a course for engineers

Prof. Anca DRAGHICI ancadraghici2003@yahoo.fr

2010 - UPT International Studies
Microeconomics 1

Why microeconomics? Can you buy ALL the clothing, vacations, sport equipment, health care, food, beauty products, yoga classes, seasons tickets to sport event, donations to charity you want? NO  Microeconomics helps you decide how much to spend and on what;  Microeconomics will help you decide to be your own BOSS ……have a nice life……

Microeconomics 2

Course/Seminar Brief Outline:
    

Firms typology. The External environment of the firm Production factors: Land; labor; capital; neo-factors Production costs. Break-even point Factors’ productivity. Labor productivity Pricing with Market Power. Price Discrimination and Bundling. Price and pricing Competitive Markets. Supply and demand. Competition Consumer Theory. Producer Theory Welfare. Expected Utility and Risk Aversion Profit and profitability rates
Microeconomics 3

   

Learning Microeconomics Program and Objectives:

Learning procedures:  Studying theory and concepts -course  Debate and solve problems – course and seminar  Prepare and present a rapport (through individual study) - seminar



Our Common Program – 10 weeks
 

3h of course each week – Friday, 08:00 – 11:00, Seminar:

II ETC (1h/week) Friday 11:00 – 12:00 Amphitheatre A1, 14 Remus str. at the Faculty of Management in Production and Transportation II Civil Engineering specialization (Asist. Dr. Mihaela Vartolomei) (2/week) Thursday 16:00 – 18:00



Grading: exam type ED (distributive examination)
 

Final Exam: 60% Participation in class discussions and debates + Homework presentation: 40%


Distributive examination: ED1 – week 5 and ED2 week 10 ED(1+2) bis … will be somewhere from 11-14 week




Frank A. Cowell, MICROECONOMICS. Principles and Analysis, London School of Economics, December 2004 Quantum Microeconomics with Calculus, Version 4.02, January 2009, Available with and without calculus at:http://www.smallparty.org/yoram/quantum MIT Open Courses



References in Romanian Language:

Important authors from our university – books are in the UPT library:  Prof. Mariana DOBRAN  Lecturer Diana Barglazan RO-ENGL and/or ENGL-RO economics DICTIONARY will be good to help you better understand concepts and terminology! The .ppt course with some notes of yours will be good for the exam!



I. What Economics Is?
Economics is the study of how human beings coordinate their wants and desires, given the decision-making mechanisms, social customs, and political realities of the society.  A good definition of economics: Study of choice under conditions of scarcity  Scarcity: Situation in which the amount of something available is insufficient to satisfy the desire for it



I.1. The Economic Problem

Scarcity exists because individuals want more than can be produced.

Scarcity – the goods available are too few to satisfy individuals’ desires.

 

The degree of scarcity is constantly changing. The quantity of goods, services, and usable resources depends on technology and human action.



Does Bill Gates face the problem of Scarcity?



Scarcity and Individual Choice:

There are an unlimited variety of scarcities, however they are all based on two basic limitations:
 

Scarce spending power; Scarce time. Bill Gates certainly does not face poverty, but despite his wealth, he faces scarcity. Poverty is kind of scarce in spending power.

Scarcity vs. Poverty:



Scarcity and Economics:

The scarcity of resources - and the choices it forces us to make - is the source of all of the problems studied in economics:  Households allocate limited income among goods and services;  Business firms choices of what to produce and how much are limited by costs of production;  Government agencies work with limited budgets and must carefully choose which goals to pursue. Economists study these decisions to:  Explain how our economic system works;  Forecast the future of our economy;  Suggest ways to make that future even better.
Microeconomics 13

Scarcity and Social Choice:
The problem for society is a scarcity of resources:  Labor: time human beings spend producing goods and services;  Capital: something produced that is long-lasting, and used to make other things that we value, like human capital and physical capital;  Land/natural resources: physical space on which production occurs, and the natural resources that come with it;  Entrepreneurship: ability and willingness to combine the other resources into a productive enterprise;  Technology: physical and scientific "recipes" of history .



Examples of scarcity of resources:
Suppose you attend the UPT International to study Computer sciences
  

What are you consuming? Knowledge from university lectures, from books in the library, from Internet etc. What is the labor? I learn (intellectual work/stress). What is the Capital?  Physical Capital: desk, chairs, computers, hard & soft …  Human Capital: instructor’s specialized knowledge and lecturing skills

A physician's knowledge and skills are referred to by economists as: a. human capital b. labor c. physical capital d. entrepreneurship



Understanding Economics:

Any economic system must solve three coordination problems:  What, and how much, to produce;  How to produce it;  For whom to produce it. To understand the economy, you need to learn:  Economic reasoning;  Economic terminology;  Economic insights about issues and theories that lead to those insights;  About economic institutions;  Information about economic policy options.



People are rational:
 

Decision-Makers choose purposefully. We weigh the costs and benefits when we make a decision. (Based on all the information we have) Economizing - Getting the maximum benefit at the minimum cost

People respond to Economic Incentives:

Human beings act from a variety of motives, including religious belief, envy and compassion. FBI’s advice on bank robberies.



Optimal decisions are made at margins!
 

Economic thinking is marginal thinking! What does the word marginal mean here???  "additional“;  "adding (+) or subtracting (-) from what is already there“.

Economic Reasoning:  Economic reasoning is making decisions by comparing marginal costs and marginal benefits.  Marginal cost – the additional cost over and above costs already incurred.  Marginal benefit – the additional benefit above and beyond what has already accrued.



The economic decision rule:

If the marginal benefits of doing something exceed the marginal costs, do it. If the marginal costs of doing something exceed the marginal benefits, don’t do it.

Economic Reasoning – imagine the case:
If you do decide to skip this class, you have weighed the benefits and the costs and you have decided that the benefits of skipping the class exceed the benefits of attending the class???????  What are the costs of attending class? **Tuition is not a part of the day-to-day marginal cost  What are the benefits of attending class?
Microeconomics 19

Economic insights:

Economic theories are generalizations that are insights into how economies work. Theories may be embodied in economic models or economic principles.

Economic model is a framework that places the generalized insights of the theory in a more specific contextual setting. Economic principle is a commonly held insight stated as a law or general assumption.



Invisible hand theory:

1776 book “An Inquiry into the Nature and Causes of the Wealth of Nations”

Adam Smith

Microeconomics 21

The Invisible Hand Theory:

Price has a tendency to fall when the quantity supplied is greater than the quantity demanded. Price has a tendency to rise when the quantity demanded is greater than the quantity supplied. According to the invisible hand theory, a market economy, through the price mechanism, will allocate resources efficiently. Efficiency means achieving a goal as cheaply as possible.



I.2. Microeconomics - Definition
 

Micro comes from Greek word mikros, meaning “small”. Microeconomics is the study of individual choice, and how that choice is influenced by economic forces:
 

Choices they make; Interaction in specific markets.

Focuses on individual parts of an economy, rather than the whole.



Official Definitions:

Microeconomics is the study of how individuals and firms make themselves as well off as possible in a world of scarcity and the consequences of those individual decisions on the markets and the entire economy. Microeconomics is the study of the allocation of scarce resources. Microeconomics is also often called PRICE THEORY.

This is to emphasize the important role that price plays. Products and services prices …… think of health care market or price of education.
Microeconomics 24

In other words:

Economics, as a science, belongs to social sciences, as it studies the human beings, in their activities directed towards the best satisfaction of their unlimited needs with the limited resources available. Human needs are unlimited, while the resources – the elements people use for satisfying their needs – are limited. This is why we say resources are scarce. Economics is the study of how societies choose to use scarce productive resources that have alternative uses, to produce commodities of various kinds, and to distribute them among different groups. Economics must provide the answer for 3 important questions:
  

What kinds and quantities should be produced? How should resources be used? And for whom are the goods produced?


Microeconomics is concerned with the behavior of individual entities such as markets, companies, and households. Macroeconomics views the performance of the economy as a whole. There is also international economics. In time, the economy evolved from natural economy, based on auto-consumption, to an exchange economy, based on exchange and on the social division of work. Nowadays, there are 2 main forms of exchange economies: the command economy and the market economy. They do not exist in pure form – national economies are mixed economies, where elements specific to one or another type of exchange economy prevail.
Microeconomics 26

Economic indicators:

 

In economics a lot of economic indicators are used. For any indicator X, the value of X at a certain moment indicates the level of the indicator X at that moment. In order to analyze the dynamics of economic indicators, dynamics indicators are used, the most important being the absolute modification of an indicator (ΔX), the relative modification (%) of the indicator (ΔX(%)) and the index of the indicator considered (IX). Economic indicators can be divided into 2 categories: quantitative indicators and qualitative indicators. For qualitative indicators it is usually calculated not only the level at a given moment (level corresponding to a certain level of a quantitative indicator), but also the average level (the level corresponding to o physical unit), and in dynamics, the marginal level (the modification of the indicator corresponding to a change by 1 unit of the quantitative indicator).
Microeconomics 27

Because we can’t have everything, we need to make tradeoffs and microeconomics helps us make those tradeoffs.

A society faces 3 key tradeoffs:
1. 2.

Which goods and services to produce? How to produce them? How much labor and inputs should a firm use to produce a specific good and/or service Who gets the good and services (allocation)?


Observations:  Workers need to choose how to allocate their time between labor and leisure.  Firms need to choose how to allocate their investment between human capital and machines.  Households need to choose how to allocate their incomes between savings and expenditure.
Microeconomics 28

Macroeconomics definitions

Macro comes from Greek word, makros, meaning “large”; Macroeconomics study of the economy as a whole; Focuses on big picture and ignores fine details.

 



What is the difference between micro- and macroeconomics?

Microeconomics: behavior of individual economic units like consumers, producers, landowners, families, etc. How and why do they make the decisions they make?

Macroeconomics: analyzes how the entire national economy performs. It analyzes unemployment, inflation, price levels, interest rates (many things we take as given in microeconomics).



Economic Policies

Economic policies are actions (or inactions) taken by government to influence economic actions.

Objective policy analysis keeps value judgments separate from the analysis. Subjective policy analysis reflects the analyst’s view of how things should be.



Policy Analysis:

To make clear the distinction between objective and subjective analysis, economics is divided into three categories:  Positive economics;  Normative economics;  Art of economics. Positive economics – the study of what is, and how the economy works. Normative economics – the study of what the goals of the economy should be. Art of economics – the application of the knowledge learned in positive economics to achieve the goals determined in normative economics.



Positive Economics:
 

Study of how economy works; Statements about how the economy works are positive statements, whether they are true or not; Accuracy of positive statements can be tested by looking at the facts - and just the facts. Study of what should be  Used to make value judgments, identify problems, and prescribe solutions;  Statements that suggest what we should do about economic facts, are normative statements (based on values);  Normative statements cannot be proved or disproved by the facts alone.
Microeconomics 33

Normative Economics:

Positive economics vs. Normative economics
Positive economics:

Normative economics:

A statement can be tested, proven or proven false. The scientific study of “what is” among economic matters. A positive economics can be true or false.

Judgments about “what ought to be” in economic matters. Cannot be proved false, because they are based on opinion. A normative economics can be true or false.



Examples of positive and normative:

Positive or Normative? “Bill Clinton is a good president.” Normative because this judgment can’t be proven false and is based on opinions.



Example of positive vs. normative:

Positive or Normative? “The Cat is Fat!”

Positive because … obviously I can prove that. In this case, even “the cat is slim” is a positive statement.



More examples on positive vs. normative:
Positive or Normative?
 

Taxes are too high - Normative. All children should be provided with a quality education Normative. Market allocate income according to our marketable skills - Positive

Example: “We lose an estimated 10 to 1,000 species each year to extinction”.




II. About Firms / Companies
II. 1. Companies/Firms represent the main form of
existence for enterprises in a modern economy. Entrepreneurship can manifest itself in other forms, such as authorized persons, family associations, state enterprise etc. In Romania, the main law referring to companies is the Law no.31/1990. In our country, there are five forms of companies, recognised by the law:  general partnership (societate în nume colectiv – SNC),  limited partnership (societate în comandită simplă – SCS),  commercial partnership limited by shares (societate în comandită pe acţiuni – SCA),  public limited company or joint stock company (societate pe acţiuni – SA) and  limited liability company (societate cu răspundere limitată – SRL). The forms most frequently met are joint stock company and Microeconomics 38 limited liability company (SA and SRL).

Companies can be classified into personal companies (SNC and SCS) and capital companies (SCA and SA). SRL is a mixture form of personal and capital companies.

The stock capital of a limited liability company is divided into social shares, which can hardly be exchanged (sell or bought) on the market. The stock capital of a joint stock company is divided into shares – negotiable securities that can be exchanged freely on the market (on specialized financial market, called stock exchange). Bonds represent securities that are acknowledgements of a debt, and are issued either by the state (by public institutions – and they are called public bonds), either by private entities (companies). All securities bring some form of income to their owner. Stocks bring variable incomes, in the concrete form of dividends, while bonds bring fixed incomes, in the concrete form of interests.
Microeconomics 39

The income brought by bonds (interest) is determined based on the nominal value of the bond and the interest rate mentioned on the bond. The income brought by stocks (shares) (dividend) is determined based on the profit obtained by the company and the number of shares issued.

The price of securities is called rate (market price) and it is established on the market, under the heavy influence of the interest rate for newly issued bonds. The price of the securities depend on the income brought by each type of security (the higher the income brought, the higher price). When a company issues new shares, after its founding, most probably the new shares will be sold a little under the market price (so they can be sold rapidly). This issue makes the market price for the shares of the company decrease a little, reaching the weighted arithmetic average between the price of old shares and new shares.




Each firm is an economic, social and technical entity “born” to produce goods or services for market and for the customers satisfactions. The main purpose of firms activity is profit maximization. Firm’s economic processes are linked with technology, know-how property and use. Social aspects of firm include the relationship complex (interpersonal or multi-personal relations developed between different employees). SME are important “actors” of the market economy ….because of their economic role (the most taxes collected for the national budget and new job created – employment problem solving).



II.2. SMEs phenomena

SMEs are linked with entrepreneurship competencies!

Advantages and PRO arguments:  Being you own boss (managing better your own time);  Work place security;  Creativity in practice;  Work in a desire field, so, job is his/her passion;  Self-learning person;  Direct contact with customers/clients/users;  Support for the local economy;  The firm profit allows him/her to build a nice life when retire (for whole family).  Better satisfy your hobby.
Microeconomics 42

 

High activity risk; Working over program, under time stress (short deadlines); The incomes are variable (sometime, can be zero!); Permanent knowledge up-date in the field of economics, management, marketing, law etc.

 



II.3. The cybernetic model of the firm
In-put (resources)


f(X) = Y

Out-put (results)


Internal environment

∆ Y

External environment

Regulation/adjustment mechanism

Resources: materials, financial, human, information, time / costs Results: products and/or services, information / outcomes, profit
Microeconomics 44

f(X) = Y the function that represent the firm activity (technology, know-how) and shows the modality of transform/process resources X into results Y; ∆ Y = the results Y errors measure/evaluate by the regulation/adjustment mechanism:+/- and then adjust the resource X, in terms of quantity and quality; The regulation/adjustment mechanism is used by the firm management and describe the modality of firm evolution in its external environment. From the economics point of view: X = C costs and Y = V incomes, so: Y – X = V – C = P profit.



The cybernetic model’s properties:
A good firm functions in the external environment can be assure in two conditions:

The firm’s activity stability: Y = constant, the existing of a continuous activity assure continuous results in accord with the environment conditions, requirements and constraints. The results fidelity: ∆ Y → 0, the quality and the quantity of results has to better satisfy customers needs. This will assure the economic cycle development in profitable conditions.


The properties are linked with the firm behavior regarding the external environment conditions.



Firm behavior in the external environment:
Firm behavior = attitude = evolution Behavior typology:  Adaptive attitude – based on the external environment evolution forecasts, the firm can adapt its processes, activities in the internal environment. This is a desire attitude and require flexibility, mobility, agility from the firm;  Adaptive-participative attitude – is characteristics for big companies with a good market position or having monopole on market. Firms use forecasts to anticipate the external environment evolution but simultaneously, they try to influence environment evolution to create opportunities for their own;  Passive attitude – firms do not use either adaptive or participative behavior and they can only take measures to survey on the market and avoid bankruptcy.
Microeconomics 47

III. External environment components
III.1 The Micro-environment
The micro-environment consists of components that are in direct relation with the firm activities/processes.



III.2. The Macro-environment

The macro-environment consists of components that are in indirect relation with the firm activities/processes.



IV. Firm’s resources. Production Factors (in-put) Theory
IV.1. Firm’s resources
The main resources used by a firm are:  Raw Materials (RM) related with the real capital or the real assets;  Financial resources, (RF) linked with the monetary capital;  Human resources, (RU) related with the number and qualification of the employees;  Touristic resources (RT) or the local/regional/national touristic potential is a precious resource for companies that operate in the field of tourism industry. This resource consist of natural and entropic resources;  Information resources (I) that determine the knowledge capital of each firm;  Time ………..
Microeconomics 50

IV.2. The Production Factors
The resources attracted by economic entities in the production process are known as in-puts or production factors. There are 3 traditional production factors: 1. the natural factor - land; 2. the human factor - labor and 3. the material factor - capital.  There are also “neo-factors” – information, knowledge, abilities, scientifically and technological progress etc. 1. In a wide approach, the natural factor refers to all primary resources, obtained directly from nature and which can be used in the production process. In a narrow meaning, it refers to a certain space where productive activities take place. Although in the field of industry and services the role of the natural factor is marginal; this factor is still an indispensable one.
Microeconomics 51

2. Labor is a typically human activity, being the conscientious effort done by a person, issued from his/her own will, directed towards achieving some results.

3. Capital represents the assembly of material and financial elements used by a company for its productive activities. It is an extremely complex and heterogeneous production factor. The most frequently used classification divides the capital of a company in non-current capital and current capital. The total capital used by a company, at a given moment, is the sum of the two components.

At a macroeconomic level, the human factor is the active population (population able to work), formed by occupied population and inactive population. At the microeconomic level, the human factor is determine by the company’s employees (although entrepreneurs are also included).

The every company’s capital is represented in the balance sheet, as assets and liabilities. Only the assets are studied by microeconomics and considered here as economic capital of a firm (and production Microeconomics 52 factor).

The assets are divided into:  non-current assets (intangibles assets, tangible noncurrent assets and long-term investments) and  current assets (inventory, receivables, short-term investments and cash and cash equivalents). There are many indicators calculated when the capital is analyzed. Some of them are common indicators (dynamics indicators), but there are also, specific indicators for the circulating capital (velocity of capital - turnover indicators) and for the fixed capital (physical state of fixed capital indicators and efficiency indicators).

Neo-factors are formed by immaterial elements, mainly informational, and their role is constantly growing.
Microeconomics 53


The production can be expressed as a function of the known production factors. In the economic literature many types of production functions are analyzed, from very simple ones to very complex ones. Usually, economists are choosing one specific function trying to reach equilibrium between simplifying as much as possible and perfectly reflecting the reality. The production-possibility frontier (PPF) represents the assembly of efficient combinations possible while using resources with alternative uses. With given resources and technology, the production choices between two goods can be summarized in the PPF. The PPF then shows how the production of one good is traded off against the production of another good.



V. Economic Models
How do economists allocate resources? They develop theoretical model.

“Everything should be made as simple as possible but not simpler” - Albert Einstein



The models are abstractions of the real world:
 

Too complicated to take into consideration all factors; Without simplifications we would not be able to make predictions; Like a roadmap, does not give each house, but the bare essentials i.e. major streets, highways and sometime main attractions.

It may appear that the model makes heroic abstractions (assumptions) from the complexities of the real world.



Example: Determinants of Poster Demand on Campus
You are advertising a big event for the freshman class (ro. “Balul Bobocilor”) how many posters will you need?

Factors in your model:

Price to make poster, size of freshman class Content of poster, placement of poster, relative size of poster the amount of budget you have to spend on poster advertising.

Factors not in your model:

Are there any constraints to this model?



Types of Variables in a Model:
Exogenous Variable: one whose value is taken as given in a model. Endogenous Variable: one whose value is determined within the model being studied Which factor(s) would have you taken as given in the poster example?  Price, size of freshman class (exogenous) Which factor(s) are determined by your model?  The quantity of posters needed (or demanded)



Tools of Microeconomic Analysis:

Constrained Maximization / Marginal Analysis Equilibrium Analysis Comparative Statics





V.1. Constrained Optimization:
Constrained optimization is an analytical tool used when a decision maker seeks to make the best (optimal) choice, taking into consideration possible restrictions on the choice. This tool has two parts: 1. Objective function: is the relationship the decision maker seeks to optimize (maximize or minimize). 2. Constraint: limits or restrictions that are imposed on the decision maker.

SIMPLEX problems, CPM, PERT are methods to solve problems with function to be optimize (profit - max, costs – min, production time – min, time to market – min etc.)
Microeconomics 60

You want to maximize your happiness during your winter holiday!

Objective function: Happiness =f (days of skiing per week, no. beers per week). Constraints: s.t. (subject to) Income, time for leisure



Marginal Analysis:

Solution to a constrained optimization problem depends on the marginal impact of the decision variables on the value of the objective function.

But what is marginal?

The term marginal tells us how the value of the objective function changes as a result of adding one unit of a decision variable.



Happiness % $ spent 0 25 50 75 100 From beer 0 80 90 92 94 From skiing 0 4 10 15 20

Marginal Happiness % From beer From skiing 80 10 2 2 4 6 5 5

Happiness Optimization:
Happiness % $ spent 0 25 50 75 100 From beer 0 80 90 92 94 From skiing 0 4
 

$100 spend on beer = 94 % of happiness $75 spend on beer plus $25 spend on skiing = (92+4) 96 % of happiness. $50 on beer and $50 on skiing = (90+10)100 % of happiness. Yes a day of skiing with a nice after ski program makes you very happy!

10 15 20



You just did a constrained optimization problem regarding  Optimize happiness (beer and skiing) subject to you $100 weekly entertainment budget. Max H(B, S) subject to (s.t.) Pb*B + Ps*S = 100% Max H(B, S) = (s.t.) Pb*B + Ps*S = 100%

Where: B= quantity of beer; Pb=price beer S=days of skiing; Ps=price skiing.



V.2. Equilibrium Analysis:
Price (P)
(1) Doctors visit (2) Product price

Qd: Demand

Qs Supply


50 25

Equilibrium: Qd=Qs Excess Demand

Quantity (Q) Q1 10 Q2


(1) Number of appointments/day (2) Number of products (production volume)


In a competitive market, equilibrium is achieved at a price at which the market clears – that is, at a price at which the quantity offered for sale just equals the quantity demanded by consumers. Since Qd = Qs at P*, there is no upward or downward pressure on price. Hence, price could stay at P* indefinitely.



What is Excess Supply?
Price (P)
(1) Doctors visit (2) Product price

Qd Demand Excess Supply

Qs Supply

70 50

Quantity (Q) 8 13

(1) Number of appointments/day (2) Number of products (production volume) 68

What is Excess Demand?
Price (P)
(1) Doctors visit (2) Product price

Qd Demand

Qs Supply

70 50 30 Excess Demand Q Quantity 5 13

(1) Number of appointments/day (2) Number of products (production volume)


V.3. Comparative Statics:

Examine how a change in an exogenous variable will affect the level of an endogenous variable.

First, look at the value of the endogenous variable at the initial level of the exogenous variable; Second, look at the value of the endogenous variable at the new level of the exogenous variable.



Comparative Statics Example:
Price (P)
(1) Doctors visit (2) Product price

Qd Demand

Qs Supply



Q Quantity . Q* 10

(1) Number of appointments/day (2) Number of products (production volume)


Comparative Statics Example:

Suppose we are in China and there is an outburst of the Avian Flu. A few weeks later there are some new regulations put on doctors and they are unhappy about it. So, they do a rotating strike. How will these factors affect our Supply and Demand curve and the price? Follow the next graphics regarding this scenario ……



Price (P) Doctors visit



P2 P1

60 50

S1 Outbreak of Avian Flu moves demand to the right (increase demand for medical services), but supply curve does not change (same number of doctors). So, Q increases and P, too.







Q Number of appointments per day per doctor 73

Price (P) Doctors visit P3 65



The rotating strike will lead to:
S2 S1 A reduction in supply, decrease of S. This is a shift to the left.



Q Number of appointments per day per doctor 74

VI. How Microeconomics Characterize the Firm’s Production Function
VI.1. Depreciation of fixed capital

From an economic point of view, the depreciation is the monetary expression of the non-current capital depreciation. The depreciation is a part of the non-current capital value, the part included in the production costs in a given year. It is one of the few costs which do not imply a payment. Among the elements constituting the non-current capital, there are some elements which are not subject to the depreciation process - those elements for which the value does not continuously depreciate in time (land and long-term investments). Only for intangible assets and tangible noncurrent assets there is calculate the depreciation value rate – because the value of these assets is gradually lost in time and
it must be included in costs.
Microeconomics 75

In Romania, the fixed depreciation is legiferated by the Law 15/1994 on the depreciation of the existing capital as tangible and intangible assets (Law no.15/1994 regarding the depreciation of the invested capital in tangible and non-tangible assets). The non-current assets depreciation value is established by applying depreciation quotas on the initial value of the non-current assets. Each element subject to depreciation has a certain duration of normal use (durată normală de utilizare – DNU). The law establishes that the following three depreciation regimes can be legally used in Romania: linear regime, accelerated regime and digressive regime. Linear depreciation is calculated applying the average yearly amortization quota (the linear depreciation quota) to the initial value of the non-current assets. The linear depreciation represents the general rule for depreciation.
Microeconomics 76

Linear depreciation calculation:

It is very simple to calculate the norm of the linear depreciation (Na) based on the value of the normal use duration (DNU): 1

Na =


× 100%

The annual depreciation (Am) is calculate base on the acquisition value or the initial value of the fixed capital:

Am = Na × Vi

In conclusion, the annual depreciation is:

V i A = m DU N
Microeconomics 77

Digressive depreciation is based on digressive depreciation quotas, obtained by multiplying the linear depreciation quotas with a specific depreciation coefficient. The digressive depreciation quotas are applied to the remained value (the value not yet included on costs through depreciation). Every year, the result obtained through this digressive method is compared to the result that would have been obtained if the linear depreciation applied, for the remained value and the years remaining. From the year when the linear depreciation is higher or at least equal to the digressive depreciation, for the remained value and the remained period of time (from the duration of normal use) the linear depreciation applies. The digressive depreciation regime can be applied in two forms, ignoring the moral depreciation (AD1) or considering the moral depreciation (AD2). The management of a company can decide to use the linear depreciation or the digressive one, without restrictions. Digressive depreciation allows considering as costs higher amounts (larger parts of the initial value) in the first years, but it has the inconvenient of more difficult and complex calculations. Accelerated depreciation consists in using a higher depreciation quota, up to 50%, in the first year. Afterwards, the remaining value is passed on costs through the linear depreciation model, for the remaining number of years. A company can use accelerated depreciation only with the approval of the Finance Ministry, in Romania. Microeconomics 78

VI.2 Production Costs

In order to obtain goods and services, companies consume inputs (production factors). The production costs express the value of the total production factors consumption generated by the production activity. The production costs are covered from the incomes realized by companies from selling the goods and services produced on the market. The profit represents the difference between the total incomes of a company and its total costs. If the difference is negative, when the costs are higher than the incomes, the company suffers a loss. The profit and loss account is the financial document containing the expenses and the incomes of the company, broken down on categories of activities (operating activity, financial activity, and extraordinary activity).
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Cost type:

The expenses (costs) of a company can be classified in many ways, using different classification criteria: the type of activity that generated them, the production factor concerned, the way they depend on the physical production. Costs TC Considering the level of the costs, we can distinguish 3 categories of global costs: fixed costs (FC), variable VC costs (VC) and total costs (TC). If we keep all things the same, except the production level, we shall notice that the fixed costs remain constant, while the variable costs and the total costs increase when the company is FC producing more. Also incomes increase when the company is producing (and selling) more.

TC = FC + VC



The average (unitary) costs can be obtained dividing the global costs to the level of the physical production. Corresponding to the 3 categories of global costs, there are 3 categories of average costs:

fixed average costs: variable average costs: total average costs:









Marginal cost:

The marginal cost (Cmg) represents the absolute modification (increase) of total costs induced by a modification (an increase) with one unit in the physical production.


where ΔTC = TC1 – TC0 and ΔQ = Q1 – Q0

∆TC = ∆Q

If we keep all things the same, except the production level, we shall notice that the fixed average costs decrease when the company is producing more. The variable average costs and the total average costs decrease up to a point, then they increase with the increase of the production level. So, do the marginal costs. The total average cost is at its minimum when its level is equal to the marginal cost.
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Profit maximization strategies:
  

The main objective of every company is profit maximization. Profit is: P = CA – TC In detail: CA = Q x p, and CT = Q x TAC, so: P = Q (p – TAC) In order to reach this objective, a company can take actions in 3 directions:  increasing the quantity of goods and services sold (Q max),  increasing the price of the goods and services, or/and (p max)  reducing the total average cost (TAC min).



Breakeven point:

Because there are fixed costs, for very low production levels, a company will not be able to obtain profit. The level of production for which the total (global) costs equal the total incomes of the company is the breakeven point. At the level of the breakeven point the profit is zero and the total average cost is equal to the price. A company must know its breakeven point because it can obtain profits only by producing and selling more than the breakeven point. The economic model of the breakeven point is: TC = CA, P = 0 and TAC = p There is one more level of the production level that companies are interested in, the so-called “dead point” – the level of production from which the total incomes are equal to the variable (global) costs (and the price is equal to variable average costs) When the production level of a company drops below the dead point, the company should be closed (or restructured).
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Graphic representation:





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VI.3 Factors’ productivity. Labor productivity

Factors’ productivity measure the efficiency of the use of production factors, comparing the results obtained with the efforts represented by the consumption of production factors. The productivity can be calculated either dividing the results (the production obtained and sold) to the factors used, either dividing the factors used to the production level. There are many forms of productivity. The global productivity measures the use efficiency of the assembly of available production factors (Fi),
Q WF = while the partial productivity measures the efficiency of ∑ Fi using one production single.

Q can be replace with CA.



We can also distinguish:  the total productivity, Q  the average productivity W Fi = Fi

WFi =

Fi Q

∆Fi ∆Q The marginal productivity gives us information about the productivity dynamics, and this analysis is usually completed by the information given by the dynamics indicators calculated for the average productivity. WmgFi =

the marginal productivity. WmgFi = ∆Q ∆Fi



The partial productivity can be calculated for each production factor: Land productivity represents the efficiency of land and it is extremely important in the case of agricultural activities.  Capital productivity expresses the return of capital, the efficiency of capital use. It is calculated as capital productivity (production divided to capital), but also as capital coefficient (capital divided to production).  Labor productivity (average value or marginal) represents one of the most important indicators of economic performance, reflecting the efficiency of the working force. Q ∆CA ∆Q CA W mgL = WL = WmgL = WL = ∆L ∆L L L where L is the work force.




For every company, the best situation is the one maximizing the factors’ productivity. In terms of dynamics, the productivity should have a positive dynamics – should increase over time (while the capital coefficient should be minimized, and it should decrease in time). Every company should be preoccupied to increase its labor productivity. The economic theory shows many way of increasing the labor productivity, among which, the most efficient seem to be introducing scientific and technological progress, improving the level of qualification of the employees, and giving material/financial incentives to the employees. When labor productivity increases, wages tend to increase and this is a perfectly normal evolution, as long as the wages increase in a slower pace than the labor productivity (it is a way of giving some incentives to the employees, in order to encourage them to further improve the productivity). When wages increase faster than the labor productivity, the Microeconomics 89 company does not benefit from the increase of productivity.

VII. How Microeconomics Characterize the Firm’s Commercial/Marketing Function
VII.1 Market. Demand and supply

The market can be defined as the place where demand and supply meet. The price of the goods sold and bought on the market is formed on the market, issued from the confrontation of demand and supply. The demand (C) represents the quantity of a certain product that the economic entities from a certain market are willing to buy, at a certain moment and at a certain price. The main factors influencing the demand evolution are the price (P) and the consumers’ incomes (V).
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The evolution of demand based on price (the law of demand): when the price a product is increasing, the quantity demanded from that product decreases; when the price a product is decreasing, the quantity demanded from that product increases. The analysis of the evolution of demand based on price is using the price elasticity of demand (Ecp). The evolution of demand based on incomes: when the consumers’ incomes are increasing, their demand is increasing; when the consumers’ incomes are decreasing, their demand is decreasing. Similarly to the price elasticity of demand, we can calculate an income elasticity of demand (Ecv).



The supply (O) represents the quantity from a certain product that the economic entities from a certain market are willing to sell, at a certain moment and at a certain price. The main factors influencing the supply evolution are the price (P) and the production costs. The evolution of supply based on price (the law of the supply): when the price a product is increasing, the quantity supplied from that product increases; when the price a product is decreasing, the quantity supplied from that product decreases. The analysis of the evolution of supply based on price is facilitated by the use of the price elasticity of supply (Eop).



The market reaches its equilibrium when the demand is equal to the supply. Left alone, the market will reach its equilibrium, without interventions (the market equilibrium is reached automatically). The equilibrium price (Pe) is the price for which the demand and the supply expressed on the market are equal. It is also the price for which the level of transactions is maximum (all economic entities willing to make a transaction will find partners and the exchanged quantity of products is maximum – the market equilibrium is optimum). At any given price, the exchanged (traded) quantity of products (Qtz) is the minimum between demand and supply.
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VII.2 Competition

Competition appears naturally among economic entities of the same type. More frequently, it appears among producers (sellers) but it can also appear among consumers (buyers). Theoretically, we can talk about a perfect market – a market having the following main features: atomicity, homogeneity, transparence, fluidity and inputs mobility. On a perfect market, we have perfect (pure) competition. In reality, the market is not perfect. On the real markets, the competition is not perfect. According to the number of economic agents existing on the market, several types of imperfect competition can be distinguished: monopolistic competition, monopoly, monopsony, oligopoly, oligopsony.



The strategies adopted by a company depend on the type of market to which the company belongs. On a market with monopolistic competition, the price is an exogenous variable for the company; if the function of variable costs depending on the production is linear, the profit maximization is realized through the maximization of the production sold on the market. In case of monopoly, the price depends on the quantity of products obtained by the company and offered on the market (the price is an endogenous variable). Therefore, the company should establish its optimum production level – the production level that maximizes the profit for the company. There are also other situations when profit maximization is not realized through production maximization, but the maximal profit can be obtained for a certain level of production – e.g. when the function of the variable costs depending on production is not linear.
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VII.3 Utility

Utility represents the satisfaction obtained by a consumer from using (possessing and consuming) certain products and services. The main objective of each consumer is maximizing the utility obtained from using his/her available income. Utility can be expressed in an ordinal system or in a cardinal system. For any good we can analyze the individual utility (marginal utility), and the total utility. When the quantity of the product consumed increases, the total utility increases. The individual utility(the marginal utility – the utility of the last unit consumed) decreases with the increase of the quantity consumed from a given good (The theory of decreasing marginal utility); when the quantity reaches a certain level, the phenomenon of saturation manifest itself, and the marginal utility reaches zero (the consumer does not want to consume any supplementary unit).
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A consumer will define his/her demand of goods and services in a manner allowing the maximization of the total utility. In order to have a maximum total utility, we analyze and calculate the maximum of the total utility function, considering also the budgetary restriction. For a given number of goods, the total utility is maximized when the marginal utility of the last monetary unit spent for each of the considered goods is identical. The consumer surplus appears because on the market the price of a product is constant, identical for all the units acquired from a given product, while for the first units consumed, a buyer would have been willing to pay more. At a given moment, considering the limited income that every consumer has, in order to buy a supplementary unit form one product, the consumer will have to give up a certain quantity from a different product (the opportunity cost).
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VII.4 The price

In a modern, market economy, the price is established on the market, based on demand and supply. In order to obtain a profit, a company must be able to sell at a price superior to its unitary total cost. For companies working in trade, a very common practice is to calculate the selling price of merchandises as the acquisition price, plus a trade mark up. For companies having a production activity (producers offering goods and services on the market), most frequently the price is established based on the total unitary cost – by adding a certain profit spread to the total unitary cost. The profit spread represents the profit obtained for each one of the units of product sold. Usually the trade mark up is higher than the profit spread – because a trade mark is covering not only the profit of the trader, but also a part of its costs (indirect costs – wages, rents, amortization, taxes etc.).
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The prices found on the market are heavily affected by taxation – there are many indirect taxes applied at the prices of goods and services traded on the market; among them, the most important are: value added tax (VAT), excise duties and custom duties. There is a clear distinction between the production price (the price established and asked by the seller, which does not include any indirect taxes) and the consumption price (the total price paid by the buyer, with all indirect taxes included).



VII.5 The profit

Not only the level of the profit is analyzed, but also the profitability rates (or profit rates), which express the profit as a percentage of another economic indicator (usually total cost, value of the sales or capital used). The most frequently used profitability rates are the rate of profit based on total cost, the rate of profit based on the sales, the rate of profit based on capital. For the fixed capital, the profitability of fixed capital, is calculated, expressed as units of profit for 1.000 units of fixed capital. The profit is subject to taxes. Usually, the profit tax is calculated by applying a quota (of 16%, in Romania, nowadays) on the gross profit obtained by the company.



The profit remaining available to the company is the net profit, the amount of money left after paying the profit tax to the state.

All profitability rates can be calculated for both the gross profit and the net profit. Most frequently, gross profit is compared to costs and sales, while net profit is compared with the capital invested.



VII. How Microeconomics Characterize the Firm’s Human Resources Function

The wage represents the main form of income for individuals (natural persons). The wage is the remuneration received by a person for the work done.. The nominal wage (Sn) is the wage expressed in money, at a given moment - the wage in current prices. The real wage (Sr) represents the wage in constant prices (showing which would have been the nominal wage if the prices remained unchanged) – actually it is the purchasing power of the nominal wage. It can also be defined as the quantity of goods that can be bought with the nominal wage. The real wage is calculated by dividing the nominal wage to a price index (IPC).

Sn Sr = IPC
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The inflation rate is the relative modification (increase) of consumption prices. Basically, a consumption basket used the average price of goods and services contained in the basket is calculated and for that price, the index is the consumption price index (IPC) and the relative modification is the inflation rate.



The basic wage is the basis from which the wage is calculated (usually, it is the negociated wage, the onementioned in the working contract). The gross wage represents the total wage paid by the employer: basic wage, plus additional allowances, plus bonuses, plus the wage for extra hours etc.). From the gross wage several contributions are calculated, plus the wage tax. In Romania, currently, form the gross wage, the following amounts are deducted: contribution to social insurances (CAS); contribution for health insurances (CASS); contribution for the unemployment fund (somaj); wage tax (16% from the taxable wage = gross wage, minus contributions, minus personal deduction).
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× 100%

, π = IPC – 100%

The net wage represents the amount of money that the employee receives - the part from the gross wage remaining after the deduction of contribution and taxes. The difference between the gross wage (wage before taxes) and net wage (wage after taxes) represents different contributions and taxes paid by the employer to the state, in the name of the employee





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