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focuses on the behavior and purchasing decisions of individuals and firms


Demand curve

downward shifting

inverse relationship between the price and quantity demanded


Demand curve shift

curve shifts when variables other than price change

example: if the price of a substitute product increases in price, the demand for the product

they don't want to buy the substitute product if price has gone up, they will buy yours

examples: change in price of other goods and services, consumer taste, spendable income, wealth, and the size of the market


Demand curve movement

when the demand moves along the demand line, only price changes


price of other goods and services (demand curve shift)

direct relationship- as goods that may be purchased instead go up in price the demand for your product goes down


price of compliment products (demand curve shift)

inverse relationship- as the price of compliment goods go up, the demand for your product goes down

example: price of hamburger increases, the demand for hamburger buns decrease


expectations of price increase (demand curve shift)

direct relationship- if the price of the good is expected to increase in the future, there will be an increase in demand


consumer income and wealth (demand curve shift)

generally a direct relationship- as wealth goes up, the demand for many (normal) products goes down

certain goods are inferior to this (bread, potatoes, milk) and the demand for these goods actually goes up. this is because consumers buy more inferior goods when they are short money


consumer tastes (demand curve shift)

intermediate relationship- the effect depends on whether the shift is towards or away from the product


size of the market (demand curve shift)

direct relationship- as the size of the market increases, the demand for the product will increase


group boycott (demand curve shift)

inverse relationship- if a group of consumers boycott a product, the demand will be increased


price elasticity of demand

measures the sensitivity of demand to a change in price

% change in quantity demanded/ percent change in price


price elasticity of demand- arc method

to make results the same regardless of whether there is an increase or decrease in price

(change in quantity demanded/ average quantity)/
(change in price/ average price)


income elasticity of demand

measures the change in the quantity demanded of a product given a change in income

% change in quantity demanded/ % change in income


cross-elasticity of demand

measures the change in demand for a good when the price of a related or competing product is changed

% change in the quantity demanded of Product X/ % change in the price of Product Y


Substitution effect

refers to the fact that as the price of a good falls, consumers will use it to replace similar goods


Income effect

refers to the fact that as the price of a good falls, consumers can purchase more with a given level of income


Law of diminishing marginal utility

the more goods an individual consumes, the more total utility (satisfaction) an individual receives

halloween candy (the first piece tastes great but as you keep going you start to turn green)


indifference curves

illustration (in a graph) the combination of two items that provide equal utility

page 137


budget constraint

the optimal level of consumption of two items that provide equal utility

the graph will show that the line intersects the highest possible utility curve


personal disposable income

amount of income consumers have after receiving transfer payments from the government (welfare payments) and paying their taxes

when personal disposable income goes up, consumers buy more. They buy less when it goes down


consumption function

the relationship between changes in personal disposable income and consumption

consumption for a period= the constant + (the slope of the consumption function x disposable income for the period)


marginal propensity to consume (MPC)

the constant in the consumption function measures the marginal propensity to consume

it describes how much of each additional dollar in personal disposable income that the consumer will spend


marginal propensity to save (MPS)

the percentage of additional income that is saved


it has to equal one


non-income factors that affect consumption

1. expectations about future prices of goods
2. quantity of consumer liquid assets
3. amount of consumer debt
4. stock of consumer durable goods
5. attitudes about saving money
6. interest rates



shows the amount of a product that would be supplied at various prices

graphically a supply curve shows a direct relationship between price and quantity sold

the higher the price, the more products that would be supplied

a change in market price of the product results in a movement along the existing supply curve


supply curve shift

occurs when supply variables other than price change

example: if the cost to procude the product increase, the supply curve would shift upward and to the left


variables that cause the supply curve to shift

changes in the number or size of producers, changes in various production costs (wages, rents, raw materials), technological advances, and government actions


change in the number of producers (supply shift)

direct relationship- generally an increase in the number of producers will cause an increase in the amount of goods supplied at a given price


change in production costs or technological advances (supply shift)

inverse relationship- as production costs go up fewer products will be supplied at a given price.

if costs go down, more products will be produced


government subsidies (supply shift)

direct relationship- in effect reduce the production cost of goods and, therefore, increase the goods supplied at a given price


government price controls (supply shift)

inverse relationship- price controls would tend to limit the amount of goods supplied by holding the price artificially low


price of other goods (supply shift)

inverse relationship- if other products can be produced with greater returns, producers will produce those goods instead


price expectations (supply shift)

direct relationship- if it is expected that prices will be higher for the good in the future, production of the good will increase


elasticity of supply

measures the percentage change in the quantity supplied of a product resulting from a change in the product price


elasticity of supply formula

% change in quantity supplied/ % change in price


market equilibrium

a products equilibrium price is determined by demand and supply

it is the price at which all the good offered for sale will be sold (quantity demanded=quantity supplied)

the equalibrium price is the price at which the demand and supply curve intersect


governing intervention

government actions that may change market equilibrium through taxes, subsidies, and rationing

example: subsidy paid to farmers will reduce the cost of producing a particular farm product and therefore cause the equilibrium price to be lower than it would be without the subsidy

import taxes on the other hand would increase the cost of an imported item and cause the equilibrium to be higher


price ceiling

a specified maximum price that may be charged for a good

if the price ceiling is set for a good below the price equilibrium it will cause shortages because suppliers will devote their production facilities to produce other goods


price floor

a price floor is a minimum specified price that may be charged for a good

if the floor is set for a good above the equilibrium price, it will cause overproduction and surpluses will develop (farmers will get more than what it actually cost them to make it and it is more than what they would normally sell it for)



another factor that cause inefficiencies in the pricing of goods in the market

the term is used to describe damage to common areas that is caused by the production of certain goods

example: pollution

because externalities are not included in the production cost, supply is higher and the price is lower than is appropriate

govt laws and regs attempt to force firms to change their production methods to make externalities part of the cost of production (this causes the market price to be a more accurate reflection of the cost to society)


average fixed cost (AFC)

fixed cost per unit of production

goes down as more units are produced


average variable cost

total variable costs divided by the number of units produced

initially stays constant until the inefficiencies of producing in a fixed-sized facility cause variable costs to begin to rise


marginal cost

the added cost of producing one extra unit

it initially decreases but then begins to increase due to inefficiencies


average total cost

total costs divided by the number of units produced

its behavior depends on the makeup of fixed and variable costs


law of diminishing returns

as we try to produce more and more output with a fixed productive capacity, marginal productivity will decline



looks at the economy as a whole

it focuses on measures of economic output, employment, inflation, and trade surpluses or deficits


three major sectors of the economy



nominal gross domestic product (GDP)

price of all goods and services produced by a domestic economy


real GDP

the price of all goods and services produced by the economy at price level adjusted (constant) prices

adjust for inflation


Potential GDP

maximum amount of production that could take place in an economy without putting pressure on the general level of prices

without inflation


GDP gap

the difference between potential GDP and real GDP


net domestic product (NDP)

GDP minus depreciation


gross national product (GNP)

the price of all goods and services produced by labor and property supplied by the nation's residence


business cycles

a fluctuation in aggregate economic output that lasts for several years

peaks and troughs


Okums Law

high output growth is generally associated with a decrease in the unemployment rate

makes perfect sense because when output increases less, then everyone is busy working to contribute to GDP



a period of negative GDP growth



a deep long lasting recession


cyclical business sector

perform better in periods of expansion and worse in periods of recession


defensive business sector

affected little by business cycles and some may actually perform better in periods of recession

if you sell an inferior good, people buy in recession


leading indicators

this is what is going to happen

average weekly hours
manugacturers new orders
stock prices
interest rate spread, 10 year treasury bonds


coincident indicators

this is whats happening right now

number of employees on payroll
personal income minus transfer payments
industrial production


lagging indicators

this is what has already happened

average duration of unemployment
inventories to sales ratio
average prime rate (rate you give to your best customers)
commercial and industrial loans
chronic unemployment



expenditures for residential construction, inventories and plant and equipment

the most important determinant of business investment is expectations about profitability


factors that affect investment spending

(most volatile portion of GDP)

the rate of technology growth
the real interest rate (nominal rate - the inflation premium)
the stock capital of goods
actions by the government
the acquisition and operating cost of capital goods (if there's not deflation- people don't buy today because they think the price will be cheaper tomorrow)


autonomous investment

includes expenditures made by businesses based on expected profitability that are independent of the level of national income

they are constant regardless of whether the economy is expanding or contracting


induced investment

is incremental spending based on an increased level of economic activity


accelerator theory

as economic activity increases, capital investments must be made to meet the level of increased demand

the increased capital investment in turn creates additional economic demand which further feeds the economic expansion



the unemployment rate is the percent of the total labor force that is unemployed at a given time

unemployed because of cyclical, frictional, or structural causes


frictional unemployment

occurs because individuals are forced or voluntarily change jobs

also new entrants into the work force fall into this category (recent graduates)


structural unemployment

occurs due to changes in demand for products or services, or technological advances causing not as many individuals with a particular skill to be needed

reduced by retraining programs


cyclical unemployment

caused by the condition in which real GDP is less than potential GDP

therefore, such unemployment increases during recessions and decreases during expansions



rate of increase in the price level of goods and services, usually measured on an annual basis

generally causes economic activity to contract and redistributes income and wealth



a term used to describe a decrease in the price levels

havent had since 1930s

very damaging because businesses dont want to bottow money that has more purchasing , and they dont want to invest in plant and equipment given that the cost of plant and equipment is declining


price index measures

the prices of a basket of goods and/or services at a point in time in relation to the prices in a base period

consumer price index
producer price index
GDP deflator


consumer price index

measures the price that urban consumers paid for a fixed basket of goods and services in relation to the price of the same goods and services purchased in some base period


producer price index

measures the prices of finished goods and materials at the wholesale level

price index for 2013 with the reference period as 2008 formula is:

(price of 2013 market basket in 2013/ price of 2013 market basket in 2008) x 100


GDP deflator

measures the prices for net exports, investment, government expenditures, and consumer spending

is the most comprehensive measure of price level (price index)


causes of inflation




inflation occurs when aggregate spending exceeds the economy's normal full-employment output capacity

real GDP exceeds potential GDP

usually happens a the peak of a business cycle



inflation occurs from an increase in the cost of producing goods and services

decreases aggregate output and unemployment because consumers are not willing to pay the inflated prices


relationship between inflation and unemployment

is inverse

when unemployment rate is low, inflation tends to increase

inflation tends to decrease when the unemployment rate is high

the relationship is depicted by the Philips Curve


personal disposable income

the amount of income that individuals receive and have available to purchase goods and services

personal income minus personal taxes


interest rates

price paid for the use of money

they are affected by credit risk, maturity (time you have to borrow for), and administrative costs

the intersection of demand and supply curves for money determines the equilibrium price or interest rate


interest rates are often quoted as..

real interest rate
nominal interest rate


real interest rate

interest rate in terms of goods

adjusted for inflation


nominal interest rate

interest rate in terms of the nations curency

these are the rates quoted by financial institutions


inflation premium

difference between real interest rate and nominal interest rate

the higher the expected inflation rate, the larger the inflation premium

the interest rate charged to a particular business or individual will be higher than the nominal rate due to credit risks (risk of not repaying)


government budget surplus (deficit)

the excess of government raxes in relation to government transfer paymnts and purchases

to finance a deficit the government issues debt (treasury bonds)


Monetary Policy

what the central bank does to influence the economy (reserve requirements, open market operations, discount rate, economic analysis, and rational expectations)

works on the principal that a decrease in interest rates will stimulate the economy and an increase in interest rates will slow the economy

the effects of monetary policy depend on their effects on the expectations of investors, businesses and consumers


reserve requirements

a banking institution must hold a reserve (much of which is on deposit at the federal reserve bank) a certain percentage of their total banking deposits

aka they cant dip into the reserve to lend out money


open market operations

a more common monetary policy that involves the purchase or sale of government securities using the federal reserve bank deposits

expansionary open market operation: when a central bank is purchasing government securities and expanding the money supply

contractionary open market operations: if a central bank is selling government securities and reducing the money supply


the discount rate

when a bank has a reserve deficiency it may borrow funds from the federal reserve bank

the cost an institution has to pay to borrow money


economic analysis

federal open market committee does extensive economic analysis when making monetary decisions

they decide whether they are going to follow expansionary or contractionary open market operations


the federal reserve uses monetary policy to

attempt to sustain economic growth while keeping inflation under control


rational expectations

assume that investors, firms, and consumers develop expectations about inflation, interest rates, and output based on consideration of all the above information

adaptive expectations: contrast to rational expectations in that investors, firms and consumers adjust their expectations based on new information

example: if they find that inflation is higher than expected, they adjust their expectation upward


fiscal policy

government actions, such as taxes, subsidies, and government spending, designated to achieve economic goals

example: reduction of taxes increases personal disposable income, which should stimulate the economy

can have a large effect on the size of budget deficits


fiscal expansion

an increase in deficit, either due to an increase in government spending or to a decrease in taxes


fiscal contraction

increases in taxes to reduce a deficit



levied by a government based on two general principals
1. the ability to pay (progressive income taxes)
2. derived benefit (gasoline taxes used to pay for roads)


income tax

levied on taxable income

us rate is generally progressive


property tax

property taxes are levied on wealth or value of property



sales tax

levied based on the amount of income spent



wage taxes

the most significant wage tax in the US is social security tax

borne both directly (employees share) and indirectly (employers share) by employees because without the tax, wages would be higher


value-added tax

commonly used in other industrial nations (not in US)

levied on the increase in value of each product as it proceeds through production and distribution process

ultimately the tax is paid by the final consumer


reasons monetary and fiscal policy take time to have the desired effects

1. consumers take time to adjust their consumption based on changes in personal disposable income

2. firms take time to adjust investment based on changes in sales

3. firms take time to adjust spending based on changes in interest rates

4. firms take time to adjust production based on changes in sales


budget deficit effects

in the long and medium run, a reduction is likely to be beneficial to the economy

lower budget deficits usually mean more savings and investment, and therefore more output.

in the short run, a reduction leads to reductions in spending and therefore less output


economic theories

classical economic theory
keynesian theory
monetarist theory
supply-side theory
neo-keynesian theory


classical economic theory

this theory holds that market equilibrium will eventually result in full employment over the long run without government intervention

does not support the use of fiscal policy to stimulate the economy


keynesian theory

this theory holds that the economy does not necessarily move towards full employment on its own

it focuses on the use of fiscal policy to stimulate the economy


monetarist theory

this theory holds that fiscal policy is too crude a tool for control of the economy

it focuses on the use of monetary policy to control economic growth


supply-side theory

this theory holds that bolstering an economy's ability to supply more goods is the most effective way to stimulate growth

a decrease in taxes (especially for high income brackets) increases employment, savings, and investments and is an effective way to stimulate the economy

only works if tax rates are too high


laffer curve

attempts to explain how consumers react to changes in rates of income tax

illustrates that if taxes are already too low decreasing them will result in less tax revenue


neo-keynesian theory

this theory combines keynesian theory and monetarist theory

focuses on using a combination of fiscal and monetary policy to stimulate the economy and control inflation


the global economy and international trade

economic globalization refers to the increasing economic interdependence of national economies across the world through a rapid increase in cross-border movement of goods, services, technology, and capital

has led to a single world market in which developed economies have integrated with less developed countries by means of foreign direct investment, the reduction of trade barriers, and the modernizations of the developing countries


absolute advantage in the production of a particular good

there is an incentive for that country to produce more than its citizens need to export the good to countries with higher production costs

this is especially true if it also has a comparative advantage


comparative advantage

means the country has no alternate uses of its resources that would involve a higher return (opportunity costs are less)

in the long run, production of specific goods and services will migrate to countries that have a comparative advantage

by exporting, these countries can then import goods for which they have a comparative disadvantage


michael porters diamond of national advantage four points

explains how a country can create a new advanced factor endowments that contribute to the country's comparative advantage

1. factor conditions
2. demand conditions
3. related and supporting industries
4. firm strategy, structure, and rivalry


obsticles to free trade

even though trade can be a source of major gains, many nations restrict free trade by various means

example: imposing tariffs and quotas (protectionism)



tax on an imported product

designed to discourage the consumption of goods from foreing companies or to raise revenue, or both

a trigger price mechanism authomatically imposes a tariff barrier against cheap imports by imposing a duty on all imports below a trigger price


import quota

a restriction on the amount og a good that may be imported during a period



a total ban on the importation of specific goods


voluntary export restraint

an exporting country may limit the quantity of goods that can be exported to appease importing countries and keep them from imposing stiffer import restrictions


foreign-exchange control

a control imposed by a government on the purchase or sale of foreign currencies by residents, or on the purchase or sale of local currency by nonresidents

examples of such controls:
1. banning the use of foreign currency in the country
2. banning possession of foreign currency by citizens
3. restricting currency exchange to government-approved exchangers
4. fixed exchange rates


arguments in favor of trade restrictions

1. to protect domestic labor against inexpensive foreign labor
2. to reduce domestic unemployment
3. to protect young or infant industries
4. to protect industries important to the nation's defense

trade restrictions are advocated by labor unions and firms making products that are inexpensively produced in other nations

these firms usually include industries that have lost their competitive advantage (producers of shoes, textiles, and steel)


effects of trade restrictions

generally impose a burdon on society as a whole because they reduce the availability of goods and increase their prices


arguments against trade restrictions

1. businesses of developed nations are disadvantaged by social laws in their coutnries that do not exist in developing countries (laws restricting pollution, child labor, minimum wage, etc.)
2. disproportionate taxing of domestic manufacturing


most arguments for trade restrictions are not valid because

they usually have negative effects in that economic activity is inappropriately shifted to less-productive protected industries, resulting in a devline in total world output



pricing policy that sells products at a lesser value to another country than the company would charge in its domestic country

the World Trade Organization (WTO) Agreement is not prohibited if it causes material injury to a domestic industry in the importing country

file an antidumping petition if a company needs to be challenged


export subsidies

payments made by a government to encourage the production and export of specific products


countervailing duties

duties imposed by an importing country to neutralize the negative effects of export subsidies


World Trade Organization

organization of countries designed to supervise and liberalize trade among participating countries

facilitates agreements and resolutions


North American Free Trade Agreement (NAFTA)

free trade agreement between Canada, Mexico and US

adopted by congress in 1993


NAFTA advantages

1. ability to take advantage of lower labor costs in Mexico (manufacturing and assembly)
2. opening of new markets for goods of US industries have a comparative advantage (such as technology)


NAFTA disadvantages to US businesses and labor markets

1. firms will be hurt by the availability of elss expensive products from mexico (producers of shoes and apparel)
2. lost jobs because of lower labor and relaxed social laws in mexico


balance of payments

account summary of a nation's transactions with other nations

three major sections:
1. current account (balance for a period of total goods exported and imported -surplus=export more than import)

2. capital account (shows flow of investments in fixed and financial assets- has surplus and deficit)

3. official reserve account (shows the changes in the nation's reserves- gold and foreign currency)



a group of finance ministers and central bank governors from 20 economies (EU and 19 countries)

studies and reviews and promotes discussion of policy to address issues


European Union

economic and political union of 27 countries



an economic and monetary union (officially the euro area)

composed of 17 memer countries that use the euro currency

European Central Bank est. monetary policy for members of the eurozone


world bank

objective of promoting world-wide economic development


international monetary fund

objective of maintaining order in the international monetary system by preventing currency, banking, and financial debt crises


reduction in trade and investment barriers

reduction in trade barrieers can be traced to the establishment of the General Agreement on Tariffs and Trade (GATT)

reduction by countries on foreign direct investment (FDI)


technology advancements

improvements in information technology and transportation make global communication and movement of goods more economical


foreign exchange rates

are relationships among the values of currencies (international firms should be concerned with rates)


factors influencing exchange rates

determined by supply of and the demand for currencies

exchange rates are often said to be determined by managed float

1. inflation- tends to deflate the value of a currency because holding the currency results in reduced purchasing power

2. interest rates- if interest returns in a particular country are higher relative to other countries, individuals and companies will be enticed to invest in that country; results in increased demand for the country's currency

3. balance of payments- if country X is a net exporter of goods and therefore has a surplus balance of trade (export more than you import), countries purchasing goods must use country X's currency; this increases the demand for the currency and its relative value

4. government intervention- (buying or selling the currency in the foreign exchange markets) the central bank of a country may support or depress the value of its currency

5. other factors- political and economic stability, extended stock market rallies, or significant declines in the demand for major exports


exchange rate regime

the way a country manages its currency in respect to currencies of other countries


basic types of exchange rate regime

1. floating exchange rate- exchange rate is dictated by market factors above

2. pegged exchange rate- country's central bank keeps the rate from deviating too far from a target band or value

3. fixed exchange rate-rate is tied to the value of another currency, such as US dollar or the euro

4. managed exchange rate- country's central bank attempts to control the movement of the currency value


spot rate

exchange rate for the currency for immediate delivery- right now


forward rate

exchange rate for a currency for future delivery

forward contract might obligate a company to purchase or sell euros at a specific echange rate three months from now


discount or premium

difference between spot rate and forward rate

if the forward rate is greater than the spot rate, the market believes that the value of the currency is going to increase

if the forward rate is less than the spot rate, the market believes that the value of the currency is going to decline


forward premium or discount (of one currency with respect to another currency)

((forward rate-spot rate)/spot rate) X
(month (or days) in year/month (or days in forward period)


translation (accounting) risk

the exposure that a multinational company has because its financial statements must be converted to its functional currency


transaction risk

relates to the possibility of gains and losses resulting from income transactions occurring during the year

can cause volitility in the reported earnings that motivates management to use strategies to minimize the company's exposure


contracts to hedge (minimize risk or exposure) foreign currency

1. options
2. forwards
3. futures
4. curency swaps
5. money market hedge


FC options

allow, but do not require, the holder to buy (call) or sell (put) a specific or standard commodity or financial instrument, at a specified price during a specified period of time (american option) or at a specified date (european option)


FC forwards

forward-based standardized contracts to take delivery of a specified financial instrument, foreign currency, or commodity at a specified future date or during a specified period, generally at the then-market price

if you know you will be receiving Euros in 120 days, but are concerned about the price declining, you will lock in a price now to sell those Euro's you'll get in 120 days at the contracts specific price; if price goes down, it doesnt matter because you've already locked in a rate


FC currency swaps

forward-based contracts in which two parties agree to exchange an obligation to pay cash flows in one currency for an obligation to pay in another currency


FC money market hedge

example (p. 154):
borrow money in yen whe the agreement is executed

this strategy immediately converts the yen to US dollars

then, when the yen are collected from the sale, the loan can be repaid, resulting in no foreign exchange loss or gain over the six month period


foreign direct investments

usually quite large and are exposed to political risk

repatriation (transfer) of a foreign subsidiary's profits may be blocked

in the extreme case a foreign government may even expropriate (take) the firm's assets


strategies to reduce risk of foreign direct investment

joint ventures (50/50), financing with local-country capital, and purchase of insurance


transfer pricing

the price at which services or products are bought and sold across international borders between related parties

example: US co purchases products from its french subsidiary, a transfer price must be established for the products

transfer prices can minimize their overall tax burden in jurisdictions with higher income tax rates; and maximize net income in jurisdictions with lower tax rates

Other benefits:
1. avoid foreign witholding of taxes on cash payments
2. avoiding import duties
3. circumventing profit repatriation restrictions


methods used to determine transfer prices

1. cost method- price is determined based on the cost of producing the item (used when market price is not available)

2. market price method- determined based on the external market of the item

3. negotiated price method- determined based on a negotiated instrument


business risk

conditions that threaten managements ability to execute strategies and achieve the firm's objectives


the general global environment factors

1. economic- inflation rates, interest rates, budget deficits, personal savings rate, GDP

2. demographic- population size, workforce, ethnic mix, income distribution, geographic distribution

3. political and legal- antitrust laws, tax laws, deregulation, philosophies

4. sociocultural- workforce diversity, environmental concerns, shifts in consumer preferences

5. technological segment- societal innovations in technology and products, focus of the economy on research and development

6. global- important global political events, developments in global markets, natural disasters

the general aspects of the environment are out of the control of the management of the firm but management must adapt to the general environment


industry environment

the set of factors that influence the firms competitive actions


porters five forces is used to analyze the industry

competitors (intensity of rivalry)
potential entrants into the market
equivalent products
bargaining power of customers
bargaining power of input suppliers


Entry Barriers (threat of new entrants)

1. economies of scale
2. proprietary produt of differences
3. brand identity
4. switching costs
5. capital requirements
6. access to distribution
7. absolute cost advantages (proprietary learning curve and access to necessary inputs)
8. government policy
9. expected retailiation


Rivalry determinants (intensity of rivalry)

industry growth
fixed (or storage) costs/value added
intermittent overcapacity
product differences
brand identity
switching costs
concentration and balance
informational complexity
diversity of competitors
corporate stakes
exit barriers


Determinants of Supplier Power (bargaining power of suppiers)

1. differentiation of inputs
2. switching cost of suppliers and firms in the industry
3. supplier concentration
4. importance of volume to supplier
5. cost relatie to total purchases in the industry
6. impact of inputs on cost or differentiation
threat of forward integration relative to threat of backward integration by firms in the industry


Determinants of Substitution of Treat (threat of substitution)

1. relative price performance of substitutions
2. switching costs
3. buyer propensity to consume


Determinants of Buyer Power (bargaining power of buyers)

Bargaining Leverage:
1. buyer concentration versus firm concentration
2. buyer volume
3. buyer switching costs relative to firm switching costs
4. buyer information
5. ability to backward integrate
6. substitute products
7. pull-through

Price Sensitivity:
1. price/total purchases
2. product diferences
3. brand identity
4. impact on quality/ performance
5. buyers profits
6. decision makers's incentives



a study of all segments in the general environment

mgmt uses this to modify its strategies and operating plans



a study of environmental changes identified by scanning to spot important trends



developing probable projections of what might happen and its timing

example: personal disposable income in the future and the effects on our product



determining changes in the firm's strategy that are necessary as a result of the information obtained from scanning, monitoring, and forecasting

is the process of evaluating the implications of changes in the general environment on the firm



a group of firms that produce products that are substitutes or close substitutes

often classified by their fundamental economics as:
perfect competition
pure monopoly
monopolistic competition


perfect competition

1. it is composed of a large number of sellers, each of which are too small to affect the price of the product or service
2. the firms sell a virtually identical product
3. firms can enter or leave the market easily (no barriers to entry)


perfect competition characteristics

there are few perfectly competitive markets; common examples are commodity markets, such as markets for wheat, soybeans, and corn

the firms demand curve is perfectly elastic (horizontal); the firm can sell as many goods as it can produce at the equilibrium price but no goods at a higher price

the firm is a price taker

market demand curve is downward sloping- demand will increase if all suppliers lower prices and will decrease if all suppliers increase their prices

will produce and sell products until the marginal cost is greater than the marginal revenue

theoretically, no economic profits can be generated in the long-run

no product differentiation- key to being successful is low cost; innovation is restricted to making production, distribution, and sales processes more efficient


pure monopoly

a market in which there is a single seller of a product or service for which there are no close substitutes (e.g. electric company)

a monopoly may exist because:
1. increasing returns to scale
2. control over the supply of raw materials
3. patents (drug manufacturers)
4. government franchise (public utility)


pure monopoly characteristics

exist when economic or technical conditions permit only one efficient supplier

monopolist sets the price for the product (unless it is set by regulation)

demand slope is negatively sloping; co. must reduce price to sell more output

firm will continue to produce and sell products as long as the marginal revenue is greater than average variable cost

entry barriers make it possible for the firm to make a profit in the long run

little incentive to innovate or control costs

work to keep a positive image because population will complain to government

laws are in place to discourage the development of monopolies (prices are higher and output is lower)


monopolistic competition

characterized by many firms selling differentiated products or services (e.g. cell phone companies)

the differentiation may be real or only created by advertising, and there is relatively easy entry into the market but not as easy as in a perfectly competitive market

this market is prevalent in retail (groceries, detergents, breakfast cereals)

demand curve is negatively sloped and firms tend to produce and sell products until the marginal revenue is less than the average variable cost (price is higher than perfect competition but less than monopoly)

focus on product or service innovation; spend heavly on product development



characterized by significant barriers to entry (e.g. automobile, airline companies, computer companies, cigarettes)

there are few, but generally large sellers of a product (actions of one affects the other)

engage in nonprce competition (product differentiation or producing high levels of service)

Kinked-demand-curve model holds that the demand curve is kinked down at the market price because other oligopolists will not match price increases but will match price decreases

if left unregulated, ologopolists tend to establish cartels that engage in price fixing (US prohibits collusion by firms to set price)



a market where only one buyer exists for all sellers

example may be the federal government


techniques for industry analysis

1. competitor analysis: (1) gatering info about competitors capabilities, objectives, strategies and assumptions (2) using the info to understand the competitors behavior

2. price elasticity analysis


response profile (competitor analysis)

information from the competitor analysis of the competitors objectives, assumtions and strategy and capabilities can be developed into a response profile of possible actions that may be taken by the competitor under varying circumstances

this allows management to anticipate or influence the competitor's actions to the firms advantage


Multiple R

coefficient of correlation


Adjusted R Squared

measures the percent of the variance in the dependant variable explained by the independant variable

percentage of the variation in quantity demanded is explained by price


strategic planning

involves identifying an organizations long-term goals and determining the best approaches to achieving those goals

begins with the development or review of the organization'smission

next, situational analusis will be performed which involves collection and evaluation of past and present economical, political, social, and technological data (an environmental scan) to:
1. identify internal and external forces that may affect the organization's performance and choice of strategies
2. and to assess the organization's strengths, weaknesses, opportunities, and threats (SWOT analysis)

then, SWOT analysis is use to develp strategies to minimize risks and take advantage of major opportunities

after performing situational analysis, specific strategies will be developed consistent with the mission and vision of the organization



sets for the purpose of the organization, including its distinguishing characteristics



sets forth where the organization would like to be in the future


product differentiation

development of unique product to make it more attractive to the target market or to differentiate from competitors products

may differentiate in the following ways:
1. physical characteristics: aesthetics, durability, reliability, performance, serviceability, features
2. perceived differences: advertising, brand name
3. support service differences: exchange policies, assistance, after-sale support

by differentiation, a firm may be able to charge higher prices than its competitor or higher prices for the same product sold in different market segments


product differentiation

development of unique product to make it more attractive to the target market or to differentiate from competitors products

may differentiate in the following ways:
1. physical characteristics: aesthetics, durability, reliability, performance, serviceability, features
2. perceived differences: advertising, brand name
3. support service differences: exchange policies, assistance, after-sale support

by differentiation, a firm may be able to charge higher prices than its competitor or higher prices for the same product sold in different market segments


cost leadership

involves focusing on reducint the costs and time to produce, sell, and distribute a product or service

techniques used to reduce are:
1. process reengineering
2. lean manufacturing
3. supply chain management


process reengineering

invovles a critical evaluation and major redesign of existing processes to achieve breakthrough improvements in performance

difference between reengineering and TQM is TQM involves gradual improvement, while reengineering is radical redesign


lean manufacturing

involves the identification and elimination of all types of waste in the production function

operations are reviewed for those components, processes, or products that add cost rather than value


supply chain

describes the flow of goods, services, and information from basic raw materials through the manufacturing and distribution process to delivery of the product to the consumer, regardless of whether those activities occur in one or many firms

chart on page 162


Supply Chain Management

used to improve operations and manage the relationships with their suppliers

a key aspect is the sharing of key information from the point of sale to the final consumer back to the manufacturer, the manufacturer's suppliers, and the suppliers' suppliers

Supply chain management also focuses on improving processes to reduce time, defects, and costs all along the supply chain


supply chain management example

example: if a manufacturer/distributor shares its sales forecasts with its suppliers an they in turn share their sales forecasts with their suppliers, the need for inventories for all firms is significantly decreased

the manufacturer/distributor needs far less raw materials than normally would be the case because its suppliers are aware of the manufacturers projected needs and is prepared to have the materials available when needed (dont keep inventory on hand when the supplier knows how much you will need and when)


problems and risks presented to the company by supply chain management

1. incompatible information systems
2. refusal of some companies to share information
3. failure of suppliers or customers to meet their obligations


target market

a market in which the firm actually sells or plans to sell its product or services

a thorough understanding of the firms target market is key to accurate sales forecases

target market analysis should be performed to understand exactly who the firm's customers are (just defining the geographic area is not enough)

management needs to understand why customers purchase the firms product or service

the greater the understanding management has of the firm's market, the more effective it can be at making marketing decisions (e.g. tailored advertising)


Target market analysis

used in implementing a generic strategy

generally involves market segmentation, which involves breaking the market into groups that have different levels of demand for the firms product or service

example: a clothing store like GAP, that sells clothing primarily for teens, is interested in the size of the segment of the market-- the number of teens in the geographical are that the store serves


segmentation may be performed along any dinimension that defines the firms market including:

1. demographics (sex, education, income, etc)
2. psychographics (lifestyle, social class, opinions, activities, attitudes, etc)


if the firms customers are businesses, segmentation might be performed in terms of other relevant dimensions including:

1. industry
2. size (in terms of sales, total employees, etc.)
3. location
4. how they purchase (e.g. seasonally, volume, who makes the purchasing decisions)

unlike individuals, businesses purchase products to increase revenue, decrease costs, or maintain status quo



involves developing strategies to deal with, and capitalize on, markets in other contries

companies in developed countries are able to compete with companies in developing countries in a number of ways, including:
1. use of sophisticted technology to reduce costs
2. effective process management
3. inovation in products or services
4. product quality
5. customer service
6. adopting a global strategy

when operating in a global economy, firms should be aware of cultural differences and the effects those differences may have on business


organizations that pursue global strategy can benefit in the following ways:

1. pooling international production to one or a few locations can achieve increased economies of scale
2. manufacturing costs can be cut by moving production to low-costing countries
3. a firm that can switch production among different countries has increased bargaining power over labor, suppliers, and host governments
4. worldwide access to resources, labor, suppliers, and customers



involves contracting for the performance of processes by other firms

provides a way for firms to focus on their core competencies and value creation activities

if a firm does not have a competitive advantage for a process, they may outsource that process and decrease costs


outsourcing advantages

1. cost savings
2. higher quality
3. reduced time to delivery
4. scalability


outsourcing risks

1. example: agreements must be appropriately structured to allow the firm to control performance, quality and ethical employment practices of the other firm

2. risk to the firms reputation

3. legal risk and foreign currency risk