Interaction of Consumer and Firm Choices in Markets
For an economy to thrive, there is a need for the three most important aspects – consumer, firm, and the markets – to coexist in perfect order. It is not normal that one will be superior to another, or where one can be better than the other. Decisions made by one affects all the others—the theory of microeconomy of built on the principles of decision making by firms and individuals. If there is a problem in the market, say, for instance, lending, chances of involved firms raising interest rates are very high. And this means consumers have to decide whether to borrow or not. Many will be afraid to engage in such deals, which leads the firms to produce less and make fewer profits. In many instances, markets have failed not because there is a lack of natural resources, but because they did not relate well with other aspects of an economy.
Consumer and firm decisions
We are always faced decisions in our daily existence, which leads consumers to give up one product for the other. Many economic experts have, in the past, commented that there is nothing like a ‘free lunch’ when it comes to making decisions. If you decide to take one way, it means you have had to sacrifice the other. Take, for instance, a family that has been saving for years. It reaches a point when they have to decide between buying a new car they really need, or going on a fancy vacation they have been planning for. Referring back to the great recession of the 2007/2008 financial crisis, the whole world went into a state of financial constrains as markets collapsed. The rate of unemployed spiked as prices of commodities surged. As such, families had to make decisions choosing the most important needs over all others. It all began with the collapse in the housing and financial markets, which, at the time, were booming, they may not have anticipated that bubble to turn things to the worst.
And because of this, there was an increase in the consumption of certain goods, while others declined. For instance, it was recorded that more people visited groceries more than they did restaurant because they chose to eat from home as a way of saving on some chase. This brings us to the question of how households make decisions. Why would the family choose a car and forego the trip or vice versa?
The biggest challenge to consumer decisions is scarcity. In the modern world, human needs often exceed natural resources that are supposed to quench these needs. Economics states that humans’ needs are infinite, while resources are finite. This means, there is never enough for most people. One may want, for instance, to buy a house, but they will need money for this. They will have to work to earn money, whereby job opportunities are always limited. This makes it very hard to make decisions. Hence, consumers have to draw what is called a budget line.
In this case, it is all about calculating what a consumer can afford. And to get this, you have a factor in the budget constraint of the individual. Let’s think, for instance, of a Mr. X who loves to buy shirts and food from fancy restaurants. In one instance, this individual has $50. A single movie costs $10, and a place of the food he eats costs $25. On a chart with food, the x-axis, and the movies on the y-axis, a budget line can be drawn to show all the possible combinations of each product. For instance, if he has only the $50 to spend, he can by two plates of means at the expense of the movies, or buy five movies at the cost of his favorite meals. Mr. X can also choose to balance the two.
The point is, consumers are always faced with tough decisions, which are based on current financial situations and the prices of goods. However, it is a must that they leave one product and chooses another. There are never any two ways about it, considering budget lines don’t allow them to pick anything beyond what they can afford.
Firm and markets decisions
Let us refer back to the development of automobiles. Back in 1908, there was a great revolution in the industry that greatly changed the cause of history. Note that the industry had been around since the 15th century owing to the drawings of Leonardo Da Vince. Late on, Karl Benz invented the first gas-powered automobile in 1885, which opened ways for more improvements in 1893 and the years that followed.
However, the greatest revolution came in 1903 when Henry Ford opened an assembly line for cars. Before this, cars were only a luxury reserved for the rich and elite in society – no one else could afford them. But all this changed during this period because the assembly line greatly reduced the production costs and the time it would take to make a single car. Now cars were more affordable, leading to the popularity of Model T, which were all over the market by 1927.
In the case of producer decisions, it depends on the status of a market. A perfectly competitive market is where everything is on the same line. There is no producer who is great than the other, they are price takers, and consumers have all the information about the products’ features. But such a market only exists in theory. If it were so, the producers would make a decision based on:
- If the price is greater than marginal cost, in which case they will produce more.
- If the price is less than marginal cost, in which case they will produce less.
- If the price is equal to marginal cost, in which case they will maximize profits.
Now, every firm is faced with different categories of costs. And these costs vary depending on the industry. In the case of short-run expenditure, the firm is faced with fixed costs, which cannot be altered. They include things like costs for purchasing a working an industrial building; this is called sunken cost. Apart from this, there is also the cost of buying machinery research and development market. There is also what we call variable costs, which, as you may have already guessed, can be altered. For instance, if a firm’s production increases, they may have to hire more workers or by more machines. That means they will be spending more.
Just like consumers, a producer is also faced with challenging situations where they have to make decisions. And these decisions are also based on different factors, including, and majorly, the rate of consumption. If we assume other factors like the competition are obsolete, then we can say a firm will produce as much as they are able to sell completely. They will keep watching their inventory so that there are not many products sitting on the shelves.
Where is the equilibrium?
A firm is defined as the business of a company. In a basic marketplace, there is a transaction between households and firms. In any case, a firm looks at production factors like land, labor, and capital to make goods for households. And they come in different ways, including corporations, partnerships, and collectives, among others. When studying the theory of a firm, economists attempt to describe, explain, and predict the general appearance of a firm. They will, therefore, look at its existence, behavior, and market status.
Not every market and society is linked to a firm. Consider production in the medieval times, for instance, where the most process was don’t by skilled individual artisans. They would loosely get organized into guilds, or through farmers who rented some land. In this case, trade was mostly among individuals.
Today, firms have become a more prevalent and perhaps reliable alternative to exchange between individuals. This is true, especially when referring to a non-market environment. Consider the labor market; for instance, firms cannot just only engage in production when they have the option of firing and hiring workers based on demand and supply. No one can deny there are many advantages of consolidation for efficiency; however, there is an underlying concept where including operational aspects can have positive impacts on a firm.
Firms play a central role in economic development, and not only for themselves but for the wider society. It is, therefore, important to separate the business from the individual who started it. Buy so doing, the funding, insurance, and liability of the firm do not fall on the individual. This separation also allows for the application of certain laws and regulations pertaining to the operation of a firm.
Note that there is a detailed implication of a firm and how it relates to individuals and the community. It may be hard to understand the complexity of this relation, but you can only take that a firm plays a central role in an economic structure.
Why firms transact
Firms make a profit by transacting. Ronald Coase states that people are only motivated to organize their firm’s production when there is an excellent percentage of transaction cost on the market than the cost within the fire. He recorded that a firm may be connected markets not under its control but due to how its internal resources are organized. Inside a firm, the complexity of a market is taken over by the entrepreneur who takes care of productions. He wonders, therefore, why firms cannot use internal prices through the production process, or perhaps we just get one big firm to handle the entire economy, based on alternative production ways.
In his though on the establishment of a firm, he says the major purpose for starting a company is to avoid some transaction costs that come with using the price mechanism. Processes like identifying relevant prices, which may be eliminated at the expense of striking a deal and drafting applicable contracts for every transaction, lets a company decide the mode of action.
Trade and profit
The main reason why consumers and producers trade is because the process helps each to gain a better position in society. Economists may measure the benefit of a transaction based on how much the producer benefits. On the other hand, the consumer profits by utilizing the product, and the extend of profit gained is measured so.
The consumer also benefits from trade because from consumer surplus, which is the monetary profit when a consumer is able to buy a product with far less than the original price. This happens a lot when firms place discounts on such products. Understand that the consumer may be willing to pay the highest price, but are glad to get the lowest option.
The opposite producer surplus. This is the excess a producer receives when they sell at a higher market price than the least, they could. When it comes to making decisions, the allocation of resources is described at Pareto. This the decision of making one individual better leave the other worse.
In summary, there is always a profit in every transaction. Both the consumer and the producer receive gains, either as direct profits, and consumer or producer surplus. When you these surpluses on a standard supply and demand curve, you can see the amount of they have gained. Sometimes, a consumer may be willing to buy two products at slightly the equilibrium price, yet they end up paying for each unit at the equilibrium, without any addition.
According to economists, firms that are always seeking to make profits make the difference between total revenue and total cost count. On the other hand, consumers seek to get the best out utility; hence they can be described as total satisfaction than the from goods and services or actions. If there is efficiency in the allocation of resources, then consumers and producers will gain maximum surplus. Marketplaces see, to operate haphazardly, and yet they produce efficient outcomes. For this reason, marketplaces can promote the common good, and perhaps they create equilibrium.
In an economic system, nothing seems to be more important than efficiency. And even though the different notions of a system may be complimentary, it is clear that consumers, firms, and markets meet at a specific point vital to their economy.
Author: James Hamilton