STRATEGIC COST MANAGEMENT

MICROECONOMICS

Economics is a social science which studies the choices that individuals,

businesses, and governments make as they cope with scarcity, all the
things that influence these choices, and the arrangements that coordinate
them.

Demand – the relationship between the price of a good and the quantity
demanded. It is also defined as the schedule of quantities of a good that
people are willing to buy at different prices.

Quantity Demanded – the amount that consumers plan to buy during a

period at a particular price.

Law of Demand - states that ceteris paribus, the higher the price of a
good, the smaller the quantity demanded. Higher prices decrease the
quantity demanded for two reasons:
1. Substitution effect
2. Income effect

Demand Curve – shows the inverse relationship between the quantity

demanded and price, ceteris paribus. Demand curves are negatively
sloped (downward sloping line).

Factors that affect Demand

Factor Effect on Demand

Price of Substitute Goods Direct
Price of Complementary Goods Inverse
Expected future prices Direct
Consumer wealth/income Direct for normal goods
Consumer wealth/income Inverse for inferior goods
Population growth Direct
Size of market Direct
Consumer tastes/preference Indeterminate

Substitute Goods – goods that can be used in place of another because

they could perform the same function (e.g. butter and margarine, pens
and pencils).

Complementary Goods – products that go hand in hand (e.g. whiteboard

and whiteboard markers; CPU and monitors).
Elasticity of Demand (ED) – measures the sensitivity of demand to changes in
price.

ED = % of Change in QD = Change in QD / Change in Price

% of Change in Price Average Average Price
Quantity

ED > 1, demand is said to be ELASTIC (sensitive to price changes)

ED = 1, demand is said to be UNIT-ELASTIC/UNITARY (insensitive to price
changes)

ED < 1, demand is said to be INELASTIC (not that sensitive to price changes)

Example: Day 1 > Unit price was set at P2.50 each, the sales reached
200 units
Day 2 > Unit price was lowered to P1.50 each, the sales
increased to 400 units

Summary of Effect of Price Changes in Revenues

Price Change Elastic Inelastic Unitary

Demand Demand
Increase Revenue Revenue Revenue is the
decreases increases same
Decrease Revenue Revenue Revenue is the
increases decreases same

Law of Diminishing Marginal Utility – marginal (additional) utility from

consuming each additional unit decreases.

Personal Disposable Income – amount of income consumers have after

paying taxes to the government.

Marginal Propensity to Consume (MPC) – describes how much of each

additional peso in personal disposable income that the consumer will
spend.

Marginal Propensity to Save (MPS) – percentage of additional income

that is saved.
MPC + MPS = 100%

Supply – relationship between the price of a good and the quantity

supplied. It is also defined as the schedule of quantities of a good that
people are willing to sell at different prices.

Quantity Supplied – amount of good that producers plan to sell at

particular price during a given time period.

Law of Supply – ceteris paribus, the higher the price of a good, the
greater is the quantity supplied.

Supply Curve – shows the positive relationship between the quantity

supplied and price, ceteris paribus. Supply curves are positively sloped
(upward sloping line).

Fact Effect on Supply

or
Production Costs Inverse
Number of Producers Direct
Price of Substitute Goods Inverse
Price of Complementary Goods Direct
Expected future prices Direct
Technology Direct
Government subsidies Direct
Government tax and tariffs Inverse

Elasticity of Supply (Es) – measures the sensitivity of supply to changes in

price.
ES = % of Change in QS = Change in QS / Change in Price

% of Change in Price Average Quantity Average Price

Es > 1, supply is said to be ELASTIC (sensitive to price changes)

Es = 1, supply is said to be UNIT-ELASTIC/UNITARY (insensitive to price

changes)
Es < 1, supply is said to be INELASTIC (not that sensitive to price changes)

EQUILIBRIUM – state wherein the demand and supply are in balance.

Below equilibrium price, shortage exists (i.e. quantity demanded exceeds
quantity supplied), and the price will rise; above the equilibrium price, a
surplus exists (i.e. quantity supplied exceeds quantity demanded), and
the price will fall.

Price Ceiling – maximum price that seller may charge for a good.
Price Floor – minimum price that seller may charge for a good.
Market – any institution, mechanism, or situation which brings together the buyers
and sellers of a particular product. It is a place where sellers and buyers meet (e.g.
grocery, internet).

Four Basic Market Models

Market Number Type Control Conditions Examples

of of over of
Produce Produ Price Entry
rs ct
Pure Large Virtually None Very Easy Agricultur
Competition Identical al
Products
Monopolistic Many Differentiate Limited Easy Retail
Competition d trade,
Food,
Gasoline,
Fashion
Oligopoly Few Standardized Limited or Hard Appliances
/ Wide , Cigars,
Cars,
Differentiate Computer
d s
Pure One Unique Wide Blocked Government
Monopoly Franchises,
Utilities

Monopsony – market where only one buyer exists for all sellers.
Black Market – illegal market

Production Cost Terminologies

Law of Diminishing Returns – states that as we try to produce more and

more outputs with a fixed production capacity, marginal productivity will decline.

Economies of Scale – (decline in average total cost) arise because of labor and
management specialization, efficient capital, and factors such as spreading
advertising cost over an increasing level of output.

Diseconomies of Scale – (increase in average total cost) arise primarily from

the problems of inefficiently managing
and coordinating the firm’s operations as it becomes a large-scale producer.

Constant Returns to Scale – are the range of output where long-run ATC does
not change.