Chapter 7
External analysis –
economic factors
Economics
Economics can be defined in
various ways, including:
• ‘the study of how society
allocates scarce resources
which have alternative uses,
between competing ends’
• ‘the study of wealth creation’.
Two aspects of economics
• It is useful to distinguish between two aspects of economics:
Microeconomics – the study of the economic behaviour of
individual consumers, firms and industries.
• Macroeconomics – considers aggregate behaviour, and the
study of the sum of individual economic decisions – in other
words, the workings of the economy as a whole.
Demand
Individual demand
It shows how much good or service
someone intends to buy at different prices.
Usually, at low price- demand is high.
Demand tends to be higher at a low price
and lower at a high price for most goods and
services.
an expansion in demand as demand rises
when the price falls
a contraction in demand as demand falls
when the price rises.
Law of demand- inversely proportional-
downward sloping
This is the result of two processes.
• There is a substitution effect. This is where a
consumer buys more of one good and less of
another because of the relative price changes.
Thus is two goods are substitutes, a fall in price of
the first will lead consumers to switch some
demand to the lower-price good.
• There is an income effect. This is where a change
in the price of a good affects the purchasing
power of the consumers’ income (a change in
their real income). If the price of a good falls, the
consumer experiences a rise in their real income
and, as a result, tends to buy more of all normal
goods and services.
*Price of product decrease->Consumer will buy more
products
Market demand and Conditions of demand
Market demand shows the total amount of effective demand from all
the consumers in a market.
Individual and market demand consider exclusively the influence of
price on the quantity demanded, assuming other factors to be
constant.
These factors, termed the ‘conditions of demand’, will now be
considered, with price held constant.
If the shift in the demand curve is outward, to the right, such a shift is
called an increase in demand.
If the shift in the demand curve is inward, to the left, such a shift is
called a decrease in demand.
Conditions that affect demand
Income
• Higher Income: Leads to less demand for necessities and more for luxuries
(e.g., more spending on services and leisure).
• Lower Income: Leads to more demand for necessities.
• Income vs. Inflation: If wages rise faster than inflation, people have more
disposable income and can spend more flexibly.
• Inferior Goods: As income rises, demand for inferior goods falls.
Example: With higher incomes, people use less public transport and buy more cars.
Changing Tastes and Fashions: Demand for goods can be volatile.
Health concerns increase demand for brown bread and vegetable
oil, reducing demand for white bread and animal fats.
Advertising Influence: Can create markets for new products.
A celebrity endorsing a particular brand of sneakers can lead to a
Taste and surge in demand for those sneakers..
Prices of Other Goods:
Prices of
Other Goods • Unrelated Goods: No effect on each other.
• Complements: Joint demand; a price change in one affects the
other.
If car prices fall, demand for cars rises, increasing demand for
tyres.
• Substitutes: A price rise in one increases demand for the other.
If coffee' price rises, demand for Tea increases
Population: Creates a larger market, shifting demand outwards.
TYU
• Relation between two variables and measure the
Elasticity of demand responsiveness of one variable to a change in
another variable.
• Price elasticity of demand (PED) – explains the
responsiveness of demand to changes in price.
• if a percentage change is negative, the minus sign
is typically ignored.
>1 is 'elastic'. A price drop should increase
revenue.
< 1 is inelastic. A price increase should
increase revenue
TYU
Solutions
Link between PED and total
revenue
If total revenue increases following a price cut, then
demand is price elastic.
If total revenue increases following a price rise,
then demand is price inelastic.
Factors that influence PED
Proportion of income spend on goods Groceries-
inelastic. Luxury clothes- elastic
Substitutes- Lamborghini vs Ferrari- inelastic.
Pepsi vs coca cola- elastic.
Necessities – needs inelastic, wants elastic
Habit- cigarettes, alcohol, drugs- inelastic
Time and awareness- telephone vs cell phone vs
smartphone
Cross elasticity of demand
