Market Influences on Business

Question 1

What is the fundamental law of demand?

Answer 1

states that the price of a product or service and the quantity demanded of that product or service are inversely related (as price increases, demand decreases)

Question 2

What are the 2 reasons that quantity demanded is inversely related to price?

Answer 2

• Substitution effect- consumers tend to purchase more of a good when price falls in relation to the price of other goods (ex: when the price of Pepsi decreases, demand for Coca-Cola decreases)
• Income effect- as prices are lowered with income remaining constant, people will purchase more or all of the lower-priced products (a decrease in the price of a good increases a consumer’s real income when nominal income remains constant resulting in the consumer purchasing more of all goods)

Question 3

Define changes in wealth (a factor that shifts demand curves)

Answer 3

A positive or negative change in wealth for people will result in a shift in the demand curve (if people become wealthier it may increase (shift) their demand for luxury items)

Question 4

Define changes in the price of related goods (substitutes and complements)

Answer 4

• if the price of a similar good (a substitute good) increases, the demand curve will shift to the right (increase) for the original good, now perceived as a bargain
• if the price of a good used in conjunction with the original good (complementary good) decreases, the demand for the original good increases (ex: if car prices fall, demand increases for gas)

Question 5

How will changes in consumer income affect the demand curve?

Answer 5

an increase in income will shift the demand curve to the right (increase)

Question 6

What is an example of changes in consumer tastes or preferences for a product

Answer 6

if the clothing industry experiences a revival of the 1960s era, the demand for bell-bottom jeans will increase

Question 7

Define changes in consumer expectations

Answer 7

if consumers anticipate that there will be a future price increase, immediate demand will increase for that product (ex: if commuters expect that the price of a monthly or annual bus pass will increase in the near term, there should be a spike in demand for bus passes)

Question 8

Define the changes in the number of buyers served by the market

Answer 8

an increase in the number of buyers will shift the demand curve to the right (increase) (ex: as the number of senior citizens grows, there will be more buyers of prescription drugs, increasing demand)

Question 9

Define changes in price expectations of the supplying firm (a factor that shifts supply curves)

Answer 9

if prices are expected to decrease, the firm will supply more now at each price level to take advantage of the currently higher prices

Question 10

Define changes in production costs (price of inputs) (a factor the shifts supply curves)

Answer 10

when production costs are expected to decline there will be shift in the supply curve to the right (and vice versa)

Question 11

Define changes in price or demand for other goods (a factor that shifts supply curves)

Answer 11

a decrease in the demand for another good supplied by a firm would cause the firm to shift its resources and increase the supply of its remaining goods (and vice versa) (ex: if there is an industry-wide increase in the price of butter that lowers demand, the firm will start making more margarine)

Question 12

Define changes in subsidies or taxes (a factor the shifts supply curves)

Answer 12

a decrease in taxes or an increase in subsidies would increase the amount supplied at each price level (ex: if a cigarette making company believes that a tax increase will negatively affect the demand for cigarettes, it will decrease the supply of cigarettes, shifting the curve to the left)

Question 13

Define changes in production technology (a factor the shifts supply curves)

Answer 13

an improvement in technology would cause a shift to the right of the supply curve

Question 14

Explain the effect of inflation on prices

Answer 14

• as the price level rises, the value of money (purchasing power) declines
• entities holding monetary assets will be hurt by inflation and the loss of purchasing power
• entities holding monetary liabilities will benefit from increasing price levels because they will be repaying debt with inflated currency

Question 15

Explain the effect of inflation on investments

Answer 15

• inflation erodes the purchasing power of fixed-coupon payments and the final principal payment, reducing the present value of the investment

Question 16

Explain the effect of inflation on debt

Answer 16

• future interest rate deductions may make floating payments based on variable interest rates more attractive
• principal payments will be lower in real terms (after adjusting for the effect of inflation) when price levels are rising

Question 17

What are the 2 major forms of competitive advantage?

Answer 17

Product differentiation and cost leadership

Question 18

How can the differentiation advantage best be obtained by a firm?

Answer 18

when the firms builds market share or increases its price

Question 19

How can the cost leadership advantage best be obtained by a firm?

Answer 19

when the firm builds market share or matches the price of its rivals

Question 20

What is an inferior good?

Answer 20

when demand declines for the good as income increases (ex: hamburger, cotton swabs, light bulbs)

• most likely to use cost leadership strategies

Question 21

What are examples of superior goods?

Answer 21

luxuries such as fine china, jewelry and cruise packages

• most likely to use differentiation strategies