Summary of Chapters
Summary of Chapters
Chapter 7: Commodity Markets
The customers are major players in the commodity market today. They are the major influencers of the market demand and supply. Demand refers to the ability and willingness of a consumer to purchase any given commodity per unit time. Supply refers to the quantity of commodity that a supplier is willing to offer at different market prices. An important aspect of the commodity market is the consumer sovereignty. This refers to the action of the markets of being fully dependent on the behavior of consumers. Suppliers respond to an increased demand by increasing their production and reduce production levels when the level of demand reduces.
The diagram above represents the demand and supply curves on the commodity market. The demand curve is represented by (D) and the supply curve is represented by (S). Equilibrium of the commodity market is determined by the point, which the two curves intersect. The point of intersection between the two curves represents the level in the market where the quantity of goods in demand is equal to the amount goods being supplied. Point Q denotes the equilibrium quantity while P is the equilibrium price. The producing firms are maximizing their profits at equilibrium therefore, have no incentive to produce. Significant changes in demand usually result in a change in the position of the demand curve.
Factors other than price of that commodity cause the shift of a demand curve to the right. This shift is caused by a change in factors other than the price of that commodity. These may include factors such as an increase in the price of other substitute commodities, an increase in the consumer’s income, a change in the consumer’s tastes and preferences and other factors that may increase the demand of the commodity. The increase in the level of demand results in a subsequent increase in the price of the product since the suppliers want to maximize on their profits. If the entry of the market is not restricted, firms will enter the market freely and supply will increase. Consumers will be unwilling to purchase at the current prices and as a result, the firms will be compelled to push the prices down in order to stimulate demand. If the entry into the market is restricted such as through regulations, firms will not be able to enter freely into the market and the buyers will be stuck with the high prices.
When demand decreases, the suppliers reduce their prices in order to encourage consumers to buy the commodity. Suppliers reduce their production in order to avoid making losses. This state of reduced demand may result in some firms making losses and this may compel them to exit the industry. A reduction in the number of suppliers in the market results in a shortage of goods in the market and the remaining suppliers push the prices upward to maximize on their profits moving the market to equilibrium. The entry and exit of firms from the market leaves the firm with very little profits in the long term.
In some instances, the firm may increase their prices to meet the rising costs of production. An increase in price will result in the consumers buying less. As a result, the suppliers will need to cut down on their production on order to maintain their profits. Some firms may not be able to sustain the negative profits that result from the reduced demand and will therefore exit the market. Once a significant number of firms have left the market, there will be a shortage of goods being supplied, the few remaining firms will increase their prices and people will be compelled to buy. The increased demand will result in a subsequent increase in supply of the product. Costs of production may reduce because of different factors such as technological advancement or labor that is more productive. These firms will lower their level of production in order to maintain the same level of profits and encourage the buyers to keep buying. The constant changes in the market forces result from consumer behavior and the entry and exit of firms into the market.
Chapter 8: Non-commodity Markets
In any common market structure, products being produced by different firms are usually heterogeneous. Each producer’s commodity has distinct features. Because of this, every supplier operates in his or her own individual market. In such a dynamic market, the supplier is able to make profits and the buyer has a wide variety of product to choose from depending on their tastes and preferences. Conversely, there may exist a few competing products in the market and in this case competition will be steep. In such cases, a firm is expected to maximize on their scarce resources in order to make profits. Government regulations and funding keeps large firms in the market to prevent free entry that may cause changes in prices in the market setting. The government would be required to take a pragmatic approach to ensure that firms stay in the market. This may be by facilitating the use of resources in new ways such as by retraining workers or short-term financing.
An efficient producer a non-commodity market maintains their profits through employment of the right production methods that save on cost and are still of good quality. Such a firm is able to maintain long-term profits. Product efficiency may also be possible when the firm utilizes their available resources at the least possible average costs. A firm may also be productive efficient when it employs the most efficient combination of currently available resources. Firms can only realize maximum profits if they ensure that they arrive to any of these three types of production efficiency. Although quite unlikely, it is possible for a firm to operate at these three types of efficiency. Blockage of firms from entry into the market helps sustain firms in a state of production efficiency. Free entry into the market will reduce the demand since the supply will have increased. A firm’s production efficiency will be reduced in such a situation. This simply means that non-commodity markets tend to be rather production inefficient. They however give consumers a wide variety of commodity and this improves the standards of living of the consumer.
Peak efficiency in allocation of resources requires that the price of goods is equal to the firm’s marginal costs. Unlike commodity markets, non-commodity markets do not always achieve peak efficiency in resource allocation. This is because non-commodity markets do not always produce a quantity of goods that is socially optimal. The society believes that the non-commodity markets under produce their products thereby utilizing very little inputs. This misallocation of resources creates a negative impact in the standards of living of the society. The non-commodity market reaches equilibrium in the end. At this point, the level of supply is equal to the level of demand. This state of long run equilibrium discourages free entry of firms into the market. The few existing firms in the market are able to enjoy a significant amount of profits, which sustains them in the industry. The firm as a result is inefficient in terms of allocation of resources and production.
The demand in the non-commodity market may increase and in such instances, the firms that aim to meet the market demand will increase their level of production. Some firms on the other hand will increase their prices in order to maximize their profits. This combination of price and production increments tends to yield positive economic profits and thus attracts firms into the market. The entering firms will reduce the demand being experienced by the firms already in the market and the overall output in the market will increase. This in turn reduces the price and the profits will shrink. In this market, consumer sovereignty also applies. The firms always respond to the desire of the consumers.
The costs of production in this market may also change after the firm has reached equilibrium. This increase in cost may be due to, rising energy costs, wage increases that are not necessarily a result of increased productivity among the workers or government regulations. The cost of producing an extra unit of commodity increases and exceeds the revenues that the firm earns. The firms will lower their output in order to maintain their profits. Reduced output will push the prices up and cause the market demand to reduce. Firms will leave the market because they incur losses in this situation. The supply will reduce and this will create shortage of goods in the market. Demand will be higher and so the price level will increase and go back to its former position. Entry and exit plays a crucial role in this market as well.
Chapter 9: Special Topics
Mark up Pricing
Markup pricing also referred to as cost-plus pricing is an alternative method of enabling a firm to reach its maximum profits where the value of the marginal cost is equal to the marginal revenue. Mark up refers to the amount or percentage added to the cost of a commodity to increase the profits of the firm. A firm usually identifies the profit-maximizing level for output and then using the demand value in the market, the mark up is determined. It is important for a firm to determine the correct mark up factor in order to maximize their profits. When the marginal cost or the level of the demand increases, the mark up factor also increases. A reduction in the marginal cost results in a subsequent reduction in the mark up factor. It is therefore very important that firms select the correct mark up factor.
This refers to the process of selling the same product to different customers at different prices. Price differentiation is common in the entertainment joints where different prices apply to different age groups. Vacation travelers also pay less than business travelers do. Firms differentiate their prices in order to maximize their revenues. Price differentiation depends upon the concept of elasticity and inelasticity of demand.
A monopoly firm is a supplier a product with no close substitutes. Monopolies tend to experience large profits because of being producers of goods that are not close substitutes and lack of competition. Monopoly markets tend to be characterized by government regulations that prevent entry of other firms into the market. These regulations may include copyrights and patents for certain technologies or methods of production. This kind of monopoly power is given to these firms in order to prevent any competition. Such monopolies may include public utility monopolies such as garbage collection companies and water production companies.
Collusions involve two or more firms combining their businesses entities to form cartels and gain monopoly powers in the product market. Although cartels are illegal in the United States, they are legal in many parts of the world. Cartels gain the ability to control the prices in the market with little to no competition, something that would not be possible before the merger.
Externalities occur when parties other than sellers and buyers are affected by production, use or sale of a product. For instance, automobiles and cigarettes cause pollution that affects even those that do not purchase or use these products. The demand curve in such a market reflects the concerns and desires of the buyers while the supply curve symbolizes the concerns and desires of the suppliers. The concerns and desires of parties outside the market are however not addressed in the market structure. Externalities usually result in misallocation of resources.
Use of Inputs
Suppliers require various inputs such as labor, capital, and resources in order to operate efficiently. The law of diminishing marginal returns relates that, as one product continues to be used relative to other inputs its marginal product reduces. It is very important that firms employ the right combination of inputs in order to maximize their profits.
Supply and Demand. Transtutors.com. 2013. Web. 27 November 2013.
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