REGINA F.

AGADIER
HRDM-III

THEORIES AND PRINCIPLES

1. LAW OF DEMAND
The law of demand introduces an inverse relationship between price and demand for a good or
service. It simply states that as the price of a commodity increases, demand decreases, provided
other factors remain constant. Also, as the price decreases, demand increases.

 The law of demand works with the law of supply to explain how market economies
allocate resources and determine the prices of goods and services that we observe in
everyday transactions.
 The law of demand states that quantity purchased varies inversely with price. In other
words, the higher the price, the lower the quantity demanded. This occurs because of
diminishing marginal utility, it’s because consumers use the first units of an economic
good they purchase to serve their most urgent needs first, and use each additional unit
of the good to serve successively lower valued ends.

Understanding the Law of Demand

 The law of demand focuses on those unlimited wants.

 People prioritize more urgent wants and needs over less urgent ones in their economic
behavior, and this carries over into how people choose among the limited means available
to them.

For any economic good, the first unit of that good that a consumer gets their hands on will tend
to be put to use to satisfy the most urgent need the consumer has that that good can satisfy.

For example:

A survivor from a sunken ship was stranded on a desert island who obtains a six pack of bottled,
fresh water washed up on shore.

1. The first bottle will be used to satisfy the castaway's most urgently felt need, most likely
drinking water to avoid dying of thirst.
2. The second bottle might be used for bathing to get rid off disease, an urgent but less
immediate need.
 3. The third bottle could be used for a less urgent need such as boiling some fish to have a
hot meal, and on down to the last bottle, which the survivor uses for a relatively low
priority like watering a small potted plant to keep him company on the island.

In our example, because each additional bottle of water is used for a successively less highly
valued want or need by our survivor, we can say that the survivor’s values each additional bottle
less than the one before. Similarly, when consumers purchase goods on the market each
additional unit of any given good or service that they buy will be put to a less valued use than the
one before, so we can say that they value each additional unit less and less. Because they value
each additional unit of the good less, they are willing to pay less for it. So the more units of a
good consumers buy, the less they are willing to pay in terms of the price.

By adding up all the units of a good that consumers are willing to buy at any given price we can
describe a market demand curve, which is always downward-sloping, like the one shown in the
chart below. Each point on the curve (A, B, C) reflects the quantity demanded (Q) at a given price
(P). At point A, for example, the quantity demanded is low (Q1) and the price is high (P1). At
higher prices, consumers demand less of the good, and at lower prices, they demand more.

Demand vs Quantity Demanded

In economic thinking, it is important to understand the difference between the phenomenon of

demand and the quantity demanded. In the chart, the term "demand" refers to the green line
plotted through A, B, and C. It expresses the relationship between the urgency of consumer wants
and the number of units of the economic good at hand. A change in demand means a shift of the
position or shape of this curve; it reflects a change in the underlying pattern of consumer wants
and needs vis-a-vis the means available to satisfy them. On the other hand, the term "quantity
demanded" refers to a point along with horizontal axis. Changes in the quantity demanded
strictly reflect changes in the price, without implying any change in the pattern of consumer
preferences. Changes in quantity demanded just mean movement along the demand curve itself
because of a change in price. These two ideas are often conflated, but this is a common error;
rising (or falling) in prices do not decrease (or increase) demand, they change the quantity
demanded.

Factors Affecting Demand

The shape and position of the demand curve can be impacted by several factors.

 Rising incomes tend to increase demand for normal economic goods, as people are willing
to spend more. The availability of close substitute products that compete with a given
economic good will tend to reduce demand for that good, since they can satisfy the same
kinds of consumer wants and needs.
  The availability of closely complementary goods will tend to increase demand for an
economic good, because the use of two goods together can be even more valuable to
consumers than using them separately, like mobile phones and powerbanks, or laundry
detergent and washing machines.
 Other factors such as future expectations, changes in background environmental
conditions, or change in the actual or perceived quality of a good can change the demand
curve, because they alter the pattern of consumer preferences for how the good can be
used and how urgently it is needed

2. THE LAW OF SUPPLY

The law of supply is a fundamental principle of economic theory which states that, keeping other
factors constant, an increase in price results in an increase in quantity supplied.[1] In other words,
there is a direct relationship between price and quantity: quantities respond in the same
direction as price changes. This means that producers are willing to offer more of a product for
sale on the market at higher prices by increasing production as a way of increasing profits.[2]

In short, the law of supply is a positive relationship between quantity supplied and price and is
the reason for the upward slope of the supply curve.

3. THE LAW OF DIMINISHING RETURNS

Diminishing returns is the decrease in the marginal output of a production process as the amount
of a single factor of production is incrementally increased, while the amounts of all other factors
of production stay constant.

We can divide the behavior of output when varying one input, keeping other inputs fixed in the
short run, into three stages.

Stage I: Increasing Returns

Stage II: Diminishing Returns

Stage III: Negative Returns

The Law of Variable Proportions

The law of variable proportions is a new name for the law of diminishing returns, a concept of
classical economics. But before getting on with the law, there is a need to understand the total
product (TP), marginal product (MP) and average product (AP).

Total Product: Total product is the total output obtained from the combined efforts of all the
factors of production. Further, if we wish to find the effect of one factor of production, say labor,
on the total product, we need to keep all the other factors constant. In this case, the total product
would vary with the factor kept variable.

Marginal Product: The change in the total product when one more unit is added to the variable
factor is known as the marginal product.

Average Product: Average product is the total product per unit of the variable factor. In other
words, it is the ratio of total product to the quantity of variable factor.

THE RELATIONSHIP BETWEEN AVERAGE PRODUCT AND MARGINAL PRODUCT

When there is a rise in the average product due to an increase in the quantity of the variable
input, the marginal product is more than the average product.

The maximum average product is equal to the marginal product. Simply put, the maximum point
of the average product curve is also a point on the marginal product curve, a point where both
of these curves intersect.

When the average product falls, the marginal product is less than the average product.

The law of diminishing returns operates in the short run when we can’t change all the factors of
production. Further, it studies the change in output by varying the quantity of one input.

Technically, the law states that as we increase the quantity of one input which is combined with
other fixed inputs, the marginal physical productivity of the variable input must eventually
decline.

In simpler words, the total productivity, for a given state of technology, is bound to increase with
an increase in the quantity of a variable input. However, as the quantity of the inputs keeps on
increasing, the marginal product rises to a maximum, then starts to decline and eventually
becomes negative.

This is because the crowding of inputs eventually leads to a negative impact on the output. Lastly,
The law of diminishing returns also comes with some assumptions:

We assume the state of technology to be constant. A variable state of technology would impact
the marginal and average product. In that case, we would not be able to accurately study the
relationship between output and the fixed input.

Only one input should be variable, keeping other inputs constant. This law does not apply to cases
when all the inputs vary proportionately. In that case, the returns to scale comes to the rescue.

The law does not apply to a production scenario where we require specifically fixed proportions
of inputs. In such a case, an increase in any input would not have any impact on production, since
the marginal product will be equal to zero.
We consider only physical inputs and outputs and not economic profitability in monetary terms.

We can divide the behavior of output when varying one input, keeping other inputs fixed in the
short run, into three stages.

Stage I: Increasing Returns

We characterize this stage with the total output increasing at an increasing rate with each
additional unit of the variable input. This continues to point A on the TP curve. Further, the MP
curve rises to the point X corresponding to the point B on the TP curve, also known as the point
of inflexion.

After point B, the TP curve continues to rise but now at a decreasing rate. The MP also starts to
fall but is positive. The end of this stage sees the maximum point of the average product, where
the AP and MP curves intersect.

We get increasing returns in the first stage because initially, the fixed factors are abundant
relative to the variable factor. The introduction of additional units of the variable factor leads to
the effective utilization of the fixed factors. Evidently, production increases at an increasing rate.

For example, if a machine requires four workers for its optimum utilization, and in the current
scenario is two workers are operating the machine, the factor would be underutilized. Addition
of another worker would definitely lead to an increase in the output. Further addition of a worker
would lead to optimum utilization and hence production would increase.

Now we cannot divide the fixed factor (here the machine) to suit the availability of the variable
factor (here the workers) because generally the fixed factors are indivisible. Indivisibility of a fixed
factor means that due to technological requirements, a minimum amount of the factor must be
employed whatever the level of output.

Another reason for rising returns is the increase in the efficiency of the variable factor itself. This
is because, with a sufficient quantity of variable factor, the introduction of specialization and
division of labor becomes possible which leads to higher productivity.

Stage II: Diminishing Returns

Throughout the stage of diminishing returns, the total product keeps on increasing. However
unlike the stage of increasing returns, here the total product increases at a diminishing rate. This
happens because the marginal product falls and becomes less than the average product, which
also sees a downwards slope.

Thus, this stage is known as the stage of diminishing returns. The end of this stage is marked by
the total product attaining its maximum value and the marginal product becoming zero. Further,
this stage is very important because the firm will seek to produce in its range.
After the addition of a certain amount of variable inputs which lead to the optimum and efficient
utilization of fixed input, the output starts diminishing. This is because any further addition to the
variable factor after the point of efficient utilization renders the fixed factor inadequate relative
to variable factor. Again, this is the reason why the marginal and average product decline at this
stage.

In other words, the contribution of extra variable inputs is actually nil. This further means that
the fixed indivisible factor is being worked too hard. Another reason for the law of diminishing
returns is the lack of availability of a perfect substitute.

In case of the availability of a perfect substitute, an increase in its quantity would have made up
for the scarcity of the fixed factor. This, in turn, would have prevented the ineffective utilization.

Stage III: Negative Returns

The origin of stage 3 starts from the maximum point of the TP curve. In this stage, the TP curve
now starts to decline. Moreover, the MP curve becomes negative coupled with a fall in the AP
curve.

The excessive addition of variable inputs leads to negative returns at this stage. This is because
of the crowding of the variable factors. The variable and fixed factors now start getting into each
other’s ways. Effectively, there is no coordination and hence the output falls.

Stage of Operation

A major dilemma in the world of the law of diminishing returns is deciding the stage where a
rational producer would look to operate. Let’s examine each of these stages from his perspective.

The stage of negative returns or stage III is probably not a stage of the producer’s choice. This is
because the fixed factors here are over utilized. Thus a rational producer would know that he is
not having optimum production.

Further, production can be increased by decreasing the number of variable inputs. Effectively,
even if the inputs are free of cost, the producer would stop before the advent of stage III.

Stage I or the stage of increasing returns is a better stage, to start with. However, a rational
producer would again not operate in this stage. This is because he would know that he is not
making efficient utilization of the fixed inputs. In simpler words, the fixed inputs are
underutilized.

Furthermore, the producer would have an opportunity to increase production by employing

more variable inputs and hence firing production on all engines. Eventually, even if the fixed
factor is free of cost in this stage, a rational producer would continue adding more units of the
variable factor.
So now we understand that both stage I and stage III are not viable stages of production.
Evidently, they are also known as the stages of economic absurdity or economic non-sense.

Solved Example on Law of Diminishing Returns

Q: What is the behavior of TP, MP, and AP at stage III?

A: At the stage of negative returns, the total product starts to decline. Further, the average
product falls with the marginal product becoming negative.

4. THE LAW OF DIMINISHING UTILITES

The law of diminishing marginal utility states the utility function is upward sloping and concave.
Neoclassical microeconomic theory assumes that all commodities are infinitely divisible. This
allows economists and mathematicians to assume continuous utility functions and use calculus
to analyze marginal changes.

This brings us to the conclusion that a rational producer would operate in the second stage of
production, where both average and marginal products tend to decline. At which particular point
in this stage, the producer decides to produce depends upon the prices of the factors.

The law of diminishing marginal utility explains that as a person consumes an item or a product,
the satisfaction or utility that they derive from the product wanes as they consume more and
more of that product. For example, an individual might buy a certain type of chocolate for a while.
Soon, they may buy less and choose another type of chocolate or buy cookies instead because
the satisfaction they were initially getting from the chocolate is diminishing.

In economics, the law of diminishing marginal utility states that the marginal utility of a good or
service declines as its available supply increases. Economic actors devote each successive unit of
the good or service towards less and less valued ends. The law of diminishing marginal utility is
used to explain other economic phenomena, such as time preference.

THE LAW OF DIMINISHING MARGINAL UTILITY

Whenever an individual interacts with an economic good, that individual acts in a way that
demonstrates the order in which they value the use of that good. Thus, the first unit that is
consumed is dedicated to the individual's most valued end. The second unit is devoted to the
second most valued end, and so on. In other words, the law of diminishing marginal utility
postulates that when consumers go to market to purchase a commodity, they do not attach equal
importance to all the commodities they buy. They will pay more for some commodities and less
for others.

As another example, consider an individual on a deserted island who finds a case of bottled water
that washes ashore. That person might drink the first bottle indicating that satisfying their thirst
was the most important use of the water. The individual might bathe themselves with the second
bottle, or they might decide to save it for later. If they save it for later, this indicates that the
person values the future use of the water more than bathing today, but still less than the
immediate quenching of their thirst. This is called ordinal time preference. This concept helps
explain savings and investing versus current consumption and spending.

THE LAW APPLIED TO MONEY AND INTEREST RATES

The example above also helps to explain why demand curves are downward-sloping in
microeconomic models since each additional unit of a good or service is put toward less valuable
ends. This application of the law of marginal utility demonstrates why a rise in the money stock
(other things being equal) reduces the exchange value of a money unit since each successive unit
of money is used to purchase a less valuable end.

The monetary exchange example provides an economic argument against the manipulation of
interest rates by central banks since the interest rate affects the saving and consumption habits
of consumers or businesses. Distorting the interest rate encourages consumers to spend or save
according to their actual time preferences, leading to eventual surpluses or shortages in capital
investment.

THE LAW AND MARKETING

Marketers use the law of diminishing marginal utility because they want to keep marginal utility
high for products that they sell. A product is consumed because it provides satisfaction, but too
much of a product might mean that the marginal utility reaches zero because consumers have
had enough of a product and are satiated. Of course, marginal utility depends on the consumer
and the product being consumed.

5. LOCAL AND GLOBAL MARKET

Clients and customers who will buy a product in the region or area in which it is produced. For
marketing purposes it is important to know who will buy the product, where they are located
and how far they will travel to obtain the product. The local market includes customers located
within the region the product or service is produced or made available.

Local marketing—also referred to as local store marketing or neighborhood marketing—

specifically targets the community around a physical store or restaurant. Promotional messages
are directed to the local population, rather than the mass market.

In practice, local marketing can take several forms. Many local businesses directly contact
consumers through mail, in-town events, local team sponsorships, or advertisements in the town
paper. Hoping to not only attract new customers but to drive repeat business, a successful local
marketing push allows a store to stake out a significant presence in local consumers’ mental maps
of their communities.

Local marketing is used primarily by small businesses—stores and restaurants with a single
location or outlet. Owners of franchised businesses may also employ local marketing to promote
their specific locations, supplementing the larger franchise’s regional or national marketing
campaigns which promote the franchise’s name and products, but not specific locations.

Global market is more than simply the setting where selling a product internationally. Rather, it
includes the whole process of planning, producing, placing, and promoting a company’s products
in a worldwide market. Large businesses often have offices in the foreign countries they market
to; but with the expansion of the Internet, even small companies can reach customers
throughout the world.

Since global marketing involves a variety of different products and opportunities, it’s impossible
to identify a single customer profile. A global company must be prepared to develop multiple
profiles for each of the different regions it trades in. The United States’ biggest trading partners
are Canada, Mexico, China, and the European Union; but international trade by no means ends
there.

Depending on the product, customers can be reached nearly anywhere in the world. In order to
do so, global companies may rely on local distribution networks; but as they grow in particular
markets, they may establish their own networks. Companies attempting to enter new markets
tend to start with heavily populated urban centers, before moving out to surrounding regions.

6. MONOPOLY VERSUS OLIGOPOLY

A monopoly contains a single firm that produces goods with no close substitute, while an
oligopoly market has a small number of relatively large firms that produce similar, but slightly
different products. In both cases, there are significant barriers to entry for other enterprises.

The market's geographical size can determine which structure exists. One company may control
an industry in a particular area with no other alternatives to the same product, even though there
may be a few similar companies that operate in the country. In this case, a company may be a
monopoly in one region, but operate an oligopoly market in a larger geographical area.

 A monopoly occurs when one firm that produces a product or service controls the market
with no close substitute.
  In an oligopoly, two or more firms control the market without any significant influence in
the industry.
 The United States government has anti-trust laws in place to prevent monopolies from
controlling the market, price gouging, and stifling consumer choices.
 A government can create a monopoly by nationalizing a product or service such as the
postal service.

A monopoly exists in areas where one company, firm, or entity is the only—or dominant—force
that sells a product or service in an industry. This gives the entity enough power to keep other
competitors away from the marketplace. This may be because of the industry's requirement for
technology, high capital, government regulation, patents, and/or high distribution overheads.

Once a monopoly is established, a lack of competition can lead the seller to charge consumers
high prices. A monopoly also reduces the available choices for consumers. The monopoly
becomes pure when there is absolutely no other substitute available in the market.

Along with high barriers to entry for competing firms, companies that operate monopolies are
price makers. This means they determine the cost at which their products are sold. These prices
can be changed at any time.

Monopolies are allowed to exist when they benefit the consumer. In some cases, governments
may step in and create the monopoly to provide consumers with a specific services such as a
railway, public transport company, or the postal service. For example, the government
nationalized the United States Postal Service, allowing it to develop into a monopoly, providing
daily mail service to the population.

In an oligopoly, a group of smaller firms—usually two or more—controls the market. However,

none of them can keep the others from having significant influence in the industry, and they may
sell products that are slightly different.

Prices in this market are moderate because of the presence of competition. When one firm sets
a price, the others will do the same to remain competitive. But if one firm drops its price for
consumers, the others typically follow suit. Prices are usually higher in an oligopoly than they
would be in perfect competition.

Because there is no dominant force in the industry, firms may collude with one another rather
than compete, which can keep other players from entering the marketplace. If they don't collude,
they would be forced to open up the market to smaller firms. This cooperation makes them
operate as though they were one firm. Because there must be some degree of competition in an
oligopoly, this changes the market structure to a monopoly.
Collusion by an oligopoly occurred in the U.S. publishing market. In 2012, the Department of
Justice sued six major book publishers for price-fixing electronic books. In a free market, price
fixing—even without judicial intervention—is unsustainable. If one company undermines its
competition, others are forced to quickly follow. Firms that lower prices to the point where they
are not profitable are unable to remain in business for long. Because of this, members of
oligopolies tend to compete in terms of image and quality rather than price.

LEGALITIES OF MONOPOLIES VS. OLIGOPOLIES

Unless it can be proven that a company tries to restrain trade, both oligopolies and monopolies
are legal in the United States.

Because of the lack of competition, companies can fix prices and create product scarcities which
can lead to corruption, inferior products and services, and high costs for consumers. When this
happens, the government generally steps in. Anti-trust laws are in place to penalize companies
that operate monopolies and oligopolies. These laws are in place to protect consumers, to
maintain competition within the market, and to prevent companies from price gouging.
Companies may be forced to pay hefty fines and/or break up into smaller entities.

WHEN OLIGOPOLY BECOMES ILLEGAL

 One or more firms must demonstrate the intent to corner a market using anti-
competitive practices. Collusion is the most typical infraction to lead to anti-trust
proceedings. This is different from circumstances in which companies that have
unintentionally come to dominate an industry via a better product or service, superior
business practices, or uncontrollable developments, such as a key competitor leaving the
market.

EXAMPLES OF MONOPOLIES AND OLIGOPOLIES

A company with a new or innovative product or service enjoys a monopoly until competitors
emerge. Some of these monopolies are actually protected by law.

Examples:

 Pharmaceutical companies in the United States are granted monopolies on new drugs for
20 years. This is necessary due to the time and capital required to develop and bring new
drugs to market. Without the benefits of this status, firms would not be able to realize
returns on their investments, and potentially beneficial research would be stifled.
 Utilities like gas and electric companies are also granted monopolies. These, however, are
heavily regulated by the government. Their rates are controlled, along with any rate
increases the company may pass on to consumers.
Oligopolies exist throughout the world, and are common in specific markets. Fuel Companies like

 Pilipinas Shell Corporation

 Petron Corporation
 Phoenix Petroleum Philippines Inc.

Entertainment is a big place where oligopolies exist.

This includes mass media, where a handful of companies control the market. Some of the big
names include

 Disney
 Viacom
 CBS
 NBC Universal

Another area of the entertainment world is the music business, where Sony, BMG, and Universal
all have a big grip on the market. Airlines also form oligopolies, where a small number of players
float over the rest, keeping other competitors at bay.

7. SUPPLY VERSUS DEMAND

The equilibrium between the price and the quantity demanded of a product or the commodity
at a certain period is called as demand. To the contrary, the equilibrium between the price of the
product or goods and the quantity that is supplied at a given period is called as supply.

Supply has a direct relationship with the price of a product or service which means that if the
price of the same rises, its supply will also increase and if the price falls, then the same will also
fall whereas, demand has an indirect relationship with the price of a product or service which
means that if the price of the falls, demand will rise and vice-versa.

 Supply can be defines as the quantity of a commodity that is made available to the buyers
or the consumers by the producers at a certain or specific price.
 Demand can be defines as the desire of the willingness of the buyer along with his ability
or say capability to pay for the service or commodity at a specific price.
 Demand can be referred to as how much (i.e. quantity) of a service or product is desired
by the buyers. The quantity that is demanded will be the amount of that product that
 people are willing to purchase at a certain price; the relationship between quantity
demanded and the price is called the demand relationship.
 Whereas, Supply does represent how much the whole market can offer a certain product
or service. The quantity that is supplied can be referred to as the amount of certain good
producers that they are supplying willfully that they receive for a certain price.
 The Law of Supply states that the higher the price of the goods, the higher the quantity
will be supplied. Producers are ready to supply more at a higher price and the reason for
same being selling a higher quantity at a higher price will increases their revenue.
 The Law of Demand says that, if all other factors remain equal, the higher the price of a
product or goods, the lesser the people will demand for that product or goods. Speaking
differently, the higher the price of the good, the lower the quantity will be demanded.