Market Influences on Business

Question 1

What is the demand curve?

Answer 1

it illustrates the maximum quantity of a good that consumers are willing and able to purchase at each and every price, all else being equal

Question 2

What is quantity demanded?

Answer 2

it is the quantity of a good or service individuals are willing and able to purchase at each and every given price, all else being equal

Question 3

What is change in quantity demanded?

Answer 3

it is movement along the demand curve; it is a change in the amount of a good demanded resulting solely from from a change in the price

Question 4

What is change in demand?

Answer 4

it is movement of the demand curve; it is a change in the amount of a good demanded resulting from a change in something other than the price of the good; a change in the demand cannot be due to a change in price

Question 5

What is the fundamental law of demand?

Answer 5

it states that the price of a product or service and the quantity demanded of that product or service are inversely related; as the price of the product increases (decreases), the quantity demanded decreases (increases); quantity demanded is inversely related to price for two reasons:

substitution effect - refers to the fact that consumers tend to purchase more (less) of a good when its price falls (rises) in relation to the price of other goods

income effect - as prices are lowered with income remaining constant, people will purchase more or all of the lower-priced products

Question 6

What are some factors that shift the demand curve other than price?

Answer 6

changes in wealth, changes in the price of related goods (substitutes and complements), changes in consumer income, changes in consumer tastes or preferences for a product, changes in consumer expectations, and changes in the number of buyers served by the market

Question 7

What is the supply curve?

Answer 7

it illustrates the maximum quantity of a good that sellers are willing and able to produce at each and every price, all else being equal

Question 8

What is quantity supplied?

Answer 8

it is the amount of a good that produces are willing and able to produce at each and every given price, all else being equal

Question 9

What is change in quantity supplied?

Answer 9

it is movement along the supply curve; it is a change in the amount producers are willing and able to produce resulting solely from a change in price

Question 10

What is change in supply?

Answer 10

it is movement of the supply curve; it is a change in the amount of a good supplied resulting from a change in something other than the price of the good; a change in supply cannot be due to a change in price

Question 11

What is the fundamental law of supply?

Answer 11

it states that price and quantity supplied are positively related; the higher the price received for a good, the more sellers will produce

Question 12

What are some factors that shift the supply curve other than price?

Answer 12

changes in price expectations of the supplying firm, changes in production costs (price of inputs), changes in the price or demand for other goods, changes in subsidies or taxes, and changes in production technology

Question 13

What is market equilibrium?

Answer 13

when there are no forces acting to change the current price/quantity combination; the market supplies just as much as is demanded, and there is no pressure to change prices

Question 14

What happens when there are changes in equilibrium?

Answer 14

if supply and/or demand curves shift, the equilibrium price and quantity will change; market clearing quantity is the equilibrium quantity; market clearing is the idea that the market will eventually be cleared of all excess supply and demand (all surpluses and shortages), assuming that prices are free to change

effects of a change in demand on equilibrium - a rightward shift of the demand curve will result in an increase in price and an increase in market clearing quantity while a leftward shift of the demand curve will result in a decrease in price and a decrease in market clearing quantity

effects of a change in supply on equilibrium - a rightward shift of the supply curve will result in a decrease in price and an increase in market clearing quantity while a leftward shift of the supply curve will result in an increase in price and a decrease in market clearing quantity

general effects of changes in demand and supply on equilibrium - an increase in demand and supply results in an increase in equilibrium quantity, but the effect on price is indeterminate; if the increase in demand is larger than the increase in supply, the equilibrium price will rise; conversely, if the increase in supply is larger than the increase in demand, the equilibrium price will fall

Question 15

What is a price ceiling?

Answer 15

it 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 (this is government intervention)

Question 16

What is a price floor ?

Answer 16

it is a minimum price set above the equilibrium price which causes surpluses to develop; price floors are minimum prices established by law, such as minimum wages and agricultural price supports (this is government intervention)

Question 17

What is elasticity?

Answer 17

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

price elasticity of demand - it is the percentage change in quantity demanded divided by the percentage change in price

formula: price elasticity of demand = % change in quantity demanded / % change in price

interpretation of price elasticity of demand:

inelastic - absolute price elasticity of demand < 1.0 (0 = perfect inelasticity)

elastic - absolute price elasticity of demand > 1.0

unit elasticity - absolute price elasticity of demand = 1.0

price elasticity of supply - it is the percentage change in quantity supplied divided by the percentage change in price

formula: price elasticity of supply = % change in quantity supplied / % change in price

interpretation of price elasticity of supply:

inelastic - absolute price elasticity of supply < 1.0 (0 = perfect inelasticity)

elastic - absolute price elasticity of supply > 1.0

unit elasticity - absolute price elasticity of supply = 1.0

factors affecting price elasticity of supply: the feasibility of producers storing the product will affect the price elasticity of supply (ex. storing a perishable vs a nonperishable item; it is more difficult to increase the supply of perishable items when the prices rise); the time required to produce and supply the good will also affect the price elasticity of supply (ex. longer production time leads to lower price elasticity)

Question 18

What is cross elasticity and income elasticity of demand?

Answer 18

cross elasticity of demand (or supply) is the percentage change in the quantity demanded (or supplied) of one good caused by the price change of another good

formula: cross elasticity of demand (supply) = % change in number of units X demanded (supplied) / % change in price of Y

interpretation of cross elasticity:

substitute goods - positive coefficient (the price of Y goes up which causes the demand for X to go up)

complementary goods - negative coefficient (the price of Y goes up which causes the quantity demanded for X to go down)

unrelated goods - the coefficient is zero

income elasticity of demand measures the percentage change in quantity demanded for a product for a given percentage change in income

formula: income elasticity of demand (supply) = % change in number of units of X demanded (supplied) / % change in income

interpretation of income elasticity of demand:

positive income elasticity = normal good; as income goes up, demand goes up

negative income elasticity = inferior good; as income goes up, demand goes down

Question 19

What is inflation?

Answer 19

it is a sustained increase in the general prices of goods and services; it occurs when prices on average are increasing over time; inflation has an inverse relationship with purchasing power; as the price level rises, the value of money (purchasing power) declines

alternative investments (ex. real estate, precious metals, energy, etc.) may be used to effectively hedge against inflation

Question 20

What are factors that influence strategy?

Answer 20

firms use the SWOT analysis to assist in devleoping their appropriate strategic plans; any strategy must consider these factors in its development

internal = strengths (S) and weaknesses (W)

external = opportunities (O) and threats (T)

Question 21

What is Porter’s Five Forces?

Answer 21

barriers to entry - the firm faces the threat of new firms entering the market in which it operates; new companies will attempt to enter the competition when barriers to entry are low, potential high profits exist in the market, and the risk of retaliation by other firms is low; unless barriers to entry exist, firms will enter until profits fall to a competitive level

types of barrier to entry include: government regulation, supplier access, high up-front capital requirements, pre-existing customer preferences and loyalties, economies of scale, learning-curve issue, and other up-front competitive cost disadvantages like patents and trade barriers

market competitiveness (intensity of competition) - the existence of competition from rival firms is often the most significant of the five forces of competition; competition is increased when rival firms can respond to changes in input costs, technology changes, etc.; rival firms spend significantly on advertising and R&D; there are strong alliances between rival firms and suppliers; market growth has slowed, such that increasing market share is the only way to sustain profitability; and the cost to exit the market exceeds the cost of staying in the market

existence of substitute products - if the firm faces heavy competition from substitute products, the ability of a firm to sustain profits is significantly affected by the maximum amount that buyers are willing to pay for a product; this is especially true if the substitutes are readily available to consumers, have equal performance, and are priced at or below the price of the firm’s product; the effect is further intensified when the costs of the buyer switching to the substitute product are low; if few substitutes exist, buyers have little choice of products and may be willing to pay a higher price for the products that are available; if close substitutes exist, buyers may have a limit on the maximum price that they are willing to pay, and this has a direct effect on the profits of the firm

bargaining power of the customers - if buyers are in the position to bargain with suppliers on the conditions of service, price, and quality, they are a strong force in the competitive market in which the firm operates; buyers may be quite price sensitive and change products solely based on price, or they may have such brand loyalty and strong preferences that they will stay with a product regardless of price (oftentimes depending on the elasticity of demand); consumer bargaining power is increased when a customer group makes up a large volume of a firm’s business (high buyer concentration), information is readily available, there is a low cost to the buyer of switching products, there is a high number of alternative suppliers

bargaining power of the suppliers - when the bargaining power of the suppliers of inputs to the production process is high, supplies can take profits away from a firm simply by increasing the cost of the inputs to the firm’s production process; supplier bargaining power is increased when a firm is unable to change suppliers and the supplier has an excellent reputation, such that there is plenty of demand for its goods/services from other firms

Question 22

What is competitive advantage?

Answer 22

building a successful competitive strategy requires being able to attain some sort of competitive advantage while still holding customer loyalty and having value for the customer

the overall competitive advantage of a firm is determined by the value the firm offers to its customers minus the cost of creating that value; firms that seek to achieve competitive advantage with respect to products will choose from two basic forms of advantage

cost leadership advantage - this stems from the fact that the buyers of the product are better off because the firm has been able to produce and sell its product for less than its rivals; if the total costs of the firm are less than those of rival firms, the first has a competitive market advantage; this advantage may be used by the firm by building market share and by matching the prices of its rivals

differentiation advantage - this stems from the fact that buyers are better off because the customer perceives the firm’s product to be superior in some way to those of its rivals; therefore, they are willing to pay a higher price for its uniqueness; all parts of the buying decision are affected by the perceived value of the product (quality, service, timeliness of delivery, etc.); after the product has been differentiated, the firm must always be sure to remain profitable and coup the cost of the premium included with the product; this advantage may be used by the firm by building market share and by increasing the price to the point at which it exactly offsets the value the customer perceives in the product

Question 23

What are some types of competitive strategies other than competitive advantage?

Answer 23

the basic types of competitive strategies that firms can employ include cost leadership focused on broad or narrow (niche) ranges of buyers, differentiation focused on broad or narrow (niche) ranges of buyers, and best cost provider

organizations may choose to achieve their organizational missions by selling their product or service for less than any other participant in the marketplace; cost leaders undermine the profitability of their competitors as a means of achieving overwhelming market share; cost leadership strategies work well when buyers have bargaining power and low switching costs, and price competition is heavy; cost leadership strategies fail when cost cutting is excessive, and when customers are not as willing to sacrifice quality for cost

organizations may choose to achieve their organizational missions by creating the perception that their product is better or has a unique quality that differentiates it from competitors in the marketplace; firms that successfully differentiate their products are able to command higher prices; differentiation strategies work well when customers see the value in products and are willing to pay for uniqueness; differentiation strategies fail when firms do not properly assess customer requirements, fail to create value exceeding cost, and when customers would rather pay less for more generic products

the best cost strategy combines the cost leadership strategy with the differentiation strategy to give customers higher value for their purchase price; if a firm is able to achieve the lowest cost among its closest competitors while matching them on features desired by consumers, it will succeed; best cost strategies work well when buyers are sensitive to price but generic products are unacceptable; best cost strategies may fail because a “middle” strategy will not appeal to customer who want either fully differentiated or low-cost products

firms with cost leadership or differentiation strategies may choose to focus their chosen strategy on a select, small group of consumers, or a niche where consumers have specialized needs and preferences; focus/niche strategies work well when the niche has large demand and there are few competitors, but they may fail when competitors see a profitable niche and enter the market, or when firms are not easily responsive to customer needs