INTRODUCTION OF MARKET AND WELFARE

MARKET

- Serve as platforms where buyers and sellers interact to exchange goods and services.

-A market is any place where two or more parties can meet to engage in an economic transaction.

Welfare

- study of how the allocation of resources and goods affect social welfare.
- It encompasses the satisfaction and benefits derived from consuming goods and services, as well as the
overall quality of life within a given economy.

PARETO EFFICIENCY

- named after Italian economist Vilfredo Pareto, describes a situation where it's impossible to make one
person better off without making someone else worse off.

MARKET STRUCTURE

- depicts how firms are differentiated and categorized based on the types of goods they sell
(homogeneous/heterogeneous) and how their operations are affected by external factors and elements.

homogeneity and heterogeneity refer to the degree of similarity or dissimilarity among products offered
by different firms.

Homogeneous markets: Often characterized by perfect competition or monopolistic competition.

Identical products: Products that are virtually indistinguishable from one another.

Perfect substitutes: Consumers perceive no difference between products offered by different firms.

Examples of homogeneous products:

 Commodities like oil, wheat, or gold

Heterogeneous markets: Typically associated with monopolistic competition or oligopoly.

Products that are perceived as different by consumers due to factors like brand, quality, features, or
packaging.

Imperfect substitutes: Consumers may prefer one product over another, but they can still substitute if
necessary

 Examples of heterogeneous products: Branded clothing, Automobiles, or Restaurant

meals

TYPES OF MARKET STRUCTURE

 PERFECT COMPETITION
  MONOPOLY
 OLIGOPOLY
 MONOPOLISTIC COMPETITION

WHY MARKET STRUCTURE IS IMPORTANT?

Market structure is important for a firms use as its motivations, decision making, opportunities. This will
incur changes to current market standings affecting: market outcomes, price, availability and variety.

PRICING BEHAVIOUR

Pricing behavior refers to the strategies and tactics businesses use to set prices for their products or
services. These strategies can be influenced by various factors, including production costs, market
demand, competition, and consumer psychology.

KEY PRINCIPLE OF BEHAVIOURAL

1. Price Perception and Processing: Consumers don't simply see a price tag; they interpret it based
on their past experiences, beliefs, and emotional states. Factors like brand reputation, perceived
quality, and even the way a price is presented can significantly influence their perception.

2. Reference Prices: Consumers often compare prices to a reference price, which can be a previous
price they've seen, a competitor's price, or a price they've mentally established as "fair." This
comparison can influence their willingness to pay, making a price seem more or less attractive.

3. Price Anchoring: The first price a consumer sees for a product can act as an anchor, influencing
their subsequent price judgments. This is why businesses may initially offer a product at a high
price before "discounting" it to a more appealing level, creating a perception of value.

4. Price Thresholds: There are psychological price thresholds where consumers' willingness to pay
significantly changes. For instance, a consumer might be willing to pay $1 for a small chocolate
bar but not $2. Understanding these thresholds is crucial for maximizing profit margins while
maintaining customer loyalty.

BEHAVIOURAL PRICING STRATEGIES

5. 1. Charm Pricing: This strategy uses prices ending in 9 or 5 (e.g., $9.99) to create a perception of
lower cost and increased value. Consumers often perceive these prices as significantly cheaper
than the next whole dollar amount.
6. 2. The Three Options Principle: Offering consumers three choices, including a "good," "better,"
and "best" option, can encourage them to choose the middle option, which is often the most
profitable for the business.
7. 3. Nudge Effect: Businesses can use subtle cues, such as labels like "best buy for the price" or
"hot deals," to nudge consumers towards specific products and create a sense of urgency and
value.
 8. 3.Framing and Context: The way a price is presented and the context in which it's shown can
significantly influence consumer perception. For example, offering a "free" item with a purchase
can increase perceived value and encourage buying.

PERFECT COMPETITION

is a market structure where many small firms sell identical products, and no single firm has control over
the price. All firms are price takers, meaning they must accept the market price as it is.

KEY FEATURES OF PERFECT COMPETITION

 Many Buyers and Sellers

 Identical Products
 Free Entry and Exit
 Perfect Information

MONOPOLY

- The word monopoly is a Latin term. ‘Mono’ means single and poly means seller
- Monopoly is a form of market organization in which there is only one seller of the company.
- There is no close substitute for the commodity sold by seller.

KEY FEATURES OF MONOPOLY

 Single seller
 Price maker
 Barriers to entry
 Lack of substitute

MONOPOLISTIC COMPETITION

-When there is a numerous quantity of small firms competing against each other.
- There are many buyers and sellers of the product but the product is not a perfect substitute.
-Differs in brand, style, packaging and pricing strategies.

FEATURES OF MONOPOLISTIC COMPETITION

 Many Firms
 Freedom of entry and exit.
 Product differentiation. Slightly different from each other
 Non price competition. Business use other means to compete.

OLIGOPOLY
is a market structure characterized by a small number of firms that dominate the market. These firms
have significant market power, which allows them to influence prices and production levels.

KEY FEATURES OF OLIGOPOLY

 Few Sellers
 Price Rigidity
 Barriers to Entry
 Product Differentiation
 Collusion
 Price Control and Efficiency
Price Control
Price control- refers to government-imposed limits on the prices that can be charged for goods
and services in the market.
Types of Price Control
• Price ceilings – These are maximum prices set by the government, beyond which sellers cannot
charge for a product. The goal is to make essential goods more affordable.
• Price floors – These are minimum prices, below which products cannot be sold. They are often
implemented to protect producers, such as with minimum wages or agricultural price supports.
Efficiency
Efficiency - in economics refers to the best allocation of resources to maximize total welfare in a
society.
• Productive efficiency - is achieved, meaning goods are produced at the lowest possible cost.
• Allocative efficiency - meaning the goods produced match consumer preferences the mix of
goods and services is ideal according to society’s needs and desires.

Examples of Price Ceiling and Price Floor

Example of Price Ceiling:

Imagine a government sets a price ceiling on rent at ₱5,000 per month to make housing more
affordable. Even if landlords want to charge more due to high demand, they can't legally charge
above this price.
Potential Effect:
• Shortages: More people can afford the rent, so demand increases. However, landlords may be
less willing to rent or maintain properties, reducing supply.
Example of Price Floor
Consider the minimum wage. If a government sets a price floor of ₱100 per hour for labor,
employers cannot legally pay workers less than that amount, even if the market would otherwise
lead to lower wages.
Potential Effects:
• Surplus: In the labor market, this could result in a surplus of workers (unemployment), as
employers may hire fewer workers at the higher wage.

• Higher prices: For goods like agriculture, a price floor may cause higher prices for consumers
because farmers are guaranteed a minimum price for their products.
Pros and Cons of Price ceiling
Pros:
• Consumer Protection: Helps protect consumers from rapid price increases, making essential
goods more affordable (housing, food).
• Accessibility: Ensures that low-income individuals can afford, necessary goods, particularly
during crises like natural disaster.
Cons:
• Shortages: If the ceiling is set below the equilibrium price, it can lead to shortages, as demand
exceeds supply.
• Reduced Quality: Producers may lower the quality of goods since they cannot charge higher
prices to cover costs.
• Black Markets: May lead to the emergence of black markets where goods are sold at higher
prices, undermining the intended protection.
Pros and Cons of Price Floor
Pros:
• Producer Protection: Helps ensure that producers receive a minimum income, supporting their
livelihoods (minimum wage laws)
• Market Stability: Can stabilize prices in unstable markets (agricultural products) encouraging
production.
Cons:
• Surpluses: If the floor is set above the equilibrium price, it can lead to surpluses, as supply
exceeds demand.
• Inefficiency: May result in inefficiencies in the market, with resources allocated to less
productive firms or sectors.
• Higher Prices for Consumers: Consumers may face higher prices, reducing their purchasing
power and overall
 THE ECONOMICS OF THE PUBLIC SECTOR Externalities, Public Goods and Common Resources

Externalities and Market Outcomes

 Externalities are costs or benefits that affect third parties who are not directly involved in the
market transaction
 These external effects can lead to inefficient market outcomes because the true social costs or
benefits are not considered in private decision-making.

Two types of Externalities

 Negative Externalities: These occur when the production or consumption of a good imposes
external costs on others. Examples include pollution from factories, where the private cost is
lower than the social cost, leading to overproduction.
 ✓Positive Externalities: These happen when the production or consumption of a good provides
benefits to third parties. For instance, when individuals get vaccinated, they help protect others
by reducing the spread of diseases. However, the market underinvests in such goods, leading to
underproduction.

Impact on Market Outcomes:

 Negative externalities cause overproduction because producers do not account for the external
costs.
 Positive externalities cause underproduction because consumers do not receive all the benefits.

Real-life Examples of Externalities

Negative Externality:

 Air Pollution Factories and vehicles emit pollutants into the air, causing health problems for the
public and environmental damage
 However, individuals may underinvest in vaccinations because they do not fully capture the
social benefits, leading to lower vaccination rates

Positive Externality:

 Vaccination When individuals get vaccinated, they reduce the spread of diseases, benefiting
others by contributing to herd immunity.
 However, individuals may underinvest in vaccinations because they do not fully capture the
social benefits, leading to lower vaccination rates

Common resources
  are natural or man-made resources that are shared by many people, but overuse can lead to
their depletion.
 Fisheries: Fish in the ocean are common resources. They are rival (one person catching fish
leaves fewer for others) and non-excludable (it's hard to stop people from fishing).

Rival: A resource is rival if one person’s use of it reduces the availability for others. For example, if one
fisherman catches a lot of fish, fewer fish are left for others.

Non-rival: A resource is non-rival if one person’s use does not affect the availability for others. An
example is a streetlight—everyone can benefit from it without reducing its usefulness to others.

Excludable: A resource is excludable if people can be prevented from using it. For instance, movie
theaters can exclude people by charging for tickets.

Non-excludable: A resource is non-excludable if it is difficult to stop people from using it. For example,
no one can be easily excluded from enjoying fresh air.

Public goods are non-excludable and non-rivalrous, meaning that one person's use of the good does not
reduce its availability to others, and it is difficult to prevent people from using the good even if they do
not pay for it.

Examples of Public Goods: National defense, street lighting, and clean air.

The Free-Rider Problem arises when people benefit from a good without contributing to its cost. For
instance, individuals can enjoy the benefits of a public park without paying taxes, which leads to
underfunding or deterioration of public goods.

Characteristics of Public Goods:

Non-excludable: Impossible to exclude people from using it.

Non-rivalrous: One person’s consumption does not reduce the availability for others.

Externalities and Public Goods: Lecture Discussion

Both externalities and public goods are sources of market failure. Markets do not efficiently allocate
resources to deal with external costs (negative externalities) or benefits (positive externalities), nor do
they provide adequate public goods due to the free-rider problem. Governments often step in to correct
these inefficiencies through taxes, subsidies, and regulation, ensuring better resource allocation.

Examples:

Negative externality: Air pollution from vehicles.

Positive externality: Education.

Public good: National defense.

Common resource: Fisheries (where overuse, also known as the tragedy of the commons, can occur
because the resource is overexploited without regulation).

Some people may free-ride because they genuinely can't afford to contribute, especially for essential
services like clean water, healthcare, or public transportation. This makes the free-rider issue more
complex because it's not always about avoiding payment—sometimes it's about affordability.

In these cases, government intervention is the key. For example:

Taxes help distribute the cost fairly, where those who can afford more contribute more.

Subsidies or free services for low-income individuals ensure that everyone can access important public
goods without being left out, even if they can’t pay.

So, while free-riding can be a problem, it's important to recognize why it happens and address it in a way
that balances fairness with accessibility.
 Consumer Behavior
Importance of Consumer Behavior?
Knowing how consumers behave helps companies to increase their sales and create products and
services that meets the customer’s needs. For example, the company notices that customers
prefer affordable products, then the company can shift its focus to create products like it. This
aligns with consumer preference, leading to increased sales and customer loyalty because their
preference is being valued. By studying what drives purchases like quality or price companies
can remake their marketing strategies ensuring they meet customer needs and avoid product
failures.

Factors Influencing Consumer Behavior

-Social Factor Example: If your friend recommends a restaurant, it could influence where you go
next time.
-Economic Factor Example: If you have less money this month due to financial difficulties, it
might affect what kind of food or clothes you can buy.
-Cultural Factor Example: In some cultures, wearing certain types of clothing is considered
respectful or traditional which can influence purchasing decisions related to attire.

Types Of Buyers
-Impulsive Buyer Example: Buying something on impulse without much thought like grabbing
snacks while shopping for groceries because they look tasty even though not planned initially.
-Price-Conscious Buyer: Always looking out deals online before making any purchase ensuring
best value possible within budget limits set beforehand by individual themselves. Health-
Conscious Buyer: Always looking at the expiration date.

Buying Decision Process

-Need Recognition This is when a consumer realizes they need something. For example, if your
phone breaks, you recognize the need for a new one.
-Information Search Once the need is recognized, the consumer looks for information about
possible products. This could involve searching online, asking friends, or reading reviews.
-Evaluation of options At this stage, the consumer compares different options based on factors
like price, quality, and features. For instance, if you're looking for a new phone, you might
compare brands like Apple and Samsung.

Examples of Buying Decisions

When people decide to buy something, they go through steps. For example, if someone wants to
buy a new phone:
- Need Recognition: They realize their old phone is slow or broken. - Information Search: They
look online for reviews or ask friends for recommendations.
- Evaluation of Options: They compare different phones based on features, price, and brand.

Psychological Factors
Psychological factors play a big role in how we buy things:
- Motivation: This is what drives us to buy. For instance, someone might want a new pair of
shoes because they want to look good.
- Perception: This is how we see a product. If a brand advertises its shoes as "the most
comfortable," people might believe it and choose those shoes over others.

Buying Motives
People have different reasons for buying things:
- Comfort and Convenience: Many people buy products that make their lives easier, like a
microwave for quick meals.

- Health: Some consumers choose organic food because they believe it’s healthier for them and
their families.

Types of Buying Behavior

Consumers can be grouped based on how they buy:
- Habitual Buying: This is when people buy the same items regularly without thinking much
about it. For example, buying milk every week.
- Complex Buying: This happens when someone buys something expensive or important, like a
car. They spend more time researching and comparing options.
Consumer Psychology
Consumer psychology studies how our feelings and thoughts affect our buying choices:
- Feelings: If someone feels happy about a brand, they are more likely to buy from it.
- Attitudes: If a person believes that a product is high quality, they may choose it over cheaper
options.

Post-Purchase Behavior
After buying something, consumers go through feelings of satisfaction or regret:
- Satisfaction: If the product works well and meets expectations, the buyer feels happy and may
buy again.
- Regret: If the product doesn’t work as expected, the buyer may feel disappointed and avoid that
brand in the future.

Impact of Advertising
Advertising is everywhere and influences what we buy:
- Good ads can catch our attention and make us interested in a product.
- Ads often show happy people using the product, which can make us want it too.

Brand Loyalty
Brand loyalty means sticking with a brand you trust:
- For example, if someone always buys Nike shoes because they believe they are high quality,
that person is showing brand loyalty.
- Loyal customers often recommend the brand to others, helping it grow.

Online Shopping Trends

More people are shopping online than ever before:
- Online shopping is convenient because you can do it from home at any time.
- Many websites offer reviews from other buyers, helping consumers make informed choices.

Cultural Influence on Buying

Culture affects what we buy:
- During holidays like Christmas or Diwali, people often buy gifts for family and friends.
- Different cultures have unique traditions that influence purchasing decisions, such as food
preferences during festivals.

Social Media's Role

Social media plays a huge part in consumer decisions:
- People often check reviews or recommendations from friends on platforms like Instagram or
Facebook before buying something.
- Influencers can sway opinions by showcasing products in their posts or videos.

Conclusion
Understanding consumer behavior helps businesses create better marketing strategies. When
companies know what customers want and why they buy, they can develop products that meet
those needs and create advertisements that attract attention.
 FIRM BEHAVIOR AND PRODUCTION

 A firm is an economic entity that transforms inputs into outputs to generate profits.
 Understanding firm behavior is essential to analyze how firms make production decisions that
affect market outcomes.
 The production function is the technical relationship between inputs (labor, capital) and the
quantity of output produced.

Formula: Q = f(L, K)

- Q: Quantity of output

- L: Labor input

Inputs:

 Labor (human effort)

 Capital (machinery, equipment)
 Land (natural resources)
 Entrepreneurship (management, innovation)

Output:
 quantity of goods
 services, or products
 obtained as a result of a production process or system

fixed resources
In economics, fixed resources are inputs that remain the same regardless of the level of
output. For example, the physical space of a store is a fixed resource because it doesn't change
whether there are two or ten customers inside.

In economics, fixed resources are inputs that remain the same regardless of the level of
output. For example, the physical space of a store is a fixed resource because it doesn't change
whether there are two or ten customers inside.

variable resources
Resources that change depending on the level of output

Examples
Examples of variable resources include labor, raw materials, commissions, production supplies,
delivery costs, packaging supplies, and credit card fees

SHORT RUN VS LONG RUN PRODUCTION

Short Run Production:

 At least one factor of production is fixed (e.g., a factory size), meaning firms can only adjust
variable inputs like labor.

Example: Hiring more workers but using the same factory space.

Long Run Production:

 All factors of production are variable, allowing the firm to scale both labor and capital. Firms can
scale operations up or down completely.

Specialization
an economic practice where a company or individual focuses their resources and labor on a
specific type of production.

LAW OF DIMINISHING MARGINAL RETURNS

Definition: As successive units of a variable input (e.g., labor) are added to a fixed input (e.g.,
machinery), the marginal product of each additional unit will eventually decline.

As you add variable resources to fixed resources the additional output will eventually decrease.

Example: Adding more workers to a fixed number of machines will initially increase production, but over
time, workers will become less productive because they crowd the

workspace.
The three stages of returns in economics are increasing returns, diminishing returns, and
negative returns

Increasing returns: The first stage, also known as the Law of Increasing Marginal Returns

Diminishing returns: The second stage, also known as the Law of Diminishing Marginal
Returns

Negative returns: The third stage, also known as the Law of Negative Marginal Returns

TOTAL, MARGINAL, AND AVERAGE PRODUCT

Total Product (TP):

 The total quantity of output produced with given inputs.

Marginal Product (MP):

 The additional output produced by one more unit of input.

Formula: MP = TP/L

Average Product (AP):

 The average output per unit of input.

Formula: AP = TP/L
COSTS OF PRODUCTION

 Refers to the total expenses incurred by a firm to produce goods or services. It includes various
types of costs that help determine the firm’s overall profitability and pricing decisions.

Fixed Costs (FC):

 Costs that remain constant regardless of output (e.g., rent, salaries of permanent staff).

Variable Costs (VC):

 Costs that change with output (e.g., raw materials, energy).

Total Cost (TC):

 The sum of fixed and variable costs.

Formula: TC = FC + VC

MARGINAL AND AVERAGE COSTS

 Marginal Cost (MC) and Average Cost (AC) are both important concepts in economics,
particularly in understanding a firm’s production and cost structure.

Marginal Cost (MC):

  The additional cost is incurred by producing one more unit of output.

Formula: MC = ATC/AQ

Average Cost (AC):

 The cost per unit of output, calculated by dividing total cost by the quantity produced.

Formula: AC = TC/Q

PROFIT MAXIMIZATION

Profit Maximization Rule:

 A principle used by firms to determine the optimal level of production to achieve the highest
possible profit. Firms maximize profit where Marginal Revenue (MR) = Marginal Cost (MC).

Marginal Revenue (MR) is the additional revenue generated from selling one more unit of a product.

Marginal Cost (MC) is the additional cost incurred from producing one more unit of a product.

 In Perfect Competition, firms are price takers, and profit maximization occurs where P = MC.
 In a Monopoly, firms set prices above marginal cost to maximize profits.

ECONOMIES AND DISECONOMIES OF SCALE

Economies of Scale:

 As production increases, the firm’s average costs decrease due to factors like specialization, bulk
purchasing, and operational efficiency.

Example: Bulk purchasing of materials reduces cost per unit.

Diseconomies of Scale:

 As production expands too much, average costs begin to increase due to inefficiencies like
overcomplex management and worker congestion.

Example: Communication issues in very large organizations.

CONCLUSION

 The production function shows the relationship between inputs and outputs.
 Firms face various costs (fixed, variable, total) and seek to minimize costs for profit maximization.
 The goal is to balance economies and diseconomies of scale to produce at the most efficient
level.
 Firm behavior shapes the supply side of the market, influencing prices and competition.