Microeconomics: Understanding Key Concepts and Their Impact on Business

This report delves into fundamental microeconomic concepts, exploring their implications for business decision-making. It examines the principles of international trade, including absolute and comparative advantage, and analyzes the relationship between price and quantity demanded, highlighting exceptions to the law of demand. The report further investigates the connection between marginal and average product, explaining their relationship through the lens of diminishing marginal returns. Finally, it addresses the misconception that firms should leave an industry when making zero profits, clarifying the distinction between accounting and economic profits and the concept of normal profits in perfect competition.

ECO101 – Microeconomics
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Contents
Introduction..........................................................................................................................................3
1. International Trade.......................................................................................................................4
2. Treatment of Demand Curve if Price and Quantity is increasing................................................7
3. Marginal and Average Product Relation....................................................................................10
4. If the firm is making Zero profits it should leave the industry...................................................12
Conclusion...........................................................................................................................................14
References...........................................................................................................................................15
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Introduction
This report explains about the various factors of the microeconomics which may impact the price
of the organization. The relationship between the price and the demand are explains so that the
relation between both can be determined and how they affect the organisation is decision making
can also be evaluated. With that the report also explains about how the absolute advantage helps
in the organisation for the trading process. The aspects of the marginal product and the average
product are also examined. The competitiveness of the organisation in the external market is
depicted with that how the profits may impact the organisation to sustain in the market and run
its operations are also highlighted. The micro economic factors are those factors which help in
determining the internal factors of the organisation which may help in attaining the sustainability
such as the demand, supply and the income of the customers so that the product can be
purchased.
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1. International Trade
International trade means the exchange of goods and services across the international borders
and the territories (Intelligent Economist, 2018). The economic patters of the nation are based on
the unique combination of various factors of production such as physical capital, human capital
and the natural resources.
Absolute Advantage: The absolute advantage is referred to the ability of one country to produce
the products in which it is more efficient and export to other trading nation. As the ABC
company has the absolute advantage in the production of steel so it will produce the steel and
export it to the US company XYZ. Same goes with that of sugar the ABC also have the
advantage in the production sugar as well (Intelligent Economist, 2018).
Image: Absolute advantage
Source: Intelligent Economics, 2018
ABC Company XYZ Company
Steel 4 2
Sugar 6 1
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So, it can be seen that the ABC company is producing the 4 tones of the steel in per labor hour
while the 6 tones of the sugar in the same labor hour so the ABC company has the absolute
advantage in the production of sugar as well as the steel (Intelligent Economist, 2018).
Comparative Advantage: The comparative advantage which was given by the David Ricardo
who believes that the nation will specialize in those areas where they can produce at the lower
cost than the other countries (Amadeo, 2018).
Image: Comparative Advantage
Source: Economics Online, 2018
From the above diagram it can be seen that the organisation has the comparative advantage in
trucks than that of the car as trucks are 3.5 times better than car and only 1.17 times than that o
the cars (Amadeo, 2018).
In the scenario, it was seen that the ABC company has the absolute advantage in producing both
the products that is sugar as well as the steel but the comparative advantage will be of the sugar
as the ABC is 2 times better at the sugar then that of the steel while only 2 times better at steel.
So, the absolute advantage both the goods can be there with one country but the comparative
advantage is only on one product of the country (Amadeo, 2018). However it can be seen that the
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company ABC of Australia will specialize in sugar while the US Company XYZ will specialize
in the production steel.
The company will get the comparative advantage as the goods are produced by the fewer
resources (Amadeo, 2018). If the production of one will increase the production of another will
decrease. So, to increase the production of sugar the company has to lose some units of steel.
When both the countries are producing different this means that the opportunity ratio for both is
different (Economics Online, 2018). So, the statement above terms to be true that both the
countries will get benefit as the gradients of both is different (Amadeo, 2018).
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2. Treatment of Demand Curve if Price and Quantity is increasing
Yes, the statement is true that if the price and the quantity are increasing then the demand curve
will be sloping upward. Though demand and the price have the inverse relationship but in some
cases there exists direct relation between the price, quantity and the demand for the product
(Financial Dictionary, 2018).
Law of Demand: The law of demand states that if the price of the goods increases then the
demand will fall and if the price for the goods and services decreases then the product’s demand
will increase, by keeping other things constant (Financial Dictionary, 2018).
Image: Law of Demand
Source: By Author, 2018
The equilibrium point exists when the supply is equal to its demand. The change in the demand
means there is the shift in the demand curve which may be either in downward direction or the
upward direction. The downward is when the price of the product is decreased and the quantity
demanded by the individual’s increases (Financial Dictionary, 2018).
Upward Sloping Demand Curve:
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When price of product
goes up
The Quantity demanded
goes down

The demand curve is said to be upward sloping when with the increase in prices the quantity of
the goods also increases (Financial Dictionary, 2018).
Image: Demand Curve
Source: Financial Dictionary, 2018
It can be seen from the above graph that the demand curve is upward sloping and with the price
P1 the quantity demanded is Q1 but when there is increase in price to P2 the demand for quantity
also increases to Q2 so it shows the direct relationship between the price and the demand for the
product instead of the inverse relationship (Beggs, 2017).
Exceptions to the Law:
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Image: Veblen and Giffin Goods Graph
Source: Beggs, J., 2017
Veblen Goods (High Status Goods): This is the exception of the law of demand which is given
by the economists Prof. T. B. Veblen. He believes that the consumers measure the utility for the
product on the basis of its price (Beggs, 2017). It can be evaluated from the above figure that D1
is the first demand cure where the price of the product is P1 and the quantity demanded is Q1
when the demand curve shifts to D2 the price of the product is increased from P1 to P2 and the
quantity demanded is also increased from Q1 to Q2 (Beggs, 2017).
Giffin Goods (Higher Inferior goods): With this the exception was also given by the Sir Robert
Giffin who also believes that if the prices of the bread will increases so the workers who are of
low income group will purchase more of the product so which will increase the demand for the
bread and vice versa (Beggs, 2017). It can be said that the consumers buy less of the products
when the price of the product is low and they believes that the low price products have the less
utility for the product. The above graph shows the effects of the Giffin goods that with the
increase in the price the quantity demanded is also increasing. The change in the prices of the
product is due to the income and the substitution effect (Beggs, 2017).
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3. Marginal and Average Product Relation
The marginal product is the addition to the total product when one more unit of the product I
produced (Capozzi, 2018). It can be determined as:
MP=TPn-TPn-1
The average product is evaluated by dividing the total product to that of the unit produced during
production (Medico, 2018).
AP=TP/Output
Relationship between marginal and average product
Image: Relation between marginal and average product
Source: Medico, 2018
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The statement stated is true that their exist the positive relationship between the average as well
as the marginal product (Capozzi, 2018). If the marginal product is falling than the average
product is also falling. From the above figure it can be seen that X axis shows the quantity of
labor and Y axis depicts the average and the marginal product. The point where both the product
meets is the point of equilibrium. As soon as the curve of marginal product is below the average
product curve, the curve of the average product is declined (Jael, 2014).
The relationship between the marginal and the average product can be explained with the law of
marginal returns (Capozzi, 2018). The value of marginal product reduces with that of
diminishing marginal returns. The marginal curve outline shows that the marginal product is first
increasing and then decreasing same goes with that of the average curve (Medico, 2018). The
law of diminishing marginal returns states that as more and more unit of the variable production
are added the each unit of the variable resources decreases (Jael, 2014). The law of marginal
diminishing also explains that the increasing production is not suitable situation to earn
profitability. With the decrease in the marginal returns the average product declines (Capozzi,
2018). When the marginal product falls then it is the situation where it interacts with the average
product. When the marginal product continues to fall and fall below the average product, this is
the reason due to which the average product declines (Capozzi, 2018).
Therefore, it can be said that the average product and the marginal product plays the sort of catch
up with that of leader (Capozzi, 2018). As, the change in the marginal product also causes the
change in the average product if the marginal product increases the average product also
increases and if the average product declines the marginal product also declines (Capozzi, 2018).
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4. If the firm is making Zero profits it should leave the industry
No, this statement is not true that if the firm is making the zero economic profit so that
organization should leave the industry (Gupta, 2014). The situation of the Zero profits considers
the economic profit rather than the accounting profits (Frew, et. al., 2017). The accounting
profits are also called the explicit costs as it does not require the outlay of money in the
organisation. The economic profit is the opportunity as well as the implicit cost (Frew, et. al.,
2017).
Image: Equilibrium in perfect competition
Source: Intelligent Economists, 2018
New firms enters the market in the long run so the price of the product goes down as the supply
for the same increases the cost of factors of production will also increase due to the intense
competition (Gupta, 2014). The entry of the new firms will be continued until and unless the cost
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is equal to the average cost so that the normal profits can be earned by the organisations (Frew,
et. al., 2017). In the short run curve which lies below the long run there will be no chances to
leave the industry. The firms will leave the industry until and unless the price is equals to the
average cost (Gupta, 2014). The normal profits are also known as the zero economic profit or
breakeven point. This is the point where the total cost is equals to the total revenue (Frew, et. al.,
2017). So, if the firm is making the normal profits so that industry will remain in the market.
This means that the firm has utilized its resources efficiently that will help in making the normal
profits rather than incurring losses or making higher profits. In the long run equilibrium perfect
competition helps in making the normal profits for the industry (Frew, et. al., 2017).
Image: Normal Profit Graph
Source: Gupta, S., 2014
In the figure above it can be seen that the X axis reveals the quantity and Y axis eaxmines the
price of the product and the condition is of the perfect competition. There is the perfect
competition so the average revenue is equals to the marginal revenue (Gupta, 2014). MC is the
marginal cost curve and AC is the average cost curve. The blue area show the normal profit of
the industry where the resources are efficiently utilized by the workers of the organisation (Frew,
et. al., 2017).
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Conclusion
From the above discussion it can be concluded that the price of the product is dependent upon
the demand and supply of the organisation. The demand curve shows the inverse relationship but
in some cases it also shows the positive relationship. The international trade helps in gaining the
advantage to both the countries in which they are inefficient to produce. The relationship
between the average and the marginal product shows that how they behave with the addition of
the production. Besides, the report also explains that how the profit is impacted in the long and
short run under the perfect competition which the change in the amount of cost as well as
revenues. Therefore, overall report gave the understanding about various concepts of the micro
economic factors so that the profitability can be earned.
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References
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Balance. Available at: https://www.thebalance.com/comparative-advantage-3305915.
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ThoughtCo. Available at: https://www.thoughtco.com/overview-of-giffen-goods-
1146960. [Accessed On 26 May 2018]
 Capozzi, C., 2018. Relationship Between Marginal & Average Productivity. [Online].
Chron. Available at: http://smallbusiness.chron.com/relationship-between-marginal-
average-productivity-16120.html. [Accessed On 26 May 2018] Economics Online, 2018. Comparative advantage. [Online]. Economics Online.
Available at:
http://www.economicsonline.co.uk/Global_economics/Comparative_advantage.html.
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 Financial Dictionary, 2018. Upward sloping Demand Curve. [Online]. Financial
Dictionary. Available at: https://financial-dictionary.thefreedictionary.com/upward-
sloping+demand+curve. [Accessed On 26 May 2018]
 Frew, B.A., Clark, K., Bloom, A.P. and Milligan, M., 2017. Marginal Cost Pricing in a
World without Perfect Competition: Implications for Electricity Markets with High
Shares of Low Marginal Cost Resources (No. NREL/TP-6A20-69076). National
Renewable Energy Lab.(NREL), Golden, CO (United States). Gupta, S., 2014. Price determination under perfect competition. [Online]. Wordpress.
Available at: https://swatiguptaphd.wordpress.com/2014/10/08/price-determination-
under-perfect-competition/. [Accessed On 26 May 2018] Intelligent Economist, 2018. Absolute Advantage. [Online]. Intelligent Economist.
Available at: https://www.intelligenteconomist.com/absolute-advantage/. [Accessed On
26 May 2018] Jael, P., 2014. Full Cost, Profit and Competition. Medico, 2018. What is the relationship between average product and marginal product.
[Online]. Medico. Available at: http://www.mrmedico.info/apps/blog/show/42119309-
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