Many factors affect the demand for a product, which is a concern for management

Question

Many factors affect the demand for a product, which is a concern for management and the decision-making process. To correctly assess the demand for their products, managers must determine the effect of all relevant variables.

Select a particular industry or product and define the following variables:

Inferior versus normal goods

Substitution and income effects

Derived demand

Changes in real and projected incomes

Discuss how these variables can affect the demand for your product or industry and what methods could be used to estimate the effect of these variables.

Consider this statement: Long-run cost curves are planning curves, while short-run cost curves are operating curves. Do you agree or disagree with this statement? Support your answer with an appropriate rationale. In your response, use the various cost concepts you have learned, as well as the concepts of economies and diseconomies of scale, incremental costs, and sunk costs. Provide examples and applications of these costs in your response.

Explanation / Answer

First consider what determines the demand for a product, besides its price. There are substitutes that can be used in place of it, there are complements that are used in combination with it, there is the budget of the consumer that enables her to make a purchase, and then there are tastes and preferences of consumers that can change dramatically.

When the income of consumer increases she might spends the entire increase in income in buying more of the one particular good and reduces the consumption of the other. This other good whose demand falls with rise in consumer's income is called inferior good and the other one is called normal good.

When a person has similar preferences for a combination of two commodities and she is indifferent between them, then she would choose only the one that has a lower price. These commodities for which the consumer feels indifferent are called perfect substitutes.

Income effect is the influence that guide the consumer to change its consumption when the income of consumer changes. Substitution effect is the influence that guide the consumer to change its consumption when the price of a product changes.

Economies and diseconomies of scale shape the long-run average cost curve. Economies of scale are certain advantages that become available when the firm increases the size and scale of its operations.

These forces bring necessary reductions in the cost of production and so the long-run average cost falls as the output rises. Volume discounts, capital substitution for labor, more efficient machines, conducive working and legal environment all contribute in the cost reduction.

Diseconomies of scale results when firm continues to operate and produce a level of output beyond the level suggested by its minimum long-run average cost curve. These forces eventually raise the average cost of the firm. Communication problems, management failures, coordination failures contribute in the cost increase.

Long-run cost curves are planning curves, while short-run cost curves are operating curves. In a sense, firms just attempt to cover the variable cost in the short-run. It is the long run that decides the possibility of its survival as well as its growth.

A profit maximizing competitive firm always produce the quantity of output at which the total revenue exceeds the total cost by the greatest possible amount or the marginal revenue and marginal cost are equal.

Though it tries to maximize its profit, but since it has no control over its price, it can only change the cost of production. Hence, in the long run, it produces an output at the minimum of LRATC curve but in the short-run, it may continue to operate even if it is bearing economic losses.

Sunk cost is the cost that is forever lost after it is paid. This suggests that a sunk cost is irrecoverable. Once made or incurred, they cannot be taken back. It may be or may not be a part of fixed cost.

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