Micro-economic Environment: We know that micro means small. Micro- economy basically covers the individual households and firms decision making process on allocation of limited resources. Micro- economics has various goals. One of them is, to analyze the market mechanism to establish relative prices. Micro-economy also analyzes market failure to produce effective result.
Although economists all agree that the price of a product or service is a major factor in the consumer decision-making process, it's not the only factor, and it may not always be the deciding factor. But a principle of microeconomics assumes that, if all other factors are equal, as the price of a product or service goes up, demand for that product or service declines. Conversely, if the price declines, demand goes up.
Based on pricing, therefore, microeconomics can forecast with reasonable accuracy what a consumer may buy, and how much of that product or service will be bought. Consumer demand - what a consumer wants and in what quantity - is called a demand curve and may be graphically plotted in a chart, like the one below.
The demand curve for apple pies may change if a factor in the decision-making process changes. Let's say a competing bakery offers cherry pies that are bigger and cheaper than the apple pies. The demand curve for apple pies may then change, with demand falling off as demand for the cherry pies goes up.
Consumer demand for both apple pies and cherry pies will depend on this price and size relationship - cherry pies are bigger and cheaper than apple pies. If the apple pie baker makes a new batch of apple pies as big as his competitor's cherry pies and offers to sell them at the same price or lower than the cherry pies, then demand for apple pies should go up.
In Business Context
Another price or cost to the consumer which must be calculated as part of consumer buying patterns is what microeconomics calls the opportunity cost.
This "expense" or cost represents what consumers must give up in order to buy something - in other words, the tradeoffs factor. If a consumer has a dollar to spend and buys a cup of coffee for a buck, then there's no money left for a donut. Conversely, if the consumer buys the donut, he or she has nothing to dunk it in. What the consumer gives up, or trades off, to buy one thing and not another is the opportunity cost.
Prices changes in a product or service, either up or down, will influence the opportunity cost to consumers. A steep increase in the price of coffee for a confirmed coffee drinker may not prevent that consumer from buying the same amount of coffee. But for the random drinker of coffee who does not need a cup or two to start the day, the price increase may cut that consumer's coffee buying.
The change in the quantity of coffee bought by the consumer as the price changes is called demand elasticity. Demand may expand like a stretched rubber band - reflecting its elasticity - if the price of coffee goes down. Or demand may contract, or become inelastic, if the price goes up
Task 2
Business is affected by the external environment as it is by the competitors. It is important that firms are aware of the changes in the external environment to be successful. Understanding the influence of Macroeconomic factors helps the firms to determine the current market conditions and how beneficial will they be for the success of their business. Various macroeconomic factors that influence the business are:
Economic Growth
Economic activities refer to the level of buying and selling activities happening in an economy over a time period. It is a highly complex activity and keeping accurate track of it is beyond comprehension. Economic activity is not constant and can change rapidly, thereby affecting the business. Economic activity changes could happen due to the following reasons:
Changes in income levels
Future prospects of individuals.
Future of the economy
The level of economic activity in the world as a whole
Political activities around the world
Natural disasters - like hurricanes, earthquakes, or flood etc
Changes in prices of raw materials - oil, metals, fuel, energy and so on
Changes in world stock markets
The level of economic activity is usually measured by GDP (Gross Domestic product). It refers to the total amount of goods and services a country produces. Businesses are greatly influenced by the economic activities. When GDP rate falls or slows down, there will be a fall in demand for good or services offered by businesses. As a result, businesses will witness a fall in revenues and profit margins. To curb this business will have to reduce their prices to increase the sales. This could further lead to increase in unemployment. On the other hand when there is an increase in GDP, the demand for products will automatically increase and hence the prices will go up. To cope with the increase in demand business will need to employ new people resulting in reduction in Unemployment rates.
Task 3
The microeconomic effects of fiscal policy
Taxation and work incentives
Can changes in income taxes affect the incentive to work? This remains a controversial subject in the economic literature!
Consider the impact of an increase in the basic rate of income tax or an increase in the rate of national insurance contributions. The rise in direct tax has the effect of reducing the post-tax income of those in work because for each hour of work taken the total net income is now lower. This might encourage the individual to work more hours to maintain his/her target income. Conversely, the effect might be to encourage less work since the higher tax might act as a disincentive to work. Of course many workers have little flexibility in the hours that they work. They will be contracted to work a certain number of hours, and changes in direct tax rates will not alter that.
The government has introduced a lower starting rate of income tax for lower income earners. This is designed to provide an incentive for people to work extra hours and keep more of what they earn.
Changes to the tax and benefit system also seek to reduce the risk of the 'poverty trap' - where households on low incomes see little net financial benefit from supplying extra hours of their labour. If tax and benefit reforms can improve incentives and lead to an increase in the labour supply, this will help to reduce the equilibrium rate of unemployment (the NAIRU) and thereby increase the economy's non-inflationary growth rate.
Taxation and the Pattern of Demand
Changes to indirect taxes in particular can have an effect on the pattern of demand for goods and services. For example, the rising value of duty on cigarettes and alcohol is designed to cause a substitution effect among consumers and thereby reduce the demand for what are perceived as "de-merit goods". In contrast, a government financial subsidy to producers has the effect of reducing their costs of production, lowering the market price and encouraging an expansion of demand.
The use of indirect taxation and subsidies is often justified on the grounds of instances of market failure. But there might also be a justification based on achieving a more equitable allocation of resources - e.g. providing basic state health care free at the point of use.
Taxation and labour productivity
Some economists argue that taxes can have a significant effect on the intensity with which people work and their overall efficiency and productivity. But there is little substantive empirical evidence to support this view. Many factors contribute to improving productivity - tax changes can play a role - but isolating the impact of tax cuts on productivity is extremely difficult.
Taxation and business investment decisions
Lower rates of corporation tax and other business taxes can stimulate an increase in business fixed capital investment spending. If planned investment increases, the nation's capital stock can rise and the capital stock per worker employed can rise.
The government might also use tax allowances to stimulate increases in research and development and encourage more business start-ups. A favourable tax regime could also be attractive to inflows of foreign direct investment - a stimulus to the economy that might benefit both aggregate demand and supply. The Irish economy is often touted as an example of how substantial cuts in the rate of corporation tax can act as a magnet for large amounts of inward investment. The very low rates of company tax have been influential although it is not the only factor that has underpinned the sensational rates of economic growth enjoyed by the Irish economy over the last fifteen years.
Capital investment should not be seen solely in terms of the purchase of new machines. Changes to the tax system and specific areas of government spending might also be used to stimulate investment in technology, innovation, the skills of the labour force and social infrastructure. A good example of this might be a substantial increase in real spending on the transport infrastructure. Improvements in our transport system would add directly to aggregate demand, but would also provide a boost to productivity and competitiveness. Similarly increases in capital spending in education would have feedback effects in the long term on the supply-side of the economy. (BUSHAWAY, Robert W., 2003)
