Question

The activities of consumers and firms:

	A.	have both costs and benefits.
	B.	have costs but not benefits.
	C.	are too complex to be analyzed with economic theory.
	D.	have benefits but not costs.

Answer 1

In order to understand the activities of consumers and firms, we need to understabd the term (Consumers and Firms): -

*CONSUMERS:

Consumers, by definition, include us all," President John F. Kennedy offered his definition to the United States Congress on March 15, 1962. This speech became the basis for the creation of World Consumer Rights Day, now celebrated on March 15. In his speech, JFK outlined the integral responsibility to consumers from their respective governments to help exercise consumers' rights, including:

• The right to safety: To be protected against the marketing of goods which are hazardous to health or life.

• The right to be informed: To be protected against fraudulent, deceitful, or grossly misleading information, advertising, labeling, or other practices, and to be given the facts he needs to make an informed choice.

• The right to choose: To be assured, wherever possible, access to a variety of products and services at competitive prices; and in those industries in which competition is not workable and Government regulation is substituted, an assurance of satisfactory quality and service at fair prices.

• The right to be heard: To be assured that consumer interests will receive full and sympathetic consideration in the formulation of Government policy, and fair and expeditious treatment in its administrative tribunals.

*FIRMS:

A firm is a commercial enterprise, a company that buys and sells products and/or services to consumers with the aim of making a profit. In the world of commerce, the term is usually synonymous with ‘company’, or ‘business’ as in “She runs a forex trading business.”

A business entity such as a corporation, limited liability company, public limited company, sole proprietorship, or partnership that has products or services for sale is a firm.

Law, accountancy and management consultancy partnerships are known as firms, and are rarely referred to as companies.

Situation-1 When both have costs and benefits: -

Price Discrimination involves charging a different price to different groups of consumers for the same good. Price discrimination can provide benefits to consumers, such as potentially lower prices, rewards for choosing less popular services and helps the firm stay profitable and in business. The advantages of price discrimination will be appreciated more by some groups of consumers.

Benefits of Price Discrimination

In the above diagram, there is no single price which enables the firm to make normal profit and stay in business. They would need price discrimination to increase profits.

1. Allows an unprofitable business to avoid going bankrupt. In some cases, it may be possible that there is no one price that would enable a firm to make normal profits. (i.e. average costs would always be higher than demand curve) However, price discrimination may enable the firm to turn a loss into a small profit. This means that a business activity can keep going, rather than closing down. This is obviously beneficial for consumers because it increases their choice of goods and services. An example might be train services. Without price discrimination (off-peak, peak) train companies would make a bigger loss and may be discontinued.
2. Some groups benefit from cheaper prices. Price discrimination means that firms have an incentive to cut prices for groups of consumers who are sensitive to prices (elastic demand). For example, firms often offer a 10% reduction to students. Students typically have lower income so their demand is more elastic. This means they benefit from lower prices. These groups are often poorer than the average consumer. The downside is that some consumers will face higher prices.
3. Avoid Congestion. Price discrimination is one way to manage demand. If there were no price discrimination rush hour trains would be more overcrowded. Price discrimination gives an incentive for some people to go later in the day. This means that those who have to travel at rush hour benefit from less congestion.
4. Low-income consumers may be able to benefit from cheaper prices. One form of indirect price discrimination is to offer lower prices to consumers who collect coupons. This imposes a cost on consumers (time to collect). So if consumers are time-rich and money poor, they can take advantage of lower prices.
5. Investment. Price discrimination helps a firm to become more profitable. This may enable the firm to invest in increased capacity. For example, an airline which maximises profits from price discrimination can invest in updating its aircraft to the latest technology.

Situation 2 Having costs but no benefits:

Monopolies are firms who dominate the market. Either a pure monopoly with 100% market share or a firm with monopoly power (more than 25%) A monopoly tends to set higher prices than a competitive market leading to lower consumer surplus. However, on the other hand, monopolies can benefit from economies of scale leading to lower average costs, which can, in theory, be passed on to consumers.

*MONOPOLIES DIAGRAM:

Situation 3 are too complex to be analyzed with the economic theory:

Microeconomics focuses on the role consumers and businesses play in the economy, with specific attention paid to how these two groups make decisions. These decisions include when a consumer purchases a good and for how much, or how a business determines the price it will charge for its product. Microeconomics examines smaller units of the overall economy; it is different than macroeconomics, which focuses primarily on the effects of interest rates, employment, output and exchange rates on governments and economies as a whole. Both microeconomics and macroeconomics examine the effects of actions in terms of supply and demand.

Microeconomics breaks down into the following tenets:

• Individuals make decisions based on the concept of utility. In other words, the decision made by the individual is supposed to increase that individual's happiness or satisfaction. This concept is called rational behavior or rational decision-making.
• Businesses make decisions based on the competition they face in the market. The more competition a business faces, the less leeway it has in terms of pricing.
• Both individuals and consumers take the opportunity cost of their actions into account when making their decisions.

Total and Marginal Utility

At the core of how a consumer makes a decision is the concept of individual benefit, also known as utility. The more benefit a consumer feels a product provides, the more that consumer is willing to pay for the product. Consumers often assign different levels of utility to different goods, creating different levels of demand. Consumers have the choice of purchasing any number of goods, so utility analysis often looks at marginal utility, which shows the satisfaction that one additional unit of a good brings. Total utility is the total satisfaction the consumption of a product brings to the consumer.

Utility can be difficult to measure and is even more difficult to aggregate in order to explain how all consumers will behave. After all, each consumer feels differently about a particular product. Take the following example:

Think of how much you like eating a particular food, such as pizza. While you might be really satisfied after one slice, that seventh slice of pizza makes your stomach hurt. In the case of you and pizza, you might say that the benefit (utility) that you receive from eating that seventh slice of pizza is not nearly as great as that of the first slice. Imagine that the value of eating that first slice of pizza is set to 14 (an arbitrary number chosen for the sake of illustration).

The below figure, shows that each additional slice of pizza you eat increases your total utility because you feel less hungry as you eat more. At the same time, because the hunger you feel decreases with each additional slice you consume, the marginal utility—the utility of each additional slice—also decreases.

Notice the difference that total utility and marginal utility create.

The decreasing satisfaction the consumer feels from additional units is referred to as the law of diminishing marginal utility. While the law of diminishing marginal utility isn't really a law in the strictest sense (there are exceptions), it does help illustrate how resources spent by a consumer, such as the extra dollar needed to buy that seventh piece of pizza, could have been better used elsewhere.

Situation 4 Have benefits but no costs:

Marginal Benefit vs. Marginal Cost: An Overview

Marginal benefit and marginal cost are two measures of how the cost or value of a product changes. While the former is a measurement from the consumer side of the equation, the latter is a measurement from the producer side. Companies need to take both concepts into consideration when manufacturing, pricing, and marketing a product.

A marginal benefit is the maximum amount of money a consumer is willing to pay for an additional good or service. The consumer's satisfaction tends to decrease as consumption increases. The marginal cost, which is directly felt by the producer, is the change in cost when an additional unit of a good or service is produced.

KEY TAKEAWAYS

• Marginal benefits are the maximum amount a consumer will pay for an additional good or service.
• The marginal benefit generally decreases as consumption increases.
• The marginal cost of production is the change in cost that comes from making more of something.
• The purpose of analyzing marginal cost is to determine at what point an organization can achieve economies of scale.

Marginal Benefit

A marginal benefit is a small, but measurable, change in a consumer's advantage if they use an additional unit of a good or service.

A marginal benefit usually declines as a consumer decides to consume more of a single good. For example, imagine that a consumer decides she needs a new piece of jewelry for her right hand, and she heads to the mall to purchase a ring. She spends $100 for the perfect ring, and then she spots another. Since she does not need two rings, she would be unwilling to spend another $100 on a second one. She might, however, be convinced to purchase that second ring at $50. Therefore, her marginal benefit reduces from $100 to $50 from the first to the second good.

Another way to think of marginal benefit is to consider the satisfaction that a consumer gets from each subsequent addition. One ring would make the consumer very happy, while a second ring would still make her happy, just not as much. The lessening of appeal for additional consumption is known as diminishing marginal utility.

Marginal benefit is often expressed as the dollar amount the consumer is willing to pay for each purchase. It is the motivation behind such deals offered by stores that include "buy one, get one half off" promotions.

Marginal Cost

On the opposite side of the equation lies the producer of the good or service. Producers consider marginal cost, which is the small but measurable change in the expense to the business if it produces one additional unit.

If a company captures economies of scale, the cost to produce a product declines as the company produces more of it. For example, imagine a company makes shoes. Each shoe requires $5 worth of leather, rubber, thread, and other materials to create. The shoes also require a factory, which, for simplicity's sake, let us say is a one-time $1,000 expense. If the company makes 100 shoes, each shoe costs $15 to make: $1,000 ÷ 100 + $5.

The workers learn how to move from one task to the next quickly, and the factory can produce more shoes per hour. As more footwear is made in the same specified period, the cost of the factory is further distributed over more shoes, and the cost per unit falls. The cost of materials may go down as well, as more shoes are made and the materials are purchased in bulk, therefore, decreasing the marginal cost.

The cost-benefit from this approach has a ceiling. Buying materials in bulk can only push the price down so far, and production in a factory can only go up so far before machines and workers are exhausted. This means a new factory must be built or new workers hired. Building a new factory is only profitable if the consumer demand continues to rise for the new product.