Markets and Competition

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(upbeat music) In the following lessons, we'll be exploring the nature of the marketplace in a so-called free market economy and how competition can both work for and against the best allocation of scarce resources. We'll be talking about normal and inferior goods, substitute goods, complimentary goods, consumer tastes and preferences, and profits. Disposable income is what we as consumers have left after taxes and other charges. When our disposable income rises, we tend to buy more of certain items and less of others. The things we buy more of like vegetables for example, are called normal goods. On the other hand, for some products, demand decreases as disposable income increases. Let's say your local grocery store stocks organic vegetables, mass produced vegetables and cheap canned vegetables. We might predict as managerial accountants that the cheap canned vegetables are an inferior good and that as overall consumer disposable income rises, the store will sell less canned vegetables and more fresh vegetables. Also, as consumer income rises, we may see more people switching from mass produced vegetables to organic vegetables. In this case, the mass produced vegetables might be seen by an economist as a substitute for the organic vegetables. You might see in the store that organic vegetables command a higher price, not just because they cost more to produce, but also because they have different supply and demand curves than the mass produced vegetables. There will be a point on the demand curve where consumers will look at the price of organic vegetables and opt instead for the mass produced vegetables. To managerial accountants then, mass produce vegetables might be both an inferior good and a substitute good. If the price of coffee gets too high and more and more people switched to tea, we would see that tea is a substitute good. Some goods compliment each other. For example, let's say your company produces toner and ink cartridges for printers and makes a small profit on each sale. In addition, your company sells printers at a slight loss, but the more printers you sell, the more printer supply customers you gather. Even though your customers only buy a printer once every five years, they buy ink and toner on a regular basis. One of the economic issues for management is this, what happens if we stop selling printers. Would ink and toner sales decrease? And if so, would that drop in profit be greater than gains We would make by discontinuing printer sales? In addition to the effect that disposable income has on overall demand for goods and services, the very nature of the marketplace is constantly changing. For example, 20 years ago, organic vegetables may have only been found in a few specialty stores. However, in recent years, they have become more common in many countries as consumers become aware of potential health benefits and benefits to society as a whole. Even if those benefits turn out to be minimum, just the shared idea that organic vegetables are healthier than mass produced vegetables creates more demand. Buggy whips are a famous example of how demand changes as consumers and markets change. With the arrival of the automobile at the turn of the 20th century, the market for buggy whips mostly dried up and now they are a specialty item. On the other hand, the advent of the automobile created demand for roads, tires, parking structures, and many other goods and services around the world that had not existed before. More recently, cell phones, smartphones and wireless internet services have significantly changed the communications industry and so demand for rotary phones and landlines is almost non-existent in our modern world. Firms sell products and services for two basic reasons, to make a profit and to benefit society. A company makes an economic profit when total revenues exceed total costs, plus an expected return on investment. Revenues are what the consumers pay for the goods and services. Costs are what the company has to pay out in order to make the goods or provide the services. In economics, we say that economic profit is zero when revenues are equal to costs plus a return on investment. In other words, if your firm is bringing in $2 million a year in revenue and spending $1.7 million to make the product you are selling, your accounting profit is $0.3 million or $300,000. However, if the owners of the firm expect and demand a return on investment of 5%, and they have $6 million invested in the firm, they expect to make $300,000 each year, which means that your firm has economic profits of zero. It's operating at the economic break even or equilibrium point. In addition, there are not profit firms that operate for charitable or other non-business purposes, churches, most schools, social organizations, some hospitals, government entities, and many other organizations that serve the social welfare of the community, all operate not-for-profit but for a public benefit. Not for profit firms, aren't forbidden from generating revenue in excess of expenses. It's just that they're not motivated by that because there are no owners. Not for profit organizations answer to the public and profits never go to any owner.