Georgia White 2. Consumers and Businesses

4.1 Consumer sovereignty

Consumer sovereignty – the manner in which consumers, collectively through market demand, determine what is produced an the quantity of production

Based on: Consumers sending signals to producers through their demand for g+s When demand is high, relative to supply – prices will rise Producers will then notice that higher profits can be made by producing those items for

which demand is greatest Will shift resources into those other forms of production

∴ consumer sovereignty can determine how resources are allocated in the economy

Consumer income levels determine the types of production that can occur in an economy As income levels rise, demand for luxury goods increases and so does their production

In a market economy there are a few factors that can reduce the sovereignty of consumers:

Marketing Some informative, but more aim to manipulate consumer behaviour

Consumer sovereignty = ↓ by manipulative/deceptive marketing practices

Misleading or deceptive conduct Consumers can be deceived by false claims → pay for items they don’t really want to buy

Common e.g. weightless programs Planned obsolescence Firms design products that are designed to wear out/go out of

date quickly → encourage consumers to make further purchases in future

Manipulate consumers by emphasising importance of keeping up with latest fashions

Anti-competitive behaviour Firms that operate in markets where there are few other sellers → ↓ ability of consumer to choose what they really want e.g. electronics companies manufacture so only that brand’s

accessories are compatible

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Georgia White 2. Consumers and Businesses

4.2 Decisions to spend or save

Y = C + S increase in C → equal reduction in S change in level of Y → change in level of C and S

.

APC = average propensity to consume – proportion of total income that is spent on consumption

= CY

APS = average propensity to spend – proportion of income that is saved for future consumption

= SY

Because every dollar of a consumer’s disposable income must be spent or saved

APC + APS = 1

↙ . ↘as Y ↑, people tend to save a higher proportion of their incomei.e. APS rises and APC falls

can be shown in the consumption function

over the course of our lifetime, our consumption and savings behaviour moves through several patterns

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factors that influence the decision about

whether to spend or save

personalityconfidence and future

expenctation

future savings

age level of income

tax policies

availability of credit

→ Y = disposable income after tax→ C = consumption expenditure→ S = savings.△ = difference in

Georgia White 2. Consumers and Businesses

MPC = marginal propensity to consume – the proportion of each extra dollar of income that goes to consumption

= ∆C∆Y

MPS = marginal propensity to save – the proportion of each extra dollar of income that is saved

= ∆S∆Y

MPC + MPS = 1

Consumption function – a graphical representation of the relationship between Y and C for an individual/economy

Autonomous consumption (C that is independent of Y, must be spend to survive)

C = C0 + MPC (Y)

Our total consumption is equal to autonomous consumption plus the proportion of each extra dollar that is consumed, depending on your level of income

Breakeven level of income: when Y = C

Equilibrium level of income: when S = I

e.g.

a) nominate the consumption and savings functions

MPC = ∆C∆Y

= 400500

= 0.8

C = C0 + MPC (Y)

450 = C0 + 0.8 (500)

C0 =50∴ C = 50 + 0.8Y∴ S = -50 + 0.2Y

b) calculate the breakeven level of incomebreakeven level of income when Y = C (substitute Y as C in consumption function)

Y = 50 + 0.8Y

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C = consumption C0 = autonomous consumption MPC = marginal propensity to consumeY = income

Y C I500 450 250

1000 850 2501500 1250 2502000 1650 250

Georgia White 2. Consumers and Businesses

0.2Y = 50

Y = 250

c) calculate the equilibrium level of incomeequilibrium level of income when S = I (substitute I value as S in savings function)

S = -50 + 0.2Y

0.2Y = 300

Y = 1500

d) graph the consumption and savings function

Steps to draw a consumption and savings function graph:

1. Draw and label axes with C and Y, and S and Y2. Mark autonomous consumption on both the consumption and savings functions3. Draw a 45o line on the consumption function4. Mark 0 and draw a horizontal line from 05. Draw a less steep line from autonomous consumption on both the consumption and savings

functions6. Mark where C = Y (breakeven) with a line7. Label both functions with their equations

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Georgia White 2. Consumers and Businesses

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Georgia White 2. Consumers and Businesses

4.3 Factors influencing individual consumer choice

Consumers aim to maximise their utility through their expenditure decisions Achieving higher utility means they have satisfied more wants Individual demand – the demand of each consumer for a particular good or service

Factors affecting a consumer’s expenditure choices:

Level of income As individuals earn ↑ Y, they tend to choose to buy more items and items of a ↑ quality

The price of the good or service itself

Must decide whether they are willing to pay price of g/s given Y level People will buy necessities regardless of price changes Consumers are likely to reduce their demand for luxury goods as price

increasesThe price of the substitute and complement goods

The demand of a good will be affected by the price of other goods Substitute good – a good that consumers may choose to buy instead of

another good e.g. butter and margarine Complement good – a good that is used in conjunction with another good

e.g. DVD player and DVDs ↑ price g → ↑ demand for substitute good ↓ price g → ↑ demand for good and its complement

Consumer tastes and preferences

Buy g+s that give them the highest utility Consumer preferences change over time → change in demand for goods Innovation + technical progress → consumers demand new/better

products at the expense of other onesAdvertising Can create demand for g+s that didn’t exist before

Can make demand for g+s less responsive to price increases by building consumer loyalty

4.4 Sources of consumer income

Returns to factors of production

Consumer income – the rewards to the owners of the factors of production Wages from labour – main source Y, when participate in labour market, also incl non-wage Y

e.g. employer contributions to superannuation, workers compensation payments Rent from land – investment property generates property Y Interest from capital – people with greater wealth tend to enjoy a higher Y level because

wealth creates ongoing Y through returns from owning capital e.g. ownership of shares, interest on S in cash management accounts

Profit from entrepreneurial skills – profit is return for use of entrepreneurial skill

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Georgia White 2. Consumers and Businesses

Social welfare

Social welfare payments – the payments made to increase the incomes of individuals/families in need of assistance by the government

Y collected through taxation then redistributed by gov through transfer payments Aim: provide a min. Y safety net → allow consumers to by necessities

o Assistance to the aged: 65+, retiredo Unemployment benefits: seeking but unable to find worko Disability support payments: not able to work due to personal factors e.g. illnesso Family payments

5.1 Business firms and industries

Firm – an organisation involved in using entrepreneurial skills to combine factors of production to produce a good or service for sale

Industry – consists of the firms involved in making a similar range if items that usually compete with each other

5.2 Production decisions

What to produce Skills and experience of the business operator – likely to be most successful in industry they

know well i.e. understand consumer demand Industries where there is strong consumer demand – more likely to find opportunities to

expand business Specific business opportunities – e.g. a region that doesn’t have a type of business, find a

niche market Amount of capital required to start the business – more likely to be attracted to lower start-

up costs, minimise risk

How much to produce Based on level of consumer demand + ability to convert demand into sales Produce too much – goods may spoil, too little – harm relationship w/ potential consumers

o Market research – determine likely sales + prices Hard to anticipate consumer demand following changes in external conditions

How to produce Depends on relative efficiency of factors of production which can change over time

o Natural resources – discovered, new technology → ↑ improve productivity, diminished though exploitation

o Labour – investment in edu + training → ↑ productivity, decline in birth rate/aging pop → ↓ people available for work

o Capital – can increase capital through investment in goods used in prod process, over time old capital will become obsolete = depreciation

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Georgia White 2. Consumers and Businesses

o Enterprise – supply of entrepreneurs – increase under favourable political and economic conditions, decrease when political instability or economic downturn

Will use combination of factors of production that is most efficient

5.3 What business contributes to the economy

Growing private sector → ↑ economic growth, stronger revenue base to fund services provided by gov

Growing businesses employ → ↓ u/e Add to tourism → economic development Growth in individual businesses → ↑ economy’s productive capacity over time

o Outward shift of production possibility frontier → ↑ productive capacity → ↑ living standards

5.4 Goals of the firm

Maximising profits o Using lowest-cost combination of resources + charge highest possible price

Meeting shareholder expectationso Company directors represent shareholder’s interests – aim to meet their

expectationso Can create tension when conflict between actions that maximise share price and

dividends in short term but reduce firm’s value in long term Increasing market share

o Shareholders take on risk – risk capital, seek max profits as rewardo Managers – seek increased salaries, power + prestige o Compromise between profit maximisation and increasing market share

Maximising growtho Long term – larger asset base → ↑ profitso Can sometimes lead to failure e.g. Starbucks

Satisficing behaviour o Doesn’t attempt to maximise any objective, seeks to achieve adequate level in each

areao May seek to earn satisfactory level of profit (acceptable rate of return for

shareholders) rather than maximising profitso Excessive profits → invite new competitors into industry, gov regulationo Social enterprise – goal of positive social/environ impact

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Georgia White 2. Consumers and Businesses

5.5 Efficiency and production

An increase in productivity = an increase in output per factor of production (input) per unit of time

To ↑ productivity – need to ↑ production proportionately more than the ↑ in inputs of resources

Resources are used more efficiently Overall living standards increase i.e. able to satisfy more wants

o Less wastage of scarce resourceso Lower production costs + higher profitso Lower inflation rateo Higher incomeso Improve international competitiveness of industries

Specialisation – factors of production are used more intensely for a smaller number of production processes

Type Definitiondivision of labourspecialisation of labour

break down production process into sub-processes allowing labour to specialise e.g. assembly line approach in car manufacturing

localisation of industry specialisation of industry

large number of businesses producing similar goods congregate in same area, share common infrastructure

large scale production specialisation of capital

grow so large can use highly specialised capita equipment in production process

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Georgia White 2. Consumers and Businesses

Internal economies and diseconomies of scale

Internal ← firm expands scale of operations economies of scale Cost saving advantages

Specialisation of labour – break up production process Invest in more efficient capital equipment Buy raw material in bulk Find a market for by-products Put resources into research and development

diseconomies of scale Cost disadvantages Management lose touch with day-to-day running Duplication and paper work, red tape Problems in workplace relations Decrease in managerial and administrative efficiency

LRAC – long-term average cost

External ← factors outside firm’s control, nothing to do with level of production economies of scale Cost saving advantages

Localisation of industry Industry grows as a while Growing, competitive and more sophisticated capital

marketdiseconomies of scale Cost disadvantages

Increased pollution from growth of industry Concentration of industry and people in existing urban

areas Increase price of resources (exp if limited) due to

growth of industry

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Georgia White 2. Consumers and Businesses

The law of diminishing returns

Increasing quantities of a variable factor added to a fixed factor → decline in total output → diminishing returns to variable factor

Assumptions: Only 2 factors of production – land and labour One factor is fixed, the other is variable Producer uses various quantities of variable factor in combination with fixed factor Level of technology and all other factors of production remain constant

e.g. production of wheat on a farm

Fixed factor (land) Variable factor (labour)

Total physical product (TPP)

Average physical product (APP)

Marginal physical product (MPP)

1 0 0 0 01 1 5 5 51 2 12 6 71 3 21 7 91 4 32 8 111 5 45 9 131 6 54 9 91 7 56 8 21 8 56 7 01 9 50 5.5 -6↓ ↓ ↓

output output/variable factor

difference per variable factor in

output

As you add workers to the farm output increases, but with the addition of the 6 th worker, the law of diminishing returns sets in

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