Economics Preliminary Unit 2 - Consumers and Business

The role of consumers in the economy

Essential Question: How do consumers influence the economy in the choices they make?

Consumer Consumers ultimately determine which goods and services are produced by
Sovereignty exercising freedom to choose what they buy.
By doing so they:
-- enforce technical efficiency [produce goods at the least cost to maximise
profit]
-- enforce allocative efficiency
[allocate resources in a way to satisfy consumer preferences]
-- enforce dynamic efficiency [responding to changing consumer preferences
and technological improvements over time]

Production is geared toward what people want and their wants satisfied.

Factors that diminish consumer sovereignty:

Marketing
❏ Advertisements exert a powerful influence over the spending patterns
of consumers.
Misleading or deceptive information
❏ False or misleading claims about a product, leading them to pay for
items that they do not really want to buy.
Planned obsolescence
❏ Sometimes firms produce goods that are designed to wear out quickly
in order to keep consumers buying their products, allowing them to
manipulate consumer behaviour
Monopoly behaviour
❏ Firms that operate in a market where there are limited suppliers
diminish consumer sovereignty, as the ability to choose is diminished.

Patterns Y=C+S
influencing Where
decisions to spend Y = disposable income (after tax)
or save C = consumption
S = savings
The equation indicates that an increase in consumption will lead to a decrease
in savings, vise versa

The proportion of an individual’s total income that is spent on consumption is

called the average propensity to consume, calculated using the equation
C
= APC
Y
The proportion of an individual’s total income that is saved is known as the
S
average propensity to save, =APS
Y

Minor factors influencing decisions:

❖ Cultural factors
❖ Personality factors
❖ Consumer confidence and future expectations
 ➢ When consumers are worried about the economic outlook,
they are likely to save more,
➢ If a consumer is confident about wage growth/economic
outlook, they may consume more
❖ Future spending plans
❖ Tax Policies
➢ Taxes can make it more attractive to save rather than spend
(ie. lower taxes on superannuation savings) or vise versa
(abolishment/lowering of GST)
❖ Availability of credit.

INCOME:
● As income rises, people tend to save more of their income, therefore
APS rise and APC falls.
● Consumers on lower incomes spend proportionately more of their
disposable income [APC>APS]
● Marginal Propensity to Save: the proportion of each extra dollar of
ΔS
income that goes to savings. =MPS
ΔY
● Marginal Propensity to Consume: the proportion of each extra
ΔC
dollar of income that is consumed. =MPC
ΔY
● Since every extra dollar must be either spent or saved,
MPS+ MPC=1
AGE:
● Life cycle theory of consumption

Factors
influencing Factors influencing individual consumer choice:
individual ❖ Income
consumer choice ➢ The higher the level of income of a person, the more they can
purchase, and higher quality
❖ Price
➢ Necessities: people will purchase regardless of price change
➢ Consumers are likely to reduce their demand for other goods
such as luxury goods as price increases
 ❖ Price Of Substitutes
➢ If the price of a substitute rises, consumers will be more
willing to purchase the original good.
❖ Price of Complements
➢ If the price of a complement rises, consumers will be less
likely to purchase the original good.
❖ Preferences/Tastes
➢ Consumers will generally buy the good that gives them the
highest level of personal satisfaction.
❖ Advertising
➢ Can generate demand, convince consumers they need/want the
good.

Sources of Income is derived from the sale of factors of production. The return for these
Income resources:
Labour Wages

Natural Rent
Resources

Capital Interest

Enterprise Profit

Social Welfare:
Income collected through taxation and reallocated from government to
consumers. A candidate for social welfare many be someone who is:
- Disabled
- Old age [pension]
- Family benefits
- Unemployed
Social welfare is aimed to provide a minimum “safety net” which allows
consumers to buy the necessities for life.

The role of businesses in the economy

Definition of a A business firm is an organisation involved in using entrepreneurial skills to

firm and an combine the factors of production in order to produce a good or service and
industry create a profit.
 An industry is a collection of business firms that are involved in making the
same product and generally compete with each other.

Production Businesses must determine what to produce, how to produce and how much to
decisions produce. In a free market economy, these are generally determined by the
market, and consumer demand.

What to produce:
❖ Determined by:
➢ The skills and experience of the business operator
➢ Consumer demand
➢ Specific business opportunities
■ ie. a region where there is less competition/niche
market
➢ Amount of capital required
How much to produce:
❖ Determined by the level of consumer demand for the product / service.
A business may commission market research
How to produce:
❖ How to combine inputs in order to create outputs.
❖ Depends on the relative efficiency of the 4 factors of production
❖ The entrepreneur must create an operation plan

Business as a Goals of the firm:

source of Profit Maximisation:
economic growth ❏ Defined as making the biggest profit or smallest loss.
and increased ❏ The main goal of the firm
productive ❏ Profit is the total difference between the firm's total revenue and cost
capacity of production.
❏ This goal can also lead to: economic growth, employment, regional
development, infrastructure development and productive capacity.

Other goals may include:

❖ Meeting Shareholder Expectations
➢ Company directors make decisions to serve the interests and
meet the expectations of all owners of the business
❖ Maximising Growth
➢ Accumulating assets in order to growth the business and
dominate the market more over time
❖ Increasing Market Share
➢ More emphasis on increasing sales which could mean
sacrificing profits in the short term
❖ Satisficing
➢ Pursuing a satisfactory level in all goals rather than
maximising a single goal

Efficiency and the Productivity refers to the quantity of goods and services the economy can
production produce with a given amount of inputs.
processes OUTPUT PER UNIT OF INPUT PER UNIT OF TIME
Production: total amount of goods and services produced.

Increased productivity allows a firm to satisfy a greater number of wants using

the same resources.
In order to increase productivity, we need to increase production
proportionately more than the increase in inputs of resources. This stimulates
an increase in outputs per unit of inputs.

Higher productivity =
- Higher standard of living
- Less wastage of resources
- Lower production costs and higher profits
- Lower inflation rate
- Higher income
- Improved international competitiveness

Specialisation:
One of the most common ways to increase productivity is through
specialisation - using the factors of production more intensively for a smaller
number of the production processes.
❖ Division of labour
➢ A person is trained to do one specific job
❖ Location of industry
➢ A number of business producing similar goods and services
congregate in the same area to reduce production costs by
sharing common infrastructure
❖ Large scale production
➢ When a business grows so large they can use highly
specialised capital

In most cases a firm is able to decrease their cost of production as output

increases. The concept that a firm needs to achieve a large scale of production
in order to minimise cost is known as internal economies of scale.

Internal economies of scale are the cost saving advantages that are a result of
a firm expanding its scale of operations. When
Economies of scale are achieved when average costs per unit of production
falls as output increases. BELOW TECHNICAL OPTIMUM

Where AC = total cost / total outlay, TC = total cost and Q = quantity.

Internal diseconomies of scale are the cost disadvantages faced by a firm as a

result of a firm expanding its scale of operations beyond a certain point.
Generally related to management problems. As the size of the business grows,
management may become inefficient in organising all areas of production.
ABOVE TECHNICAL OPTIMUM.
 Technical Optimum: the point at which per unit costs of production are
minimum.

External economies and diseconomies of scale are the

advantages/disadvantages that accrue to a firm because of external factors.
- Growth of an industry in which the firm is operating in, not changes
their own operations
See textbook page 68-71

Impact of Investment: the purchase of new capital to increase production in the future.
investment, Technology: “new” information/knowledge
technological Ethical decision making: considering the impacts production has on society
change and ethical (rather than just considering profit maximisation)
decision-making
on a firm through: