Chapter 5

Micro economic
factors
Tran Thi Hai Van, MSc, FCCA, CIA
1. The micro-environment
 The micro environment refers to the immediate
operational environment including suppliers, competitors,
customers, stakeholders and intermediaries.
2. Internal Micro environment
 Internal Micro environment: Input, process, Output,
final consumption.
+ Input: 5M: Materials, Money, Men, Machines,
Management
 Customer value proposition (offer): Total benefit received
in return for total payment.
 Value proposition=What the customer gets for what he
pays.
 Customer evaluate value proposition on two dimension:
+ Relative performance: what customer gets from
competitor offering?
+ Price: Payment the customers made to acquire the
product
3. The concept of a Market:
 In a free market, the Price mechanism signals demand & supply
conditions to producers (supplier) and consumer. => Allocate
resources
 Market involves the buyers & sellers of goods. => Situation when
potential buyers and sellers come together for the purpose of
exchange.
 A good or service has a price if it is useful as well as scare.
Usefulness shown by the fact that consumers demand it.
 Utility: is the word used to describe the pleasure or satisfactions or
benefit from consumption of good.
 Total utility: is the total satisfaction from consumption of good.
 Marginal utility: is the satisfaction gain from consuming one
additional unit of good.
 The consumer attempts to maximise the total utility attainable with a
limited income
4.The demand schedule
 Demand for a good or service is the quantity of that good or service
that potential purchasers would be willing and able to buy, or
attempt to buy, at any possible price.
 A demand curve generally slopes down from left to right because
as price falls, larger quantities are demand. As price rises, smaller
quantities are demand.
Factors determining demand for a good:

 + The price of the good

 + The size of household income
 + Price of substitute/ complement goods
 + Taste & fashions
 + Expectation of future price changes
 + Increase in population
Moving along a demand curve reflects a change in price
when other factors are unchanged.
=> The difference between change in demand and a shift in
demand curve is very important.
Movements along a demand curve are caused solely by
changes in its price.
Variations in the conditions of demand create shifts in the
demand curve.
Substitutes and compliments:
 Substitute goods are goods that are alternatives to each
other, so that an increase in the demand for one is likely
to cause a decrease in the demand for another.
Ex: Coca cola and Pepsi, tea & coffee, different kind of
entertainment
 Complements are goods that tend to be bought and use
together, so that an increase in the demand for one is
likely to cause an increase in the demand for the other.
Ex: Cups & Plate, Bread & butter, Moto cars &
components
Price elasticity of Demand (Price EOD)

 Price EOD (or PED) explains the relationship

between change in quantity demanded and
changes in price
 Price EOD = %ϪQ/ %ϪP
 Price EOD has negative value, however, it is
usual to ignore the minus sign
Example: arc elasticity of demand
1. The price of a good is $1.20 per unit and annual demand
is 800,000 units. Market research indicates that an
increase in price of 10 cents per unit will result in a fall in
annual demand of 70,000 units. What is the price
elasticity of demand measuring the responsiveness of
demand over this range of price increase?
2. If the price per unit of X rises from $1.40 to $1.60, it is
expected that monthly demand will fall from 220,000
units to 200,000 units. What is the arc price elasticity of
demand over these ranges of price and output?
Example: point elasticity of demand
1. The price of a good is $1.20 per unit and annual
demand is 800,000. Market research indicates
that an increase in price of 10 cents per unit will
resultin a fall in annual demand for the good of
70,000 units.
Required : Calculate the elasticity of demand at
the current price of $1.20.
2. If the price per unit of x rises from $1.40 to
$1.60, itis expected that monthly demand will fall
from 220,000 units to 200,000 units.
What is the point price elasticity of demand when
the price is $1.40?
Income elasticity of demand
 Income EOD measures the responsiveness of demand
to changes in household income.
 Income EOD=%ϪQ/ %ϪI
 Normally (for normal goods), demand rise when Income
raise => Income EOD is positive
 * IF Income EOD>1: demand for good is income elastic
 * If Income EOD<1: demand for good is income inelastic
 For inferior goods, demand falls as income rise. =>
Income EOD is negative.
Cross elasticity of demand
 Cross elasticity of demand is the
responsiveness of quantity demanded for one
good following a change in price of another
good.
 Cross EOD=%ϪQ a/ %ϪP b
 * If substitute goods, Cross EOD will be positive. If
Price of b rise, demand of a rise. Cross EOD >0
 *If complement goods, cross EOD will be negative. If
Price of b rise, demand of a fall. Cross EOD <0
 * If Cross EOD=0: unrelated products
Shifts of the demand curve
 When there is a change in the conditions of demand, the
quantity demanded will change even if price remains
constant. In this case, there will be a different
price/quantity demand schedule and so a different
demand curve. We refer to such a change as a shift of
the demand curve:
 A rise in household income(including a reduction in
direct taxes)
 A rise in the price of substitutes
 A fall in the price of complements
 A change in tastes towards this product
 An expected rise in the price of the product
 An increase in population.
Shifts of the demand curve
5. The supply schedule
 a. Supply: refer to the quantity of goods that
existing suppliers or potential supplier would
want to produce for the market at a given price.
 If supply > demand: excess supply/ over supply
=> Price fall

 b. Supply curve: is an upward sloping curve

from left to right. Greater quantities will be
supplied at higher price.
 Factors influencing the supply quantity
 The quantity supplied of good depends on prices and cost.
 + Cost of making the goods: raw materials cost & production cost
(wages, interest rate, land rent…). Cost increase -> Supply reduce
 + Prices of other good: substitute and complement good.
 Rise in price of substitute goods make the supply of other good less
attractive to supply
 Rise in price of complement goods make the supply of other good
(joint supply) also increase.
 + Expectation of price changes: if supplier expects the price of a good to
rise, current supply will be reduced
 + Changes in technology: Technology developments which reduce the
cost of production, increase productivity, will raise quantity of supply.
 + Other factors: changes in weathers, natural disaster…
 => Noted the distinction between movement along the supply curve and
shift in supply curve: a change in price will cause a change in aupply along
the supply curve. A change in other supply condition will cause a shift in
the supply curve itseft.
Short run supply curve
 In the short run, a firm will continue to produce if price is greater
than average variable cost, even if price is less than average total
cost. => Firm’s supply curve is its Marginal cost curve above the
variable cost curve.
 (Price= Marginal revenue MR= Marginal Cost MC)
 For each unit sold, marginal profit (Mπ) equals marginal revenue
(MR) minus marginal cost (MC). Then, if MR>MC at some level of
output, marginal profit is positive and thus a greater quantity should
be produced, and if MR<MC, marginal profit is negative and a lesser
quantity should be produced.
 At the output level at which MR=MC, marginal profit is zero and this
quantity is the one that maximizes profit. Since total profit increases
when marginal profit is positive and total profit decreases when
marginal profit is negative, it must reach a maximum where marginal
profit is zero - or where marginal cost equals marginal revenue - and
where lower or higher output levels give lower profit levels
 In the short run, both supply and demand are relatively
unresponsive to changes in price as compare to long run. In case of
supply, changes in the quantity of good supplied often require some
time to implement. Therefore, demands will often response more
rapidly than supply to changes in price.
Shifts of the market supply curve
 A shift of the market supply curve occurs when supply
conditions (other than the price of the good itself) change
6.The equilibrium price
 The competitive market process results in an
equilibrium price, which is the price at which
market supply and market demand quantity are
in balance.
 This is also known as Market clearing price,
since at this price there will be neither surplus
nor shortage in the market.
Consumer surplus and producer surplus
 Consumer surplus: is the situation where the market price is lower
than the price the consumer was prepared to buy.
 Producer surplus: is the situation where the market price is higher
than the price the producer was prepared to sell.
7. Demand and supply analysis
 In this section we look at a Case Example
involving the analysis of demand and supply
conditions.
 We will examine the likely effects on the price
and quantity sold of second hand cars in the
event of:
 (a) A large increase in petrol prices
 (b) A big increase in the price of new cars
 (c) A massive investment in public transport
Demand and supply analysis
8. Maximum and minimum prices
 The government can set a maximum price (price ceiling) or minimum
price (price floor)
 Maximum price:
 The government may try to prevent price rise by establishing a price
ceiling below the equilibrium price.
 If price ceiling is higher than the equilibrium price, setting a ceiling
price will have no effect at all.
 Because ceiling price is lower than equilibrium price, there will be
excess demand. Limited supply has to be allocated by means of
rationing or waiting list. Black marketers may seek to operate.
 Minimum price:
 Minimum price aims to ensure that suppliers earn at least the
minimum price (or floor price). Floor price must be higher than the
equilibrium price; otherwise there will be no effect at all. (Minimum
price guarantee)
 Because floor price is higher than equilibrium price, there will be
excess supply. A system of production quotas might be introduced.
9 Competition and restrictive practices
Types of competition:
 Perfect Competition
 Imperfect competition
 Monopoly
 Oligopoly
 Monopolistic competition
Types of competition
Types of competition
Types of competition