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Chapter 2

Theoretical Foundations: Prices, Markets, and Management

UNDERLYING FORCES Demographics, Beliefs, Values, Cultures, International Events, Discoveries, Resources, Natural Events

Societal Element Changes Energy and the Physical Environment Labor & Human Resources Technology Economic Climate Regional & Local Issues International Trade Market System

Public Sector Response Regulation Taxation Spending Provision of Services

Political System

Social InvolvementBusiness Social Responsibility

Political System

Marketplace Response Prices Quantities Produced Product Quality Costs of Production

Business Response Managerial Decision-Making Strategy Implementation Market System

Types of Economic Systems

Laissez Faire Capitalism

Modern Mixed Economy Democratic Socialism Communism

Laissez Faire Capitalism

Ownership of Resources
Markets Government Involvement

Modern Mixed Economy

Ownership of Resources
Markets Government Involvement

Democratic Socialism

Ownership of Resources
Markets Government Involvement


Ownership of Resources
Markets Government Involvement

The Concept of Demand

Demand is a Schedule of the different quantities of a good or service that a consumer is Willing and Able to purchase at each and every possible price

Determinants of Demand

What are some determinants of the demand for a good or service?

Determinants of Demand

Normal Goods and Services Inferior Goods and Services

Price Price of Substitute Goods and Services Price of Complementary Goods and Services Attitudes and Tastes

An Individuals Demand for Beer Price/

Price per Glass

Glasses 8 6 4 2 1

glass $ 0.40 $ 0.80 $ 1.20 $ 1.60 $ 2.00

$2.50 $2.00 $1.50 $1.00 $0.50 $0 2 4 6 8 10

Glasses Demanded

The Law of Demand

The lower the price, the more of a good or service that will be purchased, the higher the price, the less that will be bought

Market Demand Curve

Summation of all individual demand curves in the market Law of Demand Downward Sloping Determinants of Demand


Supply is a schedule of the different quantities of a good or service that a seller is ready and willing to sell at each and every possible price

Hypothetical Firm Supply Curve

Price of Product

Quantity Supplied

Factors Affecting Supply

What factors affect the supply of a good or service?

Factors Affecting Supply

Resource Prices Labor Costs Taxes Subsidies Technology

Market Supply vs. Firm

P firm 1

S firm 1

Q firm 1

S market Q

Where do we get S curve?

Summation of supply curves for

P firm 2 S firm 2 Q firm 2

each firm in market or industry

Marginal Cost

The additional or extra cost incurred in producing one more unit of a good or service MC = TC/ Q

Hypothetical Firms Marginal Cost Curve

$1.80 $1.60 $1.40 $1.20 $1.00 $0.80 $0.60 $0.40 $0.20 $0.00 480 500

Price, Cost





Quantity Produced

S Curve for Firm is MC Curve

P1 D



Price and Quantity Determination in a Competitive Marketplace





Role of Prices In a Free Enterprise System (I)

Transmits Information ...

To producers, consumers, resource suppliers,

labor Signals to produce more or less, to enter new markets, produce new products, etc.

Shift in Demand for Shoes

D1 P D0 S

P1 P0

What happened here?





Shift in Supply of Shoes

S D P S P1
What happened here?


D S Q1


Effect of Price Controls


International Market Price Controlled Maximum Price S QS Quantity of Oil QD D

Role of Prices (II)

Provides Incentives ... to consumers, producers, labor and owners of productive resources Allocate Resources ... alternative ways to provide goods and services Affect Distribution of Income

Two Goals of Society

Increase Incomes and Living Standards

Fairness and Equity in Income Distribution Two Goals in Conflict

Conflict Between Goals

Income Distribution Over Time

Poor Vs. Rich or Impact on Income over Lifetime

Food Distribution in Chicago

How does it happen?

The Invisible Hand of the Marketplace

Adam Smith, 1776 ...Wealth of Nations Individuals pursue their own self interest ... greater good of society is served Individuals moved by an Invisible Hand to promote social welfare Example: Food distribution

Environmental Analysis and Forecasting

Environmental Scanning
Analyzing and Forecasting Environmental Change

Describing the Current Environment

Projecting Future Changes

Step I - Define Areas

Define Areas to Study

Primary Involvement - Exchange relationships or marketplace relationships

Secondary Involvement -Relationships, activities and impacts that are ancillary or consequential to primary involvement

Step II - Delineate Topics

External Topics Internal Topics

Step III - Determine Time Frame and Forecasting Requirements

Short Range Long Range

Delphi Technique
Scenario Method

Step IV - Design and Implement Strategy

External/Short-term External/Long-term Internal/Short-term Internal/Long-term

Step V - Analyze Data

Cross Impact Analysis

T1 T2 T3

Television technologies (probability, year) T1 interactive (.9,2010) T2 digital (.7, 2010) T3 HDTV (.8, 2010) -10% in 2 years Enhanced 50% in 3 years Enhanced 50% in 3 years -60% in 2 years

-10% in 2 years

Enhanced 25% in 2 years

Step VI - Integrate into the Organization

Short-term Long-term
Organizational Change
Inform Top Management

Poland Case

Problems of a Socialistic System Everybody has money Too much money chasing too few goods Money becomes worthless Resort to barter Long lines for food

Poland Case

Why did they have long lines?

How does food distribution under Communism compare to the system in the USA?

Poland Case

How well can government controls replace the free enterprise system?
What is happening in Poland today?