Upon completion of this subject, students should be able to:
1. Develop a good understanding of macroeconomic theories related to the functioning and operations of organizations.
2. Acquire relevant knowledge on economic factors related to and that had impacts on how organizations function.
3. Demonstrate their knowledge and understanding of the subject matter though group discussions and written assignments.
Financial costs refer to the cost that have a certain monetary value in to enjoy benefit from a certain good or service. This is also termed as explicit costs. These are the monetary costs in return of a definite good or service (Frank & Cartwright, 2013). In order to pursue MBA studies, Mr. Hamid Mohammad will have to pay RM 25000 as tuition fee, buy books for RM 1000 and pay RM 500 for transport. Therefore, total financial cost for pursing the MBA is
Economic costs include both explicit costs and implicit cost. Implicit costs refer to opportunity cost associated with a particular decision. Opportunity cost is the cost of forgoing the benefits from the next best alternative (Moulin, 2014). In this case, to pursue the full time MBA course Mr. Hamid has to forgo the income received from the present job. Monthly salary of the present job is RM 2500. Duration of the MBA course is 15 months. Therefore, the implicit cost or opportunity cost of pursuing the full time MBA course is the forgone salary for 15 months.
Total Revenue and Total Cost of the firm is given as,
Profit maximization condition of the firm requires marginal revenue to be equal with marginal cost (Baumol & Blinder, 2015).
Equalization of marginal revenue and marginal cost yields profit maximizing level of output as
Therefore, the quantity level that maximizes profit of the firm is 10 units.
Price elasticity of demand
Price elasticity of demand refers to the measure of capturing degree of variability in demand of a good with respect to price of the same. In other way, it the percentage change in quantity demanded of a commodity in response to certain percentage change in price of the commodity (Rubinfeld & Pindyck, 2013).
The measure of computing price elasticity of demand is given as follows
Demand determinant factors
There are several factors that affect market demand of a product. The important factors influencing market demand are discussed below
This is the most important factor in determining market demand of a good. By a law of demand, there exists an inverse relation between demand of a commodity and its price. With increase in price demand for a commodity reduces and vice-versa (Carlton & Perloff, 2015).
After price, the next important factor affecting market demand is income of the consumer. Purchasing power of people depend on the income. With change in income purchasing power changes as well leading to a change in demand. The impact of income on demand depends on the nature of the product (Varian, 2014). For normal goods, demand increases with increase in income. For inferior goods however demand decreases as a result of an increase in income.
Price of related goods
Demand of a good not only depends on its own price but also depends on price of the related goods. Related goods are of two types – substitutes and complementary. In case of substitute goods, an increase in price a product lead to an increase in demand of its substitute good implying a positive relation between demand of a good and price of its substitute. Example of substitute goods are tea and coffee. For goods that are complementary to each other an increase in price of a good lead to a decline in demand of its complementary goods indicating a positive relation (Carlton & Perloff, 2015). Example of complementary goods are petrol and cars.
Firms invest in advertisement expenditure to promote sales of the good. Advertisements are made to attract consumers toward the product. Successful advertisements result in an increase in demand of the good.
Number of consumer in the market
Market demand of a good is estimated by summing the demand of individual consumers at different possible prices. Larger the number of consumer greater is the market demand of the good.
Expectation regarding future prices
Another factor determining market demand is the expectation of the consumers regarding future prices. If consumers expect there is possibility of an increase in future price, they raise their present demand in order to avoid higher prices in future (Varian, 2014). Present market demand decreases if consumer expects prices to be fall in future.
Other factors affecting market demand are taste and preferences of the consumers, distribution of income in the society, population growth, government policy and climatic condition.
Price discrimination refers to the incidence of charging different prices to different customers or different units of the same good. The formal definition of price discrimination stated by Joan Robinson is given as- it is the act of selling same product produced under the control of single seller at varying prices to different consumer (Chandra & Lederman, 2015). Price discrimination can be made possible when a monopolist operates in more than one market such that any unit of the commodity cannot be transferred from a cheaper market to a dearer one.
Condition for effective price discrimination
In order to make price discrimination effective following conditions need to be satisfied.
Price discrimination is not possible under situation of perfect competition. Price discrimination is successful only in presence of market imperfection (Cattaneo et al., 2016). Seller can divide and keep the market into separated parts only when the market is imperfect.
Agreement among rival sellers
Price discrimination is possible only when seller of the good is a monopolist or when rival sellers agree to sell the same product at different prices.
Monopolists often discriminate by taking advantage of geographical barriers. Seller may discriminate between buyers in home and foreign country by charging a lower price in foreign as compared to that in domestic country (Chandra & Lederman, 2015). This kind of discrimination is called dumping.
Discrimination is effective when buyers have the demand of same services in regards to differentiated products. In Railways, different charges are applicable for transportation of copper and coal.
Difference in demand
Price discrimination is profitable when there exists a considerably different demand in different market. Based upon the differences in elasticity different prices can be charged. A lower price is charged in a market with a relatively elastic demand and a higher price is charged in a market with relatively inelastic demand.
Price discrimination in Airline industry
Depending on the above condition significant price discrimination is observed in the airline industry. Price discrimination in the airline industry occur based upon the following circumstances.
Time of buying airline ticket
There is no strict rule regarding price of a particular flight. In general, a ticket seems to be cheaper when it is bought in advance of several months. The airline company tends to increase prices of demand of a particular flight is high. In this situation remaining tickets are only sold to the consumers who are willing to give a higher price (Belobaba, Odoni & Barnhart, 2015). The airline company does the reverse if demand of the fight is not so high.
Cheaper unsocial hours
Flight tickets tend to cheaper during less popular flight times. In popular hours like during holidays or weekend flight tickets tend to be more expensive.
Extra charge for seats having more leg room
Passengers preferring to travel with more comfort are charged with a higher fair for seats attached with more leg room.
Time of traveling
Travelling in air during rush hours are more expensive. Often tickets in weekdays are costly as most of the business man travel during this time. As they have a relatively inelastic demand charging a higher price raises profit of the airline company (Cattaneo et al., 2016). People having more flexibility in travel time tend to face a lower fare.
It is not a direct form of price discrimination rather it is a way of giving reward to the loyal consumers. The more a person travel with specific airline, the more air miles he gets and thus more likely to enjoy a discount for flying frequently.
Law of diminishing returns
The law of diminishing return is said to exist when addition of more and more units of one input keeping quantity of other inputs fixed result in a relatively smaller increase in output. Initially the quantity of total output increases at a faster rate with increase in variable input but after a certain point of time output starts to decline after reaching the maximum (Moulin, 2014).
Short-run cost curve
In the production process short run refers to the time period during which at least one of the inputs remain fixed with varying quantities of other inputs. In the short-run, generally land and machines remain fixed. Firms expands output by varying inputs like labor and capital with time. Firms hire more labor or increase capital to increase output in the short run (Rubinfeld & Pindyck, 2013). Output though can be increased in the short run but size of plant remains unchanged in the short run. Total cost of a firm in the short run divided into total fixed cost and total variables. Fixed costs are the costs associated with fixed inputs. Some examples of fixed costs include rent of land, tax, insurance, depreciation of capita and the like. Cost varied with variation in output level is called variable cost.
Short run Total Cost (TC) = Total Fixed Cost (TFC) + Total Variable Cost (TVC)
Price elasticity of demand
Economies of scale
Economies of scale refers to the phenomenon of reduction in per unit cost with increase in total output. It the advantage that large scale firms enjoy due to large scale production over the small firms. In the presence of economies of scale, firms can produce one unit at the least possible cost. The two main forms of economies of scale are internal economies of scale and external economies of scale (Becker, 2017). Internal economies of scale arise from internal factors of firm and can be managed by the internal management. External economies of scale are the result of external factors such as presence of other forms, government or geographic location.
Long run cost curve
Long run cost curve represents costs related to the quantities of output during long run. In the production process long run describes the period when firm is able to change all factor of production. The size existing plant can be increased in the long run. In the long run thus there is no fixed input. All the cost in the long run are therefore variable costs (Jain & Ohri, 2015). The long run total cost is thus same as the long run variable cost. Long run cost is always either less or equal to short run total cost but is can never exceeds short run costs.
New economies of globalization
The economies of globalization indicate increasing interdependence in the world economy as a result of growing cross border trade of goods and services, flow of capital and exchange of technologies. It represents continuous expansion of market frontier and mutual integration and has become an irreversible trend in the phase of economic development (Giddens, 2018). The two driving forces behind rapid expansion of globalization are growing importance of information related to all kinds of productive activities and spread of marketization.
Price determination under perfect competition
Perfect competition describes a form of market where large number of sellers and buyers are engaged in exchange of identical or homogenous product. Because of the presence of various buyers and sellers in the market each of them constitute only a small part of the market. Buyers and sellers in the market thus have no influence on market price. Price in the market in determined by the mechanism of free market equilibrium where market demand and market supply curve intersects (Baumol & Blinder, 2015).
The profit maximization condition of a firm requires marginal revenue to be equal with marginal cost. Now, as price is determined by market forces rather than discretion of sellers’, marginal revenue is same as price. Short run price under perfect competition thus equals marginal cost of production. Under perfectly competitive market, firms in the short run can enjoy either a supernormal profit or loss (Frank & Cartwright, 2013). In the long run however free entry or exits of the firm eliminates the supernormal profit or loss leaving only normal profit. Long run price in the competitive market equal to the minimum point of the average cost.
Demand determinant factors
Price determination under Oligopoly
Oligopoly is a defined as a form of market where few numbers of firms compete among themselves enjoying a considerably large share in the market. There are three basic theories that explain pricing in the oligopolistic market. These are the theory of kinked demand curve or non-collusive oligopoly, the cartel model and price leadership model.
Kinked demand theory
The theory of kinked demand explains price determination in a non-collusive oligopoly where market price does not change frequently. In this market demand curve in drawn with the assumption that there is a kink in the demand curve at the ruling market price. Under this situation, firm has two possible choices regarding prices.
The first option for the firm is to raise price above the ruling price. Firms are well aware that increase in prices by one firm would move customers to its rival firms (Dupraz, 2016). This indicates upper portion of the kinked demand curve is more elastic than of the lower portion.
The second option is to decrease the price below the market price. If firm lowers the price then total sales though increase but not much as its rivals also follow the same strategy.
Prices in the oligopoly market is thus determined corresponding to the kink. Firms do not have much incentive to change prices (Jain & Ohri, 2015).
The Cartel model explains price determination in a collusive oligopoly. Cartel is a form of organization of independent firms engage in producing similar kind of products. The organization jointly takes the decision regarding price and output. Firms are often interested in to involve in tacit collusion that is they are refraining competition without any formal agreement. The behavior of cartel is same as that of a monopolist. The cartel members decide combined market output corresponding to the point where combined marginal revenue equals to joint marginal cost (Colombo, 2016). Like monopolists, cartel chose to supply a lower output and charge a high price.
In a price-leadership model, one of the firm in the market is assumed to play the role of a price leader. The leader fixes price for the whole industry. Rest of the firms in the industry follows the price set by the leader and adjust output with the set price. In general, price leader is a large firm or that have a dominant role in the market or a firm that is able to produce price at a lower cost (Waldman & Jensen, 2016). Price leadership often happens as a result of price war among firms where one firm appear as a winner.
Drastic reduction in the cost of production
A decline in production cost led to an increase in supply of oil. This shifts the supply curve to the right. In the presence of excess supply of oil over its demand, price in the market falls below the earlier equilibrium price. Oversupply of oil is one factor causing a drastic fall in the oil price. In the late September 2015, global oil price declined as the oil stock piles up. Total oil production during time was increased to 9.35 million barrels per day as compared to 9.3 million barrels per day (Ikenberry, 2018). This indicates market not only is oversupplied but supply actually is increasing.
Decline in demand for oil and oil products
A decline in demand of oil and oil products shifts the market demand curve to the left. The supply of oil in the short run remain constant. Given the supply a decline in demand leads to a decline in oil price of oil. There are different factors causing global oil demand to fall. These factors include weak economic condition of Europe and other developing nations, more efficient vehicles requiring less fuel (Baumeister & Kilian, 2016). China being the largest importer of oil, a decline in oil demand from China causes a contraction in global oil demand. This in turn leads to a fall in global oil prices.
Other factors affecting oil price
Increasing use of close substitute of oil products is another factor reducing oil demand. Use of substitute goods reduce oil demand shifting the oil demand curve to the left (Kilian, 2016). Given the supply, new equilibrium is attained both a lower price and output.
In any business, taking correct decision an integral part of job of corporate managers. For business undertakings, decision are made at every steps. It is an important function of the management. Different managerial function such as planning, staffing, coordinating, directing, organizing and controlling are made through decision making process (Hair & Lukas, 2014). Appropriate decision making is considered as strength of the business. In some decision making, application of macroeconomic analysis helps to make better decision.
Study of macroeconomics is concerned with the analysis of aggregate economic variables. It is the study of whole economy and analyzes different aspects of the economy at the aggregate level such as national income, aggregate employment, government and private spending, consumption, investment, saving functions, balance of payment and fluctuation in business cycle. In the decision making process of a business, tracking movement of macroeconomic variables is one important element (Henzel & Rengel, 2017). A clear understanding of macroeconomics environment helps the CEO to run the business in a better way. Business demand and future investment depend on economic growth and overall state of the economy.
Macroeconomics analysis and business policies
Macroeconomics analysis help the business in terms of providing detail knowledge regarding the macroeconomic environment of the business in relation to industrial policy, policy for licensing, economic planning, framework of fiscal and monetary policy and overall economic policy. Given below are some of the crucial macroeconomic aspects in business decision.
Macroeconomic policies include monetary and fiscal policy, policies of income and balance of payment. A favorable policy is one that encourages business activities.
Business can attain a sustained progress only in the presence of comprehensive and efficient planning. Proper planning ensures economic progress by identifying priority areas, allocating resources efficiently and promoting coordination among different sectors in the economy (Shapiro, 2016).
Solve for macro paradoxes
Understanding of macroeconomics help to solve different macro paradoxes such as paradox of thrift and paradox of assumption by the commercial banks regarding bank deposit.
Condition for effective price discrimination
Evaluating effect of government policy
The implication of government policy on business activity needs to be understood with clarity (Caldara et al., 2016).
Additionally macroeconomic environment also offer understanding about general unemployment, trade cycles and some areas that cannot be studied with microeconomic analysis.
Linkage between macroeconomic variables and business decision
Business decision depends on economic growth. In the phase of slow economic growth, the economic environment becomes unfavorable for the business. Because of reduced aggregate demand business are left with no other option but to reduce its scale of operation.
Rate of inflation affects the business decision. Inflation resulted from an increase in aggregate demand gives opportunity to business to expand operation.
Saving and investment in a nation determine the business potential. Investment can be made in productive activities or in infrastructural development (Shapiro, 2016).
Presence of deficit in current account is not desire for business operation. This indicates a shortage of foreign exchange which restricts the ability of import.
Phases of business cycle is crucial in business decision. During the phase of expansion, business can expand its activities while business activity contracts during phase of recession (Dabla-Norris, Minoiu & Zanna, 2015).
There are four main components of aggregate demand – consumption (C), investment (I), Government spending (G) and net export (X – M).
Consumption demand in an economy represents values of all goods and services that households are able and willing to buy. This component of aggregate demand indicates planned consumption expenditure as incurred by all the household on the purchase of different goods and services. Consumption is a function of disposable income (Goodwin et al., 2015).
Investment refers to the planned expenditure spent on new capital goods such as machines, buildings and other raw materials. Investments are intended not only to increase present level of production but it also focuses on raising production capacity in future.
The component of government expenditure refers to the purchase made by government on different consumer and capital goods. Such expenditures take place mainly to satisfy different social need (Bernanke, Antonovics & Frank, 2015).
This indicates the difference between export and import of different goods and services during a given period of time.
Among the four components of aggregate demand, investment tends to be more volatile component. There are different factors that influence investment expenditure. The most significant determinant of investment is interest rate. With a higher interest rate, investment decreases leading to a decline in aggregate demand. Investment expenditure depends on the prices of capital. An increase in capital price reduces aggregate demand by reducing investment e xpenditure (Mankiw, 2014). New technologies also influence aggregate demand. Investment also varies with change in future expectation. The cyclical fluctuation in aggregate demand is most likely to be caused by volatile nature of investment expenditure.
Determinant of foreign exchange rate
Change in the rate of inflation influences foreign exchange rate. Country with a lower inflation experiences an appreciation of the domestic currency. Prices in this country increase at a slower rate (Bernanke, Antonovics & Frank, 2015). On the other hand country with higher inflation typically experiences a decline in value of its currency or depreciation.
Exchange rate of currencies change with change in interest rate. There is a correlation between foreign exchange rate, inflation rate and interest rate. Currency appreciates with an increase in interest rate. This is because higher interest rate provides higher return to lenders attracting foreign capital causing an increase in exchange rate.
Current Account Deficit
A deficit in current account balance indicates greater spending on import over its sales of export. This causes depreciation of currency. Balance of payment thus causes fluctuation in exchange rate (Uribe & Schmitt-Grohé, 2017).
A country running with high public debt tends to have less foreign capital. Foreign investors are likely to sell their bonds in the open market when there is a prediction of government debt within the nation. This follows a decrease in value of its currency.
Export and import
The volume of export and import affect exchange rate. If a country is able to export more than its import then this indicates a higher demand of domestic goods on abroad constituting a higher demand for currency (Mankiw, 2014). This leads to appreciation of currency. Reverse is the case when volume of import exceeds that of import.
Factors causing depreciation of Malaysian Ringgit
Implementation of Goods and Service Tax (GST)
Implementation of 6% GST in Malaysia results in a reduction in household consumption due to increase in prices. Malaysians will need some time to adjust with GST and consumption might back to its previous level in the long run (Quadry, Mohamad & Yusof, 2017). In the short run, the cut-back in consumption might be continued affecting business and the economy.
Political Turmoil surrounding 1 MDB
Beginning as a domestic affair it has gradually become an international event gaining attention from all over the world. According to a report published in Wall Street Journal US$700 have moved through companies and government agencies that are connected to debt-ridden 1 Malaysia Development Bhd (dollarsandsense.sg, 2018). The financial irregularities of state invested company affect confidence of the Malaysian Ringgit. Foreign funds have already been pulled out causing a depreciation of Ringgit.
Decline in oil price
Oil price in the last few years has fallen sharply mainly due to an increase in supply from US and a decline in global demand. Oil being one major export of Malaysia the falling price of Brent crude oil reduces demand for Malaysian currency (Hsing, 2017). This results in a depreciation of Malaysian Ringgit.
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