one of the inputs is permanent (fixed input) while the other one is changing (variable input) .

Variable input increases or as more dressmakers are hired, more dresses are produced. Total Product (TP) increases, keeping capital constant.

Average Product – refers to the total output produced divided by the total units of inputs used.

Total Product

Average Product =

Variable Input

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Law of Diminishing Returns for Labor – there is a decrease in the number of additional dresses produced per additional dressmaker hired.

Marginal Product – pertains to the additional output produced when 1 unit of input is added, keeping other inputs constant.

Change in Total Product

Marginal Product =

Change in Variable Input

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Production Schedule of Children’s Dresses Table 4

Dressmakers

Dresses

(TP)Marginal

Product (MP)

Average Product

(AP)

0 0

1 5 5 5

2 9 4 4.5

3 12 3 4

4 14 2 3.5

5 15 1 3

6 15 0 2.5

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At this point, the firm should stop hiring dressmakers.

That is six labor is enough to be combined with the fixed input,

sewing machine.

Total Product & Marginal Product

0

2

4

6

8

10

12

14

16

1 2 3 4 5 6Labor

TP,

MP

Total Product Marginal Product Average Product

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Cost Theory - Production involves cost. The inputs used in producing goods and services are paid for by the business firm that uses them.

Cost Concepts

Private Costs – are expenses shouldered by individual producers. The firm incurs them when it acquires resources for use in the production process. Example – Wages, rent, and cost of materials.

Social Costs – are additional costs that are not paid for by the producers but are borne by society. Example – a cement manufacturer causes pollution in the environment.

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Social Cost/benefit - can either be positive or negative in terms of effect on society. Sometimes, production may involve the benefits to the community and not negative costs.

Example: The residents in a community wherein industries are put up will benefit through jobs generated and business opportunities created, like canteens, dormitories for workers. However, they suffer in terms of pollution and a possibly high crime rate in the area.

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The private cost of the producer can either be explicit or implicit in nature.

Explicit or expenditure cost – consist of actual payments made by the firm for resources bought or hired. Examples : Payments for raw materials and salaries of hired workers.

Implicit Cost – costs of self-owned or self-employed resource.

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Variable Costs – are incurred for variable inputs.

Example : Wages of ordinary laborers, cost of raw materials, and transportation.

Fixed Costs – are spent for fixed inputs.

Example : Salaries of those in top management, rent, and insurance payments.

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SHORT-RUN COSTS

In the short run, the firms has insufficient time to vary all its inputs.

A.Total Cost: Fixed and Variable

Total Fixed Costs – refer to the costs of fixed inputs used by the firm.

Total Variable Costs – refer to the costs of variable inputs used by the firm. These are costs of labor as well as raw materials. VC changes as output changes. VC is zero when output is zero.

Total Cost – is composed of total fixed costs(FC) and total variable costs (VC)

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Average Cost : Fixed and Variable

Average Fixed Cost – decreases continuously as output increases. The greater the output, the smaller the AFC. This is due to a fixed cost that is spread to more output levels.

Total Fixed Cost

Average Fixed Cost =

Output

or

TFC

AFC =

Q

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Average Variable Cost – refers to the variables costs per unit of output produced by the firm. It is obtained by dividing VC by the level of output.

Total Variable Cost Average Variable Cost =

Output

Or

TVCAVC =

Q

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Average Cost - is obtained by dividing TC by the level of output. It is also obtained by adding the sum of AFC and AVC.

Total Cost

Average Cost =

Output

Or

TC

AC = or AC = AFC + AVC

Q

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Marginal Costs – refer to the additional costs incurred by the firm in producing an additional unit of output.

Change in Total Cost

Marginal Cost =

Change in Output

Or

∆ TC TC1 – TC0

MC = MC =

∆Q Q1 – Q0

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MARKET STRUCTURE AND

PRICE-OUTPUT DETERMINATION

Perfect Competition

Monopoly

Monopolistic Competition

Oligopoly

Determinants of Market Structure

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PERFECT COMPETITON

It is characterized by the presence of several sellers or producers in the market who offer homogeneous or identical goods. Examples are sellers of farm products like rice, corn, coconuts, and sugar.

Since numerous firms are engaged in farm products, a single seller is relatively small in comparison to the entire market or industry. Because of this, a single seller under perfect competition is a price taker, who cannot affect the market price.

Under perfect competition, there is complete mobility of goods and resources, which means that producers and sellers can freely enter into or leave the market whenever they wish.

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Total Revenue – price multiplied by quantity produced

Average Revenue – total revenue divided by quantity produced.

Marginal Revenue – additional revenue a producer gets when an additional unit of quantity is produced.

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Profit Maximization of Perfectly Competitive Firm

TR > TC = Profit

TR < TC = Loss

TR = TC = Breakeven or 0 profit

MR>MC = produce more until MR =MC

MR=MC = profit maximized

MR<MC = produce less until MR=MC

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MONOPOLY

It comes from two Greek words – mono, meaning “one”, and polist, meaning “seller”. Therefore, it refers to one seller dominating the market. This type of market structure is the exact opposite of perfect competition.

Example: Public Utility firms (Meralco)

Patent - It is the exclusive right granted an inventor to enable him to control the use of his invention – also hinders other firms from penetrating the market.

Profit Maximization of Monopolist

P > MR = MC

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MONOPOLISTIC COMPETITION

In this kind of competition, there are many firms competing and it is easy for a firm to enter and exit the market. Note that these characteristics are the same as those of perfect competition.

The difference is that the products sold in monopolistic competition are not completely homogeneous. Different producers/firms make it appear as if their own product was unique and different from the rest, but in reality, the products available in the market are close substitutes.

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OLIGOPOLY

In an oligopoly, only a few sellers control a big share of the market. In this market structure, there is some degree of control over the market price and the sellers are interdependent – a phenomenon called collusion.

Oligopolists forge price agreements to promote their own economic interests. The biggest producer among them is the price leader. In the case of oil, the price leader is Saudi Arabia. There is also some sort of output agreement among oligopolists to avoid surplus, which will cause a decline in the price of their products.

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DETERMINANTS OF MARKET STRUCTURE

A. Government Laws

B. Technology

C. Business Policies

D. Economic Freedom

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