APPLICATION OF

PREPARED BY:
DR. KATHRYN ERRASQUIN
 THE BASIC DECISION-MAKING UNITS
 A FIRM IS AN ORGANIZATION THAT TRANSFORMS
RESOURCES (INPUTS) INTO PRODUCTS (OUTPUTS).
FIRMS ARE THE PRIMARY PRODUCING UNITS IN A
MARKET ECONOMY.

 AN ENTREPRENEUR IS A PERSON WHO ORGANIZES,

MANAGES, AND ASSUMES THE RISKS OF A FIRM,
TAKING A NEW IDEA OR A NEW PRODUCT AND
TURNING IT INTO A SUCCESSFUL BUSINESS.

 HOUSEHOLDS ARE THE CONSUMING UNITS IN AN

ECONOMY.
THE CIRCULAR FLOW OF ECONOMIC ACTIVITY

 THE CIRCULAR FLOW

OF ECONOMIC
ACTIVITY SHOWS THE
CONNECTIONS
BETWEEN FIRMS AND
HOUSEHOLDS IN
INPUT AND OUTPUT
MARKETS.
 INPUT MARKETS AND OUTPUT MARKETS

 OUTPUT, OR PRODUCT,
MARKETS ARE THE
MARKETS IN WHICH GOODS
AND SERVICES ARE
EXCHANGED.
 INPUT MARKETS ARE THE
MARKETS IN WHICH
RESOURCES—LABOR,
• Payments flow in the CAPITAL, AND LAND—USED
opposite direction as the
TO PRODUCE PRODUCTS,
physical flow of resources,
goods, and services ARE EXCHANGED.
(counterclockwise).
 INPUT MARKETS
INPUT MARKETS INCLUDE:
 THE LABOR MARKET, IN WHICH HOUSEHOLDS
SUPPLY WORK FOR WAGES TO FIRMS THAT
DEMAND LABOR.
 THE CAPITAL MARKET, IN WHICH HOUSEHOLDS
SUPPLY THEIR SAVINGS, FOR INTEREST OR FOR
CLAIMS TO FUTURE PROFITS, TO FIRMS THAT
DEMAND FUNDS TO BUY CAPITAL GOODS.
 THE LAND MARKET, IN WHICH HOUSEHOLDS
 DETERMINANTS OF HOUSEHOLD DEMAND
A household’s decision about the quantity
of a particular output to demand depends
on:
• THE PRICE OF THE PRODUCT IN QUESTION.
• THE INCOME AVAILABLE TO THE HOUSEHOLD.
• THE HOUSEHOLD’S AMOUNT OF ACCUMULATED
WEALTH.
• THE PRICES OF RELATED PRODUCTS AVAILABLE TO THE
HOUSEHOLD.
• THE HOUSEHOLD’S TASTES AND PREFERENCES.
• THE HOUSEHOLD’S EXPECTATIONS ABOUT FUTURE
INCOME, WEALTH, AND PRICES.
 QUANTITY DEMANDED

 QUANTITY DEMANDED IS THE

AMOUNT (NUMBER OF UNITS) OF A
PRODUCT THAT A HOUSEHOLD WOULD
BUY IN A GIVEN TIME PERIOD IF IT
COULD BUY ALL IT WANTED AT THE
CURRENT MARKET PRICE.
 DEMAND IN OUTPUT MARKETS
ANNA'S DEMAND  A DEMAND SCHEDULE IS
SCHEDULE FOR A TABLE SHOWING HOW
TELEPHONE CALLS
MUCH OF A GIVEN
QUANTITY PRODUCT A HOUSEHOLD
PRICE DEMANDED
(PER (CALLS PER
WOULD BE WILLING TO
CALL) MONTH) BUY AT DIFFERENT
$ 0 30 PRICES.
0.50 25  DEMAND CURVES ARE
3.50 7
7.00 3
USUALLY DERIVED FROM
10.00 1 DEMAND SCHEDULES.
15.00 0
 ANNA'S DEMAND
SCHEDULE FOR

RV E TELEPHONE CALLS  THE DEMAND

D CU
A N QUANTITY
CURVE IS A
DE M PRICE DEMANDED
THE (PER (CALLS PER GRAPH
CALL) MONTH)
$ 0 30 ILLUSTRATING
0.50
3.50
25
7
HOW MUCH OF
7.00 3 A GIVEN
10.00
15.00
1
0
PRODUCT A
HOUSEHOLD
WOULD BE
WILLING TO
BUY AT
DIFFERENT
PRICES.
THE LAW OF DEMAND
 THE LAW OF
DEMAND STATES
THAT THERE IS A
NEGATIVE, OR
INVERSE,
RELATIONSHIP
BETWEEN PRICE AND
THE QUANTITY OF A
GOOD DEMANDED
This ITS
• AND means that
PRICE.
demand curves slope
downward.
 INCOME AND WEALTH
 INCOME IS THE SUM OF ALL HOUSEHOLDS
WAGES, SALARIES, PROFITS, INTEREST
PAYMENTS, RENTS, AND OTHER FORMS OF
EARNINGS IN A GIVEN PERIOD OF TIME. IT IS A
FLOW MEASURE.
 WEALTH, OR NET WORTH, IS THE TOTAL VALUE
OF WHAT A HOUSEHOLD OWNS MINUS WHAT IT
OWES. IT IS A STOCK MEASURE.
 RELATED GOODS AND SERVICES
 NORMAL GOODS ARE GOODS
FOR WHICH DEMAND GOES UP
WHEN INCOME IS HIGHER AND
FOR WHICH DEMAND GOES
DOWN WHEN INCOME IS
LOWER.
 INFERIOR GOODS ARE GOODS
FOR WHICH DEMAND FALLS
WHEN INCOME RISES.
RELATED GOODS AND SERVICES
 SUBSTITUTES ARE GOODS THAT
CAN SERVE AS REPLACEMENTS
FOR ONE ANOTHER; WHEN THE
PRICE OF ONE INCREASES,
DEMAND FOR THE OTHER GOES UP.
PERFECT SUBSTITUTES ARE
IDENTICAL PRODUCTS.
 COMPLEMENTS ARE GOODS THAT
“GO TOGETHER”; A DECREASE IN
THE PRICE OF ONE RESULTS IN AN
INCREASE IN DEMAND FOR THE
 SUPPLY IN OUTPUT MARKETS

CLARENCE BROWN'S • A supply schedule is a

SUPPLY SCHEDULE table showing how much of
FOR SOYBEANS
a product firms will supply at
QUANTITY
SUPPLIED
different prices.
PRICE (THOUSANDS
(PER OF BUSHELS • Quantity supplied represents
BUSHEL) PER YEAR)
$ 2 0
the number of units of a product
1.75 10 that a firm would be willing and
2.25 20 able to offer for sale at a
3.00 30 particular price during a given
4.00 45
5.00 45
time period.
 THE SUPPLY CURVE AND
THE SUPPLY SCHEDULE
• A supply curve is a graph illustrating how much of a
product a firm will supply at different prices.

CLARENCE BROWN'S 6

Price of soybeans per bushel ($)

SUPPLY SCHEDULE 5
FOR SOYBEANS
4
QUANTITY
SUPPLIED 3
PRICE (THOUSANDS 2
(PER OF BUSHELS
BUSHEL) PER YEAR) 1
$ 2 0 0
1.75 10
2.25 20 0 10 20 30 40 50
3.00 30 Thousands of bushels of soybeans
produced per year
4.00 45
5.00 45
 THE LAW OF SUPPLY
 THE LAW OF SUPPLY
6
Price of soybeans per bushel ($)
STATES THAT THERE IS A
5
4 POSITIVE RELATIONSHIP
3 BETWEEN PRICE AND
2
1
QUANTITY OF A GOOD
0 SUPPLIED.
0 10 20 30 40 50  THIS MEANS THAT SUPPLY
Thousands of bushels of soybeans
produced per year
CURVES TYPICALLY HAVE
A POSITIVE SLOPE.
 DETERMINANTS OF SUPPLY
• THE PRICE OF THE GOOD OR SERVICE.
• THE COST OF PRODUCING THE GOOD, WHICH IN
TURN DEPENDS ON:
• THE PRICE OF REQUIRED INPUTS
(LABOR, CAPITAL, AND LAND),
• THE TECHNOLOGIES THAT CAN BE
USED TO PRODUCE THE PRODUCT,
• THE PRICES OF RELATED PRODUCTS.
MARKET EQUILIBRIUM

 THE OPERATION OF THE

MARKET DEPENDS ON THE
INTERACTION BETWEEN
BUYERS AND SELLERS.
 AN EQUILIBRIUM IS THE
CONDITION THAT EXISTS WHEN
QUANTITY SUPPLIED AND
QUANTITY DEMANDED ARE
EQUAL.
 AT EQUILIBRIUM, THERE IS NO
TENDENCY FOR THE MARKET
PRICE TO CHANGE.
 COFFEE - THE SUPPLY CHAIN
A NESTLÉ CASE STUDY

Price - Balancing Supply And Demand

Coffee prices are determined day-to-day on the world commodity markets in

London and New York and with so many intermediaries standing between
the producer and the consumer, how can we ensure that coffee growers
receive a fair reward for their labours? Is the answer - as some believe - for
coffee manufacturers to cut out the intermediaries, buy their coffee direct
from farmers and guarantee a minimum price? The price of coffee is
determined by the relationship between the amount of coffee available to be
sold (supply) and the amount which people want to buy (demand). If there is
more coffee available than people want to buy at current prices, the price
will fall. The market thus ultimately determines the price that the farmer
receives.
 COFFEE - THE SUPPLY
CHAIN
A NESTLÉ CASE STUDY
There are circumstances in which farmers can receive more
than the market price, for example:

•if the quality of their coffee is high

•if they undertake some or all of the processing stages which

someone else would otherwise be paid to do

•if they can sell direct to a manufacturer rather than to

intermediaries.
 COFFEE - THE SUPPLY
CHAIN
A NESTLÉ CASE STUDY
Farmers can also reduce their costs if
they are able to share processing
and transportation facilities with other
farmers. Coffee farmers may sell their coffee in a number of
ways:

•they can sell to the next link in the traditional supply chain -
the collector or processor
•they may sell to government agencies in countries where
the coffee trade is government controlled, although this is
becoming less common
•or, they might sell direct to a manufacturer like nestlé.
 COFFEE - THE SUPPLY CHAIN
A NESTLÉ CASE STUDY
However, farmers usually cannot choose the
method by which they sell their coffee. Selling
directly to manufacturers is attractive as
farmers potentially receive above the market
price.
However, it would be impossible for all the
world's coffee to be bought directly by
manufacturers from individual farmers a few
bags at a time. Although direct purchasing is
attractive, it is only one of a number of
methods of trading, all of which have their
merits and none of which is necessarily fairer
than the others.
Ultimately it is the market price which
determines how much farmers receive.