Decision-making in Firms and Individuals using Microeconomic Concepts and Theories
Discuss About The Objective Is To Maximize Utility By Minimizing Cost?
Microeconomic concepts and theories are important in making decisions that solve firms’ or individual problems. The concepts and theories enable an individual or firm’s stakeholders to make informed decision that meet their needs and derive maximum utility (Baumol & Blinder, 2015). Every individual or firm has an objective of making rational decision on production or consumption. The objective is to maximize utility by minimizing cost and maximizing returns. Individuals want to buy good and service that satisfy their need at lowest price possible. Firms want to produce at a minimum cost while getting the highest possible price in the market in order to maximize profits.
The following report will discuss the decision on how much to produce in a firm by analyzing microeconomic problems the owners and management have to solve to make the decision. This will enable making of decisions on firm’s efficiency in production and profitability in the market. The report will use concepts and theories learnt from topic 1-8. The findings of the research will be used by investors, firm’s owners, and management of firms to make decisions on how much to produce.
Firms are faced with a dilemma on how much to produce while minimizing cost of production and maximizing it revenue. The management is unable to decide on the quantity and quality of goods and services to deliver in the market to meet demand and still maximize profits (Penrose, 2009). The owners and investors have an object of the firm making high profits which leads to a dilemma on what to invest in to maximize profits. Therefore, the decision on how much to produce in a firm is faced with several problems that will be addressed in this research through microeconomic theories and concepts.
The following section contains review of microeconomic theories and concepts that can solve the problem of determining how much to produce in a firm. It will include the following; comparative advantage concept, supply and demand theory, market structure and competition, elasticity and demand and perfectly competition supply.
Supply refers to amount that suppliers are willing to supply in the market at a specific price while demand is the ability and willingness of buyers in a market to purchase a product at a specific price. Suppliers are the producers of goods and services and are motivated to produce more when there are high prices of the products in the market. The supply of commodities in the market is influenced by cost of production, technology applied in production, government policies, related goods prices, and commodity price. The law of supply states that supply of goods and services increase with increase in market prices (Wetzstein, 2013). Buyers are motivated to buy when products are at low prices. Higher prices reduce customer’s purchasing power leading to decreased ability to buy. Demand increase in a market is influenced by population, income, expected future prices, price of substitute goods, and price of the product. The law of demand indicates that an increase in prices of a commodity leads to decreased demand and vice versa.
Problems in Determining Quantity and Quality of Goods and Services to Produce
The supply and demand should be equal in the market for all produced commodities to be bought by the consumers in a particular market. Supply and demand form market equilibrium. If demand is not equal to supply, there is imbalance in the market that leads to prices changing to form a new equilibrium that clears the market (Hall, & Lieberman, 2012). For instance, if there is high demand for a commodity that supplied commodities, the prices of the commodity increase and when there is high supply with low demand, the prices of the commodities goes down
Therefore, in order to supply a certain market, it important to analyze the market and determine the current demand. This helps the firm to produce in accordance with the demand in the market to avoid incurring losses.
Comparative advantage refers to a condition where a firm specializes in the product that it can produce at a lower price. Producing at a comparative advantage enables a firm to have more sales. Producing at a comparative advantage also enables the firm to offer competitive prices in the market that allow the firm to have advantage over its competitors (Spulber, 2009). Comparative advantage in a firm is derived from geographical location that has cheap labour, economics of scale, efficient internal systems, or endowment of resources. Comparative advantage concept requires businesses to produce products that they have lower opportunity cost producing.
Therefore, firms should evaluate between the products they are capable of producing in terms of comparative advantage. By adopting a product that they have a comparative advantage, the firm will be able to avail their products in the marketing at a competitive price that will attract more customers compared to their competitors.
Demand elasticity refers to responsiveness of price to quantity demanded in the market. It is the change in quantity demanded that occurs in when there is an unit change in price. Consumers in different markets respond differently to changes in price to specific products (Rios, McConnell, & Brue, 2013). For instance, an increase in price of a substitute product leads to consumers shifting to the other product. This is different from products that have no close substitute where increase or decrease in prices does not lead to elasticity in demand. Abnormal goods are also inelastic to changes in prices.
Therefore, firm’s stakeholders should understand their product and the effects of changes in prices. This is because, products with high elasticity demand require different decision compared to other products that have inelastic demand.
Microeconomic Theories and Concepts in Solving the Production Dilemma in Firms
Market structures refer to how the market of a certain industry is organized or characterized. The market structures are monopolistic, oligopoly, monopoly and perfect competition (Nicholson, & Snyder, 2011). The market structure that a firm operates in decides the choices that the stakeholders take in production and other strategic behaviors. The market structure is determined by number of suppliers (producers), buyers’ information, and homogeneity of commodities in the market. Monopoly structure refers to a market with single supplier who controls the market. The product in this structure has no close substitute. Perfect competition refers to a market structure where there are many buyers and seller and the products are homogenous. Buyers in this market structure have information about the products. The market has no restriction to entry or exit. Prices of commodities are determined by the market forces and there is no product differentiation. Monopolistic competition refers to a market organized and characterized with many buyers who have differentiated products. The products are close substitute and they are differentiated in terms of packaging, brand, price etc. The market also has no restriction to entry or exit. Oligopoly refers to a market characterized with few suppliers and many buyers. Few firms dominate the market and compete within themselves or work in collaboration to decide on prices. The market structure has a lot of barriers to new entry. The products are homogenous (Rubinstein, 2012).
The existence of the types of market structure in the industry requires stakeholders to understand which structure they operate in. Different market structures require different decisions to maximize profit (Barreto, 2013). For instance, decisions in monopoly market are different in monopolistic or oligopoly market. In monopoly market, the producer has all control in the market. The producer determines the price to charge in the market and therefore, decisions are not dependent to other firms’ actions. The decisions in monopoly involve price discrimination to create barriers in the market entry. Decisions in oligopoly market require a firm to follow what other firms are doing in order to maximize profits. The firm has to make decisions in respect to what the competitor is doing. This market structure demand is elastic above equilibrium and inelastic below equilibrium and therefore change in price by one firm influences the amount of quantities demanded (Kenrick et al. 2009). Decisions in monopolistic market structure required the stakeholders to differentiate their products and customers to avoid their customers from buying substitute products when prices change. The decision to differentiate is important to keep the firm in the market and maximize profits. The decision in perfect competitive market requires stakeholders to maximize profits through economics of scale and internal efficiency. The market has no price discriminations or product differentiations and therefore, buyers buy from any firm. The decision in this market therefore, will be based on selling more and minimizing cost to maximize the profit margins for the firm.
Supply and Demand Theory
Economic efficiency refers to optimum allocation of firm’s resources. This includes minimizing wastage and inefficiency to enable the firm gain profits (Baumol & Blinder, 2015). Economic resources are scarce and therefore the management has a responsibility to determine how much to allocate for production and allocative efficiency. Production efficiency entails combination of production resources where output is lowest in terms of average total cost. This implies that the cost to be incurred in production is minimized where the short run average total cost is lowest. It also means that the firm will produce at the point where average total cost intercepts with marginal cost because marginal cost intercepts average total cost at the lowest point (Nicholson, & Snyder, 2011). Allocative efficiency refers to producing at the point equivalent to the price consumers do pay in the market that reflects marginal cost of the firm’s production. Therefore, attaining allocative efficiency in a firm requires the managers to produce output up to a point where marginal cost is equal to price.
Analyzing and assessing economic efficiency in a firm evaluates the firm’s individual performance and the market performance to determine profitable price and maximum cost. Therefore the problem on how much to produce should be solved by combination of the market price and firm’s marginal cost.
This concept refers to an individual action or choice that affects another individual action. The concept is based on competitive theory where one’s actions or choices influence another individual or firm in making their choices or actions. This concept is important in making decisions where the firm operates in a competitive environment. The actions of one firm influences the market and the other firm has to change and act the same or better in order to survive in the market (Bowles, 2009). For instance, when one firm embarks in aggressive promotional activities, the other firms in the same industry have to start aggressive promotional activities. Failure to make this choice can lead to sales decreasing.
Therefore, stakeholders should adopt games and strategic behaviors when making decisions on how much to produce and sell in order to maximize profits.
From the analysis and discussion in this report, the decision on how much to produce in a firm can be decided by applying microeconomic concepts and theories to solve the microeconomic problems. The microeconomic problems in deciding how much to produce require firm’s managers and owners to understand the production costs and market structures. A decision to minimize the production costs enables the firm to have a competitive advantage and increase it sales in the market. Low cost of production also enables the firm to engage in price discrimination that that can create barriers in the market and increase firm’s profits in the long run. Therefore, microeconomic concepts and theories are important tools to making decisions that solve microeconomic problems and enhance profit maximizations in a firm.
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