B5 - Economic Concepts and Analysis Flashcards
What are the business cycles?
- Peak
- Recession (contraction)
- Trough
- Recovery (expansion)
What is a peak?
- The high point of economic activity.
- Firms’ profits are likely to be at the highest levels
- Firms are likely to phase capacity constraints and input shortages (raw material and labor) leading to higher costs and prices levels.
What is a trough?
- The low point of economic activity.
- Firms’ profits are likely to be at their lowest levels.
- Firms experience significant excess production capacity, leading them to reduce their workforce and cut costs.
- Unwillingness to risk investment.
What is an expansionary phase?
- It is characterized by rising economic activity (GDP) and growth.
- Firms are likely to invest and increase their workforce.
- Prices and goods are likely to be rising.
What is a recession?
When the economy experience negative economic growth (decline in national output). Potential output exceeds actual output. Real GDP is falling for at least 2 consecutive quarters.
When does a natural monopoly exists?
- A natural monopoly exists when economic and technical conditions permit only one efficient supplier.
- Unsurmountable barrier to entry (e.g., patent)
- Focus on maximizing profits, don’t worry about price.
- Single firm controls the entire market.
What is a tarrif?
- A tax assessed on imported goods.
- Generate revenue for domestic governments and help protect domestic producers by making imported goods more expensive and less attractive.
What is dumping?
Dumping occurs when the price charged to foreign customers on exported goods is less than either the price charged in the domestic market or less than the production cost.
What is the effect of the supply side inputs in the long-run?
In micro-economic analysis, in the long run all supply inputs are variable. In accounting terms, this means that in the long run all costs are variable (e.g., fixed costs of depreciation of a factory building becomes a variable cost when a secondary factory building is added).
When does a surplus result in a competitive model?
A surplus results when the quantity demanded will be less than the quantity supplied (e.g., government price support programs). A surplus results when minimum price is set above equilibrium.
When does a shortage result in a competitive model?
A shortage results when the quantity demanded will exceed the quantity supplied. A shortage results when maximum prices is set below equilibrium.
What is collusive pricing?
- Collusive pricing anticipates that competitors will collude or conspire to maintain prices and mutual profitability.
- Collusive pricing maintains prices to external customers at levels higher than they would be in a competitive market place.
What is dual pricing?
- Dual pricing involves assigning different prices to the same product in different market settings.
- Extension of competitive prices.
- results in higher prices than would be experienced in competitive markets.
What is predatory pricing?
- Predatory pricing typically result in lower prices to external customers than competitive pricing.
- It is undertaken by larger organizations that can absorb losses and deliberately do so in an attempt to drive smaller, less capitalized, competitors from the market place.
What is transfer pricing?
- Transfer pricing is the change made between affiliates for products or services.
- It may be at any level including cost and market and do no relate to the establishment of prices to external customers.
- The goal is to transfer as much cost as possible to the subsidiary with the highest tax rate.
What is elasticity of demand or supply?
it is a measure of how sensitive the demand for or the supply of a product is to change in its price.
What is the formula to compute price elasticity of demand?
- % change in Quantity demanded = new quantity - old quantity/old quantity
- % change in price = new price - old price/old price
- Price elasticity of demand = % change in quantity demanded/% change in price
If elasticity of demand is > 1.0 - it is elastic
if elasticity of demand is < 1.0 - it is inelastic.
What is the formula to compute price elasticity of supply?
- % change in Quantity supplied = new quantity - old quantity/old quantity
- % change in price = new price - old price/old price
- Price elasticity of supply = % change in quantity supplied/% change in price
If elasticity of supply is > 1.0 - it is elastic
if elasticity of supply is < 1.0 - it is inelastic.
If there is an increase in price, what is the impact in total revenue if there is a unit elastic demand?
If price increase and a unit elastic demand is used, there is no effect in total revenue.
What is an inferior good?
An inferior good is a product whose demand is inversely related to income (opposite of a normal good).
As income goes up, the demand for inferior goods decrease (e.g., hamburgers) - negative income elasticity.
What is hyperinflation?
Hyperinflation occurs when a country sees very high (and often accelerating) price level increases.
What is inflation?
Inflation is an increase in price over time.
What is deflation?
Deflation is a sustained decrease in the general price of goods and services. It occurs when prices on average are falling over time.
What is the formula to adjust an initial cost for inflation?
Real cost = initial cost before increase * (1+inflation rate)n
What is the formula to compute the cost of the debt principal adjusted for inflation?
Real Cost = Future value (debt principal amount owned at maturity)/(1 + inflation rate)n
What is demand-pull inflation?
Demand-pull inflation is the result of a surgent demand which can be caused due to a decrease in taxes (people has more money to spend)
What is cost-push inflation?
cost-push inflation happens as a result of an increase in the cost (e.g., minimum wages).
How do markets operate in a perfectly competitive market?
The firm exert no influence over the market price (thus, goods and services are produced at the lowest cost to the consumer in the long run).
How does the process of strategic planning begins?
strategic planning begins with defining the firm’s vision and mission statements and then moves to setting the goals and objectives of the firm before considering development of strategic plan.
What is strategic planning?
It is the creation of an overall strategic plan for an organization to achieve it’s overall “business objectives.” it establishes the general direction of the organization.
What are Michael Porter’s 5 Forces of profitability?
- Barriers to entry - high
- Intensity of Rivalry - low
- Existence of substitutes - not many substitutes for our product
- Bargaining power of our customers - low
- Bargaining power of our suppliers - low
What is a horizontal combination?
It occurs when companies in the same industry that produce the same goods or provide the same service join together under single management/leadership.
What is a vertical combination?
It involves the combination of companies at different stages of the production process. The companies can be from the same industry or multiple industries. It helps assure the supply of raw materials (backward integration), or, provide a stable market for products sold (forward integration).
What is a circular combination?
It occurs when different business units with relatively remote connections come together under single management. The relationship could come from using similar distribution advertising channels, or requiring similar production processes. Having one management group reduces administrative cost.
What is Diagonal Combination?
It occurs when a company that engages in an activity integrates with another company that provides ancillary support for that primary activity. The purpose is that it’s delivered in a timely manner (e.g., the acquisition of a shipping company to deliver the fresh fish from the retailer at a lower cost).
What is a merger?
Two similar asset size companies combine to create a new legal entity. The common stock of the two companies is surrendered and replaced with shares in the new company. A + B = C
What is a tender offer?
When a company makes an offer to the shareholders of a company to buy the outstanding shares of another company at a specified price.
What is the purchase of assets?
The transaction occurs when a portion (or all) of the selling company’s assets are purchased by the acquiring company, which may result in the dissolution of the selling company. As with a tender offer, shareholder approval must be obtained.
What is an equity-carve out?
Occurs when a subsidiary is made public through an IPO, thereby creating a new publicly listed company. This happens because the subsidiary is not performing well in the organization. The parent receives cash from the sale and retains the controlling interest in the sub.
What is a spin-off?
The creation of a completely new company through separating a subsidiary from the parent company. It occurs when a unit is less profitable and/or unrelated to the core parent business. This is performed by distributing stock in the new entity as a stock dividend or by offering shareholders stock in the new company.
What is sell-off?
It is an outright sell of the subsidiary because the sub’s core competencies do not align with the overall company’s or because there is a lack of synergy between the company and the sub.
What is comparative advantage?
Specialization in the production and trade of specific products produces a comparative advantage in relation to trading partners. Countries and companies use comparative advantage to maximize the value of their efforts and resources.
What is the risk of inflation when conducting international business operations?
- Higher local (economy) inflation reduces purchasing power, making imported goods more expensive and reducing local demand.
- Lower local (economy) inflation increases the purchasing power for imported goods, resulting in higher local demand.
When is the supply price inelastic?
- Price elasticity of supply equals zero
- When the supply curve is vertical
- when the price elasticity of demand is < 1.0
- When firms cannot vary inputs usage
What is a price ceiling?
A price ceiling is a maximum price that is established below the equilibrium price which causes shortages to develop. Price ceilings cause prices to be artificially low, creating a greater demand than the supply available.
What is a price floor?
A price floor is a minimum price set above the equilibrium price which causes surpluses to develop. Price floors are minimum price established by law, such as minimum wages and agricultural price supports.
What is the effect of profits in the long-run in a monopolistic competition?
in the long-run, economic profits are zero. As other firms enter the market because there is a profit potential, more entrants contribute more of the product to the market, which lowers the market price of goods and has an equalizing effect on profit. The industry reaches a state of normal profit as prices stabilize and profits decline.
What is the effect of profits in the short-run in a monopolistic competition?
In the short-run, differentiation allows firms to earn positive economic profits.
How does elasticity of demand behaves when the price of a product rises?
If the price of a product rises, the quantity demanded goes down (inverse relationship). Business will increase price to increase revenue but at some point, an increase in price will reduce quantity demanded and actually result in a decrease in revenue.
What are sourcing requirements?
Government may provide tariff reductions to companies whose imports include specified percentages of material and labor in their products.
What are foreign trade zones?
Contemplates a physical location in which tariffs are waived on imported products until they leave the zone. Foreign trade zones anticipate delay rather than reductions in tariffs.
What is value added tax?
It’s an incremental tax, not a reduction in tariffs.
What are economic indicators?
Economist attempt to predict business cycles, their severity and duration using economic indicators.
What are the 3 types of economic indicators?
- Leading
- Lagging
- Coincident economic indicator
What is leading indicator?
Tend to predict economic activity. They change before the economy starts to follow a certain trend.
What are examples of leading indicators?
- Avg. new unemployment claims
- Building permits for residences
- avg. length of the workweek
- Money supply (M2)
- S&P 500 stock index
- Order for goods
- Price change of materials.
- Index of consumer expectations
- interest rate spread
- index of supply deliveries
What is lagging indicator?
Tends to follow economic activity. They change after a given economic trend has already started. give signals after the fact. Used to confirm or dispute previous forecasts and effectiveness of policy directives.
What are examples of lagging indicators?
- Prime rate charged by banks
- Avg. duration of unemployment
- Commercial and industrial loans outstanding
- Consumer price index for services
- Consumer debt-to-income ratio
- changes in labor cost per unit of manufacturing output
- inventories-to-sale ratio
What is coincident indicators?
The change at approximately the same time as the whole company, thereby providing information about the current state of the economy. Used to identify, after the fact, the timing of a peak or trough.
What are examples of coincident indicators?
- Manufacturing and trade sales
- Industrial production (GDP)
- Personal income less transfer payments
What does the barriers to entry force from Michael Porter refer to?
- You don’t want any new firms to enter the market.
- Rival firms face barriers to entry in the form of government regulations, supplier access, high up-front capital requirements, preexisting customer preference and loyalties, economies of scale, learning-curve issues, and other up-front competitive costs.
- Barriers to entry have to be high to be profitable
What does the market competitiveness force from Michael Porter refer to?
- Intensity of rivalry against competitors to get the business.
- most important of all forces.
- Rivals respond to each other changes in prices and demand (e.g., if i lower price, you lower price as well)
- High market competitiveness, lower profitability.
What does the existence of substitutes force from Michael Porter refer to?
Firms face heavy competition from substitute products, buyers have more choices. Buyers can search the internet for low prices (information available)
How do substitutes affect demand?
- If buyer can easily switch from our product to a substitute, then low profitability, and demand for product is more elastic.
- If few substitutes exist, then high profitability and demand for product is inelastic
What does the bargaining power of customers force from Michael Porter refer to?
if bargaining power of customers is high, customers will be more sensitive to a change in price, more elastic, and lower profitability for the firm.
What does the bargaining power of suppliers force from Michael Porter refer to?
if suppliers have the bargaining power, it’s negative because supplier might not want our business but we need the supplier’s inputs, which could drive the cost of our inputs up and bring profitability down.
We prefer to have lots of suppliers and more alternatives.
What are the characteristics of an oligopoly?
- Fewer sellers with significant barriers to entry (e.g., high capital costs, need a huge plant)
- Not a lot of new players because barriers to entry are significant.
- Differentiated products and firms have control over quantity produced (production volume) and the price changed.
- Positive economic profits
- Focused on advertising for differentiation and market share.
- kinked demand curve
What is the formula to calculate the price elasticity under the midpoint method?
elasticity of demand = (new quantity - old quantity)/(new quantity + old quantity) divided by (new price - old price)/(new price + old price)
What are the characteristics of a monopolistic competition?
- Many sellers, differentiated products.
- Few barriers to entry, some influence over price because product is somewhat differentiated.
- Maintain market share
- Focus on product or service innovation (research)
- Invest in advertising, customer relations to convince customers of differentiated products.
- Downward sloping, fairly elastic demand
- Normal profits, no positive economic profits.
What are the characteristics of a perfect competition?
- large number of sellers, each too small to affect the price of the product/service
- Each firm sells an identical service
- no barriers to entry, easy access to market
- firm’s demand curve is perfectly elastic (horizontal line)
- No product differentiation.
- key to success is to be the lowest cost producer in the market (produce at the lowest output rate)
- No innovation, and prices have to be kept low to survive.
- goods/services are produced at the lowest cost to consumers in the long-run.
What are the characteristics of a contractionary policy when using monetary policy?
- Sell government securities to get the cash back
- Increase the discount rate - bank will borrow less from Fed.
- Increase the reserve requirement. Money will shut in
What are the characteristics of an expansionary policy when using monetary policy?
- Buy US Treasuries, releases more cash into the market - expansionary, interest rate will fall.
- Lower the discount rate - more banks will borrow from Fed.
- Reduce reserve requirements - bank will lend more
When will the Fed use a contractionary policy?
The Fed will use a contractionary policy to slow down the economy, when the concern is inflation.
When will the Fed use an expansionary policy?
Fed will use an expansionary policy to avoid recession.
What are the characteristics of a fiscal policy and when is it used?
Congress uses fiscal policy to avoid a recession.
Characteristics include:
1. spending more
2. Taxing less
What is the formula to compute unit elasticity of demand and/or supply?
Unit elasticity = (1 + change in price) * old units
How is income elasticity of demand computed?
income elasticity of demand = change in quantity (new quantity - old quantity/old quantity)/change in income (new income - old income/old income)
if income elasticity of demand > 0 - normal good
if income elasticity of demand < 0 - inferior good
if income elasticity of demand = 0 - no relationship
What are the 4 competitive strategies?
- Cost leadership (low cost)
- Differentiation leadership
- Cost focus
- Differentiation focus (Niche)
What are the characteristics of cost leadership (low cost) (broad)?
- Markets where business competes is broad
- low cost is the source of competitive advantage
What are the characteristics of differentiation leadership (broad)?
- Markets where business competes is broad
- Differentiation is the source of competitive advantage
What are the characteristics of cost focus (niche)?
- Markets where business competes is narrow
- low cost is the source of competitive advantage
What are the characteristics of differentiation focus (Niche)?
- Markets where business competes is narrow
- Differentiation is the source of competitive advantage
What is an acquisition?
The acquisition of one company by another company involves no new company. Only the acquirer remains after the acquisition. One large company buys a smaller company. A + B = A
What is the substitution effect?
Consumers tend to purchase more or less when the price changes. The quantity demanded is heavily dependent upon price. The substitution effect exists because people tend to substitute one similar good for another when the price of a good increases.
What is the formula to compute cross elasticity of supply?
Cross elasticity of demand/supply =
% change in quantity demanded/supplied of product A
divided: % change in price of product B
