Part 3 Microeconomic decision makers

Part 3 Microeconomic decision makers

Activities: Guidance and answers
Activity 3.1 How specialization began
Frame 1 shows that Og the caveman is clearly very disappointed with his effort
to produce spears and pots. He is not very good at making these items and should
specialize in the production of something he is good at.
Frame 2 shows that Og has planted some seeds and is watering them to help
them grow.
In frame 3 the plants have matured and have produced fruits.
Frame 4 suggests Og has produced more fruit that he needs or wants.
In frame 5 he exchanges his surplus fruit for a spear.
Frame 6 shows a happy Og because he now has good collection of pots and spears.
By specializing in fruit growing and producing surpluses Og has been able to
engage in trade with producers of other items he needs and wants but is unable to
produce efficiently himself.

Activity 3.2 Ye olde swap shop

1 There must be a double coincidence of wants for exchange to take place, i.e.
the ruler-maker must want to exchange rulers for pencils. The exchange rate
between pencils and rulers – i.e. how many pencils are needed to obtain one
ruler – must also be agreed.
2 If the pencil-maker does not want erasers then the eraser-maker must
persuade the ruler-maker to exchange some of the pencils it has acquired in
the first trade in return for erasers. Again, there must be a double coincidence
of wants between the ruler-maker and the eraser-maker and they must agree
a rate of exchange between pencils and erasers.
3 Milk, cheese and eggs are perishable items. They will go off – i.e. lose their
value – if people are unable to trade them.

Activity 3.3 Funny money

1 Due to hyperinflation the Brazilian currency, the cruzeiro, failed as a good
store of value. People lost confidence in the currency and so it had to be
replaced with a new currency, the Real.
2 The cruzeiro was failing to perform all three functions before it was replaced.
Because the rate of inflation was so high the currency lost value rapidly
so people did not want to accept it as medium of exchange. Because the
purchasing power of the currency was being eroded so quickly by rapid
inflation it also failed to provide a stable measure of value. The article states
that a product priced at $1 one day had risen to $2 a month later, and to
$1,000 by the end of the year.

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 Part 3 Microeconomic decision makers

Activity 3.4 What is a ‘good’ money?

Mountains are scarce but too big to be a good money. They are not portable.
Cheese is perishable and will not be a very good store of value.
Cigarettes are portable, relatively scarce and durable unless they are consumed.
However, they may be easily damaged and unlikely to be generally acceptable to all.
Gold is scarce, durable, divisible, a good measure of value and store of value. Gold
rings and pieces are likely to be generally acceptable mediums of exchange.

Activity 3.5 Mrs Mint’s money

1 Notes, coins and instant access savings.
2 Long-term savings, savings bonds, jewellery.

Activity 3.6 Why do we need banks?

1 If there were no banks Digital Dreams would need to use a generally
acceptable medium of exchange or exchange goods or services of equal value
to make payments.
2 In a safe of its own. Bank accounts provide a much safer way to store money.
3 Borrowing money from friends, relatives or other people. The business is
unlikely to raise very much from these sources. The money supply in the
economy will be far more limited. This is because banks create deposit money
from their lending activities.
4 Because Digital Dreams would have to organize making payments to all its
employees and suppliers and would have to collect cash or other acceptable
forms of payments from all its customers, its running costs would be much
higher. There would be no credit or debit cards to make online payments.

Activity 3.7 You can bank on it!

Central bank Commercial bank
1  Main functions To maintain the stability of the national currency The provision of financial services to
and the money supply individuals and businesses

2 Services issuing notes and coins •  accepting deposits of money and savings
managing payments to and from the government’s • helping customers make and receive
account payments
managing the national debt •  making personal and commercial loans
supervising and regulating the banking system •  buying and selling shares for their customers
acting as lender of last resort to the banking system •  providing insurance
managing the nation’s gold and foreign •  operating pension funds
currency reserves •  financial and tax planning advice
operating monetary policy •  exchanging foreign currencies
3 Organization, In most countries, the central bank is owned by the These banks are usually limited companies
control and government and run by a public corporation owned and financed by their shareholders
finance
4 Relationships The central bank in a country supervises the banking Commercial banks are regulated by the
with other system, regulates the conduct of banks, holds their central bank; they lend money to other
organizations deposits and transfers funds between them businesses and to government

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Activity 3.8 Spending patterns

1 Households with the highest incomes spent proportionally more of their
total weekly expenditure on restaurants and hotels, recreation and cultural
activities and transport than low-income households. In contrast, low-income
households spent a larger proportion of their weekly expenditure on food and
non-alcoholic drinks, housing, fuel and power, and alcohol and tobacco, than
high-income households.
2 All households will have to spend money on essential products such as food,
housing and power, but these costs will account for a far greater proportion
of the weekly budget of a low-income household than a household with a
much larger income. High-income households can afford to spend more on
satisfying their wants and the purchase of luxury items, hence the larger
proportion of their total expenditure they spend on recreation and culture,
eating out at restaurants and travel.

Activity 3.9 Shop ’til they drop

Consumer trends Reasons

Rising sales of new cars
Increased consumption of healthy
foods and drinks
Increasing household ownership of
consumer durables
Increase in mobile telephone and
broadband subscriptions; falling fixed
telephone line subscriptions
Changes in global pattern of cigarette
consumption
Changes in dietary patterns in
America
Increase in real disposable incomes and availability of motor vehicles in many
developed and especially rapidly developing economies such as China; increase in
availability of credit to buy cars; increase in demand for travel and leisure activities
as incomes have increased and tastes have changed; growing pressure to reduce
vehicle use to cut harmful emissions and increasing taxes on petrol may reduce
demand for cars and vans and travel in future. However, new low-emissions and
electric vehicles are being developed and becoming more affordable as their scale of
production is increased
Increasing health conscious diets; demand is likely to rise further as concerns about
diet and obesity grow
Rise in real household disposable incomes; increased availability and falling prices of
many consumer durables; changes in lifestyles have increased demand for labour-
saving products such as washing machines and microwaves; many products have
reached saturation point so demand is likely to fall, requiring manufacturers to
develop extension strategies and new technologies and products
Increasing demand for fast Internet access and communications while on the move;
increasing competition between broadband service providers has reduced charges;
falling cost of mobile communications relative to cost of fixed lines and likely to see
continuation of these trends; also cheaper for phone companies to supply mobile
telecommunications instead of investing in the fixed-line network and physically
having to visit buildings to connect telephones to the network
Increased taxation of tobacco products and increasing awareness of negative impact
of smoking on health has reduced consumption in many developed economies.
This trend is likely to continue. However, the reverse is true in many developing
economies in Asia, Africa and especially in China, where rising incomes have
increased cigarette consumption.
Rising incomes (reduction in demand for some basic ‘inferior’ foods such as
potatoes) and increased awareness of food related health issues has reduced the
consumption of some high fat, high carbohydrate, dairy and sugary foodstuffs
over time. These have been replaced in the average per capita diet with lower
fat, healthier alternatives including chicken, rice and yogurt. However, cheese
consumption per person has also increased, possibly due to the income effect and
related changes in tastes.

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Activity 3.10 ‘If I owe you a pound, I have a problem; but if I

owe you a million, the problem is yours’
1 Increased consumer spending and low interest rates. Both factors have
increased borrowing and therefore consumer debt.
2 Many UK households have total debts exceeding their annual income.
Many loans are short term and have variable interest rates. An increase in
interest rates will therefore increase the cost of interest charges on loans
and will therefore take a larger proportion of household income. This will
reduce disposable income available for spending on consumer goods and
services and, if significant, could create an economic recession, increase
unemployment and reduce economic growth.
3 A government could reduce consumer demand for borrowing by increasing
interest rates and by increasing taxes on incomes.
4 A young, unmarried university graduate will have a relatively low income
and is likely to spend most of his or her income on food and rented
accommodation, but also on fashionable clothes, music and going out
with friends.
A married couple with a young family will spend a larger proportion of
their income of housing costs, for example paying off a mortgage, and
on household goods and services for their home. Children’s clothes and
education costs are also likely to account for a significant proportion of
total expenditure.
A retired couple are likely to have a relatively stable income from a pension.
They will tend to spend a larger proportion of their income on heating their
homes during winter, medical care and recreational activities because they are
not working.
5 As debt rises, loan repayments and interest charges will take a larger
percentage of total income. Households will have less to spend on other goods
and services. If consumer spending falls, firms may be forced to cut back
output and employment. They may also delay plans to invest in new plant
and equipment that could expand their productive potential.

Activity 3.11 Why do people work?

1 Wages and salary levels will depend on the labour demand supply
conditions for each job. Some jobs require people with high levels of skills
and qualifications. However, the supply of labour with specific skills and
qualifications may be relatively low compared to the supply of unskilled
labour. So, for example, jobs for economists may offer high wages or salaries
to attract a supply of suitably qualified labour. Similarly, jobs that require
people to work long and unsociable hours or involve dangerous work may
need to offer attractive wages to encourage a supply of labour willing to work
in these jobs.
2 The job advertised for an economist is likely to offer the higher salary
because the supply of skilled economists may be limited. This is because
good economists may have studied for many years at university to obtain the
qualifications they need. In contrast, general labouring may offer the lowest
wages because there is a ready supply of semi-skilled and unskilled labour
willing to undertake the work.

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3 The economist job is likely to attract the least number of applicants. This is
because economist skills are in short supply. The cost of long periods of study
at college and the opportunity cost of foregone earnings during these periods
will restrict the number of people wishing to become economists.
4 Your choice of job will depend not just on your skills and interests but also the
net advantages of the positions, including the wage or salary, hours of work,
the cost and time it takes to travel to and from your workplace, promotion
prospects and many other factors.
5 This task requires you to investigate different jobs and the monetary and non-
monetary benefits they offer.

Activity 3.12 The rise and fall of labour

What has changed? Impact on labour demand? Impact on labour supply? Impact on market
wage rate?
• Nurses are offered new contracts Increase in the supply of nurses Fall
with shorter working weeks
• Consumer spending on flat-screen Increase in the demand for Rise
televisions increases significantly factory workers to make
flat-screen televisions
• The government raises the retirement Increase in the supply of people Fall
age of public sector workers seeking public sector jobs
• Overtime payments for airline Fall in the supply of airline Rise
employees are to be scrapped industry workers
• Computerized assembly lines boost Increase in the demand for Rise
labour productivity in car plants car assembly line workers
• A major retail chain announces it Fall in the supply of retail Rise
will remain open 24 hours each day workers
•  Assaults on police increase Fall in the supply of police Rise
• The government announces it will Fall in the supply of restaurant Rise
tax tips received by restaurant and and hotel workers
hotel staff from next April
• A survey finds more people are Increase in the supply of Fall
working part-time and flexible hours part-time workers and others
seeking more flexible working
arrangements
• Statutory maternity leave and pay Fall in the demand for Increase in the supply of Fall
are to be increased female workers female labour
• New technology allows more office Increase in the supply of labour Fall
workers to work from home to office-based occupations

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Activity 3.13 How’s your differential?

1 Labour demand and supply conditions for different occupations will explain
differentials in earnings and between males and females. For example,
managerial and professional occupations, such as lawyers and doctors, tend
to pay higher salaries than less skilled occupations because the supply of
professional and managerial skills is more limited. Average female earnings in
the same occupations tend to be lower than average male earnings because
many women may take career breaks to raise families and may work reduced
hours. However, it is also possible that workplace discrimination may hold
back the pay and career prospects of some females.
2 This task requires you to find examples of jobs in different occupational
groups in your country, state whether their wage rates or earnings follow the
same pattern given in the bar chart in the activity based on the UK, and use
your knowledge of factors that may affect labour market conditions to explain
the pattern of wage of earnings differentials.

Activity 3.14 The minimum wage debate

1 Arguments for a minimum wage: to lift people on low incomes out of
poverty; to boost productivity.
Arguments against a minimum wage: it raises employment costs and will
reduce the demand for labour.
If the minimum wage (MW) for an occupation is set below the market wage
rate (W) it will have no effect. If the minimum wage (MW) is set above the
market wage rate (W) there will be an excess supply of labour, equal to n1 to
n2 in the diagram below. Employment will fall from N to n1.

Dn Sn
Wage

MW

Sn Dn

0 n1 N n1
Quantity of labour employed

2 By observing changes in employment and levels of productivity in low wage

occupations.
3 a There us an excess supply of labour at W1
b
W2 is below the equilibrium wage rate and will therefore have no effect
4 Wage elasticity of demand for teenage labour = % change in quantity of
labour demanded / % change in wage. Therefore the elasticity of demand is
0.3. This suggests labour demand is relatively wage inelastic.

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 Part 3 Microeconomic decision makers

Activity 3.15 Why I’m part of the union!

1 Negotiating wages and other non-wage benefits with employers; defending
employees’ rights and jobs; improving working conditions, such as better
hours of work and health and safety; improving pay and other benefits,
including holiday entitlement, sick pay and pensions; encouraging firms
to increase workers’ participation in business decision making; supporting
members who have been dismissed or who are taking industrial action;
developing the skills of union members, by providing training and education
courses; providing social and recreational amenities for their members;
influencing government policy and employment legislation.
2 Benefits might include time savings associated with negotiating with union
representatives rather than many individual workers; unions will maintain
the skill levels of their members through on- and off-the-job training; unions
can participate in business decision making and discuss ways to improve
productivity. Problems might include increased bargaining power of unions
in negotiations over pay and working conditions, especially if there is a closed
shop or single union agreement negotiations; unions may restrict the supply
of labour to put upward pressure on wages.
3 See answer to question 1 for possible benefits of union membership. There
are costs associated with union membership including membership fees but
also foregone wages if the union requires its members to take strike action.

Activity 3.16 A tough negotiation

This activity requires you to write a report and take part in a role-play exercise.
The outcome of the exercise will depend on your skills in negotiation.
The team playing the union will need to address the following questions in
its report.
• What is your pay claim? A 5% increase in the wage rate. However, you might
also seek improvements in overtime pay and performance-related payments.
You might be willing to accept changes in these to reduce your demand for a
5% pay increase.
• Why have you made this pay claim? Because your members will be required
to operate new machinery. The new equipment will increase productivity and
reduce costs. As a result, profits are likely to rise so the union wants to secure
a share of these by raising its members’ wages but also wants to protect the
jobs of its members.
• What has been the management response? Managers have not rejected the
demand outright but have stated that they are to avoid any increase in wage
costs that may make them uncompetitive. This means they might be willing
to improve pay if there are improvements in labour productivity.
• What forms of action could the union take if necessary? Initially the
union could ask its members to work to rule and reject overtime working.
Ultimately, the union could organize a strike.
• Why are both you and the management keen to avoid a strike? Union
members will lose wages while on strike and the union does not want to
jeopardize a big customer order that will help to keep its members in jobs.
Managers similarly do not want to lose output and put the new customer
order at risk. The strike may lose the company custom it cannot recover and
ultimately may force it to close down.

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 Part 3 Microeconomic decision makers

The team playing the managers will need to address the following questions in
their report.
• What wage claim has the union made? A 5% increase in the wage rate.
However, the union may also seek improvements in overtime pay and
performance-related payments. The union might be willing to accept changes
in these to reduce to its demand for a 5% pay increase.
• What are the implications of accepting or rejecting this claim? If the union
demand is rejected its members may take strike action but the union will
know this might place the new order and future of the business, and
therefore the jobs of their members, at risk. Accepting the demand without
any improvements in labour productivity will increase production costs and
may make the business uncompetitive.
• Why you are keen to avoid a strike? It will mean lost output and revenue during
the strike because the company will not be able to meet customers’ orders. The
reputation of the company as a reliable supplier will also be damaged and it may
continue to lose customers even when the dispute is resolved.
• What will be discussed with the union? The likely impact of any disruption
on the company and therefore the jobs of union members; reducing their
immediate pay demands; linking improved pay to improvements in productivity;
how best to minimize redundancies following the introduction of the new
equipment, for example by offering generous early redundancypackages

Activity 3.17 Which stage of production?

1
Primary Secondary Tertiary
Fishing Construction Television broadcasting
Forestry Furniture making Film making
Farming Engineering Decorating
Mining Shipbuilding Health service
Chemicals Banking
Manufacture of motor Hotels
vehicles Retailing
Advertising
Universities
Restaurants

Activity 3.18 Size matters

• The largest firm depends on the measure used. Toyota is the largest employer.
Exxon-Mobil is the largest by capital employed and value of total annual
output. Google has the largest market share of the four companies.
• As the answer to the first question illustrates, it is not sensible to use just one
measure of firms’ size.
• Focusing on just one measure ignores other measures of firms’ size. For
example, labour-intensive firms may have very little capital employed. High-
tech manufacturing firms may employ many billions of dollars worth of capital
equipment on automated production lines that require very little labour input.
Similarly, a small village shop may have a large market share of its local market
because it is the only shop for many miles, but a large global retailer may have
a smaller share of a huge global market worth many billions of dollars.

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Activity 3.19 Staying small

Personal preference; the owner of a sole trader keeps all the profits; there is
preferential tax treatment of small firms to encourage enterprise; they lack
access to capital; they are able to work from home; there has been a fall in cost
of new technology; customers are attracted by more personalized service; the
market size is small.

Activity 3.20 What type of integration?

Merger or takeover Horizontal? Vertical? Lateral?
A chocolate maker takes over a cocoa plantation ✔
A travel insurer merges with a on-line holiday company ✔
A clothing retailer takes over a clothes manufacturer ✔
A bus manufacturer merges with a car maker ✔
An investment bank takes over an electronics producer ✔
An aircraft maker merges with an aero-engine company ✔

Activity 3.21 Big is beautiful

Case 1: Cleaning up their act
1,2 Larger firms tend to be more secure financially and banks are therefore more
willing to extend loans to them and at more attractive interest rates than they
would for smaller firms (financial economies); the fixed costs of new, more
efficient machinery and advertising can be spread over a much larger output
in a large firm (technical and marketing economies); larger firm produces a
range of soaps for different markets (risk-bearing economies)

Case 2: Blasting off!

1,2 The large firm was able to invest in large-scale blast furnace – the fixed cost
can be spread over a much larger output than smaller firms investing in
furnaces (technical economies); large firms are also able to invest in their
own vehicle fleet rather than using the services of road haulage providers and
paying the cost of their services and profit margins (technical economies);
large firms are able to buy in bulk from suppliers and receive discount
(purchasing economies); large firms are able to access new markets overseas
(risk-bearing economies).

Activity 3.22 Dough!

1 The chain of production for bread may be as follows.
3 Farms plant seeds to grow wheat
7 Wheat is harvested
8 
Insurance firms provide insurance to protect farms from risk of damage
or theft
13
Commercial banks provide loans and payment services for farmers
5 
Road haulage service providers transport harvested wheat and
finished breads
8 
Insurance firms provide insurance to protect road haulage companies from
risk of damage or theft

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13 Commercial banks provide loans and payment services for road

haulage companies
1 
Wheat, water, yeast and other ingredients are mixed together to
produce dough
2 Coal and oil are used to power electricity stations for use by the bakery
8 
Insurance firms provide insurance to protect the bakery from risk
of damage or theft
13
Commercial banks provide loans and payment services for the bakery
9 Dough is poured into baking pans and placed in ovens to cook
14 Food inspectors check the quality and hygiene of the breads and the
bakery
10 Sealed packets for the bread are produced and labelled in
printing machines
12
Finished loaves of bread are sealed in plastic packaging
5 
Road haulage service providers transport harvested wheat and
finished breads
4 Supermarkets and other shop sell bread to consumers
2 
Coal and oil are used to power electricity stations for use by firms
and households
8 
Insurance firms provide insurance to protect supermarkets from risk of
damage or theft
13
Commercial banks provide loans and payment services for the bakery
6 Consumers buy bread
2 
Coal and oil are used to power electricity stations for household
consumption
11
Consumers make sandwiches or toast to consume
13
Commercial banks provide loans and payment services for households
2 The task is your own research into the chain of productive activities in the
production and sale of six different products.

Activity 3.23 Passport to success

1
Year Total output achieved No. of workers Average annual labour
(*forecast) productivity
1 100,000 5 20,000
2 210,000 10 21,000
3 330,000 15 22,000
4 460,000 20 23,000
5 570,000* 25 (Option 1) 22,800
5 540,000* 20 (Option 2 using 27,000
new machinery)

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 Part 3 Microeconomic decision makers

2 The addition of five extra workers increases total output to 570,000 units
per year, but average labour productivity falls from 23,000 units per worker
per year to 22,800 units per worker per year. In contrast, employing new
machinery instead increases total output to 540,000 but average labour
productivity increases to 27,000 units per worker per year. Based on these
figures, the company is wrong to consider just increasing the workforce.
3 The company should install the new machinery because:
• 
average labour productivity is increased by 4,000 units per worker per year
(option 1 will result in it declining by 200 units per worker per year);
• 
although total annual output is greater under option 1, the company may
not be able to sell the extra output without reducing prices and this will
reduce the profit margin per unit sold;
• 
the cost of the machinery is $300,000 compared to an increase in labour
costs of $100,000 per year for five additional workers. However, the cost
of the machinery can be spread over a useful life of ten years: a cost of
$30,000 per year;
Existing workers may demand a wage increase to operate the new machinery
and may need training to operate it. This will increase costs.
4 The company could increase average labour productivity further by:
• 
replacing old plant and machinery with new, more efficient machines and
equipment for workers to use;
• 
training workers to operate the new machinery and to improve their skills;
• 
introducing lean production processes and new working practices designed
to continually reduce waste, increase speed, improve quality and raise
output.
•
motivating workers to increase their effort and output, for example, by:
– 
offering workers performance-related pay or bonuses;
– 
offering workers non-financial rewards, including free gym membership
or additional days off if they improve their productivity;
– 
increasing their job satisfaction, for example by improving the working
environment, making jobs more varied, introducing more team
working, involving workers in business decision making and giving
regular feedback on performance.

Activity 3.24 March of the robots

1 They can reduce labour requirements and costs; they can be used
continuously and increase productivity; average costs of production are
reduced; product quality can rise; firms will become more competitive.
2 Industrial robots can undertake tasks formerly carried out by employees. They
can therefore replace labour in production processes.
3 Workers may be made redundant if robots replace them. Productivity may
rise, thereby reducing business costs. Cost savings may be passed onto
consumers through lower prices. Product quality may also increase.
4 They can be expensive; business managers may not be aware of their benefits
workers may not have the skills to use them efficiently; trade unions may
resist their introduction if it means workers will lose their jobs.

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Activity 3.25 Bear Necessities

1 They are costs that do not vary with output. Examples include rents, loan
repayments, insurance premiums, lease payments for equipment and
depreciation.
2 $200
3 $200
4 They are production costs that vary directly with the amount of output, for
example cost of materials and components, power to operate machinery and
piece rate payments to employees.
5 $800
6 $8,000
7 a $1,000 b $8,200
8 17

Bears produced Total fixed costs Total variable Total costs Average cost per
per week $ costs $ $ bear $

0 200 0 200 -
50 200 400 600 12.00
100 200 800 1,000 10.00
200 200 1,600 1,800 9.00
300 200 2,400 2,600 8.67
400 200 3,200 3,400 8.50
500 200 4,000 4,200 8.40
600 200 4,800 5,000 8.33
700 200 5,600 5,800 8.29
800 200 6,400 6,600 8.25
900 200 7,200 7,400 8.22
1,000 200 8,000 8,200 8.20

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$
9,000

8,000 Total fixed costs

Total variable costs
7,000
Total costs
6,000

5,000

4,000

3,000

2,000

1,000

0 100 200 300 400 500 600 700 800 900 1000
Output of bears per week

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10 $10
11 $10
12 $1,000
13 $10,000
14 16

Bears produced and Total revenue $ Total costs $ Profit or loss $

sold per week
0 0 200 -200
50 500 600 -100
100 1,000 1,000 0
200 2,000 1,800 200
300 3,000 2,600 400
400 4,000 3,400 600
500 5,000 4,200 800
600 6,000 5,000 1,000
700 7,000 5,800 1,200
800 8,000 6,600 1,400
900 9,000 7,400 1,600
1,000 10,000 8,200 1,800

15
$
12,000

Total fixed costs

10,000 Total variable costs
Total costs Profit
Total revenue
8,000

6,000

4,000
Loss

2,000

0 100 200 300 400 500 600 700 800 900 1000
Output of bears per week

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12

10
Average cost per bear $

0 100 200 300 400 500 600 700 800 900 1000
Output of bears per week

Activity 3.26 A calculated issue

1
Magazines per Total fixed costs Total variable Total cost Average cost Total Revenue Profit or Loss
month costs
0 $4,000 0 $4,000 - 0 - $4,000
1,000 $4,000 $3,000 $7,000 7.00 $5,000 -$2,000
2,000 $4,000 $6,000 $10,000 5.00 $10,000 0
3,000 $4,000 $9,000 $13,000 4.33 $15,000 $2,000
4,000 $4,000 $12,000 $16,000 4.00 $20,000 $4,000
5,000 $4,000 $15,000 $19,000 3.80 $25,000 $6,000
6,000 $4,000 $18,000 $22,000 3.67 $30,000 $8,000
7,000 $4,000 $21,000 $25,000 3.57 $35,000 $10,000
8,000 $4,000 $24,000 $28,000 3.50 $40,000 $12,000

2 2,000 magazines per month

3
$
45,000
40,000 Total cost
35,000 Total revenue

30,000 Profit

25,000
20,000
15,000 Loss

10,000
5,000

0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000

Output of magazines per month

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© Brian Titley 2018: this may be reproduced for class use solely for the purchaser’s institute
 Part 3 Microeconomic decision makers

Activity 3.27 What’s the objective?

Firm Objectives
Large car manufacturer Survival
New small window cleaning firm Survival; market growth
Established low cost airline Market growth; long run profit maximization
Leading supermarket Market growth; long run profit maximization
Small manufacturing firm employing disabled Social welfare
people

Activity 3.28 All washed up

1 Price wars involve competing firms continually trying to undercut each
other’s prices, often to force rivals out of business. All firms involved in a price
war usually end up losing money by trying to out compete each other on
price.
2 P&G’s motives were recent price cuts and an aggressive new advertising
campaign for its main rival brand.
3 Profit margins fell.
4 HUL may have significant economies of scale. This means its average or unit
costs are likely to be lower than its rival. It can therefore afford to lower prices
and still earn a good margin for profit. Having a bigger range of well-known
products in its portfolio also means it will only have to cut the prices of those
that compete directly with those products offered by P&G, while having a
bigger market share also means it has more customers, many of whom may
be loyal to brands offered by HUL and therefore unlikely to switch easily to
rival products. It will also have a larger share of total sales revenue. This will
give the company greater financial strength to withstand a price war.
5 It is price elastic, because there are many close substitutes to choose from.
6 Price leadership could have been used to avoid a price war. Instead HUL and
P&G could charge very similar prices and could raise them or lower them
together at the same time to avoid price competition.

Activity 3.29 Creating barriers

Big Sell Supermarket plc: barriers might include the scale of the supermarket itself
and the product ranges it offers to customers allowing them the convenience of
shopping for many of the products they need and want ‘under one roof’; it could
prevent its wholesaler from supplying rival retailers by threatening to take its
custom elsewhere if the wholesaler does.
Flyhigh airlines: the airline may use predatory pricing to deter new competition
and heavily subsidize those routes under threat from competition with monopoly
profits from other routes.
Spreadwell Limited: it can threaten to withhold supplies of its popular margarine
from supermarkets that stock rival products.

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© Brian Titley 2018: this may be reproduced for class use solely for the purchaser’s institute