Pearson BTEC Level 5 Higher National Diploma in Business

Unit 1: Business and the Business

Environment

Prepared by: Vu Thi Kim Chi

September 2020
LO1 Explain the different types, size and scope of organisations

LEARNING OUTCOME 1
Characteristics of organisation
Characteristics of organisation
 Legal form
1. Sole traders
2. Partnerships
3. Companies or corporations
 Organizing a Business

The three main types of business organizations

are:

Sole
Proprietorships Partnerships Corporations
/Sole Trader
Figure 6.1

U.S. Sole
Proprietorships,
Partnerships, and
Corporations
Sole traders
Sole traders
 Sole Proprietorships

About three-quarters of
sole proprietorship/ sole
all businesses in the trader
United States are sole a business owned by one
proprietorships. person
 Graphic Organizer

Advantages of Sole Proprietorships

Proprietors are
Easy to start
in charge

Proprietors keep Taxes are lower

all the profits than a corporation’s
 Graphic Organizer

Disadvantages of Sole Proprietorships

Limited access Many run out

to credit of money

The owner may not have The business ends

the necessary skills when the owner dies
 Sole Proprietorships

A major disadvantage
unlimited liability
of owning a sole when the owner is
proprietorship is that responsible for the
the owner has company’s debts
unlimited liability.
How to set up a sole trader?
 Partnerships

To start a partnership,
partnership
you need a partnership a business owned by two or
agreement. more people who share its
risks and rewards
Partnerships
 Graphic Organizer

Advantages of Partnerships

Easy to Easier to Easier to

start obtain capital obtain credit

Not dependent
Only taxed once Diversity in skills
on a sole person
 Graphic Organizer

Disadvantages of Partnerships

If one partner
Unlimited legal and
Ownership transfer makes a mistake,
financial liability is
is difficult all partners are
shared
responsible
Unlimited liability
 How to set up partnership
•  https://www.gov.uk/set-up-business-
partnership
 Corporations

To form a corporation,
corporation
the owners must get a a company that is registered
corporate charter from by a state and operates
the state where their apart from its owners
main office will be
located.
Companies or corporations
Companies or corporations
Public limited company
Private limited company
 Graphic Organizer

Advantages of Corporation

Ability to raise Business does

Limited liability money by not end when an
selling stock owner dies
 Corporations

Limited liability is a
limited liability
major advantage of a holds a firm’s owners
corporation. responsible for no more than
the capital that they have
invested in it
 Graphic Organizer

Advantages of Corporations

Ability to raise Business does

Limited liability money by not end when an
selling stock owner dies
 Graphic Organizer

Disadvantages of Corporations

More government Difficult and

Double taxation
regulation costly to start

1.  Income is taxed.

2.  Stockholders pay taxes on
profits issued to them
Double taxation
 How to set up Corporations?
•  https://www.gov.uk/set-up-limited-company
 Other Ways to Organize a
Business

Other ways to organize a business include:

Nonprofit
Cooperative Franchise
Organization
 Other Ways to Organize a
Business

The purpose of a
cooperative
cooperative is to save an organization that is
money on the purchase owned and operated by its
of certain goods and members, who can be
customers, employees or
services. groups of businesses.
Other Ways to Organize a
Business
 Other Ways to Organize a
Business

A nonprofit
nonprofit organization
organization does not a type of business that
pay taxes because it focuses on providing a
does not make a profit. service, not making a profit
 Other Ways to Organize a
Business

To run a franchise, you

franchise
have to invest money a contractual agreement to
and pay franchise fees use the name and sell the
or a share of the profits. products or services of a
company in a designated
geographic area
 Car Sharing

Car sharing is a popular European process in

which many households share vehicles.

Mobility CarSharing cooperative in Switzerland has

over 50,000 clients.
1.  What is the difference between a sole
proprietorship and a partnership?
A sole proprietorship is owned by one person. A
partnership is owned by two or more people.
2.  If a partner makes a bad decision, what
responsibility do the other partners have?
All partners share responsibility for a
bad decision.
3.  Why are cooperatives formed?

so that the members have advantages

in buying and selling products and
services
Types of Business Activities
Types of Business Activities
Size of Organisations
 Size of Organisations
•  Case 1: Sandeep Stores
Sandeep Stores is a corner shop
located in Delhi. It sells spices and
dried fruits and has been run by
the Sandeep family for over 70
years. Over 95% of the Indian
retail market is made up of small,
family run businesses like this one.
Dilip Sandeep understands local
tastes and makes sure that he can
meet the needs of the local
market. In 2008 the shop made a
profit of $12,000.
 Size of Organisations
•  Case 2: Tata Group
Tata Group is the largest business
in India. It is involved in the
production of steel, motor cars,
chemicals, electricity and watches.
It also provides a range of services
such as telecommunications, IT
consultancy, hotels and hospitality.
The company employs more than
350,000 people and has operations
in over 80 different countries. In
2008, Tata had a turnover of $62.5
billion and made a profit of $5.4
billion
 Questions:
•  (a) What evidence is there to suggest that
Tata group is a large business?
•  (b) What evidence is there to suggest that
Sandeep Stores is a small business?
•  (c) To what extent has Tata Group grown
since 1992?
 Different measures of size
1. Number of employees
Simplest measure, easy to understand
not always as it seems that more employees mean larger
business.
2. Sales turnover
Total value of sales made by a business in a given time.
Effective when comparing firms in same industry.
3.Capital employed
It is the total value of long term finance invested in the
business.
 Different measures of size
4.Market capitalisation
The total value of company’s issued shares.
Market capitalisation =current share price * total
number of shares issues
5. Market share
Total value of sales made by a business in a given time.
Effective when comparing firms in same industry.
Formula: (Total sales of business/ total sales of
industry)/*100
6. Other measures depend on industry
EU definition of size
 Problems with measuring size

In practice, measuring the size of a business may not

be easy. Example:
•  A highly automated chemical plant may only employ
45 people, but have a turnover of €50 million.
•  A business with a turnover of €56 million may have
capital employed of just €32 million.
 The significance of small and
micro businesses
•  Employ few people
•  Low turnover
•  Very small businesses known as micro
enterprises.
•  Jobs are created by them even though they
employ less staff
•  Run by dynamic entrepreneurs with ideas of
consumer goods and services so variety is
created and more consumer choice.
 The significance of small and
micro businesses
•  Supply specialist goods and services to industries.
•  Competition for large firms to stop consumer
exploitation.
•  All great businesses were small at one time.
•  Enjoy lower average costs this benefit is passed to
consumers.
 REASONS OF GROWTH
•  To achieve economies of scale and see the
average cost of production decline.
•  To achieve a greater market share.
•  To satisfy the ego of the businessman.
•  To achieve security through becoming more
diversified.
•  To survive in an increasingly competitive market.
•  Mergers and Take-Overs
 Internal Growth
•  It is the expansion of by means of opening
new branches, shops or factories.
•  Internal growth is often a slow process.
•  Organic growth: the firm expands by selling
more of its existing products.
 External Growth
•  Involves much greater sums of money and
takes place through the use of mergers and
takeovers (often known as growth through
amalgamation, or simply integration).
•  A takeover is when one company buys
control of another.
•  A merger usually means that two companies
have agreed to join together and create a
new company.
Case study
Sainbury
 Mergers
•  – agreed amalgamation or joining between two
firms. A merger occurs where two firms combine,
with the consent of both groups of shareholders and
Directors
•  Horizontal: This occurs when two firms in the same
industry join together who produce the same
product and are at the same stage of the production
process
•  Vertical: This occurs when two firms combine who
are in the same industry, but at a different stage of
the production process.
 Synergism
•  Synergism: Whole is worth more than sum of its
parts (M&A math is 2 + 2 = 5)
–  Economies of scale – lower costs by combining
operations
•  Using excess capacity
•  Spreading fixed costs over larger volume
–  Economies of scope – can carry out more activities
profitably
•  Producing similar products
•  Backward integration – buying a supplier to reduce costs
•  Forward integration – moving control one step closer to
customers 62
 Mergers
•  Vertical vertical integration: This occurs when two
firms combine who are in the same industry, but at a
different stage of the production process.
•  Backward vertical integration: Occurs where a
company merges with, or takes-over, another
company which is closer to the source of the raw
material (e.g. a car manufacturer taking-over a
supplier of car components)
•  Conglomerate: This occurs where two firms merge
which are in different industries and produce
different goods -it is pure diversification
 EXHIBIT 8.4
Backward and Forward Vertical Integration
along an Industry Value Chain

8–64
 Types of Vertical Integration

•  Full vertical integration

–  Ex: Weyerhaeuser
»  Owns forests, mills, and distribution to retailers
•  Backward vertical integration
–  Ex: HTC’s backward integration into design of
phones
•  Forward vertical integration
–  Ex: HTC’s forward integration into sales & branding
•  Not all industry value chain stages are equally
profitable
8–65

–  Zara – primarily designs in-house & partners for

 EXHIBIT 8.5 HTC’s Backward and Forward Integration along the
Industry Value Chain in the Smartphone Industry

8–66
What is Vertical Integration?
Where your pizza comes from

Dairy Farmers
(milk)

Seed Companies Pizza Chains

(Alfalfa & Corn)

Leprino Foods
(Mozzarella Cheese)

Crop Farmers
(Alfalfa & Corn) End Consumer

Food Distributors
What is Vertical Integration?
Backward
Vertical
Dairy Farmers Integration
(milk)

Seed Companies Pizza Chains

(Alfalfa & Corn)

Leprino Foods
(Mozzarella Cheese)

Crop Farmers
(Alfalfa & Corn) End Consumer

Food Distributors Forward

Vertical
Integration
Value Chain Economies
The Logic of Value Chain Economies
Backward
Vertical
• the focal firm is able to Dairy Farmers Integration
create synergy with the (milk)
other firm(s)

• cost reduction

• revenue enhancement Leprino Foods

(Mozzarella Cheese)

• the focal firm is able to

capture above normal
economic returns
(avoid perfect competition) Food Distributors Forward
Vertical
Integration
The public and private sectors
The public and private sectors
The public sector
The public sector
Voluntary organisations
Voluntary organisations
Mission, objectives and
values of organisations
Goals
Objectives
Primary and secondary objectives
Corporate objectives
Identification of stakeholders
 What is a Stakeholder?
A Stakeholder is :

“…An individual, group or institution that

has an interest in a particular forest
resource …”
(RECOFTC 2002)

“…groups/individuals that are

affected by the outcome of a
conflict, as well as those who
influence the outcome…”
(FAO 2005)
 Stakeholders
Primary Stakeholders:
“…are those most affected by and are dependent on the
resources…”

Secondary Stakeholders :
“…are those who are more indirectly or less affected or
dependant on the resources…”
(FAO 2005)
Stakeholders

Core issue of policy

Types of stakeholders
 Internal Stakeholders
Definition: Types of IS:
Internal stakeholders are
intimately connected to
the organisation, and their
objectives are likely to
have a strong influence
on how it is run.
 Connected Stakeholders
•  Connected stakeholders can be viewed as having
a contractual relationship with the organisation.
•  The objective of satisfying shareholders is taken
as the prime objective which the management of
the organisation will need to fulfil, however,
customer and financiers objectives must be met if
the company is to succeed.
Connected Stakeholders
 External Stakeholders
External stakeholders include the government,
local authority etc. This group will have quite
diverse objectives and have varying ability to
ensure that the organisation meets their
objectives.
External Stakeholders
Stakeholder’s conflicting objectives
Rationale for Stakeholder Analysis
q  Identify who needs to participate (primary & secondary)
q  Assess how stakeholders be affected or might affect the business.
q  Identify the multiple interests and objectives of stakeholders in relation
to the companymanagement
q  Understand the actual resources, influence, authority or power that
stakeholders can have on particular company initiatives
q  Assess the most appropriate means for them to participate
q  Assess the capacity of stakeholders to participate in the planning process
q  Begin to understand potential conflicts that could arise in businesses
Why do a Stakeholder Analysis?
A Stakeholder Analysis allows you

•  To identify and define key stakeholders

•  To identify who needs to participate in the project
•  To assess how they might affect or be affected by
the business’s interventions (positively or negatively)
A Stakeholder Analysis allows you
•  To identify the multiple interests and objectives of
stakeholders in relation to the particular project
•  To understand the actual resources, influence, authority or
power that stakeholders can bring to bear on particular
company’s initiatives
A Stakeholder Analysis allows you

•  To assess the most appropriate means for them to

participate
•  To assess the capacity of stakeholders to participate in the
planning process
•  To begin to understand potential stakeholder conflicts that
could arise in the company
 Steps in Stakeholder Analysis
Steps  in  Stakeholder  Analysis   Possible  Ques6ons  &  Tools  

1.  Iden(fy  Issues  and  clarify  objec(ve   -­‐What  problem  that  need  to  address?  
-­‐The  objec(ve  &  intended  outputs  of  project  
 Tools:  problem  tree  and  objec1ve  tree  (seen  in  SES)  

2.  Iden(fy  stakeholders   -­‐ Who  are  primary,  secondary,  and  has  interest  in  the  
issue?  
-­‐ Tool:  Stakeholder  rings  (as  above)  
3.  Inves(gate  characteris(cs  of   -­‐ What  are  the  interest,  4  RS  (Rights,  Responsibili(es,    
stakeholder   Returns,  and  Rela(onship)  
-­‐ Tools:  Stakeholder  interests,  and  4R  matrix,  Venn-­‐
Diagram  ,  and  Matrix  of  conflict  &  trade-­‐off  

4.  Iden(fy  power  and  influence  of   -­‐ What  are  the  power  and  influence  of  each  
stakeholders   stakeholder  
-­‐   Tools:  Graph of stakeholders importance and
influence
4R Stakeholder Analysis Matrix

WHAT IS THE 4R
STAKEHOLDER ANALYSIS
MATRIX?

RIGHTS
RESPONSIBILITIES
RETURNS (OR BENEFITS)
RELATIONSHIPS
 4R Stakeholder Analysis Matrix

Rights
•  Access to and use of resources (statutory and
customary)
•  Ownership of resources (statutory and customary)
•  Decision-making over resource use and management
(e.g. setting by-laws, enforcement/fines, zoning/
exclusion, licensing/income, etc.)
 4R Stakeholder Analysis Matrix

Responsibilities
•  Forest/resource management (planning, monitoring,
measurement, etc.)
•  Implementing decisions in rules, regulations,
procedures, etc.
•  Abiding by rules & regulations
 4R Stakeholder Analysis Matrix

Returns (or benefits)

•  Direct benefits arising from forest resources accessed
•  Direct benefits derived from employment related to the
resource/area
•  Indirect benefits such as those accruing to entire
community from resource management agreements
 4R Stakeholder Analysis Matrix

Relationships
•  Inter-relationships among stakeholders within the
community or outside of the community
•  Conflict among stakeholders
 Group Activity

•  watch the video at http://vimeo.com/16239538

•  Break out in small groups and using the 4R Stakeholder
Analysis Matrix , fill up the template on the 4Rs(rights,
responsibilities, relationships, returns )
 Exercise: The 4R Stakeholder Analysis Matrix

Stakeholders Rights Responsibility Relationship Returns

Stakeholder
A

Stakeholder
B

Stakeholder
C
 Stakeholder Analysis - interests / influences
Interests  
  Low   Medium   High  
GoB: MoPlanning, MoLand, GoB: MoEF, FD, MoCHTA,
MoLaw, Dist.Admin, 3HDCs
IPs and Communities: IPs and Communities:
BIPNetCBD,
Maleya F.
Influences  

Civil Society: IUCN, BCAS, AF,

Civil Society: BAPA, BELA
High  

Private Sectors: Tobacco Private Sectors: Timber

company Merchant Association
Dev. Partners: CEGIS Dev. Partners: CNRS, BRAC,
UNDP, USAID, FAO, WB
Academia: BARC, SRDI
Academia: BCAS, CEGIS
Media: BTV, Observer, Media: Daily Star, Channel-I,  
Community Radio  
q  Influence  is  the  ability  (empowered  by  law/mandate  or  through  social  
m  
w   ed
iu
Lo M

hierarchy  or  access  to  powerful  actors)  to  shape  REDD+  processes;  
q  Interest  is  willingness/mo(va(on  (as  ins(tu(onal  mandate  or  as  civic  
responsibility)  to  be  engaged  in  the  REDD+  process.
Power and Influence

Group 1: Group 2:
High High
Importance / Importance /
Low Influence High Influence

Group 3: Group 4:
Low Low
Importance / Importance /
Low Influence High Influence
Power and Influence
Stakeholder mapping
The Basic Decision-Making Units
•  A firm is an organization that transforms
resources (inputs) into products (outputs).
Firms are the primary producing units in a
market economy.
•  An entrepreneur is a person who organizes,
manages, and assumes the risks of a firm,
taking a new idea or a new product and turning
it into a successful business.
•  Households are the consuming units in an
economy.
The Circular Flow of Economic
Activity

•  The circular flow of

economic activity
shows the connections
between firms and
households in input and
output markets.
 Input Markets and Output Markets
•  Output, or product,
markets are the markets
in which goods and
services are exchanged.
•  Input markets are the
markets in which
resources—labor,
•  Payments flow in the opposite
direction as the physical flow of capital, and land—used
resources, goods, and services to produce products, are
(counterclockwise).
exchanged.
 Input Markets
Input markets include:
•  The labor market, in which households supply
work for wages to firms that demand labor.
•  The capital market, in which households supply
their savings, for interest or for claims to future
profits, to firms that demand funds to buy capital
goods.
•  The land market, in which households supply land
or other real property in exchange for rent.
 Determinants of Household Demand
A household’s decision about the quantity of a particular output to demand
depends on:

•  The price of the product in question.

•  The income available to the household.
•  The household’s amount of accumulated wealth.
•  The prices of related products available to the
household.
•  The household’s tastes and preferences.
•  The household’s expectations about future income,
wealth, and prices.
 Quantity Demanded

•  Quantity demanded is the amount

(number of units) of a product that
a household would buy in a given
time period if it could buy all it
wanted at the current market price.
Demand in Output Markets
•  A demand schedule
ANNA'S DEMAND
SCHEDULE FOR is a table showing
TELEPHONE CALLS how much of a given
QUANTITY
PRICE DEMANDED product a household
(PER
CALL)
(CALLS PER
MONTH)
would be willing to buy
$ 0
0.50
30
25
at different prices.
3.50
7.00
7
3
•  Demand curves are
10.00
15.00
1
0
usually derived from
demand schedules.
The Demand Curve
ANNA'S DEMAND
SCHEDULE FOR •  The demand curve
TELEPHONE CALLS
QUANTITY
is a graph illustrating
PRICE
(PER
DEMANDED
(CALLS PER how much of a given
$
CALL)
0
MONTH)
30 product a household
would be willing to
0.50 25
3.50 7
7.00 3
10.00
15.00
1
0
buy at different
prices.
The Law of Demand
•  The law of demand
states that there is a
negative, or inverse,
relationship between
price and the
quantity of a good
demanded and its
price.
•  This means that
demand curves slope
downward.
Other Properties of Demand
Curves

•  Demand curves intersect the quantity

(X)-axis, as a result of time limitations
and diminishing marginal utility.
•  Demand curves intersect the (Y)-axis,
as a result of limited incomes and
wealth.
 Income and Wealth

•  Income is the sum of all households

wages, salaries, profits, interest payments,
rents, and other forms of earnings in a
given period of time. It is a flow measure.
•  Wealth, or net worth, is the total value of
what a household owns minus what it
owes. It is a stock measure.
 Related Goods and Services

•  Normal Goods are goods for which

demand goes up when income is higher
and for which demand goes down when
income is lower.
•  Inferior Goods are goods for which
demand falls when income rises.
 Related Goods and Services

•  Substitutes are goods that can serve as

replacements for one another; when the price
of one increases, demand for the other goes
up. Perfect substitutes are identical
products.
•  Complements are goods that “go
together”; a decrease in the price of one
results in an increase in demand for the other,
and vice versa.
Shift of Demand Versus Movement Along a Demand
Curve

•  A change in demand is not

the same as a change in
quantity demanded.
•  In this example, a higher
price causes lower quantity
demanded.
•  Changes in determinants of
demand, other than price,
cause a change in demand,
or a shift of the entire
demand curve, from DA to
DB.
A Change in Demand Versus a Change in Quantity
Demanded

•  When demand shifts to the

right, demand increases.
This causes quantity
demanded to be greater
than it was prior to the shift,
for each and every price
level.
 A Change in Demand Versus a Change in Quantity
Demanded
To summarize:

Change in price of a good or service

leads to

Change in quantity demanded

(Movement along the curve).
Change in income, preferences, or
prices of other goods or services
leads to

Change in demand
(Shift of curve).
 The Impact of a Change in
Income
•  Higher income decreases the •  Higher income increases the
demand for an inferior good demand for a normal good
 The Impact of a Change in the
Price of Related Goods
•  Demand for complement good (ketchup)
shifts left

•  Demand for substitute good (chicken)

shifts right

•  Price of hamburger rises

•  Quantity of hamburger
demanded falls
 From Household to Market
Demand
•  Demand for a good or service can be
defined for an individual household, or for
a group of households that make up a
market.
•  Market demand is the sum of all the
quantities of a good or service demanded
per period by all the households buying in
the market for that good or service.
 From Household Demand to
Market Demand
•  Assuming there are only two households in
the market, market demand is derived as
follows:
 Supply in Output Markets
CLARENCE BROWN'S •  A supply schedule is a table showing how
SUPPLY SCHEDULE much of a product firms will supply at different
FOR SOYBEANS prices.
QUANTITY
SUPPLIED
PRICE (THOUSANDS
(PER OF BUSHELS •  Quantity supplied represents the number of
BUSHEL) PER YEAR) units of a product that a firm would be willing and
$ 2 0
1.75 10
able to offer for sale at a particular price during a
2.25 20 given time period.
3.00 30
4.00 45
5.00 45
 The Supply Curve and
the Supply Schedule
•  A supply curve is a graph illustrating how much of
a product a firm will supply at different prices.
CLARENCE BROWN'S 6

Price of soybeans per bushel ($)

SUPPLY SCHEDULE
FOR SOYBEANS 5
QUANTITY
SUPPLIED
4
PRICE (THOUSANDS
(PER OF BUSHELS
3
BUSHEL) PER YEAR) 2
$ 2 0
1.75 10 1
2.25 20
3.00 30 0
4.00 45
5.00 45 0 10 20 30 40 50
Thousands of bushels of soybeans
produced per year
 The Law of Supply
6 •  The law of supply
Price of soybeans per bushel ($)

5 states that there is a

4
positive relationship
3
2
between price and
1 quantity of a good
0 supplied.
0 10 20 30 40 50
Thousands of bushels of soybeans •  This means that supply
produced per year
curves typically have a
positive slope.
 Determinants of Supply
•  The price of the good or service.
•  The cost of producing the good, which in
turn depends on:
–  The price of required inputs (labor, capital,
and land),
–  The technologies that can be used to
produce the product,
•  The prices of related products.
 A Change in Supply Versus
a Change in Quantity Supplied

•  A change in supply is not

the same as a change in
quantity supplied.

•  In this example, a higher

price causes higher
quantity supplied, and a
move along the demand
curve.
•  In this example, changes in determinants of supply, other than
price, cause an increase in supply, or a shift of the entire
supply curve, from SA to SB.
 A Change in Supply Versus
a Change in Quantity Supplied

•  When supply shifts to

the right, supply
increases. This causes
quantity supplied to
be greater than it was
prior to the shift, for
each and every price
level.
 A Change in Supply Versus
a Change in Quantity Supplied
To summarize:

Change in price of a good or service

leads to

Change in quantity supplied

(Movement along the curve).
Change in costs, input prices, technology, or prices of
related goods and services
leads to

Change in supply
(Shift of curve).
 From Individual Supply
to Market Supply
•  The supply of a good or service can be
defined for an individual firm, or for a group
of firms that make up a market or an
industry.
•  Market supply is the sum of all the
quantities of a good or service supplied per
period by all the firms selling in the market
for that good or service.
 Market Supply
•  As with market demand, market supply is
the horizontal summation of individual
firms’ supply curves.
 Market Equilibrium
•  The operation of the market depends on
the interaction between buyers and
sellers.
•  An equilibrium is the condition that
exists when quantity supplied and
quantity demanded are equal.
•  At equilibrium, there is no tendency for
the market price to change.
Market Equilibrium
•  Only in equilibrium
is quantity supplied
equal to quantity
demanded.
•  At any price level
other than P0, the
wishes of buyers and
sellers do not
coincide.
Market Disequilibria
•  Excess demand, or
shortage, is the condition
that exists when quantity
demanded exceeds
quantity supplied at the
current price.
•  When quantity demanded exceeds
quantity supplied, price tends to rise
until equilibrium is restored.
Market Disequilibria
•  Excess supply, or surplus,
is the condition that exists
when quantity supplied
exceeds quantity
demanded at the current
price.
•  When quantity supplied exceeds
quantity demanded, price tends to
fall until equilibrium is restored.
 Increases in Demand and Supply

•  Higher demand leads to •  Higher supply leads to lower

higher equilibrium price and equilibrium price and higher
higher equilibrium quantity. equilibrium quantity.
Decreases in Demand and Supply

•  Lower demand leads to •  Lower supply leads to

lower price and lower higher price and lower
quantity exchanged. quantity exchanged.
Relative Magnitudes of Change

•  The relative magnitudes of change in supply and demand

determine the outcome of market equilibrium.
Relative Magnitudes of Change

•  When supply and demand both increase, quantity will

increase, but price may go up or down.
 Price Elasticity of Demand
•  According to the law of demand, when price
goes up, consumers demand fewer quantities
of a product. If the price of a product falls,
quantity demanded will rise.
•  But when the price of a product changes, by
how much more (or less) will consumers
buy?
•  To help answer this question, we will use a
measurement called the Price Elasticity of
Demand.
 Price Elasticity of Demand
•  For some products, consumers are highly
responsive to price changes. Demand for
such products is relatively elastic or simply
elastic.
•  For other products, consumers’
responsiveness is only slight, or in rare cases
non-existent. Demand is said to be relatively
inelastic, or simply inelastic.
 The Price-Elasticity Coefficient

•  Economist measure the degree of price

elasticity or inelasticity of demand with the
coefficient Ed.

•  Ed is defined as the percentage change in

quantity demanded of good X divided by the
percentage change in price of X.
 The Ed Formula

percentage
Ed = change in quantity demanded of X
percentage change in price of X
–  Generally, when calculating percentage changes in the
equation, we divide the change in quantity demanded by the
original quantity demanded and the change in price by the
original price.
–  However, because the resulting percentage change value
differs with the direction of the change, using averages as the
reference points ensures the same percentage change
regardless of the direction of the change.
 Using Averages: An Example

•  Consider the following example:

Suppose that at a price of $10, quantity
demanded is 200 units. When the price drops
to $5, quantity demanded rises to 300 units.
Price
$10

Demand
$5

200 300 Quantity

 Using Averages: An Example
•  The percentage change in quantity demanded from
200 to 300 is a 50 percent (=100/200) increase,
while the opposing change in quantity demanded
from 300 to 200 is a 33 percent (=100/300)
decrease.
•  Likewise, the percentage change in price from $10
to $5 is a 50 percent (=$5/$10) decrease, while the
opposing change in price from $5 to $10 is a 100
percent (=$5/$5) increase.
 Using Averages: An Example

•  Using averages eliminates the “up versus

down” problem.
change in quantity change in price
Ed =
sum of quantities/2 sum of prices/2
–  For the quantity range 200-300, the quantity
reference is 250 units [=(200+300)/2].
–  For the same price range $5-$10, the price
reference is $7.50 [=($5 + $10)/2]
 Using Averages: An Example

•  The percentage change in quantity demanded

is now 100/250, or a 40 percent increase, and
the percentage change in price is now -
$5/$7.50, or about a 67 percent decrease.
•  Ed = 0.4/-.67 = -0.597
 Elimination of the Minus Sign

Because the demand curve slopes

downward, Ed will always be a negative
number. Therefore, we take the absolute
value and ignore the minus sign.
 Interpretations of Ed
The coefficient of price elasticity of demand can be
interpreted as follows:
•  Elastic Demand: Product demand for which price
changes cause relatively larger changes in quantity
demanded; Ed > 1
•  Inelastic Demand: Product demand for which price
changes cause relatively smaller changes in
quantity demanded; Ed < 1
•  Unit Elasticity: Product demand for which price
changes and changes in quantity demanded are
equal; Ed = 1
 Interpretations of Ed
Extreme Cases
•  Perfectly Inelastic: Product demand for which
quantity demanded does not respond to a change in
price.
•  Perfectly Elastic: Product demand for which
quantity demanded can be any amount at a
particular price.
Interpretations of Ed
 The Total-Revenue Test
•  Elasticity is important to firms because when
the price of their products change, so does
their profit (total revenue minus total costs).

Total revenue (TR) = price x quantity = P x Q

•  This represents the total number of dollars
received by a firm from the sale of a product
in a particular period.
 The Total-Revenue Test
Total revenue and the price elasticity of
demand are related. The total-revenue test
can determine elasticity by examining what
happens to total revenue when price
changes.
 The Total-Revenue Test
•  If demand is elastic, a decrease in price will
increase total revenue, and an increase in
price will reduce total revenue.
•  If demand is inelastic, a price decrease will
decrease total revenue, while an increase in
price will increase total revenue.
•  If demand is unit elastic, total revenue
remains constant when prices rise or fall.
The Total-Revenue Test
 Price Elasticity along a
Linear Demand Curve
•  Along a linear demand curve, elasticity varies
over the different price ranges.
•  Because elasticity involves relative or
percentage changes in price and quantity, as
you move along a demand curve, the
percentage changes in price and quantity will
vary.
 Determinants of Price Elasticity of
Demand
•  In general, there are four determinants that
can affect the price elasticity of demand:
•  Substitutability
•  Proportion of Income
•  Luxuries versus Necessities
•  Time
 Determinants of Price Elasticity of
Demand
•  Price elasticity of demand is greater:
–  the larger the number of substitute goods that are
available
–  the higher the price of a product relative to
one’s income
–  the more that a good is considered to be a
“luxury” rather than a “necessity”
–  the longer the time period under consideration
 Price Elasticity of Supply
•  Price elasticity of supply measures the
responsiveness of sellers to changes in the
price of a product.
–  If producers are relatively responsive, supply is
elastic.
–  If producers are relatively insensitive to price
changes, supply is inelastic.
 Price Elasticity of Supply
•  The price elasticity of supply coefficient Es is
defined as:

percentage change in quantity supplied of X

Es = percentage change in price of X

•  To calculate Es, we employ the midpoint

approach to determine the percentage
changes.
 Price Elasticity of Supply
•  If Es < 1, supply is inelastic.
•  If Es > 1, supply is elastic.
•  If Es = 1, supply is unit-elastic.

•  Since price and quantity supplied are directly

related, Es is never negative.
 Price Elasticity of Supply
•  The amount of time it takes producers to shift
resources between alternative uses to alter
production of a good can determine the
degree of price elasticity of supply.
–  The easier and more rapid the transfer of
resources, the greater is the price elasticity of
supply.
–  The longer a firm has to adjust to a price change,
the greater the elasticity of supply.
 Price Elasticity of Supply and Time
Periods
•  The market period is a period in which
producers of a product are unable to change
the quantity produced in response to a
change in price.
–  During this time period, the supply of a product is
fixed, or supply is perfectly inelastic.
 Price Elasticity of Supply and Time
Periods
•  In the short run, producers are able to
change the quantities of some but not all the
resources they employ.
–  This time period is too short to change plant
capacity but long enough to use fixed plant more
or less intensively.
–  The supply of a product is more elastic than the
market period.
 Price Elasticity of Supply and Time
Periods
•  In the long run, producers are able to change
all the resources they employ.
–  This time period is long enough for firms to adjust
their plant sizes and for new firms to enter (or
existing firms to exit) the industry.
–  The supply of a product is more elastic than in
the short run.
Price Elasticity of Supply and Time
Periods
 Income Elasticity of Demand

•  Income elasticity of demand measures the

responsiveness of consumer purchases to
changes in consumer income.
•  The coefficient of income elasticity of demand
Ei is determined with the formula

EI = percentage change in quantity demanded

percentage change in income
 Income Elasticity of Demand
•  Normal Goods will have an income elasticity
of demand that is positive. More of them are
demanded as income increases. Ei > 0

•  Inferior goods have a negative income

elasticity of demand. As income rises, the
demand for them falls. Ei < 0
 III. Industry Environment
q   The  Five  Forces  Model  
is   an   analysis   tool   that   uses   -ive   industry   forces   to   determine  
the   intensity   of   competition   in   an   industry   and   its  
pro7itability  level.  
Intense   competition   in   an   industry   is   neither   coincidence   nor  
bad  luck.    
Competition   in   an   industry   is   rooted   in   its   underlying  
economics,  and  competitive  forces  exist  that  go  well  beyond  the  
established  combatants  in  a  particular  industry.    
The   corporate   strategists’   goal   is   to   -ind   a   position   in   the  
industry   where   his   or   her   company   can   best   defend   itself  
against  these  forces  or  can  in-luence  them  in  its  favor  
 
 
Forces Driving Industry Competition

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Ex.  4.8    Forces  Driving  Industry  Compe((on  (watch  clip)  
 
 Threat of New Entrants
•  Threat of new entrants
–  new entrants to an industry bring new capacity, a
desire to gain market share and substantial
resources
•  Entry barrier
–  an obstruction that makes it difficult for a
company to enter an industry

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 Barriers to Entry
Economies of scale
Product differentiation
Capital requirements
Switching costs
Access to distribution channels
Cost disadvantages due to size
Government policies

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Rivalry among Existing Firms

•  In most industries, corporations are

mutually dependent.
•  A competitive move by one firm can be
expected to have a noticeable effect on its
competitors and thus may cause
retaliation.

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Rivalry among Existing Firms
(clip)
Product or
Number of Rate of
service
competitor industry
characteris
s growth tics
Height of
Amount of
Capacity exit
fixed costs
barriers

Diversity
of rivals
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 Threat of Substitute
Products or Services
•  Substitute product
–  a product that appears to be different but can satisfy
the same need as another product
•  The identification of possible substitute products means
searching for products that can perform the same
function, even though they have a different appearance.
•  Example: online learning >< teachers; robots >< teachers

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 The Bargaining Power of
Buyers
•  Bargaining power of buyers
–  ability of buyers to force prices down, bargain
for higher quality and play competitors
against each other
–  Large purchases, backward integration,
alternative suppliers, low cost to change
suppliers, product represents a high
percentage of buyer’s cost, buyer earns low
profits, product is unimportant to buyer
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 Powerful  Buyers  
A  buyer  group  is  powerful  if:    
•  It  is  concentrated  or  purchases  in  large  volumes    
•  The  products  it  purchases  from  the  industry  are  standard  
•  The  products  it  purchases  from  the  industry  form  a  component  of  its  
product  and  represent  a  significant  frac(on  of  its  cost  
•  It  earns  low  profits  
•  The  industry’s  product  is  unimportant  to  the  quality  of  the  buyers’  
products  or  services    
•  The  industry’s  product  does  not  save  the  buyer  money    
•  The  buyers  pose  a  credible  threat  of  integra(ng  backward  
The Bargaining Power of
Suppliers
•  Buyers affect an industry through their
ability to force down prices, bargain for
higher quality or more services and play
competitors against each other.

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 The Bargaining Power of
Suppliers
A buyer or a group of buyers is powerful if some of the
following factors hold true:
• Industry is dominated by a few companies
• Unique product or service
• Substitutes are not readily available
• Ability to forward integrate
• Unimportance of product or service to the industry

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 Powerful  Suppliers  
A  supplier  group  is  powerful  if:  
•  It  is  dominated  by  a  few  companies  and  is  more  concentrated  than  
the  industry  it  sells  to    
•  Its  product  is  unique  or  at  least  differen(ated,  or  if  it  has  built-­‐up  
switching  costs    
•  It  is  not  obliged  to  contend  with  other  products  for  sale  to  the  
industry    
•  It  poses  a  credible  threat  of  integra(ng  forward  into  the  industry’s  
business    
•  The  industry  is  not  an  important  customer  of  the  supplier  group  
 Industry  Analysis  &  Compe((ve  Analysis  

•  An  industry  is  a  collec(on  of  firms  that  offer  similar  products  

or  services.    
•  Structural  a:ributes  are  the  enduring  characteris(cs  that  
give  an  industry  its  dis(nc(ve  character.    
•  Concentra6on  refers  to  the  extent  to  which  industry  sales  are  
dominated  by  only  a  few  firms.    
•  Barriers  to  entry  are  the  obstacles  that  a  firm  must  overcome  
to  enter  an  industry.    
Thank you!
Any questions?