3.1 Introduction
[3.2 Demand] [3.3 Price Elasticity] [3.4 Supply]
Background
Mass markets are primarily business-to-consumer (B2C) markets with several sellers producing goods and services for many consumers. In mass markets, prices are tied to the demand and cost conditions of the market. This segment provides an analysis of demand and cost conditions to aid our understanding of price formation in mass markets, which is covered in Segment 4.
A firm’s demand for its product is determined by consumer preferences, income, the prices of related products and seasonal factors. When a firm sets its price, it needs to think about what impact this will have on its sales. The greater the impact, the less likely it is that a firm will want to increase its price. The concept of price elasticity of demand will be developed here as a means of understanding the demand conditions facing a firm.
A firm’s supply of its product depends on its production technology and its costs. As a general rule, a firm finds it profitable to produce more when the price it receives is higher. However, a firm’s supply decision may be different in the short run, as opposed to the long run when it can more easily change the inputs it uses. In addition, at any point in time, a supply decision will be related to costs that can change in the short run as opposed to a firm’s overall cost structure.
Sources
Portions
of this segment draw upon course materials prepared by Geoffrey Heal (
Segment Overview
Segment 2 introduced you to the key concepts in economics and price formation. The ‘added-value’ model of negotiations required some understanding of the drivers of demand and supply for goods and services but these were tailored towards an analysis of business-to-business (B2B) negotiations. We now turn to consider a more traditional economic focus on mass markets.
·
A key issue when pricing a good or service is how much
impact an increase in price will have on the quantity of the product you are
able to sell. This, in turn, will tell you something about what will happen to
your revenues as the price changes. At the heart of understanding the
sensitivity of demand is the concept of price elasticity. In topic 3.3, “Price
Elasticity”, you will look at what price elasticity is and the role it plays in
revenue determination and maximisation.
·
A firm’s supply of its product comes from its technology
of production, the availability of inputs it uses and the regulatory
environment it operates in. In topic 3.4, “Supply”, we consider a firm’s
willingness to supply and how this operates at market level. We investigate the
law of supply, supply functions, and factors that broadly impact on supply.
· Topic 3.5, “Production”, develops a broader understanding of what drives supply; in particular, the technology of production. It discusses how time matters and why, in the short run, firms are not able to easily expand their output as some factors of production are fixed. This changes in the long run.
·
Topic 3.6, “Costs”, then considers supply and production
issues from a cost perspective. This is a useful building block in
understanding the nature of supply and, as we will see in Segment 4, how firms
price to mass markets.
Your Learning Outcomes
Upon completing this
segment, you should be able to
·
express the law of supply and the law of demand in
equations and on graphs
·
describe the roles of a firm's inputs and outputs in its
production function
·
perform calculations to find the total, average and
marginal product of labour for a firm
·
calculate the differences
between total, average and marginal costs in the long run and short run.