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Introduction to Business

1.6 Microeconomics: Zeroing in on Businesses and Consumers

Introduction to Business1.6 Microeconomics: Zeroing in on Businesses and Consumers
  1. Preface
  2. 1 Understanding Economic Systems and Business
    1. Introduction
    2. 1.1 The Nature of Business
    3. 1.2 Understanding the Business Environment
    4. 1.3 How Business and Economics Work
    5. 1.4 Macroeconomics: The Big Picture
    6. 1.5 Achieving Macroeconomic Goals
    7. 1.6 Microeconomics: Zeroing in on Businesses and Consumers
    8. 1.7 Competing in a Free Market
    9. 1.8 Trends in the Business Environment and Competition
    10. Key Terms
    11. Summary of Learning Outcomes
    12. Preparing for Tomorrow's Workplace Skills
    13. Ethics Activity
    14. Working the Net
    15. Critical Thinking Case
    16. Hot Links Address Book
  3. 2 Making Ethical Decisions and Managing a Socially Responsible Business
    1. Introduction
    2. 2.1 Understanding Business Ethics
    3. 2.2 How Organizations Influence Ethical Conduct
    4. 2.3 Managing a Socially Responsible Business
    5. 2.4 Responsibilities to Stakeholders
    6. 2.5 Trends in Ethics and Corporate Social Responsibility
    7. Key Terms
    8. Summary of Learning Outcomes
    9. Preparing for Tomorrow's Workplace Skills
    10. Ethics Activity
    11. Working the Net
    12. Critical Thinking Case
    13. Hot Links Address Book
  4. 3 Competing in the Global Marketplace
    1. Introduction
    2. 3.1 Global Trade in the United States
    3. 3.2 Why Nations Trade
    4. 3.3 Barriers to Trade
    5. 3.4 Fostering Global Trade
    6. 3.5 International Economic Communities
    7. 3.6 Participating in the Global Marketplace
    8. 3.7 Threats and Opportunities in the Global Marketplace
    9. 3.8 The Impact of Multinational Corporations
    10. 3.9 Trends in Global Competition
    11. Key Terms
    12. Summary of Learning Outcomes
    13. Preparing for Tomorrow's Workplace Skills
    14. Ethics Activity
    15. Working the Net
    16. Critical Thinking Case
    17. Hot Links Address Book
  5. 4 Forms of Business Ownership
    1. Introduction
    2. 4.1 Going It Alone: Sole Proprietorships
    3. 4.2 Partnerships: Sharing the Load
    4. 4.3 Corporations: Limiting Your Liability
    5. 4.4 Specialized Forms of Business Organization
    6. 4.5 Franchising: A Popular Trend
    7. 4.6 Mergers and Acquisitions
    8. 4.7 Trends in Business Ownership
    9. Key Terms
    10. Summary of Learning Outcomes
    11. Preparing for Tomorrow's Workplace Skills
    12. Ethics Activity
    13. Working the Net
    14. Critical Thinking Case
    15. Hot Links Address Book
  6. 5 Entrepreneurship: Starting and Managing Your Own Business
    1. Introduction
    2. 5.1 Entrepreneurship Today
    3. 5.2 Characteristics of Successful Entrepreneurs
    4. 5.3 Small Business: Driving America's Growth
    5. 5.4 Ready, Set, Start Your Own Business
    6. 5.5 Managing a Small Business
    7. 5.6 Small Business, Large Impact
    8. 5.7 The Small Business Administration
    9. 5.8 Trends in Entrepreneurship and Small-Business Ownership
    10. Key Terms
    11. Summary of Learning Outcomes
    12. Preparing for Tomorrow's Workplace Skills
    13. Ethics Activity
    14. Working the Net
    15. Critical Thinking Case
    16. Hot Links Address Book
  7. 6 Management and Leadership in Today's Organizations
    1. Introduction
    2. 6.1 The Role of Management
    3. 6.2 Planning
    4. 6.3 Organizing
    5. 6.4 Leading, Guiding, and Motivating Others
    6. 6.5 Controlling
    7. 6.6 Managerial Roles
    8. 6.7 Managerial Skills
    9. 6.8 Trends in Management and Leadership
    10. Key Terms
    11. Summary of Learning Outcomes
    12. Preparing for Tomorrow's Workplace Skills
    13. Ethics Activity
    14. Working the Net
    15. Critical Thinking Case
    16. Hot Links Address Book
  8. 7 Designing Organizational Structures
    1. Introduction
    2. 7.1 Building Organizational Structures
    3. 7.2 Contemporary Structures
    4. 7.3 Using Teams to Enhance Motivation and Performance
    5. 7.4 Authority—Establishing Organizational Relationships
    6. 7.5 Degree of Centralization
    7. 7.6 Organizational Design Considerations
    8. 7.7 The Informal Organization
    9. 7.8 Trends in Organizational Structure
    10. Key Terms
    11. Summary of Learning Outcomes
    12. Preparing for Tomorrow's Workplace Skills
    13. Ethics Activity
    14. Working the Net
    15. Critical Thinking Case
    16. Hot Links Address Book
  9. 8 Managing Human Resources and Labor Relations
    1. Introduction
    2. 8.1 Achieving High Performance through Human Resources Management
    3. 8.2 Employee Recruitment
    4. 8.3 Employee Selection
    5. 8.4 Employee Training and Development
    6. 8.5 Performance Planning and Evaluation
    7. 8.6 Employee Compensation and Benefits
    8. 8.7 The Labor Relations Process
    9. 8.8 Managing Grievances and Conflicts
    10. 8.9 Legal Environment of Human Resources and Labor Relations
    11. 8.10 Trends in Human Resource Management and Labor Relations
    12. Key Terms
    13. Summary of Learning Outcomes
    14. Preparing for Tomorrow's Workplace Skills
    15. Ethics Activity
    16. Working the Net
    17. Critical Thinking Case
    18. Hot Links Address Book
  10. 9 Motivating Employees
    1. Introduction
    2. 9.1 Early Theories of Motivation
    3. 9.2 The Hawthorne Studies
    4. 9.3 Maslow's Hierarchy of Needs
    5. 9.4 McGregor's Theories X and Y
    6. 9.5 Herzberg's Motivator-Hygiene Theory
    7. 9.6 Contemporary Views on Motivation
    8. 9.7 From Motivation Theory to Application
    9. 9.8 Trends in Employee Motivation
    10. Key Terms
    11. Summary of Learning Outcomes
    12. Preparing for Tomorrow's Workplace Skills
    13. Ethics Activity
    14. Working the Net
    15. Critical Thinking Case
    16. Hot Links Address Book
  11. 10 Achieving World-Class Operations Management
    1. Introduction
    2. 10.1 Production and Operations Management—An Overview
    3. 10.2 The Production Process: How Do We Make It?
    4. 10.3 Location, Location, Location: Where Do We Make It?
    5. 10.4 Pulling It Together: Resource Planning
    6. 10.5 Production and Operations Control
    7. 10.6 Looking for a Better Way: Improving Production and Operations
    8. 10.7 Transforming the Factory Floor with Technology
    9. 10.8 Trends in Production and Operations Management
    10. Key Terms
    11. Summary of Learning Outcomes
    12. Preparing for Tomorrow's Workplace Skills
    13. Ethics Activity
    14. Working the Net
    15. Critical Thinking Case
    16. Hot Links Address Book
  12. 11 Creating Products and Pricing Strategies to Meet Customers' Needs
    1. Introduction
    2. 11.1 The Marketing Concept
    3. 11.2 Creating a Marketing Strategy
    4. 11.3 Developing a Marketing Mix
    5. 11.4 Buyer Behavior
    6. 11.5 Market Segmentation
    7. 11.6 What Is a Product?
    8. 11.7 Creating Products That Deliver Value
    9. 11.8 The Product Life Cycle
    10. 11.9 Pricing Strategies and Future Trends
    11. 11.10 Trends in Developing Products and Pricing
    12. Key Terms
    13. Summary of Learning Outcomes
    14. Preparing for Tomorrow's Workplace Skills
    15. Ethics Activity
    16. Working the Net
    17. Critical Thinking Case
    18. Hot Links Address Book
  13. 12 Distributing and Promoting Products and Services
    1. Introduction
    2. 12.1 The Nature and Functions of Distribution (Place)
    3. 12.2 Wholesaling
    4. 12.3 The Competitive World of Retailing
    5. 12.4 Using Supply Chain Management to Increase Efficiency and Customer Satisfaction
    6. 12.5 Promotion Strategy
    7. 12.6 The Huge Impact of Advertising
    8. 12.7 The Importance of Personal Selling
    9. 12.8 Sales Promotion
    10. 12.9 Public Relations Helps Build Goodwill
    11. 12.10 Trends in Social Media
    12. 12.11 Trends in E-Commerce
    13. Key Terms
    14. Summary of Learning Outcomes
    15. Preparing for Tomorrow's Workplace Skills
    16. Ethics Activity
    17. Working the Net
    18. Critical Thinking Case
    19. Hot Links Address Book
  14. 13 Using Technology to Manage Information
    1. Introduction
    2. 13.1 Transforming Businesses through Information
    3. 13.2 Linking Up: Computer Networks
    4. 13.3 Management Information Systems
    5. 13.4 Technology Management and Planning
    6. 13.5 Protecting Computers and Information
    7. 13.6 Trends in Information Technology
    8. Key Terms
    9. Summary of Learning Outcomes
    10. Preparing for Tomorrow's Workplace Skills
    11. Ethics Activity
    12. Working the Net
    13. Critical Thinking Case
    14. Hot Links Address Book
  15. 14 Using Financial Information and Accounting
    1. Introduction
    2. 14.1 Accounting: More than Numbers
    3. 14.2 The Accounting Profession
    4. 14.3 Basic Accounting Procedures
    5. 14.4 The Balance Sheet
    6. 14.5 The Income Statement
    7. 14.6 The Statement of Cash Flows
    8. 14.7 Analyzing Financial Statements
    9. 14.8 Trends in Accounting
    10. Key Terms
    11. Summary of Learning Outcomes
    12. Preparing for Tomorrow's Workplace Skills
    13. Ethics Activity
    14. Working the Net
    15. Critical Thinking Case
    16. Hot Links Address Book
  16. 15 Understanding Money and Financial Institutions
    1. Introduction
    2. 15.1 Show Me the Money
    3. 15.2 The Federal Reserve System
    4. 15.3 U.S. Financial Institutions
    5. 15.4 Insuring Bank Deposits
    6. 15.5 International Banking
    7. 15.6 Trends in Financial Institutions
    8. Key Terms
    9. Summary of Learning Outcomes
    10. Preparing for Tomorrow's Workplace Skills
    11. Ethics Activity
    12. Working the Net
    13. Critical Thinking Case
    14. Hot Links Address Book
  17. 16 Understanding Financial Management and Securities Markets
    1. Introduction
    2. 16.1 The Role of Finance and the Financial Manager
    3. 16.2 How Organizations Use Funds
    4. 16.3 Obtaining Short-Term Financing
    5. 16.4 Raising Long-Term Financing
    6. 16.5 Equity Financing
    7. 16.6 Securities Markets
    8. 16.7 Buying and Selling at Securities Exchanges
    9. 16.8 Trends in Financial Management and Securities Markets
    10. Key Terms
    11. Summary of Learning Outcomes
    12. Preparing for Tomorrow's Workplace Skills
    13. Ethics Activity
    14. Working the Net
    15. Critical Thinking Case
    16. Hot Links Address Book
  18. 17 Your Career in Business
    1. Introduction
    2. 17.1 Learn the Basics of Business
    3. 17.2 Developing Interpersonal Skills Is Key to Your Success
    4. 17.3 Make Your Future Happen: Learn to Plan
    5. 17.4 Going to College Is an Opportunity of a Lifetime—Never Drop Out
    6. 17.5 Get Your Career Off on the Right Track
    7. 17.6 Self-Test Scoring Guidelines
  19. A | Understanding the Legal and Tax Environment
  20. Index
  21. References
  1. What are the basic microeconomic concepts of demand and supply, and how do they establish prices?

Now let’s shift our focus from the whole economy to microeconomics, the study of households, businesses, and industries. This field of economics is concerned with how prices and quantities of goods and services behave in a free market. It stands to reason that people, firms, and governments try to get the most from their limited resources. Consumers want to buy the best quality at the lowest price. Businesses want to keep costs down and revenues high to earn larger profits. Governments also want to use their revenues to provide the most effective public goods and services possible. These groups choose among alternatives by focusing on the prices of goods and services.

As consumers in a free market, we influence what is produced. If Mexican food is popular, the high demand attracts entrepreneurs who open more Mexican restaurants. They want to compete for our dollars by supplying Mexican food at a lower price, of better quality, or with different features, such as Santa Fe Mexican food rather than Tex-Mex. This section explains how business and consumer choices influence the price and availability of goods and services.

A photograph shows a large display of the Samsung Galaxy note smart phone, with a stylus pen touching the screen.
Exhibit 1.10 Galaxy Note 7 Samsung’s strategy to take on Apple’s iPhone domination hit a terrible snag in 2016, when its Galaxy Note 7 mobile phone was recalled and the product eliminated. Defective batteries in the Note 7 made them catch fire and cause serious damage. Samsung eventually killed the entire line of Note 7 phones, recalling nearly 3 million phones, which cost the company more than $5 billion. How do businesses determine the optimum quantity of products or services to make available to consumers? (Credit: Paul Sullivan/ flickr/ Attribution-NoDerivs 2.0 Generic (CC BY-ND 2.0))

The Nature of Demand

Demand is the quantity of a good or service that people are willing to buy at various prices. The higher the price, the lower the quantity demanded, and vice versa. A graph of this relationship is called a demand curve.

Let’s assume you own a store that sells jackets for snowboarders. From past experience, you know how many jackets you can sell at different prices. The demand curve in Exhibit 1.11 depicts this information. The x-axis (horizontal axis) shows the quantity of jackets, and the y-axis (vertical axis) shows the related price of those jackets. For example, at a price of $100, customers will buy (demand) 600 snowboard jackets.

In the graph, the demand curve slopes downward and to the right because as the price falls, people will want to buy more jackets. Some people who were not going to buy a jacket will purchase one at the lower price. Also, some snowboarders who already have a jacket will buy a second one. The graph also shows that if you put a large number of jackets on the market, you will have to reduce the price to sell all of them.

Understanding demand is critical to businesses. Demand tells you how much you can sell and at what price—in other words, how much money the firm will take in that can be used to cover costs and hopefully earn a profit. Gauging demand is difficult even for the very largest corporations, but particularly for small firms.

Exhibit 1.11 Demand Curve for Jackets for Snowboarders (Attribution: Copyright Rice University, OpenStax, under CC-BY 4.0 license)

The Nature of Supply

Demand alone is not enough to explain how the market sets prices. We must also look at supply, the quantity of a good or service that businesses will make available at various prices. The higher the price, the greater the number of jackets a supplier will supply, and vice versa. A graph of the relationship between various prices and the quantities a business will supply is a supply curve.

We can again plot the quantity of jackets on the x-axis and the price on the y-axis. As Exhibit 1.12 shows, 800 jackets will be available at a price of $100. Note that the supply curve slopes upward and to the right, the opposite of the demand curve. If snowboarders are willing to pay higher prices, suppliers of jackets will buy more inputs (for example, Gore-Tex® fabric, dye, machinery, labor) and produce more jackets. The quantity supplied will be higher at higher prices, because manufacturers can earn higher profits.

The horizontal x axis is labeled quantity, and is labeled from left to right, 0 to 1,400 in increments of 200. The vertical y axis is labeled price, and is labeled, from bottom to top, 0 dollars to 200 dollars in increments of $25. Points are plotted on the graph, and connected with a solid line. The points are plotted at approximately 275, $40, and 450, $60, and 700, $80, and 800, $100, and 975, $120, and 1100, $135, and 1325, $155. A dashed horizontal line extends from 100 dollars on the y axis, and a vertical dashed line extends from 800 on the x axis and meet at the plotted point 800, $100.
Exhibit 1.12 Supply Curve for Jackets for Snowboarders (Attribution: Copyright Rice University, OpenStax, under CC-BY 4.0 license)

How Demand and Supply Interact to Determine Prices

In a stable economy, the number of jackets that snowboarders demand depends on the jackets’ price. Likewise, the number of jackets that suppliers provide depends on price. But at what price will consumer demand for jackets match the quantity suppliers will produce?

To answer this question, we need to look at what happens when demand and supply interact. By plotting both the demand curve and the supply curve on the same graph in Exhibit 1.13, we see that they cross at a certain quantity and price. At that point, labeled E, the quantity demanded equals the quantity supplied. This is the point of equilibrium. The equilibrium price is $80; the equilibrium quantity is 700 jackets. At that point, there is a balance between the quantity consumers will buy and the quantity suppliers will make available.

Market equilibrium is achieved through a series of quantity and price adjustments that occur automatically. If the price increases to $160, suppliers produce more jackets than consumers are willing to buy, and a surplus results. To sell more jackets, prices will have to fall. Thus, a surplus pushes prices downward until equilibrium is reached. When the price falls to $60, the quantity of jackets demanded rises above the available supply. The resulting shortage forces prices upward until equilibrium is reached at $80.

The x axis is labeled quantity, and the y axis is labeled price. The quantity demanded line, labeled D, falls from the upper left of the graph from approximate point 275, $160, to the bottom right of the graph at approximate point 1225, $45. The quantity supplied line, labeled S, rises from lower left to upper right, from approximate point 275, $40, to the upper right point 1200, $160. These lines intersect at a point labeled E, the point of equilibrium between supply and demand. Point E is at approximately 700, $80. Above point E, in between lines D and S, is labeled surplus at $160. Below point E, between lines D and S is labeled shortage at $60.
Exhibit 1.13 Equilibrium Price and Quantity for Jackets for Snowboarders (Attribution: Copyright Rice University, OpenStax, under CC-BY 4.0 license)

The number of snowboard jackets supplied and bought at $80 will tend to rest at equilibrium unless there is a shift in either demand or supply. If demand increases, more jackets will be purchased at every price, and the demand curve shifts to the right (as illustrated by line D2 in Exhibit 1.14). If demand decreases, less will be bought at every price, and the demand curve shifts to the left (D1). When demand decreased, snowboarders bought 500 jackets at $80 instead of 700 jackets. When demand increased, they purchased 800.

Changes in Demand

A number of things can increase or decrease demand. For example, if snowboarders’ incomes go up, they may decide to buy a second jacket. If incomes fall, a snowboarder who was planning to purchase a jacket may wear an old one instead. Changes in fashion or tastes can also influence demand. If snowboarding were suddenly to go out of fashion, demand for jackets would decrease quickly. A change in the price of related products can also influence demand. For example, if the average price of a snowboard rises to $1,000, people will quit snowboarding, and jacket demand will fall.

Another factor that can shift demand is expectations about future prices. If you expect jacket prices to increase significantly in the future, you may decide to go ahead and get one today. If you think prices will fall, you will postpone your purchase. Finally, changes in the number of buyers will affect demand. Snowboarding is a young person’s sport, and the number of teenagers will increase in the next few years. Therefore, the demand for snowboard jackets should increase.

The graph shows 3 lines, each falls down and slightly left before hooking back to the right. The line labeled D is in the middle, and falls through the point 700, $80. The line to the left, labeled D 1, falls through the point 500, $80. This is labeled as decrease in demand. The line to the right, labeled D 2 falls through the point 800, $80. This is labeled as increase in demand.
Exhibit 1.14 Shifts in Demand for Jackets for Snowboarders (Attribution: Copyright Rice University, OpenStax, under CC-BY 4.0 license)

Changes in Supply

Other factors influence the supply side of the picture. New technology typically lowers the cost of production. For example, North Face, a supplier of ski and snowboard jackets, purchased laser-guided pattern-cutting equipment and computer-aided pattern-making equipment. Each jacket was cheaper to produce, resulting in a higher profit per jacket. This provided an incentive to supply more jackets at every price. If the price of resources such as labor or fabric goes up, North Face will earn a smaller profit on each jacket, and the amount supplied will decrease at every price. The reverse is also true. Changes in the prices of other goods can also affect supply.

Let’s say that snow skiing becomes a really hot sport again. The number of skiers jumps dramatically, and the price of ski jackets soars. North Face can use its machines and fabrics to produce either ski or snowboard jackets. If the company can make more profit from ski jackets, it will produce fewer snowboard jackets at every price. Also, a change in the number of producers will shift the supply curve. If the number of jacket suppliers increases, they will place more jackets on the market at every price. If any suppliers stop making jackets available, the supply will naturally decrease. Taxes can also affect supply. If the government decides, for some reason, to tax the supplier for every snowboard jacket produced, then profits will fall, and fewer jackets will be offered at every price. Table 1.2 summarizes the factors that can shift demand and supply curves.

To better understand the relationship between supply and demand across the economy, consider the impact of 2005’s Hurricane Katrina on U.S. energy prices. Oil and gas prices were already at high levels before Hurricane Katrina disrupted production in the Gulf Coast. Most U.S. offshore drilling sites are located in the Gulf of Mexico, and almost 30 percent of U.S. refining capacity is in Gulf States that were hit hard by the storm. Prices rose almost immediately as supplies fell while demand remained at the same levels.

The storm drove home the vulnerability of the U.S. energy supply to not only natural disasters, but also terrorist attacks and price increases from foreign oil producers. Many energy policy experts questioned the wisdom of having such a high concentration of oil facilities—about 25 percent of the oil and natural gas infrastructure—in hurricane-prone states. Refiners were already almost at capacity before Katrina’s devastation.27

Factors That Cause Demand and Supply Curves to Shift
Shift Demand
Factor To the Right If To the Left If
Buyers’ incomes Increase Decrease
Buyers’ preferences/tastes Increase Decrease
Prices of substitute products Increase Decrease
Expectations about future prices Will rise Will fall
Number of buyers Increases Decreases
Shift Supply
To the Right If To the Left If
Technology Lowers cost Increases cost
Resource prices Fall Rise
Changes in prices of other products that can be produced with the same resources Profit of other product falls Profit of other product rises
Number of suppliers Increases Decreases
Taxes Decreases Increases
Table 1.2

High energy prices affect the economy in many ways. With oil at the time costing $50 to $60 a barrel—more than double the 2003 price—both businesses and consumers across the United States felt the pinch in their wallets. Midwestern agricultural businesses export about 70 percent of their grain production through Gulf of Mexico port facilities. With fewer usable docking spaces, barges couldn’t unload and return for more crops. The supply of both transportation services and grain products was inadequate to meet demand, pushing up transportation and grain costs. Higher gas prices also contributed to rising prices, as 80 percent of shipping costs are related to fuel.

More than a decade after Katrina, U.S. gas prices have fluctuated dramatically, with the cost of a gallon of regular gas peaking in 2014 at $3.71, dropping as low as $1.69 in early 2015, and moderating to $2.36 in mid-2017. Recent research by JP Morgan Chase revealed that consumers spend roughly 80 percent of their savings from lower gas prices, which helps the overall economy.28

Concept Check

  1. What is the relationship between prices and demand for a product?
  2. How is market equilibrium achieved? Describe the circumstances under which the price for gasoline would have returned to equilibrium in the United States after Hurricane Katrina.
  3. Draw a graph that shows an equilibrium point for supply and demand.
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