Applications of Microeconomics

Applications of Microeconomics

In this lesson, you’re expected to learn:
– the economic implications of competition, demand, and supply
– the economic implications of utility and labor economics
– how to perform a break-even analysis

The process by which businesses make decisions is as complex as the processes that characterize consumer decision-making.

A business draws upon microeconomic principles and data to make a variety of critical choices – any one of which could mean the success or failure of their enterprise.

What a business does with that information is decided by senior management. The major influences on their decisions may entail some or all of the following factors:

• logic
• what the competition is doing
• the state of the economy
• other variable and unknown factors

1) Economic Implications of Competition

Competition is the major mechanism of control in a free market system because it forces businesses and resource suppliers to make appropriate responses to changes in consumer wants and needs.

Use of scarce resources in a least cost and most efficient manner is good for all – buyers, sellers, resource suppliers, competition, and government.

Competition does more than guarantee responses to customer wants and needs.

It is competition that forces firms to adopt the most efficient production techniques. Inefficient and high-cost firms will eventually be eliminated from the industry.

Therefore, competition provides an environment conducive to technological advance.

Another benefit of competition is when businesses not only seek their own self-interest but also promote the public or social interest.

The key link between self-interest and public interest is the use of the least expensive combination of resources in producing a given output.

2) Economic Implications of Demand & Supply

To understand how demand and supply forces work, it’s important to understand the market in which they operate.

Markets assume a wide variety of forms: local, national, or international in scope; personal or impersonal actions by buyers and sellers; and small or large in size.

Determination of Equilibrium Price & Quantity

The equilibrium price and quantity for a product is determined by market demand and supply.

• Quantity supplied will exceed quantity demanded when a price is above the equilibrium price, resulting in a surplus of goods. This in turn reduces prices and increases consumption.

• Quantity demanded will exceed quantity supplied when the price is below the equilibrium price, resulting in a shortage of goods. This in turn increases prices and increases quantity supplied.

[Optional] Six Microenvironmental Factors That Affect Businesses
3) Economic Implications of Utility

The law of demand says that a high price usually discourages consumers from buying a product or service and that a low price encourages them to buy.

Three types of explanations exist to represent consumer behavior and the downward-sloping demand curve. These include income and substitution effects, the law of diminishing marginal utility, and indifference curves.

• Income effect indicates that, at a lower price, one can afford more of a good without giving up any alternative goods. The purchasing power of one’s money is increased due to lower prices.

• Substitution effect states that at a lower price, one has the incentive to substitute a cheaper good for similar goods that are now relatively more expensive.

Another explanation of consumer behavior is based on the budget line and indifference curves.

• A budget line shows the various combinations of two products, which can be purchased with a given money income.

• An indifference curve shows all combinations of two products that will yield the same level of satisfaction or utility to the consumer. Hence, the consumer will be indifferent as to which combination is actually obtained.

4) Economic Implications of Labor Economics

Labor economics deals with wages, wage rates, and productivity of workers.

• Wages are the price paid for the use of labor, where labor includes all blue- and white-collar workers, professionals, and owners of small businesses.

• Wage rate
 is the price paid for the use of units of labor service.

Types of Wages

There are two basic types of wages: nominal (money) wages and real wages.

• Nominal wages are the amounts of money received per unit of time (hour, day, week, month, year).

• Real wages are the quantity of goods and services that can be obtained with nominal wages. Real wages depend on one’s nominal wages and the prices of the goods and services purchased. Thus, real wages are the purchasing power of nominal wages.

[Optional] Nominal Wages vs. Real Wages 
What is Break-Even Analysis?

The break-even level or break-even point (BEP) represents the sales amount—in either unit or revenue terms—that is required to cover total costs (both fixed and variable).

Profit at break-even is zero. Break-even is only possible if a firm’s prices are higher than its variable costs per unit. If so, then each unit of the product sold will generate some ‘contribution’ toward covering fixed costs.

The Break-Even Point

In economics and business, the break-even point (BEP) is the point at which cost and revenue are equal: there is no net loss or gain, and one has “broken even”. A profit or a loss has not been made, although opportunity costs have been “paid”, and capital has received the risk-adjusted, expected return.

It is the point at which a business’s sales have generated enough income to cover all of its fixed costs and expenses.

At that point, all of the business’s incoming revenue is profit as long as the expenses and costs are not increased and the sales amounts are not reduced.

At the BEP, Revenue = Variable Costs + Fixed Costs

Calculating Break-Even Point

There are a number of ways by which you can calculate your break-even point.

One simple formula uses your fixed costs and gross profit margin to determine your break-even point:
Breakeven Point = Fixed Costs ÷ Gross Profit Margin *

The margin reflects the percentage of revenue that remains after the business pays all of its expenses. This represents the total profit after expenses.

Fixed costs exist regardless of how much you sell or don’t sell, and include expenses such as rent, wages, power, and insurance.

Gross Profit Margin = (Total Sales – Total Cost of goods sold) / Total Sales
To find the Breakeven Point in units, use the following formula:

Breakeven Point = Fixed Costs ÷ Contribution Margin

Contribution Margin is a product’s price minus all associated variable costs, resulting in the incremental profit earned for each unit sold. *

Contribution Margin = Sales Price – Variable Costs
[Optional] How to Calculate Breakeven Point
What Decisions Can Break-Even Analysis Help an Organization Make?

The break-even point is one of the simplest yet least used analytic tools in management.

It helps to provide a dynamic view of the relationships between sales, costs, and profits.

For example, expressing break-even sales as a percentage of actual sales can give managers a chance to understand when to expect to break even (by linking the percent to when this percent of sales might occur).

[Optional] Analysis of Break-Even Point
Watch this 2-minute video to learn more:
Jim Rohn Sứ mệnh khởi nghiệp