Economics in One Lesson by Henry Hazlitt in the Context of Microeconomics

Economics in One Lesson by Henry Hazlitt provides essential information about microeconomics that non-economics professionals need to know. The author provides examples of major economic misconceptions, public misinterpretations, and public policy failures. Mostly, the author talks about economic policies and their consequences. Hence, the basic rule of economics consists in looking not merely at the immediate but at the longer effects of any act or policy (Hazlitt 1952, 5). Even though the book was first published in 1946, it has not lost its relevance, and the topics laid out can be considered in the context of broader theories of microeconomics.

One of the main themes of Hazlitts book is supply and demand. Hazlitt (1952) notes that it is essential to distinguish between consumer needs and demand. According to the author, effective economic demand requires not merely need but corresponding purchasing power (Hazlitt 1952, 13). This statement correlates with the concept of the demand curve, which shows the ratio of the number of goods consumers are willing to buy and their prices. Moreover, what Hazlitt calls purchasing power can be called the income level of consumers because the more income they have, the more goods they can buy.

On the other hand, the supply curve shows the quantity of a good that producers are willing to sell at a given price (Pindyck and Rubinfeld 2018, 44). Although the concepts of supply and demand characterize the market from different angles, they are inseparably linked. High demand for some goods increases supply, which, in turn, increases the demand among producers for goods from other manufacturers.

The optimal market option for both the consumer and the producer is the one that maintains economic equilibrium. It may be a balance between the number of goods and the number of consumers willing to buy a product (Pindyck and Rubinfeld 2018). In this case, avoiding losses for both parties will be possible by preventing surplus and shortage situations. Achieving equilibrium in a free market is due to the market mechanism. According to Hazlitt (1952), the free market is quite democratic since the consumer influences the pricing and quantity of goods and manufacturers. He notes that other demand and government price controls are often less effective. In such cases, errors in economic policy, such as unreasonable pricing and resource allocation, are almost inevitable.

Discussing the prices set by the state, Hazlitt raises the issue of tariffs on imported goods. Tariffs are the main reason foreign goods are more expensive. However, imported goods often have specific characteristics that better suit the consumers needs. Therefore, consumers pay more for imported goods, reducing their ability to buy local goods (Hazlitt 1952). A decrease in demand for local goods indirectly affects the countrys overall economy by reducing wages and the number of jobs. However, Pindyck and Rubinfeld (2018) note that quotas and tariffs are, on the contrary, needed to provide the domestic industry with higher profits than it would under free trade (351). The absence of imports would lead to higher prices for domestic goods, negatively impacting consumer behavior and demand.

During inflation, the government tries to set the price below the average by controlling the market and pricing. Hazlitt (1952) believes that this leads to an economic imbalance. As the price decreases, the demand for the product increases. However, due to declining profitability, manufacturers are reducing supply. It leads to a shortage of goods and the exit of companies from the market. Furthermore, above-average price increases, such as subsidies, are considered by Hazlitt (1952) to be disadvantageous. Initially, contributions imply that the sellers price exceeds the buyers price (Pindyck and Rubinfeld 2018, 359). However, the subsidies are paid out of taxes, and the consumer pays more for the goods.

Thus, the topics discussed in the book Economics in One Lesson are relevant today. An example is a need to maintain a balance between demand and supply curves, as well as the mechanisms of the free market and the need for its control by the state. Government control, like quotas and tariffs, is necessary to maintain the efficiency and profitability of the domestic market. However, when establishing economic policy, it is required to consider all possible consequences in advance.

References

Hazlitt, Henry. 1952. Economics in One Lesson. New York: Harper & Brothers.

Pindyck, Robert S., and Daniel L. Rubinfeld. 2018. Microeconomics. Pearson.

Microeconomics: Understanding the Concept of Price Theory

This paper will throw light upon the price theory which is extremely important to understand. Demand and supply play the most pivotal role in deciding the price of a commodity or a service. The same will be elucidated further with the help of Euro star which is a fast-speed train, which covers areas in London, Brussels, and Paris. At the end of the paper, the reader will be clearly able to understand the concept of price theory.

Prices theory is one of the most important parts of Economics. Generally, the price of a commodity or service is decided by taking into consideration the production cost incurred on the production of the commodity or the service. Another important element, which decides the price is how easily or how difficult is it to get the commodity or the service. Scarce commodities are considered much more important than commodities available in abundance hence there is a significant difference between the prices of scarce commodities and the commodities which are available in abundance. Let us now consider the demand aspect of the price theory, the demand aspect of the price theory is driven by an important factor which is how desperately a consumer is in need of that commodity or service. If a consumer is urgently in need of a service or commodity, he/she wouldnt mind spending even double the amount of money, which they would have spent in normal circumstances. So the demand aspect of the price theory is all about the desire of the consumer to have that particular commodity or service at his/her disposal.

Another important aspect, which is very important is the demand curve; the demand curve gives a good enough indication of the will of consumers to buy the commodity or the service at that particular price. Demand curves and supply curves are studied by an organization to arrive at an equilibrium price. Equilibrium cost is the fixed cost and this changes only when the demand and supply are changed and it does not change unless the demand and supply change.

Let us now take into consideration the difference between luxury goods and necessities, the income elasticity of demand tends to be much higher in the case of luxury goods and this is because of a simple reason which is as people become wealthier there wants to increase and they tend to spend more money on buying themselves luxuries. The level of income of an individual goes on to decide what luxury is and what is a necessity? For instance, a rich person can stop buying bikes and as a replacement start collecting cars, this purely depends on the level of income of people. The word luxury has more meanings than one, one often mistakes luxury as a status symbol, for instance, a person can buy a Nike shoe considering it as a luxury knowing very little about how good the shoe is, so it depends on individuals on how they define luxury.

Euro Star and its Price Theory

The Euro Star is one of the fastest trains in the world. (Euro Star). Euro-star is a high-speed train that covers areas in London, Brussels, and Paris. The price theory of the high-speed train will be highlighted in the remainder of the paper. There are three different classes namely, the standard class, the Leisure select and the last one is Business Premier. The rates vary depending upon the class, for a journey from London to Paris it would roughly cost about £178 if one chooses to travel in Standard class, on the other hand, the fare is higher if one chooses to travel by Leisure select, it would cost roughly about £325 if one chooses a two-way journey from London to Paris and back. The third and the most expensive class is the Business Premier which would cost a person roughly about £328.50 for a one-way journey from London to Paris.

The demand factor of the price theory comes into effect here; people opt to travel by Euro-star because they have the willingness to pay for the service offered by the train. This is a very essential concept in price theory if people dont feel the willingness to travel by train they will stop traveling by train. This goes to show that the prices of the services offered by the train are quite reasonable and this is exactly why the people feel willing to travel by train. The tickets of the train vary depending on the time, this is again because of the demand factor of Price theory, the rates of travel are higher at night because the urgency generally is higher at night and this is why the rates are higher at night, the urgency factor is very important in price theory, price of a commodity or service rises with the rise of the level of urgency of the consumer.

What would happen if Euro star had a uniform price policy?

The occurrence of this event is highly improbable, the train will never have a uniform price policy because that would be a case in which all the principles of price theories will be defied. As discussed earlier, necessities and luxuries depend upon the level of income, and taking such a decision would mean treating all the people equally with regard to the services provided on the train. For this to become a reality, the staff will have to remove all the luxury seats from the train and make sure that all the seats on the train appear to be equal. If Euro Star adopts a uniform price policy then the services offered to the people who want luxury will surely be curtailed and this would not go down well with those people and they will certainly find an alternative mode of transport. It would not make sense to have a uniform price policy simply because people earn to make their lives comfortable and they choose luxuries depending on the level of their income and in such a case it would make no sense to those who prefer to travel by Business Premier class as this is the most luxurious class of Euro Star. If this price policy is adopted it will surely put off the people who earn more in order to afford luxuries and they would surely find an alternative arrangement of travels.

References

Euro Star. In Euro Star. 2009. Web.

Price Theory. In The Consumer. 2009. Web.

Microeconomic Theory: Wal-Mart Stores Inc.

Micro Economic Theory

The micro economic theory is a function of many micro economical factors that relate to internal affairs of a given company. The micro economic theory is based on the fact that a companys operations and success is primarily based on the companys position in terms of its micro economic factors. In essence, the micro economic theory seeks to predict a companys performance in terms of its internal dynamics (micro economic factors) (McEachern, 2008).

For purposes of the micro analysis, we will undertake an analysis of Wal-Mart Stores Inc. Wal-Mart Stores Inc. is a public limited Corporation in the US. It has a long chain of discount retail stores and warehouses located in various countries around the world. In terms of revenue, the company is deemed the largest in the world by Forbes magazine (2010 rankings). In the year 2009, the company recorded net sales of $258 billion from groceries alone and 51% of this revenue was realized from its US stores alone (Boone, 2009, p. 127).

The company had been trading in the New York Stock exchange since 1972 with various trade mark names like Asda in UK, Wal-Mart in North America, Walmex in Mexico, Wal-Mart in Puerto Rico, Seiyu in Japan and Best Price in India. The companys operations outside the US have not been consistent because some markets have proved to be successful investment destinations while others have been unsuccessful. For example, its operations in UK, South America and China have been successful. However, its operations in South Korea and Germany have been largely unsuccessful. This has even forced the company to pull out. In this respect, the companys successes and failures have been caused by its internal strengths and weaknesses with regard to its micro economic analysis. These factors are discussed below:

Global Presence

The company currently operates over 4,000 stores worldwide in 14 countries globally (out of the US) (Gupta, 2008, p. 14). Its worker base is over 664,000. Some countries like the UK, Argentina, Brazil and Canada are home to its wholly owned operations. The country has a strong presence in Canada after it acquired 122 stores in 2004 but as at 2010, the company operates more than 300 stores with more than 100 supercentres which were part of its global strategic plan of having additional supercentres in Hamilton UK, and Aurora in Ontario.

In addition to these markets, Wal-Mart is currently involved in a retail chain partnership with some Chinese retail stores (Hitt, 2007). In Japan, the company owns 53% of Seiyu and 51% of the Central American retail holding company in Guatemala, El Salvador and other South American countries. Other chains are located in Brazil and India while prospects are also rife to venture into the Russian market (Hill, 2009, p. 439).

Strong Brand

Wal-Mart has a strong brand, internationally. In North America, it is the biggest retail business in the grocery market. The brand Wal-Mart has taken many forms; close to 40% of the stores products go by local label store brands produced by the company, through contracts made with local contractors. Sams Choice was the first private label brand. This brand was produced by the company in 1991. This was a local drinks brand that was produced by Cotts beverages. In addition, it was exclusively to be sold by Wal-Marts retail stores. This was one of Wal-Marts biggest business successes because the brand slowly grew in popularity by the end of 1993 to be the third most popular beverage brand in the US.

The company still has popular business brands like the Smart price in UK. The company also produces Great Value and Equate in the US and Canada respectively. These brands increase the companys operational revenues. Due to the success of the companys brands, Wal-Mart is set to increase its marginal profits as a result of customer loyalty and increased sales, expected to sustain in the long run.

Excellent Customer Services and Value for Money

Wal-Mart currently has a business model, based on availing an array of brands in different product categories, at affordable prices (Antoni, 2007, p. 81). The company also enjoys a good relationship with its employees; with management often referring to them as associates instead of employees (Jain, 2010, p. 49). Most or all of its retail stores in US and Canada also have greeters at the reception who do a good job at welcoming customers (Bergdahl, 2004, p. 163).

Wal-Mart is unique in its supplier relations. This is occasioned by its unique element of not charging a slotting fee like most retailers do for shelf space. This has improved the relationship with one of its key stakeholder; the suppliers (Feigenbaum, 2003, p. 81). In turn, the companys credit profile is improved and the unique relationship guarantees the companys continuity even in times of financial difficulties because suppliers will always be willing to supply the company with goods even on credit. However, even though the company doesnt charge slotting fees to its suppliers, it prefers stocking popular products in its shelves as opposed to selling unpopular goods. Sometimes, unpopular goods could be dropped from the shelves in preference of popular brands.

In 2006, the company also dropped its Layaway program, citing increased costs and decreased usage associated with its adoption (Plunkett, 2006). However, the Layaway program is still used for clients who purchase goods online and have them shipped by the company to the nearest collection centre. Currently, the company has adopted increased use of other options of payment like the 6 and 12 month zero interest financing. This restructuring has improved efficiency in the organizations operations.

Wal-Marts micro economic factors are further summarized in the SWOT analysis below:

Strengths

  • Strong brand in the retail market sector
  • Strong reputation to give clients value for money
  • Excellent Services to its Customers
  • Convenience
  • High product variety
  • Strong global presence
  • Excellent inventory management due to adoption of supply chain inventory technology (RFID).
  • Excellent distribution network
Weaknesses

  • Inflexible due to varied product investments
  • Overexpansion
Opportunities

  • Mergers with other global retail giants worldwide
  • Growing economic opportunities in developing economies
  • Supercentres pose increased opportunities for more revenues
Threats

  • Local and Global competition
  • Vulnerability to economic, social and political setbacks in the country of operation

References

Antoni, A., 2007. The Impact of Wal-Mart on the British Retail Market. London: GRIN Verlag.

Bergdahl, M., 2004. What I Learned From Sam Walton: How to Compete and Thrive In A Wal-Mart World. London: John Wiley and Sons.

Boone, L., 2009. Contemporary Business 2010 Update. London: John Wiley and Sons.

Feigenbaum, A., 2003. The Power of Management Capital: Utilizing the New Drivers of Innovation, Profitability, and Growth in a Demanding Global Economy. London: McGraw-Hill Professional.

Gupta, A., 2008. The Quest for Global Dominance: Transforming Global Presence into Global Competitive Advantage. London: John Wiley and Sons.

Hill, C., 2009. Strategic Management Theory: An Integrated Approach. London: Cengage Learning.

Hitt, M., 2007. Strategic Management: Competitiveness and Globalization. London: Cengage Learning.

Jain, P., 2010. Buffett Beyond Value: Why Warren Buffett Looks To Growth And Management When Investing. London: John Wiley and Sons.

McEachern, W., 2008. Microeconomics: A Contemporary Introduction. London: Cengage Learning.

Plunkett, J., 2006. The Almanac of American Employers 2007 (E-Book): Market Research, Statistics and Trends Pertaining To the Leading Corporate Employers in America. New York: Plunkett Research, Ltd.

The Analysis of Microeconomics of Sberbank

Introduction

Exploring the nature of the companys microeconomics is an essential part of developing a successful strategy for its future growth. This paper will review the banking and financial management of the Russian company Sberbank, which began to expand globally in recent years. Frexias and Rochet (2008) describe banks as financial intermediaries, who can be seen as retailers of financial securities (p. 15). The purpose of this paper is to research the microeconomics of Sberbank, explore the state of the company on the market, and provide recommendations for its further expansion.

To begin the analysis, it is necessary to understand the past and the current state of the company. Sberbank originates from the Savings Offices, which was later transformed into the first bank and expanded into all major settlements of the Russian Empire (Sberbank history, n.d.). The company had a significant impact on the industrialization of the USSR and its success in World War II, and later became one of the primary drivers for modernization of the Russian economy (Sberbank history, n.d.). The company became less conservative and was open for investments, which allowed it to expand overboard (Sohn, 2019). The shareholders of the company are both Russian and foreign investors, however, the majority of the shares are held by the Central Bank of the Russian Federation, which began to sell the companys shares in 1996 (About Sberbank, n.d.).The company has the most significant presence in CIS markets, it began to expand into Europe in 2013, and it also has branches in India, China, and the United States (About Sberbank, n.d.). The companys existence relies heavily on its ability to resolve current issues and expand outside of the Russian Federation.

The companys operation is being put at risk due to its attempt to restructure into a technology-oriented company. In the past few years, Sberbank has purchased multiple Russian IT companies, such as Yandex, Rambler, and Rabota.ru (Gorshkov, 2019). In late September 2020, the company has announced its transformation into a tech company that aims to digitalize all aspects of peoples lives via its services (Cordell, 2020). Sberbank has decided to drop bank from its name and strives to achieve the same structure as Apple and Amazon (Cordell, 2020). It has been planning to update its strategies since 2014, and the preparations began in 2018 (Gref, 2020). Cordell (2020) states that the rebrand will cost $2.5 billion dollars and it will take the company approximately 6 years to complete the transition (p. 23). This move puts the company in an unstable position, yet it promises a significant return on investments if this plan succeeds.

Supply and Demand Conditions

The current operation of the company results in increased possibilities for demand for currency conversions. According to monetary theory, the need for money occurs through transactions, with the economic levels being the main influencing factors. The approximation of the economic level activity occurs in GDP. In this case, the demand for currency conversion occurs by examining money against final transactions. As a result, Sberbank understands that money is assumed to possess a return rate of zero, with a nominal proxies rate through the holding of currency. That means the lower the incentive that holds cash, the higher the interest rates from token rates. For such to work, the primary coinage demand function occurs in the form of M/P = L(Y, i) (Brierley, 2016). M stands for the nominal money balances, Y is the countrys real GDP, P is the level of the price and I is the nominal levels interest rate.

According to a Sberbank survey, Russian households, especially those living in mid-size and big cities, save up to 62 percent sporadically or regularly. The main currency families normally choose to build savings as much as 94% is the Russian ruble (Gref, 2020). Those who save in dollars are only 11 percent, while 9 % prefer choosing the euros, only 2 percent save in other currencies (Gref, 2020). According to this survey, the euro and dollar-dominated savings usually give up poor yielding in terms of saving cash. However, Russian societies prefer saving in these currencies as it protects savings and helps in speculating the cross and ruble exchange rates. Thus, the company understands the market change in regards to saving structures, which will be shaping up in the next few years. That means rubble has been the primary savings mechanism in various banks in the country, however considering that interest rates go down in this regard, traders are now thinking of using alternatives.

Impact of Demand for Currency Conversion to Sberbank

By understanding the currency demand conversion, Sberbank has maintained a loyal and large customer base. The global customer base is almost 140 million customers, with approximately 2 million corporate customers. From 2014 to 2017, the country has expanded the 7.5 million people, making the corporate customers grow by over 190 000. Above all, Sberbank confesses that they have achieved notable results that bind customer relations. As a result, the past few years have increased the customer satisfaction level with the firms services among corporate and individual customers. The graph below shows the companys average turnover from 2016 to 2019.

Monthly Turnover, from 2016 to 2019
Figure 1. Monthly Turnover, from 2016 to 2019

The graph shows an increment of monthly turnover, from 2016 to 2019, a fact that shows the organizations mastering of currency demand conversion that has increased the companys stability.

The company is now among the valued corporate lending firms, as shown in the following figure.

The Corporate Loan Portfolio
Figure 2. The Corporate Loan Portfolio

The figure shows the companys stability over time, proof that the organization has been stabilizing, and that is why it is among the largest banks, with stable Russian citizens as its customers. The company is also symbolic of social responsibility with a proper innovative position.

Price Elasticity of Demand of Sberbank

The available data for Sberbank show that the company is among the central banks in Russia, and it provides all the services a bank can offer. They include presenting to the customer saving accounts, domestic and international credit cards, transfer, and deposit services, which are essential services that identify the institution. Therefore, it means that the bank is successful in serving the common person, although its pricing strategy requires more discussion. According to Russian people, the bank has personal savings and current accounts, with debit and credit cards; the loan is the firms leading supplier. The organization has a varied pricing strategy that relates to the customer segment. Price elasticity is the ratio that occurs between the quantity demand change in percentage or the supply, with the corresponding price change in percentage (Brierley, 2016). The demand price elasticity is a change in the percentage in quantity demanded of services and goods when divided by the price percentage change.

Table 1. The Russian Company Data 

Date Total Equity Total Debt Cash & Short Term Investments
6/30/2020 4,827,600 3,043,700 5,321,900
3/31/2020 4,599,600 3,163,000 5,153,400

The elasticity of demand for the Sberbank will be as follows, considering the total equity of the firm. The quality percentage change = the change in quantity in percentage/total change in quantity and multiplied by 100. Results will be divided by the change in price, which in this category is under the Cash and short term investments. The change in price in percentage will be 5, 321, 900 minus 5, 153 400, recorded in the same dates as total quantities. The results will be as follows. 4827600  4599600/ 4827600 + 4599600 x 100. = 228000/ 9427200 x 100.

  • 0.0242x 100 = 2.42 %
  • The change in quantity is 2.42 %
  • Change in price in percentage will be as follows: 5321900-5153400/ 5321900+ 5153400 x 100
  • 168 500/ 10475300 x 100 = 1.61.
  • The price elasticity of demand for Sberbank is 2.42 % / 1.61 % = 1.5.

The determination of elasticity of demand is based on the data recorded as a purchase of the firms services from March to June of 2020. To get the quantity change from March to June, the total quantity of the two months, under the category of Total equity was subtracted. The amount was divided by the total quantity of the two months. To change to percentage, the results were then multiplied by 100. The procedure was the same for the pricing, which was set under the cash and short-term investment. It was assumed that the price caters to the total quantity invested in March and June, and the data used for this calculation is highlighted above.

Consumer responsiveness is affected by various factors, including an increase in population. The increase in population increases the individual per capita in terms of income levels. Such fuels the need for banking services not only in this country but also worldwide. Another factor is proper pricing on debit cards, saving accounts, and deposit rates, among other related services. The price elasticity of demand influences this firms pricing decision. The choices regarding prices ultimately lead to revenue growth as per the firms price elasticity demand. For example, a negative change that occurs due to a firms change in quantity demanded due to price will limit the consumers purchasing ability, downgrading the firms revenue. Sberbank offers prices that target the consumers knowledge, and thus quantity demand increases, which later leads to the organizations revenue growth.

Cost of Production

From the revenue, net income and cash flow as noted in the following table, it is clear that apart from the results dated 6/30/2020, the organizations revenue and net income have been increasing.

Table 2. Russian Company Data 

Date Revenue Net Income* G+A Expenses
6/30/2020 1,754,700 729,700 675,400
3/31/2020 1,848,300 792,800 667,900
12/31/2019 1,956,000 899,100 655,900
9/30/2019 1,857,900 869,000 627,600
6/30/2019 1,829,600 855,600 613,900
3/31/2019 1,784,000 822,200 595,800
12/31/2018 1,793,100 820,700 588,800
9/30/2018 1,748,000 804,200 574,200

The information means that Sberbanks production cost has been favorable to the extent of supporting the organizations growth. Sberbank is a technology-invested company, and thus most of its production is through expertise. For instance, the company operates on its own cloud and thus offers a unique experience of use and receiving infrastructure. Ordering of services is through a portal, which makes it easier for the execution of requests as well as infrastructure issues in reduced time. This event is helpful as it accelerates the product output making the bank more effective. The performance of the resource request is dependent on the peak and level of the loads needed. The organization has created an internal tariffing, making it easier for accounting to be kept in real use with the available assets. The efficiency and the firms fast ability to execute commands and services are helpful in meeting its demands and reliability, hence profiting the firms business.

The concept of variable and fixed cost has empowered Sberbank to reach the current level of service provision in the country. The fixed cost offers expenses that are predetermined but remain the same throughout a specific period. For instance, Sberbank has, for a period, stuck on the static expenses in offering debit card services. As a result, the organization has loyal followers; however, in terms of the loan, the company employs variable cost mechanisms, which change over time to help clients fit into the plan they choose.

Overall Market

Sberbank operates in multiple markets, where it possesses various shares operating on the institutes strengths and vulnerabilities. Gorshkov (2019) states that Sberbank has a 28.9% share in assets, 32.4% in corporate loans, 40.5% in household loans, 20.9% in corporate deposits, 46.1% in individual deposits, and 39.3% in the capital (p. 7). Sberbank Factoring, financial services for enterprises, retained its portfolio in the first quarter of 2020 and increased its market share to 22.2% (Sberbank increases its market share, 2020). Moreover, the company has a significant presence in Kazakhstan, Ukraine, Czech Republic, Austria, Serbia, Croatia, and other CIS and European countries (Gref, 2020). Cordell (2020) states that Sberbank is Russias most valuable publicly-listed company with a market capitalization of more than 5.2 trillion rubles ($67 billion) (p. 25). The current situation for the company allows it to take risks and experiment with new technologies.

Due to the state of the banking industry in the Russian Federation, barriers to entry are set extremely high. Primary competitors of Sberbank are other state-controlled banks, such as VTB, Gazprombank, and Rosselkhozbank, while private-owned banks lag behind (Gorshkov, 2019). Their shares of assets are 15%, 7%, and 4% respectively, and the largest private bank owns 4% of the sector (State banks dominate the Russian banking sector, 2019). This situation, while unhealthy for the market, can be viewed as positive for Sberbank.

The position of the firm on the market is stable, as it experiences constant growth and surpasses its competitors by a large margin. Moreover, the share of the state-owned banks grows steadily, while the presence of private banks diminishes, reducing the pressure from the competition (Gorshkov, 2019). Strategies of the other state-controlled banks in the Russian Federation include expansion beyond financial services as well (Gorshkov, 2019). Therefore, the market can be described as an oligopoly that features high barriers to entry. Being the largest bank in the Russian Federation in terms of operations, the company has already begun to seek new opportunities to gain more leverage abroad.

Conclusion

As Sberbank aims to expand its services beyond banking and financial intermediation and become an Amazon-like technology provider, this task requires global access to the market. At this moment, the company is held down by the restrictions that were placed on some of its subsidiaries and affiliates by the United States and the European Union (Sohn, 2019). This incident significantly impaired the companys ability to expand, led to many lost possibilities, and forced Sberbank to change its future plans to comply with these sanctions (Sberbank CEO: U.S. sanctions on Russia, 2019). One of the possible exits from this situation is to lower the state-owned percentage of the share, as it was one of the main reasons Sberbank has been added to the list of sanctioned companies (Sohn, 2019). It is essential to come with a solution to this issue first, as it places the company under unnecessary pressure which could impair its transformation.

The company can use Amazons business strategy as an example of its own future production. While the presence of Amazon and Apple on the Russian market is relatively small, outside of this country it will be difficult for Sber to obtain a significant share. Current plans of the company include a copy of Amazons services, such as streaming services, the virtual assistant, the market platform, and others (Press Trust of India, 2020). However, at this moment, it seems to lack innovative ideas to become truly competitive. It has to resolve this issue and take all measures to assume the position aimed at all customers across the globe and adopt trends as they become promising, instead of reacting to the emerged ones.

As new technologies continue to emerge, it is vital for the company to keep a close look at their efficiency for the planned expansion. Such technologies as neural networks, cloud storage, and the Internet of Things had a significant impact on similar companies performance, and Sber needs to adopt them in order to become competitive. Sberbank must become the force of innovation instead of aiming to satisfy customers demands if it wants to create a sustainable technology provider.

References

About Sberbank. (n.d.). Sberbank. Web.

Brierley, D. (2016). Sberbank sees signs of stabilization in Russia, but asset quality remains in focus

Cordell, J. (2020). Russias Sberbank unveils sweeping transformation into a tech company. The Moscow Times

Gorshkov, V. (2019). The State in Russias banking sector. Kyoto Institute of Economic Research [PDF document]. 

Gref, H. 2020 Sberbank Strategy [PDF document]. 

Press Trust of India. (2020). Russias Sberbank enters tech space; to compete with Google, FB, Amazon. Business News. Web.

Sberbank CEO: No end in sight for U.S. sanctions on Russia. (2019). Russia Business Today. Web.

Sberbank history. (n.d.). Sberbank. Web.

Sberbank of Russia: Factoring increases its market share by 3pp to 22% in 1Q20. (2020). MarketScreener. 

Sohn, E. A. (2019). Russia sanctions: The exception or the rule? KYC360. 

State banks dominate the Russian banking sector. (2019). BOFIT. 

Stock Analysis Report (n.d). Sberbank of Russia. Web.

Microeconomics and Its Main Functions

Microeconomics is the study of how individuals and firms make themselves as well off as possible in a world of scarcity, and the consequences of those individual decisions for markets and the entire economy (David A., 2004). In studying microeconomics, we examine how individual consumers and firms make decisions and how the interaction of many individual decisions that affects markets.

Microeconomics is often called price theory to emphasize the important role that prices play in determining market outcomes. Microeconomics explains how the actions of all buyers and sellers determine prices and how prices influence the decisions and actions of individual buyers and sellers.

To explain how individuals and firms allocate resources and how market prices are determined, economists use a model: a description of the relationship between two or more economic variables. Economists also use models to predict how a change in one variable will affect another variable.

Economic theory is the development and use of a model to test hypotheses, which are predictions about cause and effect. We are interested in models that make clear, testable predictions, such as “If the price rises, the quantity demanded falls”. A theory saying that “People’s behaviour depends on their tastes, and their tastes change randomly at random intervals” is not very useful because it does not lead to testable predictions.

Economists test theories by checking whether predictions are correct. If a prediction does not come true, economists may reject the theory. Economists use a model until it is refuted by evidence or until a better model is developed. A good model makes sharp, clear predictions that are consistent with reality. Some very simple models make sharp predictions that are incorrect, and other, more complete models make ambiguous predictions in which any outcome is possible that are untestable.

Microeconomics and Individual Use of Limited Resources

Individuals and firms allocate their limited resources to make themselves as well off as possible. Consumers pick the mix of goods and services that makes them as happy as possible given their limited wealth. Firms decide which goods to produce, where to produce them, how much to produce to maximize their profits, and how to produce those levels of output at the lowest cost by using more or less of various inputs such as labor, capital, materials, and energy. The owners of a depletable natural resource such as oil decide when to use it. Government decision makers decide which goods and services the government will produce and whether to subsidize, tax, or regulate industries and consumers so as to benefit consumers, firms, or government employees.

In doing this, individuals make decisions amidst of limited resources which in other ways is referred to as scarcity of resources. Scarcity means that resources are limited. There are not enough resources available to satisfy everyone’s wants. This is clearly true for individuals. An individual’s income is limited. An individual cannot buy everything they want, so they must choose between different alternatives. The act of choosing the alternative want is known the opportunity cost. The opportunity cost of an action is what one must give up when they make that choice. Another way to say this is: it is the value of the next best opportunity. Opportunity cost is a direct implication of scarcity. People have to choose between different alternatives when deciding how to spend their money and their time. Milton Friedman, who won the Nobel Prize for Economics, is fond of saying ‘there is no such thing as a free lunch.’ What that means is that in a world of scarcity, everything has an opportunity cost. There is always a trade-off involved in any decision you make.

The concept of opportunity cost is one of the most important ideas in economics. However, by considering the question, ‘How much does it cost to go to university for a year?’. We could add up the direct costs like tuition, books and school supplies. These are examples of explicit costs, which is costs that require a money payment. However, these costs are small compared to the value of the time it takes to attend class and do homework. The amount that the student could have earned if she had worked rather than attended school is the implicit cost of attending college. Implicit costs are costs that do not require a money payment. The opportunity cost includes both explicit and implicit costs.

The Theory for the Pricing of Goods and Services

In the real world, the market price is affected by the inventory of goods held by the manufacturers rather than the rate at which manufacturers are supplying goods. If the manufacturers are supplying goods at a rate equal to the consumer demand, the static classical theory would propose that the market is in equilibrium. However, what if there is a tremendous surplus in the store supply rooms? The manufacturers will lower the price and/or decrease production to return inventory to a desired level.

A pricing system model is a description of the relationships leading to price increases and decreases and the effects of these price changes on goal variables and other outcome variables. A system flow diagram is a pictorial representation of an equation system (Forrester, 1961, p.81).

That set of ideas that explains of how relative prices are determined and how prices function to coordinate economic activity is called price theory. There are at least two reasons to want to understand price theory. The first is to make some sense out of the world one live in. individuals are in the middle of a very highly organized system with nobody organizing it. The items they use and see, even very simple objects such as a pen or pencil, were each produced by the coordinated activity of millions of people. Someone had to cut down the tree to make the pencil. Someone had to season the wood and cut it to shape. Someone had to make the tools to cut down the trees and the tools to make the tools and the fuel for the tools and the refineries to make the fuel. While small parts of this immense enterprise are under centralized control (one firm organizes the cutting and seasoning of the wood, another actually assembles the pencil), nobody coordinates the overall enterprise.

The Theory of Economic Welfare

The pre-history of welfare economics is as old as political economics: classical and neo-classical economists were studying the efficiency and equity of productive systems, more specifically wondering how to value commodities or labor, and to assess the best allocation of goods and of tasks for the society (Myint 1965). Utilitarianism which, since Bentham, aimed at providing tools measure and improve individual and collective well-being, may be considered as the genuine root of welfare economics. The definition of welfare was uniformly based on strictly ordinal and subjective individual utilities. The best-known applications are the fundamental theorems of welfare economics.

The first theorem of welfare economics states that competitive equilibria are Pareto-optimal, if individual preferences are monotonic and if there are complete markets. The second fundamental theorem of welfare economics states that one can achieve any Pareto-optimal allocation in a competitive equilibrium when the social planner undertakes an appropriate redistribution of endowments. Among several Pareto optima, some are probably more satisfactory than others. The theorem points out that the preferred social optimum can be achieved by a competitive equilibrium if accompanied by proper redistribution policy which shall establish the new ‘initial’ allocations. An important consequence of this theorem is that it is not necessary to alter the competitive system to obtain Pareto optimality.

It is reasonable to say that Adam Smith (1776) has played an important role in the development of welfare theory. The reasons are at least two. In the first place, he created the invisible hand idea that is one of the most fundamental equilibrating relations in Economic Theory; the equalization of rates of returns as enforced by a tendency of factors to move from low to high returns through the allocation of capital to individual industries by self-interested investors. The self-interest will result in an optimal allocation of capital for society. He writes: “Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his own advantage, indeed, and not that of society, which he has in view. But the study of his own advantage naturally, or rather necessarily leads him to prefer that employment which is most advantageous to society”.

The second reason why Adam Smith played an important role in the development of welfare theory is that, in an attempt to explain the ‘Water and Diamond Paradox’, he came across an important distinction in value theory. At the end of the fourth chapter of the first book in Adam Smith’s celebrated volume ‘The Wealth of Nations’ (1776), he brings up a valuation problem that is usually referred to as ‘The Value Paradox’. He writes “The word ‘value’, it is to be observed, has two different meanings, and sometimes expresses the utility of some particular object, and sometimes the power of purchasing other goods which the possession of that object conveys. The one may be called ‘value in use’; the other, ‘value in exchange’. The things which have the greatest value in use have frequently little or no value in exchange; and, on the contrary, those which have the greatest value in exchange have frequently little or no value in use. Nothing is more useful than water: but it will purchase scarce anything; scarce anything can be had in exchange for it. A diamond on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it’.

The Functionality of Microeconomics

A solid foundation microeconomics makes marketing, production management, and finance far easier to master and apply. Price elasticity of demand is much of the subject matter in marketing and marginal analysis will again become central in the methods that individuals use in production management.

As a pure normative science, microeconomics does not try to explain what should happen in a market. Instead, microeconomics only explains what to expect if certain conditions change. If the manufacturer raises the prices of cars, microeconomics says consumers will tend to buy fewer than before. Also if the major copper mine in Zambia collapses, the price of copper increases because supply is restricted.

Although one economist’s model may differ from another’s, a key assumption in most microeconomic models is that individuals allocate their scarce resources so as to make themselves as well off as possible. Of all the affordable combinations of goods, consumers try to maximize their profits given limited resources and existing technology. That resources are limited plays a crucial role in these models. Was it not for scarcity, people rich beyond limit. As shown in the easy, the maximizing behaviour of individuals and firms determines society’s three main allocation decisions: which goods are produced, how they are produced, and who gets them.

Thus many of the models that we examine are based on maximizing an objective that is subject to a constraint. Consumers maximize their well-being subject to a budget constraint, which says that their resources limit how many goods they can buy. Firms maximize profits subject to technological and other constraints. Governments may try to maximize the welfare of consumers or firms subject to constraints imposed by limited resources and the behaviour of consumers and firms.

Conclusion

Microeconomics being the study of the allocation of scarce resources, consumers, firms, and the government must make allocation decisions. The three key trades-offs a society faces are which goods and services to produce, how to produce them, and who gets them. These decisions are interrelated and depend on the prices that consumers and firms face and on government actions. Market prices affect the decisions of individual consumers and firms, and the interaction of the decisions of individual consumers and firms determines market prices. The organization of the market, especially the number of firms in the market and the information consumers and firms have, plays an important role in determining whether the market price is equal to or higher than the cost of producing an additional unit of output. Models based on economic theories are used to predict the future or to answer questions about how some change, such as a tax increase, will affect various sectors of the economy. A good theory is simple to use and makes clear, testable predictions that are not refuted by evidence. Most microeconomic models are based on maximizing behaviour. Economists use models to construct positive hypotheses concerning how a cause leads to an effect. These positive questions can be tested. In contrast, normative statements, which are value judgments, cannot be tested. Individuals, governments, and firms use microeconomic models and predictions to make decisions. For example, to maximize its profits, a firm needs to know consumers’ decision-making criteria, the trade-offs between various ways of producing and marketing its product, government regulations, and other factors. For a large company, beliefs about how its rivals will react to its actions play a critical role in how the company forms its business strategies.

References

  1. Fleurbaey, M. (2008). Fairness, responsibility and welfare. Oxford University Press.
  2. McConnell, Campbell R. and Stanley Brue, (2004). Principles of Economics, sixteenth edition, New York: McGraw-Hill / Irwin.
  3. Friedman, Milton and Rose D Friedman, (1972). Capitalism and Freedom. Chicago: University of Chicago Press.
  4. Debertin David L (1986). Agricultural Production Economics. New York: Macmillan.
  5. Henderson, James M., and R.E. Quandt, (1971). Microeconomic Theory: A Mathematical Approach 2nd Ed. New York: McGraw Hill.
  6. Hicks, J.R. (1932.). Theory of Wages 1st edition, London, Macmillan.
  7. McFadden, Daniel, (1963).”Constant Elasticity of Substitution Production Functions’. Review of Economic Studies 30 pp. 73-83.

Models and Structures of Microeconomics and Their Usefulness for Public Policy Implementation

Microeconomics focuses on the activities of individual agents within the economy like households, workers and businesses. However, because human beings are at the centre of microeconomic activities, it is difficult to understand certain economic principles when you consider their ever-changing nature. Thus, to better understand microeconomic principles, economists developed theories or models, which are simplified representations of how two or more variables interact with each other enabling them to take complex, real-world issues and simplify it down to its essentials making them tools for determining the answers to a problem and not an illustrations of the answer to a problem. So, in this essay, we are going to look at some economic theories or models and structures and how they provide guidelines for the government to intervene.

To commence, we are going to look at the indifference curve model which was founded by British economist Francis Ysidro Edgeworth (Edgeworth, 1881). It was put into extensive use by economists J.R. Hicks and R.G.D Allen who criticized Marshallian cardinal approach of utility and developed indifference curve theory of consumer’s demand. This theory is also known as ordinal approach. In microeconomics, the indifference curve analysis model is an essential tool in the study of consumer behaviour.

As consumers we must allocate our money to buy a bundle (market basket or combination) of goods. The indifference curve models this behaviour by identifying those baskets of goods and services that consumers are indifferent to and are equally preferred. To do so, it assumes that the individual is rational and has a set taste or preference that guides them in choosing between goods by satisfying certain axioms of preferences which are, completeness (Perloff, 2012, p. 75), more-is-better, transitivity (Perloff, 2012, p. 75), convexity (Perloff, 2012, p. 77). Once these axioms have been satisfied, we can now model an individual’s bundle of preferences by using an indifference map which shows a complete set of indifference curves (the set of all bundles of goods that a consumer views as being equally desirable) that summarize a consumer’s tastes or preferences (Perloff, 2012). This is called the consumers theory model.

By understanding this model, we can derive the supply curve of labour. People must choose between leisure and labour. Using consumer theory, we can derive the daily demand curve for leisure, which is time spent on activities other than work. By subtracting the demand curve for leisure from 24 hours, we obtain the labour supply curve, which shows how the number of hours worked varies with the wage. Depending on whether leisure is an inferior good or a normal good, the supply curve of labour may be upward sloping or backward bending. This helps government know the effect on their taxes policy on the labour market. The shape of the supply curve for labour determines the effect of a tax cut. This helps government know the effect on their tax on the labour market and why tax cuts do not always increase the tax revenue of individuals as predicted by various administrations. (Perloff, 2012, p. 147)

We could also use the indifference Curve method can be used to gauge the effects of government subsidy on low earnings groups. We take a condition when the subsidy is not paid in money, but the consumers are supplied cereals at dispensation rates the price difference being paid by the government.

With the unrealistic hypothesis of perfect competition, the real competition cannot be ascertained. Likewise, all commodities are not divisible. Despite the criticisms, the indifference curve method is still regarded superior to Marshallian introspective cardinals (Tutorsonnet.com, 2019).

An oligopoly market structure is one in which there are a small group of firms in the market that have a substantial amount of market share and there are substantial barriers to entry and exit in the market. By better understanding the oligopolistic model, governments better understand the structures of cartels and collusive behaviours in markets enabling them to put in place policies that will take consumer welfare into account. So, we are going to look at the different models in the oligopolistic market structure – Cartels, the Cournot model, Stackelberg model, Bertrand model – how governments apply policies on real life firms that fir this model structures (Quarkoniums, 2019).

“People of the same trade seldom meet, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or some contrivance to raise prices” (Adam Smith, 1776). As Adam Smith noted, in oligopolistic markets, some firms have incentives to form cartels in which they decide to reduce their prices, and set higher prices leading to higher profits for individual firms and the firms collectively. This collusiveness comes as result because of the profit maximization property of firms. If a competitive firm produces where its marginal cost equals the market price and only one firm reduces its output, it loses profit because it sells fewer units at essentially the same price. By getting all the firms to lower their output together, the cartel raises the market price and hence individual firms’ profits. The less elastic the market demand the potential cartel faces, all else the same, the higher the price the cartel sets and the greater the benefit from cartelizing. If the penalty for forming an illegal cartel is relatively low, some unscrupulous business people may succumb to the lure of extra profits and join.

By modelling this behaviour economist helped influence government intervention against cartels as they better understood why this collusive behaviour restricts competition and minimises the consumer welfare. This permits them to create antitrust laws or competition policies—that limit or forbid some or all cartels. Examples of antitrust laws or competition policies include: Canada’s Competition Act, a federal law that governs most business conduct, contains both criminal and civil provisions aimed at preventing anti-competitive practices, the European Union’s competition policy, which, under the Treaty of the European Community (EC Treaty or Treaty of Rome) in 1957, gives it substantial powers to prevent actions that hinder competition within or across member states. In the United Kingdom, the Competition Act 1998 was introduced to ensure that businesses compete on a level footing. It does so by prohibiting certain types of anti-competitive behaviour (the Chapter I and Chapter II prohibitions). Together with EC legislation in place, the competition act prevents of anti-competitive behaviour in cartels.

However, in today’s economy there are some international cartels – OPEC – that are protected legally and even though their collusive behaviour is well known, do not face any penalties as according to them they are active for consumers benefit by market stabilization. It is also argued that non-OPEC energy suppliers have maintained enough market share for a substantial degree of worldwide competition hence OPEC does not limit competition in its markets. Moreover, because of an economic ‘prisoner’s dilemma’ that encourages each member nation individually to discount its price and exceed its production quota, widespread cheating within OPEC often erodes its ability to influence global oil prices through collective action.

There are some cases in which oligopoly market models firms that act independently, market output and the firms’ profits lie between the competitive and monopoly levels. Firstly, the Cournot model, in which each oligopoly firm sets its output at the same time. In the Cournot (Nash) equilibrium, each firm produces its best-response output given the output its rival produces. As the number of Cournot firms increases, the Cournot equilibrium price, quantity, and profits approach the price-taking levels. In a Stackelberg model, if one firm, the Stackelberg leader, chooses its output before its rivals, the Stackelberg followers, the leader produces more and earns a higher profit than each identical-cost follower firm. A government may subsidize a domestic oligopoly firm so that it produces the Stackelberg leader quantity, which it sells in an international market and example of how this model helps government policies in real life is seen in the aircraft industry where Governments like France, Germany, Spain, and the United Kingdom own and heavily subsidize Airbus, which competes in the wide-body aircraft market with the U.S. firm Boeing. The U.S. government decries the European subsidies to Airbus while directing lucrative military contracts to Boeing that the Europeans view as implicit subsidies. In 1992, the governments signed a U.S.–EU agreement on trade in civil aircraft that limits government subsidies (including a maximum direct subsidy limit of 33% of development costs and various limits on variable costs).

Irwin and Pavcnik (2004) found that aircraft prices increased by about 3.7% after the 1992 agreement. This price hike is consistent with a 5% increase in firms’ marginal costs after the subsidy cuts. Since then, Washington and the European Union have continued to trade counter-complaints in front of the WTO. Each repeatedly charged the other with illegally subsidizing its aircraft manufacturer. In 2010, the World Trade Organization ruled that Airbus received improper subsidies for its A380 super- jumbo jet and several other airplanes, hurting Boeing, as the United States charged in 2005, and the cycle of subsidies, charges, agreements, and new subsidies continues.

Now we that we have looked at the oligopolistic market structure and how it helps government policies in real life situations, we know that firms compete on many fronts beyond setting quantity or price, to gain an edge over rivals, a firm makes many decisions, such as how much to advertise, whether to act to discourage a new firm from entering its market, how to differentiate its product, and whether to invest in new equipment. This leads us now to Game theory, which is a set of tools that economists, political scientists, military analysts and others use to analyse decision making by players who use strategies. Games in this sense are competitions between players, such as individuals or firms, in which each player is aware that the outcome depends on the actions of all players.

Economists use game theory when a player’s optimal strategy depends on the actions of others, which is called strategic interdependence. For example, oligopolistic cola manufacturers such as Coca-Cola and Pepsi carefully monitor each other’s behaviour. Because relatively few firms compete in such a market, each firm can influence the price, and hence the payoffs, of rival firms. The need to consider the behaviour of rival firms makes each firm’s profit maximization decision more difficult than that of a monopoly or a competitive firm. A monopoly has no rivals, and a competitive firm ignores the behaviour of individual rivals—it considers only the market price and its own costs in choosing its profit-maximizing output. Thus, we use game theory to study oligopolistic behaviour but not competitive or monopolistic behaviour.

There are two main types of games in Game theory: static game and dynamic games. In this essay we are going to be analysing static games and how this influences government policies. Static games are games in which each player acts only once and the players act simultaneously (or, at least, each player acts without knowing rivals’ actions). In these games, firms have complete information about the payoff functions but imperfect information about rivals’ moves an example of these games are the Cournot and Bertrand Model in the oligopolistic market structure, or an employer’s negotiation with a potential employee.

In a static game, such as in the Cournot model or the prisoners’ dilemma game, players each make one move simultaneously. Economists use a normal-form representation or payoff matrix to analyse a static game. Typically, economists’ study static games in which players have complete information about the payoff function — the payoff to any player conditional on the actions all players take — but imperfect information about how their rivals behave because they act simultaneously. The set of players’ strategies is a Nash equilibrium if, given that all other players use these strategies, no player can obtain a higher pay off by choosing a different strategy. Both pure-strategy and mixed-strategy Nash equilibria are possible in static games, and there may be multiple Nash equilibria for a given game. There is no guarantee that Nash equilibria in static games maximize the joint payoffs of all the players. An example of the static game is the prisoner’s’ dilemma game whereby all players have dominant strategies that lead to a profit (or another payoff) that is inferior to what they could achieve if they cooperated and pursued alternative strategies.

Throughout this essay we have seen how economic models and structures in microeconomics help governments to implement policies to better their economy and keep consumer welfare at its interest. However, it is not in all cases that the government will need intervene in the market for example when using the prisoner’s dilemma model where they allow the ‘invisible hand’ of the market to take its course.

Bibliography

  1. Edgeworth, F. Y., 1881. Mathematical Psychics: An Essay on the Application of Mathematics to the Moral Sciences. London: C. Kegan Paul and Co.
  2. Perloff, J. M., 2012. Microeconomics. In: 6th edition ed. s.l.:Pearson, pp. 75,77,78.
  3. Tutorsonnet.com. (2019). Uses Or Application Of Indifference Curve Study | TutorsOnNet. [online] Available at: https://www.tutorsonnet.com/uses-or-application-of-indifference-curve-study-homework-help.php [Accessed 6 Aug. 2019].
  4. ThoughtCo. (2019). Introduction to Utility Maximization. [online] Available at: https://www.thoughtco.com/introduction-to-utility-maximization-1146939 [Accessed 6 Aug. 2019].
  5. Quickonomics. (2019). The Four Types of Market Structures – Quickonomics. [online] Available at: https://quickonomics.com/market-structures/ [Accessed 6 Aug. 2019].

Microeconomics and Its Main Functions

Microeconomics is the study of how individuals and firms make themselves as well off as possible in a world of scarcity, and the consequences of those individual decisions for markets and the entire economy (David A., 2004). In studying microeconomics, we examine how individual consumers and firms make decisions and how the interaction of many individual decisions that affects markets.

Microeconomics is often called price theory to emphasize the important role that prices play in determining market outcomes. Microeconomics explains how the actions of all buyers and sellers determine prices and how prices influence the decisions and actions of individual buyers and sellers.

To explain how individuals and firms allocate resources and how market prices are determined, economists use a model: a description of the relationship between two or more economic variables. Economists also use models to predict how a change in one variable will affect another variable.

Economic theory is the development and use of a model to test hypotheses, which are predictions about cause and effect. We are interested in models that make clear, testable predictions, such as “If the price rises, the quantity demanded falls”. A theory saying that “People’s behaviour depends on their tastes, and their tastes change randomly at random intervals” is not very useful because it does not lead to testable predictions.

Economists test theories by checking whether predictions are correct. If a prediction does not come true, economists may reject the theory. Economists use a model until it is refuted by evidence or until a better model is developed. A good model makes sharp, clear predictions that are consistent with reality. Some very simple models make sharp predictions that are incorrect, and other, more complete models make ambiguous predictions in which any outcome is possible that are untestable.

Microeconomics and Individual Use of Limited Resources

Individuals and firms allocate their limited resources to make themselves as well off as possible. Consumers pick the mix of goods and services that makes them as happy as possible given their limited wealth. Firms decide which goods to produce, where to produce them, how much to produce to maximize their profits, and how to produce those levels of output at the lowest cost by using more or less of various inputs such as labor, capital, materials, and energy. The owners of a depletable natural resource such as oil decide when to use it. Government decision makers decide which goods and services the government will produce and whether to subsidize, tax, or regulate industries and consumers so as to benefit consumers, firms, or government employees.

In doing this, individuals make decisions amidst of limited resources which in other ways is referred to as scarcity of resources. Scarcity means that resources are limited. There are not enough resources available to satisfy everyone’s wants. This is clearly true for individuals. An individual’s income is limited. An individual cannot buy everything they want, so they must choose between different alternatives. The act of choosing the alternative want is known the opportunity cost. The opportunity cost of an action is what one must give up when they make that choice. Another way to say this is: it is the value of the next best opportunity. Opportunity cost is a direct implication of scarcity. People have to choose between different alternatives when deciding how to spend their money and their time. Milton Friedman, who won the Nobel Prize for Economics, is fond of saying ‘there is no such thing as a free lunch.’ What that means is that in a world of scarcity, everything has an opportunity cost. There is always a trade-off involved in any decision you make.

The concept of opportunity cost is one of the most important ideas in economics. However, by considering the question, ‘How much does it cost to go to university for a year?’. We could add up the direct costs like tuition, books and school supplies. These are examples of explicit costs, which is costs that require a money payment. However, these costs are small compared to the value of the time it takes to attend class and do homework. The amount that the student could have earned if she had worked rather than attended school is the implicit cost of attending college. Implicit costs are costs that do not require a money payment. The opportunity cost includes both explicit and implicit costs.

The Theory for the Pricing of Goods and Services

In the real world, the market price is affected by the inventory of goods held by the manufacturers rather than the rate at which manufacturers are supplying goods. If the manufacturers are supplying goods at a rate equal to the consumer demand, the static classical theory would propose that the market is in equilibrium. However, what if there is a tremendous surplus in the store supply rooms? The manufacturers will lower the price and/or decrease production to return inventory to a desired level.

A pricing system model is a description of the relationships leading to price increases and decreases and the effects of these price changes on goal variables and other outcome variables. A system flow diagram is a pictorial representation of an equation system (Forrester, 1961, p.81).

That set of ideas that explains of how relative prices are determined and how prices function to coordinate economic activity is called price theory. There are at least two reasons to want to understand price theory. The first is to make some sense out of the world one live in. individuals are in the middle of a very highly organized system with nobody organizing it. The items they use and see, even very simple objects such as a pen or pencil, were each produced by the coordinated activity of millions of people. Someone had to cut down the tree to make the pencil. Someone had to season the wood and cut it to shape. Someone had to make the tools to cut down the trees and the tools to make the tools and the fuel for the tools and the refineries to make the fuel. While small parts of this immense enterprise are under centralized control (one firm organizes the cutting and seasoning of the wood, another actually assembles the pencil), nobody coordinates the overall enterprise.

The Theory of Economic Welfare

The pre-history of welfare economics is as old as political economics: classical and neo-classical economists were studying the efficiency and equity of productive systems, more specifically wondering how to value commodities or labor, and to assess the best allocation of goods and of tasks for the society (Myint 1965). Utilitarianism which, since Bentham, aimed at providing tools measure and improve individual and collective well-being, may be considered as the genuine root of welfare economics. The definition of welfare was uniformly based on strictly ordinal and subjective individual utilities. The best-known applications are the fundamental theorems of welfare economics.

The first theorem of welfare economics states that competitive equilibria are Pareto-optimal, if individual preferences are monotonic and if there are complete markets. The second fundamental theorem of welfare economics states that one can achieve any Pareto-optimal allocation in a competitive equilibrium when the social planner undertakes an appropriate redistribution of endowments. Among several Pareto optima, some are probably more satisfactory than others. The theorem points out that the preferred social optimum can be achieved by a competitive equilibrium if accompanied by proper redistribution policy which shall establish the new ‘initial’ allocations. An important consequence of this theorem is that it is not necessary to alter the competitive system to obtain Pareto optimality.

It is reasonable to say that Adam Smith (1776) has played an important role in the development of welfare theory. The reasons are at least two. In the first place, he created the invisible hand idea that is one of the most fundamental equilibrating relations in Economic Theory; the equalization of rates of returns as enforced by a tendency of factors to move from low to high returns through the allocation of capital to individual industries by self-interested investors. The self-interest will result in an optimal allocation of capital for society. He writes: “Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his own advantage, indeed, and not that of society, which he has in view. But the study of his own advantage naturally, or rather necessarily leads him to prefer that employment which is most advantageous to society”.

The second reason why Adam Smith played an important role in the development of welfare theory is that, in an attempt to explain the ‘Water and Diamond Paradox’, he came across an important distinction in value theory. At the end of the fourth chapter of the first book in Adam Smith’s celebrated volume ‘The Wealth of Nations’ (1776), he brings up a valuation problem that is usually referred to as ‘The Value Paradox’. He writes “The word ‘value’, it is to be observed, has two different meanings, and sometimes expresses the utility of some particular object, and sometimes the power of purchasing other goods which the possession of that object conveys. The one may be called ‘value in use’; the other, ‘value in exchange’. The things which have the greatest value in use have frequently little or no value in exchange; and, on the contrary, those which have the greatest value in exchange have frequently little or no value in use. Nothing is more useful than water: but it will purchase scarce anything; scarce anything can be had in exchange for it. A diamond on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it’.

The Functionality of Microeconomics

A solid foundation microeconomics makes marketing, production management, and finance far easier to master and apply. Price elasticity of demand is much of the subject matter in marketing and marginal analysis will again become central in the methods that individuals use in production management.

As a pure normative science, microeconomics does not try to explain what should happen in a market. Instead, microeconomics only explains what to expect if certain conditions change. If the manufacturer raises the prices of cars, microeconomics says consumers will tend to buy fewer than before. Also if the major copper mine in Zambia collapses, the price of copper increases because supply is restricted.

Although one economist’s model may differ from another’s, a key assumption in most microeconomic models is that individuals allocate their scarce resources so as to make themselves as well off as possible. Of all the affordable combinations of goods, consumers try to maximize their profits given limited resources and existing technology. That resources are limited plays a crucial role in these models. Was it not for scarcity, people rich beyond limit. As shown in the easy, the maximizing behaviour of individuals and firms determines society’s three main allocation decisions: which goods are produced, how they are produced, and who gets them.

Thus many of the models that we examine are based on maximizing an objective that is subject to a constraint. Consumers maximize their well-being subject to a budget constraint, which says that their resources limit how many goods they can buy. Firms maximize profits subject to technological and other constraints. Governments may try to maximize the welfare of consumers or firms subject to constraints imposed by limited resources and the behaviour of consumers and firms.

Conclusion

Microeconomics being the study of the allocation of scarce resources, consumers, firms, and the government must make allocation decisions. The three key trades-offs a society faces are which goods and services to produce, how to produce them, and who gets them. These decisions are interrelated and depend on the prices that consumers and firms face and on government actions. Market prices affect the decisions of individual consumers and firms, and the interaction of the decisions of individual consumers and firms determines market prices. The organization of the market, especially the number of firms in the market and the information consumers and firms have, plays an important role in determining whether the market price is equal to or higher than the cost of producing an additional unit of output. Models based on economic theories are used to predict the future or to answer questions about how some change, such as a tax increase, will affect various sectors of the economy. A good theory is simple to use and makes clear, testable predictions that are not refuted by evidence. Most microeconomic models are based on maximizing behaviour. Economists use models to construct positive hypotheses concerning how a cause leads to an effect. These positive questions can be tested. In contrast, normative statements, which are value judgments, cannot be tested. Individuals, governments, and firms use microeconomic models and predictions to make decisions. For example, to maximize its profits, a firm needs to know consumers’ decision-making criteria, the trade-offs between various ways of producing and marketing its product, government regulations, and other factors. For a large company, beliefs about how its rivals will react to its actions play a critical role in how the company forms its business strategies.

References

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Models and Structures of Microeconomics and Their Usefulness for Public Policy Implementation

Microeconomics focuses on the activities of individual agents within the economy like households, workers and businesses. However, because human beings are at the centre of microeconomic activities, it is difficult to understand certain economic principles when you consider their ever-changing nature. Thus, to better understand microeconomic principles, economists developed theories or models, which are simplified representations of how two or more variables interact with each other enabling them to take complex, real-world issues and simplify it down to its essentials making them tools for determining the answers to a problem and not an illustrations of the answer to a problem. So, in this essay, we are going to look at some economic theories or models and structures and how they provide guidelines for the government to intervene.

To commence, we are going to look at the indifference curve model which was founded by British economist Francis Ysidro Edgeworth (Edgeworth, 1881). It was put into extensive use by economists J.R. Hicks and R.G.D Allen who criticized Marshallian cardinal approach of utility and developed indifference curve theory of consumer’s demand. This theory is also known as ordinal approach. In microeconomics, the indifference curve analysis model is an essential tool in the study of consumer behaviour.

As consumers we must allocate our money to buy a bundle (market basket or combination) of goods. The indifference curve models this behaviour by identifying those baskets of goods and services that consumers are indifferent to and are equally preferred. To do so, it assumes that the individual is rational and has a set taste or preference that guides them in choosing between goods by satisfying certain axioms of preferences which are, completeness (Perloff, 2012, p. 75), more-is-better, transitivity (Perloff, 2012, p. 75), convexity (Perloff, 2012, p. 77). Once these axioms have been satisfied, we can now model an individual’s bundle of preferences by using an indifference map which shows a complete set of indifference curves (the set of all bundles of goods that a consumer views as being equally desirable) that summarize a consumer’s tastes or preferences (Perloff, 2012). This is called the consumers theory model.

By understanding this model, we can derive the supply curve of labour. People must choose between leisure and labour. Using consumer theory, we can derive the daily demand curve for leisure, which is time spent on activities other than work. By subtracting the demand curve for leisure from 24 hours, we obtain the labour supply curve, which shows how the number of hours worked varies with the wage. Depending on whether leisure is an inferior good or a normal good, the supply curve of labour may be upward sloping or backward bending. This helps government know the effect on their taxes policy on the labour market. The shape of the supply curve for labour determines the effect of a tax cut. This helps government know the effect on their tax on the labour market and why tax cuts do not always increase the tax revenue of individuals as predicted by various administrations. (Perloff, 2012, p. 147)

We could also use the indifference Curve method can be used to gauge the effects of government subsidy on low earnings groups. We take a condition when the subsidy is not paid in money, but the consumers are supplied cereals at dispensation rates the price difference being paid by the government.

With the unrealistic hypothesis of perfect competition, the real competition cannot be ascertained. Likewise, all commodities are not divisible. Despite the criticisms, the indifference curve method is still regarded superior to Marshallian introspective cardinals (Tutorsonnet.com, 2019).

An oligopoly market structure is one in which there are a small group of firms in the market that have a substantial amount of market share and there are substantial barriers to entry and exit in the market. By better understanding the oligopolistic model, governments better understand the structures of cartels and collusive behaviours in markets enabling them to put in place policies that will take consumer welfare into account. So, we are going to look at the different models in the oligopolistic market structure – Cartels, the Cournot model, Stackelberg model, Bertrand model – how governments apply policies on real life firms that fir this model structures (Quarkoniums, 2019).

“People of the same trade seldom meet, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or some contrivance to raise prices” (Adam Smith, 1776). As Adam Smith noted, in oligopolistic markets, some firms have incentives to form cartels in which they decide to reduce their prices, and set higher prices leading to higher profits for individual firms and the firms collectively. This collusiveness comes as result because of the profit maximization property of firms. If a competitive firm produces where its marginal cost equals the market price and only one firm reduces its output, it loses profit because it sells fewer units at essentially the same price. By getting all the firms to lower their output together, the cartel raises the market price and hence individual firms’ profits. The less elastic the market demand the potential cartel faces, all else the same, the higher the price the cartel sets and the greater the benefit from cartelizing. If the penalty for forming an illegal cartel is relatively low, some unscrupulous business people may succumb to the lure of extra profits and join.

By modelling this behaviour economist helped influence government intervention against cartels as they better understood why this collusive behaviour restricts competition and minimises the consumer welfare. This permits them to create antitrust laws or competition policies—that limit or forbid some or all cartels. Examples of antitrust laws or competition policies include: Canada’s Competition Act, a federal law that governs most business conduct, contains both criminal and civil provisions aimed at preventing anti-competitive practices, the European Union’s competition policy, which, under the Treaty of the European Community (EC Treaty or Treaty of Rome) in 1957, gives it substantial powers to prevent actions that hinder competition within or across member states. In the United Kingdom, the Competition Act 1998 was introduced to ensure that businesses compete on a level footing. It does so by prohibiting certain types of anti-competitive behaviour (the Chapter I and Chapter II prohibitions). Together with EC legislation in place, the competition act prevents of anti-competitive behaviour in cartels.

However, in today’s economy there are some international cartels – OPEC – that are protected legally and even though their collusive behaviour is well known, do not face any penalties as according to them they are active for consumers benefit by market stabilization. It is also argued that non-OPEC energy suppliers have maintained enough market share for a substantial degree of worldwide competition hence OPEC does not limit competition in its markets. Moreover, because of an economic ‘prisoner’s dilemma’ that encourages each member nation individually to discount its price and exceed its production quota, widespread cheating within OPEC often erodes its ability to influence global oil prices through collective action.

There are some cases in which oligopoly market models firms that act independently, market output and the firms’ profits lie between the competitive and monopoly levels. Firstly, the Cournot model, in which each oligopoly firm sets its output at the same time. In the Cournot (Nash) equilibrium, each firm produces its best-response output given the output its rival produces. As the number of Cournot firms increases, the Cournot equilibrium price, quantity, and profits approach the price-taking levels. In a Stackelberg model, if one firm, the Stackelberg leader, chooses its output before its rivals, the Stackelberg followers, the leader produces more and earns a higher profit than each identical-cost follower firm. A government may subsidize a domestic oligopoly firm so that it produces the Stackelberg leader quantity, which it sells in an international market and example of how this model helps government policies in real life is seen in the aircraft industry where Governments like France, Germany, Spain, and the United Kingdom own and heavily subsidize Airbus, which competes in the wide-body aircraft market with the U.S. firm Boeing. The U.S. government decries the European subsidies to Airbus while directing lucrative military contracts to Boeing that the Europeans view as implicit subsidies. In 1992, the governments signed a U.S.–EU agreement on trade in civil aircraft that limits government subsidies (including a maximum direct subsidy limit of 33% of development costs and various limits on variable costs).

Irwin and Pavcnik (2004) found that aircraft prices increased by about 3.7% after the 1992 agreement. This price hike is consistent with a 5% increase in firms’ marginal costs after the subsidy cuts. Since then, Washington and the European Union have continued to trade counter-complaints in front of the WTO. Each repeatedly charged the other with illegally subsidizing its aircraft manufacturer. In 2010, the World Trade Organization ruled that Airbus received improper subsidies for its A380 super- jumbo jet and several other airplanes, hurting Boeing, as the United States charged in 2005, and the cycle of subsidies, charges, agreements, and new subsidies continues.

Now we that we have looked at the oligopolistic market structure and how it helps government policies in real life situations, we know that firms compete on many fronts beyond setting quantity or price, to gain an edge over rivals, a firm makes many decisions, such as how much to advertise, whether to act to discourage a new firm from entering its market, how to differentiate its product, and whether to invest in new equipment. This leads us now to Game theory, which is a set of tools that economists, political scientists, military analysts and others use to analyse decision making by players who use strategies. Games in this sense are competitions between players, such as individuals or firms, in which each player is aware that the outcome depends on the actions of all players.

Economists use game theory when a player’s optimal strategy depends on the actions of others, which is called strategic interdependence. For example, oligopolistic cola manufacturers such as Coca-Cola and Pepsi carefully monitor each other’s behaviour. Because relatively few firms compete in such a market, each firm can influence the price, and hence the payoffs, of rival firms. The need to consider the behaviour of rival firms makes each firm’s profit maximization decision more difficult than that of a monopoly or a competitive firm. A monopoly has no rivals, and a competitive firm ignores the behaviour of individual rivals—it considers only the market price and its own costs in choosing its profit-maximizing output. Thus, we use game theory to study oligopolistic behaviour but not competitive or monopolistic behaviour.

There are two main types of games in Game theory: static game and dynamic games. In this essay we are going to be analysing static games and how this influences government policies. Static games are games in which each player acts only once and the players act simultaneously (or, at least, each player acts without knowing rivals’ actions). In these games, firms have complete information about the payoff functions but imperfect information about rivals’ moves an example of these games are the Cournot and Bertrand Model in the oligopolistic market structure, or an employer’s negotiation with a potential employee.

In a static game, such as in the Cournot model or the prisoners’ dilemma game, players each make one move simultaneously. Economists use a normal-form representation or payoff matrix to analyse a static game. Typically, economists’ study static games in which players have complete information about the payoff function — the payoff to any player conditional on the actions all players take — but imperfect information about how their rivals behave because they act simultaneously. The set of players’ strategies is a Nash equilibrium if, given that all other players use these strategies, no player can obtain a higher pay off by choosing a different strategy. Both pure-strategy and mixed-strategy Nash equilibria are possible in static games, and there may be multiple Nash equilibria for a given game. There is no guarantee that Nash equilibria in static games maximize the joint payoffs of all the players. An example of the static game is the prisoner’s’ dilemma game whereby all players have dominant strategies that lead to a profit (or another payoff) that is inferior to what they could achieve if they cooperated and pursued alternative strategies.

Throughout this essay we have seen how economic models and structures in microeconomics help governments to implement policies to better their economy and keep consumer welfare at its interest. However, it is not in all cases that the government will need intervene in the market for example when using the prisoner’s dilemma model where they allow the ‘invisible hand’ of the market to take its course.

Bibliography

  1. Edgeworth, F. Y., 1881. Mathematical Psychics: An Essay on the Application of Mathematics to the Moral Sciences. London: C. Kegan Paul and Co.
  2. Perloff, J. M., 2012. Microeconomics. In: 6th edition ed. s.l.:Pearson, pp. 75,77,78.
  3. Tutorsonnet.com. (2019). Uses Or Application Of Indifference Curve Study | TutorsOnNet. [online] Available at: https://www.tutorsonnet.com/uses-or-application-of-indifference-curve-study-homework-help.php [Accessed 6 Aug. 2019].
  4. ThoughtCo. (2019). Introduction to Utility Maximization. [online] Available at: https://www.thoughtco.com/introduction-to-utility-maximization-1146939 [Accessed 6 Aug. 2019].
  5. Quickonomics. (2019). The Four Types of Market Structures – Quickonomics. [online] Available at: https://quickonomics.com/market-structures/ [Accessed 6 Aug. 2019].

Microeconomics and Business Management

In this world of competition, it is very important for businesses to understand various fields of study in order to apply various concepts to operate successfully. Microeconomics is one of the fields of study that a business must learn from and implement its concepts to operate and sustain. Businesses can only sustain if it achieves its predetermined goals and objectives, which for most firms is to generate profit by selling the products and services it manufactures. Growth and success of a firm entirely depend on how effectively and efficiently it operates in given market scenario, which requires firms to carefully analyze its environment, minimize its costs, and maximize its profit.

Microeconomics is a science that studies the behavior of entities as to understand how they make their choices and decisions. It studies how these entities interact in the market and how the government tries to influence their choices and decisions. Microeconomics helps in understanding many concepts and theories, for instance, the demand and supply, market equilibrium point, price mechanism, market structure, cost analysis and profit maximization, market efficiency, the impact of government intervention and many more.

Microeconomic concepts are very important for management of a firm, as these theories help in understanding the behavior of consumers which is important to respond to their desires and demands. The number of products and services to be produced, supplied can be only determined through careful study of behaviour of the potential market. The study of demand and supply model is important in order to make decisions regarding what to a produce, how much to produce and for whom to produce and also, to determine the price per units to be produced and supplied. It is a powerful tool which helps in predicting how the changes in the behavior of entities affect the market equilibrium price and quantity.

Another important factor that impacts the business is the price elasticity of demand, it can be defined as, “the level of responsiveness of quantity demanded with the change in price”. The firms should understand that customers are very sensitive when it comes to the price of goods and services, it can be assumed that there will be an increase in the no. of customers who are willing to buy the products if the price is low, and vice versa. When determining the price of the goods and services, a business must understand and identify the nature of their goods and services, check whether it is elastic, or sensitive to price fluctuation, or inelastic. It is important to consider the nature of the product and factors affecting its demand and supply while determining the prices.

Understanding the market structure is also an important factor. There are various types of market structures categorized in microeconomics and they are oligopoly, perfect competition, monopoly, monopsony, and monopolistic competition. Each of these categories have distinctive characteristics that affect the nature of competition and market price. For instance, in perfect competition, there are many no. of firms selling homogeneous products competing, where no single firm has substantial power. Hence, the industries produce an optimum level of output as none of the business firms influences the prices. Whereas in monopolistic competition, even though there are many businesses competing against one another, they produce similar but slightly differentiated products that give them a certain level of power in the market. So, in monopolistic competition the firms to some extent charge higher prices. It is important to understand the various type of market structures as the analysis of the market structure helps a firm in understanding and predicting the market outcomes.

The sustainability of business firms in the long run also depends on its capacity to utilize its resources optimally. If the firms can operate efficiently it can generate more income and avoid facing losses. Microeconomics states that there are three types of efficiency: 1) productive efficiency (also known as ‘technical efficiency’, where a firm produces goods and services with the least amount of resources); 2) allocative efficiency (occurs when consumer preferences are reflected in production and to produce what consumer wants the resources are allocated throughout the economy); 3) dynamic efficiency (occurs when innovation and modern technology are implemented over time). Firms must understand that it depends upon factors like market conditions or market structure to identify if a firm can achieve efficiency or not. For instance, under monopolistic competition, it is challenging to have efficiency as the market price might not be the same as the price of production and consumption. Different marker scenarios affect the level of efficiency as each category has its market characteristics.

Cost analysis is another important concept in microeconomics, which plays a vital role in a business operation, and firms need to analyse the costs. Microeconomics provides numerous theories that explain various conditions of costs, such as short-run and long-run costs, fixed and variable costs, marginal and average costs. These concepts have made it easier for the firm to evaluate the production cost of the firm in a different period. This helps the firm to eliminate or control costs by developing strategies to minimize the cost to achieve higher benefits.

In my opinion another important factor the firms must understand is government intervention in the economy. The government uses various methods such as regulation, taxation or subsidies to address inefficiency in the market. These methods the government uses impacts the firms. For instance, the imposition of taxation and imposition of subsidies impact the price of goods and service produced and sold in the market. Ultimately affecting the demand and supply curve.

Economists depend on theories or models to analyze the real-world issues; the models are generated based on assumptions for economists, individuals and firm to simplify the complex economics issues. These microeconomic models help in understanding the market situation simple and easy, as it might be difficult to analyze and understand the economic situation unless the complexity is reduced. Microeconomic theories and concept are very important in managing a firm, as it helps in understanding the market situations better and guides the managers or business owners to operate their firms, predict the future situations and make decisions.