MANAGERIAL ECONOMICS

Maryhill College

III. PROFIT & MARKET STRUCTURES AND MACROECONOMICS

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PROFIT & MARKET STRUCTURES

 In the study of market structures, two concepts of profit are important:

 To an accountant: ACCOUNTING PROFIT = Total Revenue – Explicit Costs
 To an economist: ECONOMIC PROFIT = Total Revenue – Explicit Costs – Implicit Costs
 When economic profit is zero, the firm is said to have a NORMAL PROFIT (i.e., economic breakeven).
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 EXPLICIT COSTS are expenses incurred or to be paid while IMPLICIT COSTS are opportunity costs associated
with a firm’s use of resources that it owns and do not involve actual payments.

 In economics, profit is maximized when marginal revenues = marginal costs. This is because any other level
of outputs leaves the possibility of increasing profits by raising revenue or decreasing costs.
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 MARKET is any institution, mechanism, or situation which brings together the buyers and sellers. It is a
physical (e.g., grocery) or virtual (e.g., internet) place where sellers and buyers transact business.
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 The four basic MARKET STRUCTURES are:
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Market No. of Firms Products Price Control Ease of Entry Common Examples
PURE Identical or Very Easy
Very Many None Agricultural Products
COMPETITION Homogenous (No Barrier)
MONOPOLISTIC Similar but Fairly Easy
Many Limited Fast Food, Cosmetics
COMPETITION Differentiated (Low Barrier)
Standardized with Limited Appliances, Oil
OLIGOPOLY Few Hard
Differentiation or Wide Cars, Computers
PURE Government Franchise,
One Unique Wide Blocked
MONOPOLY Utility Companies
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 COMPETITION denotes rivalry between among producers, each of which seeks to deliver a better deal to
buyers when quality, price and product information are all considered.
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 In pure competition: the firm’s demand curve is PERFECTLY ELASTIC (horizontal). The firm can sell many
goods it can produce at the equilibrium price (i.e., very low sales at a higher price).
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 In monopolistic competition: consumers go for a certain product based on DIFFERENTIATION.
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 In pure monopoly: the firm has no or very little market incentive to innovate and control costs; hence,
pure monopolies are usually subject to GOVERNMENT REGULATION.
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 Oligopoly is a competition among few; if left unregulated, oligopolists tend to establish CARTEL that
engage in price fixing through collusion.
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 MONOPSONY is a market where only one buyer exists for all sellers.
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 BLACK MARKET is an illegal market wherein people conduct transactions at prices (usually high) forbidden by
the government.
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 GROSS DOMESTIC PRODUCT

 GROSS DOMESTIC PRODUCT (GDP) is the market value of all the final goods and services produced by a
country within a given time period. Intermediate goods are not directly included in measuring GDP.
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 FINAL GOOD is an item that is bought by its final user while an INTERMEDIATE GOOD is an item produced by
one firm, bought by another and used as a component of the final good.
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 Two principal methods of calculating GDP:
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 
EXPENDITURE (EXPENSE) approach INCOME approach

GDP = C + I + G + (X – M) GDP = Wages + Self-employment Income +

Where: C – Household Consumptions
I – Business Investments Rent + Interest + Profits + Indirect Business
G – Government Spending Taxes (e.g., VAT) + Depreciation & Amortization
X – Exports M – Imports + Income of Foreigners
(X – M) – “Net Exports”

 GDP is measured either in current prices (nominal GDP) or in prices of a given year (real GDP):
A) NOMINAL GDP – the value of final goods and services produced by a domestic economy for a year
atcurrent market prices.
B) REAL GDP – the value of final goods and services produced in a given year when valued at constant
prices,which is a price level adjustment that eliminates the effects of inflation on the measure.

 ECONOMIC GROWTH happens when there is an increase in real GDP in an economy.

 RECESSION happens when there is a decline in real GDP growth (i.e., negative GDP growth).
 GROSS NATIONAL PRODUCT (GNP) is the market value of all the final goods and services produced by citizens
of a country within a given time period – regardless of location (citizen’s country or abroad).
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BUSINESS CYCLES

 BUSINESS CYCLES refer to cumulative fluctuations in real GDP over a period of time.
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 There are stages in one complete business cycle as illustrated by the graph:

Peak
Real GDP Peak

Trough
Recession Expansion

Time
One Business Cycle

 The highest point of the business cycle is called a PEAK while the lowest point is called a TROUGH.
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 When an economy moves from peak to trough, real GDP is falling, and the economy is in RECESSION.
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 When an economy moves from trough to peak, real GDP is rising, and the economy is in EXPANSION.
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 Recession is a.k.a. CONTRACTION while expansion is a.k.a. BOOM or RECOVERY.
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 DEPRESSION – is the prolonged form of recession; it is a major downsizing in the economy with conditions
similar to that of a recession, but more severe and long-lasting.
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 Economists use ECONOMIC INDICATORS to forecast turns in the business cycle. Indicators may lead, lag or
coincide with economic activity. Common examples include:
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 Leading indicators – building permits, new orders for consumer goods, stock prices
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 Coincident indicators – level of retail sales, current unemployment rate, level of industrial production
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 Lagging indicators – duration of unemployment, loans outstanding, ratio of inventories to sales

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 INFLATION and UNEMPLOYMENT

 INFLATION is a sustained increase in an economy’s average price level.

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 The primary causes of inflation are:
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 DEMAND-PULL inflation – happens when too much demand for certain goods and services are not met by
a corresponding increase in the supply (i.e., excess demand propels prices to go up)


 COST-PUSH inflation – happens when there is an increase in production costs either due to higher wages
(wage-push theory) or higher cost of raw materials and other inputs (supply-shock theory).
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 The most common indices used to measure inflation are:
1) CONSUMER PRICE INDEX (CPI) measures price changes for goods & services purchased by consumers.

(CPI this year)

– (CPI last year)
Inflation Rate = CPI last year X 100

2) WHOLESALE PRICE INDEX (WPI) measures the price changes for goods at the wholesale level, specifically
finished goods, intermediate goods, and crude materials.

3) GDP DEFLATOR measures the changes in price for goods and services included in GDP.

Nominal GDP
GDP Deflator = X 100
Real GDP
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 DEFLATION is the decrease in the average price level while DISINFLATION is the decline in inflation rate.

 When prices are falling, consumers delay purchase and businesses delay investments, both in anticipation of
lower future prices. These delays create further decrease in demand and prices. This phenomenon that
adversely affects the economy is called DEFLATIONARY SPIRAL.
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 HYPERINFLATION is a very high rate of inflation while STAGFLATION occurs when an economy’s output (real
GDP) decreases and its price level rises -- production stagnates (as during a recession) while prices go up.

 There is an inverse relationship between inflation and unemployment rate:


Number of people unemployed
Unemployment Rate = X 100
Labor Force
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 LABOR FORCE equals the sum of employed plus unemployed workers.
 When unemployment rate is low (high), inflation tends to increase (decrease).
 PHILLIPS CURVE shows a relationship between the inflation rate and the unemployment rate.
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 The three (3) types of unemployment are:
 CYCLICAL unemployment – reflects changes in the business cycle; cyclical unemployment increases
during RECESSION and decreases during EXPANSION.
 FRICTIONAL unemployment – associated with the normal workings of an economy; new college graduates
or newly resigned employees who are looking for a job will fall into this category.
 STRUCTURAL unemployment – occurs when there is a ‘mismatch’ between the kind (location) of jobs
available and the skills (location) of those who are unemployed.

FISCAL POLICY vis-à-vis MONETARY POLICY

 FISCAL and MONETARY policies are created to effectively counter recessionary or inflationary tendencies.
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 FISCAL POLICY refers to government actions, such as taxes, subsidies, and government spending, designed
to achieve economic goals. Examples are:
 Reduction of taxes increases personal disposable income, which will stimulate economic activity.
 Increase in government spending may also stimulate the economy through subsidies and other reliefs.
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 An increase in deficit, either due to an increase in government spending or to a decrease in taxes, is called a
FISCAL EXPANSION while an increase in taxes to reduce a deficit is called FISCAL CONTRACTION.
 Taxes are levied by a government based on two general principles: (1) ability to pay (progressive income
tax), and (2) derived benefit (e.g., gasoline taxes used to pay for roads). The major types of taxes are:
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 INCOME TAX - levied on taxable income.
 PROPERTY TAX - levied based on wealth (i.e., based on the value of property).
 SALES TAX - levied based on the amount of income spent. Sales taxes are viewed as regressive because
low-income individuals pay the same percentage rate as high-income individuals.
 VALUE-ADDED TAX (VAT) - levied on the increase in value in each product as it proceeds through
production and distribution process. Ultimately, the tax is paid by the final consumer. The VAT is thought
to encourage savings because it taxes consumption instead of earnings.

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  If a government collects more in taxes than it spends, it has a BUDGET SURPLUS; if a government spends
more than it collects in taxes, it has a BUDGET DEFICIT.
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 Changing interest rates and the money supply in the economy is called MONETARY POLICY; these actions are
usually under the control of the Central Bank like the BANGKO SENTRAL NG PILIPINAS (BSP):
 When economy is in recession, BSP might lower interest (discount) rates, buy back government securities
in open-market operations or decrease reserve requirements to inject money in the economy.
 To prevent inflation from increasing, BSP might increase interest (discount) rates, sell government
securities or increase reserve requirements to diminish the money supply in the economy.
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 MONEY serves multiple functions in the economy, including:
1) MEDIUM OF EXCHANGE (without money, barter is necessary)
2) UNIT OF ACCOUNT (prices are measured in money)
3) STORE OF VALUE (money can be stored and exchanged at a later date – example: bank deposit)

 Money is conventionally viewed as paper currency and coins. In economics, money (M) is classified as:
 M1 – the most liquid (e.g., currency, demand deposits, current accounts and traveler’s checks)
 M2 – M1 money plus savings account, certificates of deposits, money market mutual funds, money market
deposit accounts, small-denomination time deposits.
 M3 – M2 money plus other less liquid form of money (e.g., large denomination time deposits)
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 ECONOMIC THEORIES on the role of fiscal and monetary policies in an economy:
 CLASSICAL ECONOMIC THEORY – this theory holds that market equilibrium will eventually result in full
employment over the long run without government intervention. This theory does not support the use of
fiscal policy to stimulate the economy.
 KEYNESIAN THEORY – this theory holds that the economy does not necessarily move towards full
employment on its own. It focuses on the use of fiscal policy (e.g., reduction in taxes and government
spending) to stimulate the economy.
 MONETARIST THEORY – this theory holds that fiscal policy is too crude a tool for control of the economy.
It focuses on the use of monetary policy to control economic growth.
 SUPPLY-SIDE THEORY – this theory holds that bolstering an economy’s ability to supply more goods is
the most effective way to stimulate growth. A decrease in taxes (especially for businesses and individuals
with high income) increases employment, savings, and investments.
 NEO KEYNESIAN THEORY – this theory combines Keynesian and monetary theories. It focuses on using
a combination of fiscal and monetary policy to stimulate the economy and control inflation.

INTERNATIONAL TRADE & FOREIGN CURRENCY

 Common reasons for international trades:
 EXPANSION – To develop new markets for the sale of goods and service abroad
 OUTSOURCING – To obtain commodities not otherwise available domestically
 COST-CUTTING – to obtain goods and services at lower costs than available domestically
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 COMPARATIVE ADVANTAGE exists when one country has the ability to produce a good or service at a lower
opportunity cost than the opportunity cost of the good or service of another country.
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 OPPORTUNITY COST is the money value of benefits lost form the next best opportunity as a result of choosing
another opportunity.
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 The value of exports minus the value of imports is called the BALANCE OF TRADE:
 TRADE SURPLUS – when a nation exports more than it imports.
 TRADE DEFICIT – when a nation imports more than it exports.
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 Government restricts international trade to protect domestic industries from foreign competition by imposing
TARIFF (a tax on an imported product) and QUOTA (a restriction on the amount of a good that may be
imported during a period).
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 FOREIGN EXCHANGE MARKET is the market in which the currency of one country is exchanged for the
currency of another. It is made up of importers, exporters, banks, foreign currency dealers/brokers.
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 EXCHANGE RATE is the price of one currency unit expressed in units of another country’s currency.
 DIRECT exchange rate – the domestic price of one unit of foreign currency ($ 1 = P 50)
 INDIRECT exchange rate – the foreign price of one unit of domestic currency (P 1 = $ 0.02)
 SPOT exchange rate – exchange rate between currencies for immediate delivery (“on the spot”).
 FORWARD exchange rate – exchange rate between currencies for future exchange or delivery.
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 APPRECIATION (DEPRECIATION) happens when a currency becomes stronger (weaker) since it takes less
(more) of that currency to buy another currency.
Effects of Currency Appreciation Effects of Currency Depreciation
Cheaper foreign goods Cheaper domestic goods
Downward pressure on inflation More domestic employments due to higher exports
Competition problems for domestic producers Higher cost of imported materials and other inputs

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