Fundamental of the Economics - Essay Example

TABLE OF CONTENTS DETAILS PAGE NO Costs……………………………………………………….2 2. Productivity………………………………………………..3 3. Competitive Markets………………………………………4 4. References…………………………………………………6 Economics Costs: Costs in general may refer to the price that is paid in producing a good. There are two major kinds of costs (a) outlay costs and (b) opportunity costs. The outlay costs refers to the financial expenditures that are recorded in account books, such as wages, salaries, maintenance, repair etc.(Tewari and Singh 121). Opportunity costs of a particular commodity on the other hand, refer to the value of the next best commodity that is foregone, but which can be produced with the same bundle of resources. While estimating the total costs of production, both outlay costs as well as opportunity costs are taken into account. Other kinds of costs include incremental or variable costs which vary with the level of output, while sunk costs or fixed costs refers to those costs that remain the same and do not vary with the variation in output. Variable costs tends to rise with higher levels of production, while total costs will remain the same. Hence, when the level of production is zero, then the variable costs will be zero, but fixed costs will still be incurred. Total costs would include both the variable and fixed costs. Economies of scale describe a situation where the total costs rise less proportionately to production increases, while dis-economies of scale represent the opposite situation.(Piana, 2003). The profitability of a firm is therefore measured by the total revenue less the total costs. Economic performance is reflected in the profitability or market value of a firm. The efficiency in cost usage will be measured by the level of profits and lower costs with higher profits will reflect higher productivity. Marginal costs would constitute the costs a Company incurs when it is producing one more good. Hence for example, if a Company already produces two goods and produces one additional good, then the differences in marginal cost incurred in going from two to three products would be given as follows: Marginal cost (2 to 3) =Total cost of producing 3 – Total cost of producing 2. In this way, the marginal cost of producing different goods can be assessed and totaled to arrive at total marginal costs that will be incurred. Assessment of costs is an important branch of micro economics because it helps to assess how individuals and firms make their decisions on the allocation of limited resources. (Marchant and Snell, No Date) Productivity: Productivity in Economics refers to the amount of the output that is created in reference to good produced or services rendered, per unit of input that is used. Hence, labor productivity measures the out per worker per labor hour, while cost productivity refers to the savings in cost per unit of good produced. Productivity hence measures the relative efficiency in production or costs or performance of labor or services. The assessment of current and potential economic performance must therefore take into account, the underlying forms of cost structure and production. Productivity growth measures are thus equivalent to net output growth. (Morrison, 1999:5). In microeconomic terms, productivity is simply the conversion of inputs into outputs and constitutes a process that uses resources in order to create a commodity that is suitable for exchange. In broad terms, production activity may refer to all economic activities other than consumption. Productivity will be achieved at high efficiency if the given quantity of outputs cannot be produced with any less inputs. Some of the factors of production that affect productivity are (a) raw materials (b) labor (c) capital goods (d) land (e) entrepreneur. In the short term, most of these factors of production may be fixed, but they can be adjusted in the long term. Some factors of production may be fixed and not easily changeable, for example factory space or heavy equipment, while other factors may be variable, such as power consumption or raw materials. Productivity in a firm will also be affected by the levels of demand and supply for its goods. Higher demand for its goods will result in higher levels of sales and provide higher levels of profits, however the existing levels of supply will also be a determining factor in whether or not the price of the commodity will be high enough to generate profits, yet at the same time not so high that it detracts buyer activity. There are several other factors that will affect demand. For example, there are certain goods which are luxury symbols, such as gold or designer items, for which the traditional rule that the lower the price, the more the buyer will buy may not hold. In such instances, buyers may actually be more inclined to purchase the product if it is priced higher because it is a status symbol. Similarly, certain goods which are staple foods, such as food items will be purchased by buyers even if the price increases because they are necessities. When items can be substituted by other items, for example substituting coffee with tea, then a rise in price of the commodity will produce a decline in amounts purchased by buyers. Competitive markets: Market relations between sellers and buyers of a good are described as the market relations between them. Fundamental economic theory applies to a market where prices are assumed to not be affected by buyers or sellers. The theory of supply and demand assumes that markets are perfectly competitive and that buyers and sellers do not have power over the markets, however in reality, some individual buyers or groups of sellers may have the power to influence prices through monopolies or oligarchies. The law of supply is based on the premise that price is directly related to supply, therefore the higher the price, the greater the quantity of the good the seller is likely to supply. The law of demand functions the reverse way, i.e, the lower the price of the good, the larger the quantities the buyers are likely to purchase.(www.en.wikipedia.org). Hence the effective price of a commodity in the market will be the equilibrium market price, or the price where the consumer demand and producer supply prices intersect. In a state of perfect market competition, it is assumed that no individual firm or individual buyer has any control over the market price, hence buyers and sellers must regard the market price as beyond their control - there is perfect freedom for entry and exit in any industry with firms producing homogenous products that are perfect substitutes for each other.(http:64.37.122.55). As a result, demand and supply will remain fairly constant and it is assumed that price of a commodity in the market will depend only upon the interaction between the forces of demand and supply. However, in reality, a state of pure competition rarely exists. There may be entry barriers to new firms who are unable to enter the market because of the monopoly of larger firms with better established distribution networks and supply. Similarly, buyer demand may not always be conditioned by the price of the commodity. In some instances, there may be other factors such as advertising which could increase sales of a product or the availability of substitutes which could drive down the price of a product. There may also be other factors such as Government regulations, issue of currency by the Government, forces of inflation and a variety of other factors that could influence the levels of supply and demand and the price of a commodity, thereby making supply and demand even more elastic. Within a competitive market therefore, sellers compete with each other to drive down their prices to encourage buyers to purchase their product, while buyers may also be influenced by factors other than price in making their selections of goods. As a result, markets are volatile and changeable and rarely ever exist in a state of perfect competition. Rather the forces are in a constant state of flux in a competitive market. Some of the characteristics of a competitive market are : (a) lower prices – this is due to the large number of competing firms, where demand is elastic and therefore rise in prices lead to a fall in demand and total revenue (b) low barriers to entry where new firms feel that large profits may be made (c) lower total profits and profit margins, as compared to markets where there are only a few firms exercising a monopoly (d) economic efficiency – since the existence of greater levels of competition will ensure that firms try to minimize their costs and move towards efficiencies in production. This also leads to faster diffusion of technology as firms need to be more responsive to changing needs of consumers. References: * Marchant, Mary A and Snell, William, M, No Date. “Macroeconomic and international policy terms” [online] retrieved October 1, 2007 from: http://www.ca.uky.edu/agc/pubs/aec/aec75/aec75.htm * Morrison, Catherine J and Morrison, Paul, 1999. “Cost structure and the measurement of economic performance: Productivity.” * Piana, Valentino, 2003. “Costs” [online] Retrieved September 25, 2007 from: www.economicswebinstitute.org/glossary/costs.htm * Perfect Competition – Introduction. [online] Retrieved September 25, 2007 from: http://64.37.122.55/economics/content/topics/monopoly/perfect_competition.htm * Supply and Demand.[online] Retrieved September 24, 2007 from: http://en.wikipedia.org/wiki/Supply_and_demand * Tewari, Devi D and Singh, Katar, 1996 “Principles of Microeconomics” New Age Publishers. Read More