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CPA BEC > B5: Economic Concepts > Flashcards

B5: Economic Concepts Flashcards

1
Q

Economics

A

a science that studies human behavior as the relationship b/w ends and scarce means that have alternative uses
- economics is about people and the choices they make

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2
Q

Business Cycles

A

the rise and fall of economic activity relative to its LT growth trend

  • although economy tends to grow over time, growth is not stable
  • economic activity is characterized by fluctuations and these fluctuations are known as business cycles
  • vary in duration and severity
  • analysis of business cycle is part of macroeconomics
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3
Q

Macroeconomics

A

study of economy as a whole
- examines determinants of national income, unemployment, inflation, and how monetary and fiscal policies affect economic activity

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4
Q

Gross Domestic Product (GDP)

A

GDP is the total market value of all final goods and services produced w/i the borders of a nation in a particular period

  • the term “final goods and services” excludes used goods that have been resold
  • GDP is the nation’s output of goods and services
  • includes output of foreign-owned factories in the US but excludes output of US owned factories abroad
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5
Q

Nominal GDP

A

measures value of all final goods and services at historical cost

  • not adjusted for inflation
  • current prices
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6
Q

Real GDP

A

measures value of all final goods and services in constant prices

  • adjusted for inflation/change in price level
  • most commonly used measure of economic activity and national output

% change in real GDP = (CY real GDP/past year real GDP)-1

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7
Q

Price Index (GDP deflator)

A

used to calculated real GDP

real GDP = (nominal GDP / GDP deflator) * 100

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8
Q

Real GDP Per Capita

A

= real GDP / population

  • used to compare standards of living
  • also used to measure economic growth
  • economic growth is the increase in real GDP per capita over time
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9
Q

Composition of Business Cycles

A
  1. Expansionary Phase
    - characterized by rising economic activity (real GDP) and growth above its LT growth trend
    - firms’ profit increases as demand increases
    - unemployment decreases
    - prices increase
  2. Peak
    - high point of economic activity
    - end of expansionary phase and beg. of contractionary phase
    - firms likely to face capacity constraints and input shortages, leading to higher costs and overall prices
  3. Contractionary Phase
    - falling economic activity following a peak (GDP decreasing)
    - profits decreasing, unemployment increasing
  4. Trough
    - low point of economic activity
    - profits at a low, unemployment at a high
  5. Recovery Phase
    - economic activity begins to increase and return to its LT growth trend
    - profits begin to stabilize

overall LT trend is upwards

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10
Q

Recession and Depression

A

Recession: two consecutive quarters of falling national output

  • contractionary phase
  • GDP decreases, profits decrease, unemployment increases

Depression

  • very severe recession
  • long period of stagnation in business activity and high unemployment rates
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11
Q

Economic Indicators

A

statistics that historically have been highly correlated w economic activity
- gathered by The Conference Board

Leading Indicators
- tend to predict economic activity

Lagging Indicators

  • tend to follow economic activity
  • used to confirm or dispute previous forecasts and the effectiveness of policy directives

Coincidence Indicators

  • change at approximately the same time as the economy
  • provide info about current state of the economy

examples B5-6

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12
Q

Reasons for Fluctuations (Business Cycles)

A

gr agreed that business cycles result from shifts in aggregate demand and/or aggregate supply
- AD and AS curves can be used to illustrate the relationship b/w country’s output (real GDP) (x-axis) and price level (GDP deflator) (y-axis)

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13
Q

Aggregate Demand (AD) Curve

Reasons for Fluctuations (Business Cycles)

A
  • illustrates max qty of goods and services that households, firms, and the government is willing/able to purchase at a given price level
  • total demand in the economy as a whole
  • downward sloping
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14
Q

Aggregate Supply (AS) Curve

Reasons for Fluctuations (Business Cycles)

A

max qty of goods and services producers are willing and able to produce at any given price level

  • total supply in economy as a whole
  • upward sloping

Short-Run AS Curve (SRAS)
- upward sloping, illustrating that as price levels rise, firms are willing to produce more

Long-Run AS Curve (LRAS)

  • vertical (Y*)
  • in the LR, if all resources are fully utilized, then output is determined solely by factors of production not by price
  • corresponds to potential output level in the economy
  • Y* = GDP at the potential (equilibrium) level of output
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15
Q

Potential Level of Output (potential GDP)

Reasons for Fluctuations (Business Cycles)

A

the level of real GDP (national output) that the economy would produce if its resources (capital and labor) were fully employed

  • when real GDP is below: recession
  • when real GDP is above: expansion
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16
Q

AD, AS, and Economic Fluctuations

Reasons for Fluctuations (Business Cycles)

A

business cycles are result of shifts in AD or SRAS
- shifts in LRAS are associated w LR growth and do not affect business cycles

Reduction in Demand (from individuals, businesses, or govs)

  • GDP ^, profits v, unemployment ^, prices v
  • contraction or recession

Increase in Demand (from ind., businesses, or govs)

  • GDP v, profits ^, unemployment v, prices ^
  • recovery or expansion

Reduction of Supply (from firms)

  • GDP v, profits v, unemployment ^, prices ^
  • contraction or recession

Increase in Supply (from firms)

  • GDP ^, profits ^, unemployment v, prices v
  • expansionary
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17
Q

Factors that Shift AD

Reasons for Fluctuations (Business Cycles)

A

“TWICE G”: Taxes, Wealth, Interest rates, Consumer confidence, Exchange rates, Government spending

Changes in Wealth

  • increase: AD ^ (GDP ^, profit ^, unemp v, prices ^)
  • decrease: AD v (GDP v, profit v, unemp ^, prices v)

Changes in Real Interest Rates

  • increase: AD v
  • decrease: AD ^

Changes in Expectations about Economic Outlook (consumer confidence)

  • confident: AD ^
  • uncertain: AD v

Changes in Exchange Rates

  • appreciated: AD v
  • depreciated: AD ^

Changes in Government Spending (fiscal policy)

  • increase: AD ^
  • decrease: AD v

Changes in Consumer Taxes (fiscal policy)

  • increase: AD v
  • decrease: AD ^

governments can affect AD through fiscal policy that affects changes in gov. spending and consumer taxes

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18
Q

Multiplier Effect

Reasons for Fluctuations (Business Cycles)

A

an increase in consumer, firm, or gov spending produces a multiplied increase in the lvl of economic activity

  • results from marginal propensity to consume (MPC)
  • MPC is change in consumption due to a $1 increase in income
  • bc ppl tend to save part of their income, MPC is gr < 1

multiplier = 1 / (1-MPC)
or = 1 / MPS
- MPS is marginal propensity to save = 1-MPC

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19
Q

Factors that Shift SRAS

Reasons for Fluctuations (Business Cycles)

A

Changes in Input (Resource) Prices

  • increase: SRAS v (GDP v, unemployment ^, prices ^)
  • decrease: SRAS ^ (GDP ^, unemp v, prices v)

Supply Shocks

  • supplies are plentiful: SRAS ^ (GDP ^, unemp v, prices v)
  • supplies are curtailed: SRAS v (GDP v, unemp ^, prices ^)
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20
Q

Economic Measures

A

most common: real GDP, unemployment rate, inflation rate, and interest rates
- these economic measures tend to move together

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21
Q

National Income Accounting System

A

National Income and Product Accounting (NIPA) system developed by US Dept of Commerce to monitor the health and performance of the economy

  • 2 methods for measuring GDP
  • combined economic output of 4 sectors is called GDP: households/consumers, businesses, governments, and the foreign sector
  • expenditures should equal income, that’s why they’re the 2 ways to measure GDP
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22
Q

2 Methods of Measuring GDP

A
  1. Expenditure Approach: sum of “GICE”
    - Government purchases
    - gross private domestic Investment (business)
    - personal Consumption expenditures
    - net Exports (exports - imports)
  2. Income Approach: sum of “I PIRATED”
    - Income of proprietors
    - Profits of corporations
    - Interest (net)
    - Rental income
    - Adj. for net foreign income and misc. items
    - Taxes (income of gov)
    - Employee compensation (wages)
    - Depreciation (aka capital consumption allowance)
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23
Q

Other Measures of National Income

A

Net Domestic Product (NDP)
- GDP minus depreciation (the capital consumption allowance)

Gross National Product (GNP)

  • market value of final goods and services produced by residents of a country in a given time period
  • diff from GDP bc includes production by US firms overseas and excludes production in US by foreign firms

Net National Product (NNP)
- GNP minus economic depreciation

National Income (NI)
- NNP less indirect business taxes
Personal Income (PI)
- income received by households and noncorporate businesses

Disposable Income (DI)

  • personal income less personal taxes
  • amt of income households have to either spend or save
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24
Q

The Unemployment Rate

A

ratio of # of ppl classified as unemployed to the total labor force
- the total labor force: all non-institutionalized individuals 16+ who are working or actively looking for work

unemployment rate = (# of unemployed / total labor force) * 100

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25
Q

Types of Unemployment

A
  1. Frictional Unemployment
    - normal unemp. from workers routinely changing jobs or being temporarily laid off
  2. Structural Unemp
    - jobs available in the market do not correspond to skills of the workforce or unemployed workers do not live where the jobs are located
  3. Seasonal Unemp
    - seasonal changes in the demand and supply of labor
  • frictional, structural, and seasonal are normal
  1. Cyclical Unemp
    - resulting from declines in real GDP during periods of contraction or recession in any period when the economy fails to operate at its potential
    - caused by decrease in AD or SRAS
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26
Q

Natural Rate of Unemployment and Full Employment

A

Natural Rate of Unemployment: normal rate of unemployment

  • sum of frictional, structural, and seasonal unemployment
  • unemployment rate that exists when economy is at its potential output level

Full Employment: no cyclical unemployment

  • does not mean 0 unemployment
  • when economy is operating at full employment, there is still frictional, structural, and seasonal unemp (natural rate)
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27
Q

Inflation and Deflation

A

Inflation

  • sustained increase in general prices
  • from increase in AD or decrease in SRAS

Deflation

  • sustained decrease in general prices
  • from decrease in AD or increase in SRAS
  • most economists believe deflation is a bigger problem than inflation bc consumers hold off on purchasing bc they expect prices to continue to decline, thus profits will fall
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28
Q

Inflation/Deflation Rate

A

= the % change in the consumer price index (CPI) from one period to the next

  • CPI is a measure of the overall cost of a fixed basked of goods and services purchased by an average household
    = (current cost of market basked / base year cost of market basket) * 100

Inflation Rate = (CPI CY - CPI PY) / CPI PY * 100

Producer Price Index (PPI)
- measures overall cost of a basket of goods and services typically purchased by firms

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29
Q

Causes of Inflation and Deflation

A

inflation and deflation are caused by shifts in AD and SRAS curves

  1. Demand-Pull Inflation
    - caused by increases in AD
    - ^ gov spending, v taxes, ^ wealth, or ^ in money supply
  2. Cost-Push Inflation
    - caused by decrease in SRAS
    - ^ in oil prices or ^ in nominal wages
  3. Deflation
    - increase in AD or decrease in SRAS
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30
Q

Inflation and the Value of Money

A

inflation has an inverse relationship w purchasing power

Monetary Assets and Liabs
- fixed in $ amt regardless of changes in prices

Nonmonetary Assets and Liabs
- fluctuate w inflation and deflation

In in inflationary economy:

  • holding monetary asset: lose purchasing power
  • holding monetary liabilities: gain purchasing power

Stagflation
- unemployment ^ and prices ^

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31
Q

Inverse Relationship b/w Inflation and Unemployment

A

The Phillips Curve

  • inflation and unemp have inverse relationship in SR illustrated by The Philips Curve
  • when AD ^ causes inflation so prices ^ and unemp v
  • in oil shocks of 1970s TPC broke down and both unemp and prices increased bc inflation caused by SRAS instead of AD
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32
Q

Budget Deficits and Surpluses

A

Budget Deficits: when country spends more than it takes in

  1. Financing Budget Deficits: usually by government borrowing, which affects interest rates
    - could also by printing new money, but causes inflation so no
  2. Cyclical Budget Deficit: temporarily low economic activity
  3. Structural Budget Deficit: caused by a structural imbalance b/w gov spending and revenue

Budget Surplus: gov revenues > gov spending

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33
Q

Nominal and Real Interest Rates

A

Nominal Interest Rate

  • amt of interest paid or earned measured in current dollars
  • not adjusted for inflation

Real Interest Rate
- measure of purchasing power of interest earned or paid
= nominal interest rate - inflation rate

Relationship b/w them

  • they naturally move together
  • nominal interest rate = real interest rate + inflation
34
Q

Definition of Money and the Money Supply

A

Money: set of liquid assets that are gr accepted in exchange for goods and services

Money Supply: stock of all liquid assets available for transactions in the economy at any given point in time

M1: money used for purchases of goods and services
- coins, currency, checkable deposits, and traveler’s checks

M2: M1 + liquid assets that cannot be used as medium of exchange but can be converted easily into M1
- CDs < 100,000, money market accounts, mutual fund accounts, and savings accounts

M3: M2 + CDs > 100,000

35
Q

Monetary Policy

A

use of the money supply to stabilize the economy

  • the Federal Reserve uses monetary policy to increase or decrease the money supply in an effort to promote price stability and full employment
  • changes in money supply lead to changes in interest rates, price level, and real GDP
  • FR controls the money supply through:
  1. Open Market Operations (OMO): purchase and sale of government securities in the open market by the FR
    - most common method used by FR to impact monetary policy
    - increase in MS: FR purchases gov. securities (MS ^ IR v AD ^)
    - decrease in MS: FR sells gov. securities (MS v, IR ^, AD v)
  2. Changes in the Discount Rate
    - discount rate: interest rate the FR charges member banks for ST (normally overnight) loans
    - raising the disc. rate discourages borrowing by member banks and decreases the money supply (contractionary)
    - lowering the disc. rate encourages borrowing by member banks and increases the money supply (expansionary)
  3. Changes in Required Reserve Ratio (RRR)
    - required reserve ratio: fraction of total deposits banks must hold in reserve/cannot loan
    - raising the RRR decreases the MS
    - lowering the RRR increases the MS

Quantitative Easing: Fed buys financial assets (gov securities and other securities) from banks in order to increase money supply

36
Q

Interest Rates and the Demand for and Supply of Money

A

Demand for Money is Inversely Related to Interest Rates

  • as IR ^, becomes more expensive to hold money rather than saving or investing and earning interest, thus reducing demand for money
  • money demand is downward sloping

Supply of Money is Fixed at a Given Point in Time

  • money supply is vertical
  • at a level set by the Fed
  • the intersection of the money demand curve and the money supply line determines the interest rate
  • an ^ in MS will cause IR to fall
37
Q

Monetary Policy and Its Effects on Interest Rates, The Price Level, Output (Real GDP), and Unemployment

A

Expansionary Monetary Policy
- MS ^, IR v, AD ^, GDP ^, unemp v, prices ^

Contractionary Monetary Policy
- MS v, IR ^, AD v, GDP v, unemp ^, prices v

38
Q

Demand Curve

A

illustrates the max qty of a good that consumers are willing and able to purchase at any given price, all else being equal

  • similar to AD curve, except x-axis is quantity not real GDP
  • downward sloping
39
Q

Quantity Demanded

A

qty of good individuals are willing and able to purchase at each and every price, all else being equal

40
Q

Change in Quantity Demanded

A

change in amt of good demanded resulting solely from change in price
- movement along the demand curve

41
Q

Change in Demand

A

change in amt of a good demanded resulting from a change in something other than the price
- shift of the demand curve

42
Q

Fundamental Law of Demand

A

states the price of a product and the quantity demanded are inversely related for 2 reasons:

  1. Substitution Effect
    - consumers tend to purchase more of a good when its price falls in relation to the price of other (substitute) goods
    - ppl tend to substitute one good for another when the price of a good they usually purchase increases
  2. Income Effect
    - as prices are lowered w income remaining constant, ppl will purchase more of all of the lower-priced products
43
Q

Factors That Shift Demand Curves (other than price)*

A

“WRITEN”

  • change in Wealth
  • change in price of Related goods (substitutes and complements)
  • change in consumer Income
  • change in consumer Tastes or preferences
  • change in consumer Expectations
  • change in Number of buyers served by the market (^, D^)
44
Q

Supply

A

fundamental law of supply states that price and quantity supplied are positively related
- upward sloping

Supply Curve

  • illustrates the max qty of goods sellers are willing and able to produce at any given price, all else being equal
  • similar to AS, except x-axis is qty not real GDP

Quantity Supplied

  • determined by price
  • amt producers are willing and able to produce at a given price

Change in Qty Supplied (move along supply curve)
- change in amt producers are willing and able to produce resulting solely from change in price

Change in Supply (shift supply curve)
- change in amt of a good supplied resulting from change other than price

45
Q

Factors That Shift Supply Curves

A

“E COST”

  • change in price Expectations of the supplying firm
  • change in Production costs
  • change in price or demand for Other goods
  • change in Subsidies or taxes
  • change in production Technology
46
Q

Market Equilibrium

A

point where the supply and demand curves intersect
- aka market clearing price

if price is below equilibrium price

  • price ceiling
  • shortage will result

if price is above equilibrium price

  • price floor
  • surplus will result
47
Q

Changes in Equilibrium

A

if supply and/or demand curves shift, the equilibrium price and quantity will change

  • effects of change in demand
  • effects of change in supply
  • B5-33
48
Q

Elasticity

A

measure of how sensitive the demand for, or the supply of, a product is to a change in price

49
Q

Price Elasticity of Demand

A

= % change in qty demanded / % change in price

  • in a normal demand curve, the price elasticity of demand is usually negative bc as price goes up (positive), the qty demanded goes down (negative)
  • thus, the absolute value of the elasticity coefficient is considered

Price Inelasticity

  • absolute price elasticity of demand < 1
  • if price inelasticity is 0, demand is perfectly inelastic and demand stays the same no matter how price changes

Price Elasticity
- absolute price elasticity of demand > 1

Unit Elasticity
- absolute price elasticity of demand = 1

Factors Affecting Price Elasticity of Demand

  • more elastic w more substitutes, less for few substitutes
  • the longer the time period, the more produce demand becomes elastic bc more choices are available

Price Elasticity Effects on Total Revenue

  • price inelasticity (+ relationship) P^, R^
  • price elasticity (- relationship) P^, Rv
  • unit elasticity, no effect
50
Q

Price Elasticity of Supply

A

= % change in qty supplied / % change in price

Price Inelasticity: e. supply < 1
- perfectly inelastic: e. supply = 0

Price Elasticity: e. supply > 1

Unit Elasticity: e. supply = 1

Factors Affecting Price Elasticity of Supply

  • feasibility of producers storing the product will affect the price elasticity (if perishable, even if prices increase they physically can not produce more)
  • time required to produce will affect the price elasticity of supply
51
Q

Cross Elasticity

A

= % change in # of units of X demanded (supplied) / % change in price of Y

Substitute Goods
- if coefficient is positive

Complement Goods
- negative coefficient

if coefficient is 0
- the goods are unrelated

52
Q

Income Elasticity of Demand

A

= % change in # of units demanded / % change in income

Positive Income Elasticity

  • normal good
  • as income increases, demand goes up

Negative Income Elasticity

  • inferior good
  • as income increases, demand goes down
53
Q

Production Measures

Production Costs in the SR

A

used by companies to evaluate optimal production levels based on available inputs

3 main production measures are:

  1. Total Product (TP): total amt of output (Q) produced
  2. Marginal Product (MP): change in TP resulting from 1 unit increase in the qty of an input
  3. Average Product (AP): total product divided by qty of an input
54
Q

Law of Diminishing Returns

Production Costs in the SR

A

states that when more and more units of an input are combined w a fixed amt of other inputs, output increases but at a diminishing rate
- one of the main economic concepts that governs production

55
Q

Cost Functions

Production Costs in the SR

A

4 major cost functions:

  1. Average Fixed Cost (AFC) = total FC / quantity (Q)
  2. Average Variable Cost (AVC) = total VC / quantity (Q)
  3. Average Total Cost (ATC) = total costs (TC) / quantity (Q)
  4. Marginal Cost (MC) = change in total cost associated w a change in output quantity over a period
    - depends solely on VC, not FC
56
Q

Analysis of SR Cost Curves

B5-42

A
  • AFC curve decreases continuously
  • ATC is the sum of AFC and AVC. Thus, the vertical distance b/w AVC and ATC is equal to AFC
  • ATC curve is U- shaped; at low lvls of output, ATC are high bc AFC are high; as output increases, MC and AC increase, causing ATC to rise
  • MC intersects the AVC and ATC curves at their minimum points
  • SR supply curve is the MC curve above the min. point of its AVC curve
57
Q

Production Costs in the LR

A
  • in the LR, all resource inputs are variable
  • gr, the LR ATC curve is u shaped; thus, optimal size or # of plants is at the minimum point

Economies of Scale

  • comps are able to reduce per-unit costs by using large plants to produce large amts of output
  • reductions in unit costs from increased size of operations
  • economies of scale will eventually be lost and diseconomies of scale will result
  • factors enabling economies of scale: 1. opportunity for specialization 2. utilization of advanced technology 3. mass production is normally more efficient

Diseconomies of Scale

  • may occur when these large firms become inefficient and are no longer cost productive
  • increases in avg costs of operations resulting from problems in managing large-scale enterprises
  • factors causing diseconomies of scale: 1. bottlenecks and costs of transporting materials 2. difficulty of supervising and managing a large bureaucracy
58
Q

Perfect (Pure) Competition

A

no individual firm can influence the market price of its product

  • large # of suppliers, firms are small relative to their industry
  • no barriers to entry
  • very little product differentiation
  • firms are price takers; price is set by market
  • firms control only qty produced
  • demand is perfectly elastic
  • bc no barriers to entry, entry and exit of new firms ensure that economic profits are zero in the LR; thus, firm earns a normal rate of return

Strategic Plans
- maintaining the market share and responsiveness to the sales price to market conditions

59
Q

Monopolistic Competition

A

many sellers compete to sell a differentiated product in a market into which the entry of new sellers is possible

  • numerous firms w differentiated products; firms are small relative to industry
  • few barriers to entry
  • some influence over price and market through differentiation, but have more control over qty produced than price
  • highly elastic, but downward sloping demand curve
  • zero economic profits in the LR

Strategies

  • maintaining the market share
  • enhanced product differentiation and advertising, marketing, etc
60
Q

Oligopoly

A

a few sellers dominate the sale of a product and entry of new sellers is difficult or impossible

  • few firms w differentiated products, firms are large relative to industry
  • fairly significant barriers
  • products are differentiated and firms have control over qty and prices
  • strongly independent firms*
  • face a kinked demand curve bc firms match price cuts of competitors but ignore price increases
  • economic profits positive in LR

Strategies

  • maintain market share
  • call for proper amt of advertising for product differentiation
  • ways to properly adapt to price changes
61
Q

Monopoly

A

concentration of supply in the hands of a single firm

  • single firm w a unique product
  • insurmountable barriers to market entry
  • price setters; sets both output and prices
  • no substitute products; demand is inelastic
  • economic profits are positive in LR bc of insurmountable barriers to entry

Strategies

  • ignore market share
  • focus on profitability from production lvls that max profits
62
Q

Market Assumptions and Conditions

A
  • regardless of the model, the firm will operate best when marginal revenue = marginal costs
  • microeconomic theory holds that firms make decisions based on MC and MR, ignoring FC/sunk costs
  • summary table B5-47
63
Q

Production and Demand for Economic Resources

Economy as a System of Markets

A

Factors of Production (resources)

  • primary resources: labor (human capital), land, and capital
  • bought and sold in markets just as final goods and services are
  • to max profits, firms need to decide optimal lvls of inputs

Types of Inputs

  1. Complementary Inputs
    - if an increase in usage of one input results in an increase in the usage of the other
  2. Substitute Inputs
    - if an increase in the usage of one input results in a decrease in the usage of the other

Derived Demand

  • demand for factors of production
  • demand for inputs is directly related to the demand for the goods and services those inputs produce
  • if marginal product of an input increases, the demand for that input will also increase
64
Q

The Labor Market

Economy as a System of Markets

A

just as in any other market, the supply of labor and demand for labor determines the price (wage) of workers

  • monopsony occurs when there is only 1 employer in a market; results in lower wages and lower lvls of employment
  • unions: workers gain market power to bargain for higher wages or restrict the supply of labor
  • wages in a nonunion sector may fall as a result of ^
  • min. wage laws: controversial
65
Q

Factors That Influence Strategy

A

firms use SWOT analysis to assist in developing their appropriate strategic plans

  1. Internal Factors (strengths and weaknesses) SW
    - innovation of product lines
    - competence of mgmt
    - core competencies
    - high-lvl managers
    - capital improvements
    - leadership in RnD
    - cohesiveness of values
    - marketing effectiveness
    - effectiveness of communication
    - clarity of the strategic mission
  2. External Factors (opportunities and threats) OT
    a) Factors that affect the Overall Industry and Competitive Environment of the Industry
    - B5-51
    b) Factors that affect the Competitive Environment of the Firm*
    - must know
    - porter’s 5 forces
66
Q

Five Forces that Affect the Competitive Environment of the Firm

A
  1. Barriers to Entry
    - Types of Barriers: government regulation, supplier aces, high up front capital requirements, preexisting customer preferences/loyalty, economies of scale, and other restrictions
    - if industry is earning a profit, other firms will want to enter the market. Unless barriers to entry exist, firms will enter until profits fall to a competitive level
    - high: oligopoly and monopoly; low: perfect competition and monopolistic competition
  2. Market Competitiveness
    - often the most significant of the 5 forces
    - the any of these are higher, the more competitive
    a) ability of rival firms to respond to change
    b) amt of money spent on advertising
    c) amt of money on research and development
    d) alliance of rival firms and suppliers
    e) competition even stronger force when market is not growing fast
  3. Existence of Substitute Products
    - if substitutes exist, buyers have a limit on the max price they’re willing to pay, this has a direct effect on profits of the firm
    - substitution increases elasticity: price ^, profits v
  4. Bargaining Power of the Customers
    - if buyers are in the position to bargain w suppliers, they are a strong force in the market in which they operate (Wal-Mart)
    - if one group of customers makes up a large volume of the firm’s business, the bargaining power of the customer will affect the competitive environment of the firm
  5. Bargaining Power of Suppliers
    - suppliers can take profits away from a firm by increasing the cost of the inputs to the firm’s production process
67
Q

Competitive Advantage in General

Types of Competitive Strategies

A

overall competitive advantage is determined by the value the firm offers to its customers minus the cost of creating that value

2 basic forms:

  1. Cost Leadership Advantage: able to produce and sell products for less than its rivals
    a) Build Market Share: lower price of product below competitors (profit through volume)
    b) Match Price of Rivals: bc lower costs, beat profitability of rivals
  2. Differentiation Advantage: “better” product, customers willing to pay a higher price for uniqueness
    a) Build Market Share: lower price below what it would charge to recoup the differentiation premium, but make it back through volume
    b) Increase Price: profit through revenue
68
Q

Five Basic Types of Competitive Strategies

Types of Competitive Strategies

A
  1. cost leadership focused on broad range of buyers
  2. cost leadership focused on narrow range of buyers
  3. differentiation focused on broad range of buyers
  4. differentiation focused on narrow range of buyers
  5. best cost provider: cost leadership + differentiation
69
Q

Cost Leadership Strategies

Types of Competitive Strategies

A

selling their product or service for less than rivals

Works Well
- in markets in which buyers have large amts of bargaining power and are able to switch b/w competitive products w/o incurring significant costs

Fail

  • if firms focus too much on cutting costs and overlook technological advances that could help lower costs
  • or overlook the fact that consumers want improvements on the product and dont care as much about lower price
70
Q

Differentiation Strategies

Types of Competitive Strategies

A

creating perception their product is better or unique

Works Well

  • when customers are able to see value in the product
  • when product appeals to different ppl for different reasons

Fail

  • cost > benefit
  • customers dont care about differentiation
71
Q

Best Cost Strategies

Types of Competitive Strategies

A

combines cost leadership w differentiation to give higher value (high quality product at reasonable price)

Work Well
- when generic products are not acceptable, but buyers are still sensitive to the value they’re receiving for the price

Fail
- bc best cost strategy plays the “middle”, faces risk of losing customers to those focused on either cost leadership or differentiation

72
Q

Focus/Niche Strategies

Types of Competitive Strategies

A

firms w cost leadership or differentiation strategies may choose to focus on a select small group of consumers, a niche

Work Well

  • if niche has large enough demand to create profit
  • few firms are focusing on the niche

Fail
- when other firms sees its successful, they’ll try to cater to the niche too

73
Q

Value Chain Analysis

A

strategic tool that assists a firm in determining how important its value is w respect to the market

  • managers must determine the flow of activities undertaken by the org to produce a product and critique the value added to the customer by each link in the value chain
  • helps assess the ability of the firm to obtain a competitive advantage
  • must be used in conjunction w the strategic plan of the org
  • what adds value to the customer?
74
Q

Approach of Value Chain Analysis

Value Chain Analysis

A

3 major forms of analysis are performed

  1. Internal Cost Analysis
    - source of profit and costs of the internal activities
  2. Internal Differentiation Analysis
    - create value through differentiation
  3. Vertical Linkage Analysis
    - understanding the activities of the suppliers and buyers of the product and determining where value can be created external to the firm’s operations
75
Q

Steps in Value Chain Analysis

Value Chain Analysis

A
  1. Identify Value Activities
    - gr processes that involve designing, preparing, manufacturing, and delivering a good or service
  2. Identify Cost Drivers
    - cost driver: factors that increase TC
    - helps determine areas in which it has a competitive advantage
    - also might identify areas in which outsourcing is valuable
  3. Develop a Competitive Advantage
    - cost leadership strategies will look at cost-saving opps
    - differentiation strategies will look at innovation opps
    - analysis of cost drivers should show where org is not competitive, elimination or outsourcing of those items is gr proposed
  4. Exploit Linkages Among Activities in the Value Chain
    - analysis of value chain may show synergies that can create greater efficiencies or value
    - each step of the value chain should produce some value
76
Q

Global Competitive Advantage and Value Chain Analysis

Value Chain Analysis

A 
Michael Porter (also did 5 forces) focused on competitive forces that exist globally for worldwide competitive advantage
- when various parts of the value chain exist in diff parts of the world, may pose problems of cost of transportation and lack of control and communication

4 major factors that impact global competitive advantage:

  1. conditions of Factors of Production
    - strong set of land, labor, and capital is good
  2. conditions of Domestic Demand
    - demand w/i the nation is high, good
  3. Related and Supporting Industries
    - if suppliers exist w/i the nation, it’s good!
  4. Firm Strategy, Structure, and Rivalry
    - laws and regulations of the nation
    - management and organization
77
Q

Integrated Supply Chain Management (ICSM) and benefits

A

exists when a firm and the entire supply chain (producers, distributors, retailers, customers, and service producers) are able to reasonably predict the demand of consumers for a product and plan accordingly to meet the demand

  • collaborative effort b/w buyers and sellers
  • goal: to understand needs and preference of customers

Benefits

  • reduce cost in inventory mgmt
  • reduce cost in warehousing
  • reduce cost in packaging
  • enhance revenues
  • improve service times
  • improve delivery times
  • identification of inefficiencies in supply chain activities
78
Q

Supply Chain Operations Reference (SCOR) Model

Integrated Supply Chain Management (ICSM)

A

assists a firm in mapping out its true supply chain and configuring it to best fit the needs of the firm

  • developed by the Supply Chain Council
  • 4 key mgmt processes or activities
  1. Plan
    - developing a way to balance demand and supply w/i goals and objectives of the firm and prepare for necessary infrastructure
  2. Source
    - obtain resources for production
  3. Make
    - production
    - turn raw materials into finished products that are produced to meet a planned demand
  4. Deliver
    - all activities of getting finished product into hands of consumers to meet planned demand
79
Q

returns to scale

A

focus on relationship b/w input and output quantities

- when output increases by less than the proportional change in inputs, that is decreasing returns to scale

80
Q

compared to firms in a perfectly competitive market, a monopolist tends to

A

produce substantially less but charge a higher price

CPA BEC (7 decks)

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