Chapter 1 F1 Accountant in Business

Chapter 1:
The business organization, its
stakeholders and the external
environment

Mahfuzah Binti Ahmad

Chapter 1: The business organization, its
stakeholders and the external environment
1. The purpose and types of business organisation
2. Stakeholders in business organizations
3. Political and legal factors affecting business
4. Macro economic factors
5. Micro economic factors
6. Social and demographic factors
7. Technological factors
8. Environmental factors
9. Competitive factors

1.1 The purpose and types of business
organisation: Definition & Reason formation
A. Definition of organisation – social arrangement for
the controlled performance of collective goals
(Buchanan and Huczynski).

B. Reason of formation:
– Overcome people individual limitation whether physical and
intellectual
– Enable people to specialize
– Save time – combine work (multi tasking work by different
people at the same time, effective and efficient application
of resources).
– Accumulate and sharing knowledge – quality, speed
– To create synergy advantages

1.1: C. Features: Common, distinguished characteristics
and basic component
Common features:
• Formal, documented systems and procedures
• Different people do different things or specialize in one activity.
• Variety of objectives and goals.
• Obtain inputs, process and convert to outputs.

Distinguished characteristics:
• Ownership and control
• Activity
• Profit or non-profit orientation
• Size – small, medium, family & multinational
• Source of finance – bank, government funding

Basic component part – resource inputs (e.g. labour, raw materials),
organizational activities (e.g. purchasing, manufacturing, accounting)
and outputs (e.g. products/services, taxes, waste, employment)

1.1:

Commercial /
profit seeking
org.

Cooperatives Not-for-
profit (NFPs
D. Types or NPO)
of
business

Non-
Public
governmental
Sector
org

1.1: D. Types of business organisation
i. Commercial / profit seeking organisation
a) General and applies to any group(s) with "specific aim" of making a
profit.
b) Make a profit for the owner, shareholders, or both, by providing
products and services. Followed by continue in existence, maintained
growth, etc.
c) E.g. commercial organizations specialize in entertainment, commercial
broadcasting, banking, agriculture and organized crime, etc.

ii. Not-for-profit (NFPs or NPOs)
a) Do not consider profit but to satisfy particular needs of their members
or the sectors of society that they have been set up to benefit.
b) E.g. clubs, associations, charitable organizations, government
department.

iii. Public sector
a) Owned and run by the government and local government (part of economy
and services).
b) Referred - the state sector or the government sector.
c) Composition varies by country, but in most countries includes services such as
the police, military, public roads, public transit, primary education and
healthcare for the poor.
d) Services that cannot be excluded from (such as street lighting), services which
benefit all of society rather than just the individual who uses the service (such
as public education), and services that encourage equal opportunity.

iv. Non-governmental organizations (NGOs)
a) (NGOs) is an independent voluntary association of people acting together for
some common purpose (other than achieving government office or making
profit).
b) General characteristics - independence from the direct control from
government, not constituted as a political party and non-profit making.
c) E.g. Amnesty International, WWF, etc.

v. Cooperatives
a) An autonomous association of persons who voluntarily cooperate for
their mutual social, economic, and cultural benefits. For example
housing, retail, workers, agricultural, consumer, insurance, banking, etc.
b) There may be for-profit or not-for-profit organizations.
c) Legal entity owned and controlled by its members. Members often
have a close association with the enterprise as producers or consumers
of its products or services, or as its employees
d) Features:
 Voluntary and open membership
 Democratic member control
 Economic participation by members
 Autonomy and independence, education, training and information,
 Concern for community.

1.2 Stakeholders in business organizations:
Definition
• Those persons, groups or organisations that have an
interest in the strategy of and organisation. (legitimate
interest)
Stakeholder

• Consider only the relationship between the principal
Agency (shareholders) and agents (e.g. top management team, CEO)
to maximize the shareholders’ wealth.
theory

• Every corporation or organization was created to serve more
than just its shareholders, but instead to serve a diverse
Stakeholder range of people who have a legitimate stake in the
theory organization’s outcome and performance and indeed to
serve a broad societal purpose.

1.2: B. Types of stakeholders
1. Internal stakeholder – those are intimately connected to the organization
and their objectives are likely to have strong influence on how it is run.
For example, directors, sub-board management, company secretary,
managers, employees, etc.

2. Connected stakeholder – can be viewed as having contractual relationship
with organization.
For example, shareholders, suppliers, finance creditors, trade unions.
3. External stakeholders – those are individuals and groups that do not have core
contractual connections with the organization but impacted by the corporate and
social actions of the organization.
These groups will have diverse objectives and have varying ability to ensure that
the organization meets their objectives.
For example government (national and local), lobbying groups
(environmentalists), local communities, regulators, external auditors, professional
bodies, competitors, etc.

Different objectives of stakeholders lead to:

CONFLICT?
Solve

1.2: C. Mendelow’s Stakeholder Mapping
Matrix

1.2: C. Mendelow’s stakeholder mapping matrix
Category of matrix Explanation

Low power and low interest • Can be largely ignored when considering
(A) – minimal strategic objectives.
effort/direction • They are more likely to accept what they are told
and follow instruction.
• Ethical view, they should still be considered as
ignoring them may awaken their interest.

Low power and high interest • Kept informed and not underestimated.
(B) – keep • Lobby others to support their strategy or
informed/education and alternatively join forces to pressure the
communication
organisation.
• The company’s strategy must be presented in a
logical way and shown to be rational; this may
stop them joining forces with more powerful
dissenters.

1.2: C. Mendelow’s stakeholder mapping matrix
Category of matrix Explanation
High power and low interest • Kept satisfied and stay dormant to avoid them
(C) – keep gaining interest.
satisfied/intervention • If they become more interested, they can easily
become key players (might frustrate the
adoption of a new strategy).
• Therefore, the organisation must reassurance
them of the likely outcomes of the strategy well
in advance.
High power and high interest • The organization must put extra priorities on the
(D) – key key players.
players/participation • The stakeholder has the ability to prevent the
company achieving its strategy (e.g. upsetting
customers will drive them to competitors).
• The organization should communicate to assure
them that the change is necessary, followed by
discussions on the implementation of the
strategy and how it affects them.

1.3 Political and legal factors affecting business
3. Government policy affect the organisation
2. Three levels of political a. Law and regulations – criminal law,
system to analyze and company law, employment law, health and
apply: safety, data protection
a) Global - WTO b. Taxation – based on profits, capital gains,
VAT, etc.
b) National – National
c. Economic policies – e.g. low inflation, low
government policy.
interest rates, appropriate exchange rate.
c) Local – local government d. Government policies/incentives (include
policy trade policy).Government also can imposed
policy on industry entry barriers such as tariff
to protect local car. Government
incentives in the forms of subsidies
1. Definition of and tax relief will influence the organization’s
strategy.
political system - set
of formal legal
institutions that A. Political systems
constitute a and government
"government" or a policy affect the
"state." organization

1.3: B. Sources of legal authority
• Include statute law, case law
• Stature law – acts created by national
parliaments or equivalents bodies.
1. National • Case law – judge-made law based on available
precedent and in the absence of prior
decisions. The decisions become binding on
future courts and important as statute law
• Regional/state governments pass resolutions
2. Regional and may have the authority to levy taxes. E.g.
the State and Federal system within the USA.

• Forms of law come from bodies outside of the
national jurisdiction. For example, The
3. Supra- European Union, The World Trade
Organisation (WTO), etc.
national • The World Trade Organisation (WTO) – set up
bodies to promote free trade and resolve disputes
between trading partners with the objectives
to help producers of goods, services,
exporters and importers in their business.

1.3: C. Employment law
a. The body of law that governs the employer-employee relationship,
including:
 Individual employment contracts, the application of TORT and contract
doctrines, and
 large group of statutory regulation on issues such as the right to organize
and negotiate collective bargaining agreements, protection from
discrimination, wages and hours, and health and safety.
b. The organization must be aware on the employment laws which protect
the employee’s interest to prevent legal action taken on them that
could result in bad publicity.
c. Employment law covers:
 Employment contract - basic principles, procedures and responsibilities between
employer and employees.
 Basic remuneration (minimum level) and working hours (e.g. Malaysia employment
act does not allowed the employees to work more than 48 hours or exceeding 8
hours a day excluding a period of rest, 5 consecutive hours of work without a period
of rest of not less than 30 minute).
 Working environment and conditions - safe and healthy working environment against
dangerous machinery, hazardous materials, and noise, etc.
 Termination of employment - unfair dismissal, proper compensation, etc.
 Discrimination at workplace on the basis - race, colour, religion, national origin, or
sex, etc.

1.3: C. Employer’s and employee’s responsibilities –
health and safety
Employees
Employers
1. If employees have long hair or wear
1. Plant and machinery is safe a headscarf, make sure it's tucked out
to use, and that safe working of the way (it could get caught in
practices are set up and machinery).
followed.
2. To co-operate with employer,
ensure employee get proper training
2. All materials are handled,
and understand and follow the
stored and used safely and
company's health and safety policies.
provide adequate first aid
facilities
3. If the employees operate
machinery, to tell the employer if
3. Ventilation, temperature, take medication that makes himself
lighting, and toilet, washing and drowsy - employer should
rest facilities all meet health, temporarily move him to another
safety and welfare requirements. job if they have one for him to do.

1.3: D. Data protection and security

• Protecting individuals personal data
against the misuse of information held
a. Data
by organizations (protection from
protection
misuse of personal information stored
on electronic systems and manual).

• Keeping data safe from various hazards
that could destroy or compromise it.
b. Data • Data corruption (due to viruses,
security hacker), the organization must install
anti-virus and firewall software,
passwords and user number limits and
off-site back-up copies of data files.

1.3: D. Data protection and security cont’d…
• The UK Data Protection Act includes eights Data Protection Principles which
data users must comply. The principles as follow:

1) Personal data shall be processed fairly and lawfully and, in particular, shall
not be processed unless fulfil certain condition.
2) Personal data shall be obtained only for one or more specified and lawful
purposes, and shall not be further processed in any manner incompatible with
that purpose or those purposes.
3) Personal data shall be adequate, relevant and not excessive in relation to the
purpose or purposes for which they are processed.
4) Personal data shall be accurate and, where necessary, kept up to date.
5) Personal data processed for any purpose or purposes shall not be kept for
longer than is necessary for that purpose or those purposes.
6) Personal data shall be processed in accordance with the rights of data subjects
under this Act.
7) Appropriate technical and organisational measures shall be taken against
unauthorised or unlawful processing of personal data and against accidental
loss or destruction of, or damage to, personal data.
8) Personal data shall not be transferred to a country or territory outside the
European Economic Area unless that country or territory ensures an adequate
level of protection for the rights and freedoms of data subjects in relation to
the processing of personal data.

1.3: E. Consumer protection – general principle, simple contract and
sale of goods
a. Contract - A contract is an agreement between two parties that
creates an obligation to perform (or not perform) a particular duty.
b. Legally enforceable contract - an offer, acceptance and consideration (in exchange for goods).
c. A consumer user of goods and services. Any person paying for goods and services , expect that the goods and
services are of a nature and quality promised to him by the seller.
d. Any business buying and selling goods is considered making and discharging contract either written or
unwritten or implied by behavior (e.g. purchase groceries at supermarket).
e. If one party of the contract fails the agreement, the other party can take legal action for breach contract or
contract void (e.g. either party disappears without trace).
f. Sale of good and supply of services:
1. This transferred legal responsibility to the retailer ("caveat vendor" - let the seller beware).
2. Seller to ensure that goods are of merchantable quality, as described, fit for their purpose, and
conforms to sample. Services must be provided by persons with due skill, the materials used must be
of merchantable quality and any goods supplied as part of the service must be of merchantable
quality.
3. Signs limiting the liability of retailers were now to be illegal.
4. Guarantees could not affect statutory rights and the time period must be clearly stated.
5. Hire purchase goods are protected by the act but the consumer may complain to either the retailer
or HP Company.
6. Unsolicited goods (unordered goods sent to your home) may be kept within thirty days of telling
the seller to collect them or within six months if no notice is given.
7. Motor vehicles sold privately have an implied condition that the car must be free from any defect,
which renders it dangerous to the public.

1.4 - Macro-economic factors
1. Definition
2. Determination of business activity
a. GDP: principle & component (private consumption,
investment, government, balance of payments).
b. other factors: recession, confidence, capital and
exchange rate.
c. business cycles: recession, depression, recovery and
boom.
3. Impact of economic issues: inflation, unemployment,
stagnation, international payments disequilibrium
4. Types of economic policies:
a. monetary policy; and
b. fiscal policy

1.4 - Macro-economic factors
A. Definition of macroeconomic:

• Studies the behaviour of the aggregate
economy.
• Macroeconomics examines economy-wide
phenomena such as changes in:
• Unemployment, national income, rate of
growth, gross domestic product, inflation and
price levels.
• The objectives of macro economics:
• To achieve full employment, growth national
income, real economic growth, price stability,
balance of export and import, etc.

1.4: B. Determinant of business activity - GDP
Gross Domestic Product (GDP) – The total market
value of all final goods and services produced within
the country in a given period of time (calculated on
annual basis).

The components of GDP consist the following: GDP =
private consumption + gross investment +
government spending + balance of payments (exports
− imports), or

 Principle: High GDP, lead to better business activity.

1.4: B. GDP - Components
Components Explanation
1. Consumption Based on private consumption (except for purchase of new house) and
determined by the level of household incomes, the rate of tax and
portion of a household’s income saved.
a) Higher the overall taxation, the lower will be the amount of net
income for spending on consumption (includes both direct and
indirect taxes).
b) High tax rate imposed on goods and services - reduce private
consumption. The same apply for portion of income that is saved
where
 Depend on fluctuation of saving interest rate (high interest rate,
consumer will save more).

2. Investment Investment made on capital items.
a) Business investment in equipment, but does not include exchanges
of existing assets.
b) E.g. construction of a new mine, purchase of software, or purchase
of machinery and equipment for a factory. Spending by households
(not government) on new houses is also included in Investment.
c) 'Investment' in GDP does not mean purchases of financial products.
 Buying financial products (e.g. stock and bond) is classed as
'saving', as opposed to investment.

1.4: B. GDP - Components

3. Government a) Government spending of final goods and services and investment
spending (e.g. infrastructure).
b) Includes salaries of public servants, purchase of weapons for the
military, and any investment expenditure by a government.
c) It does not include any transfer payments, such as social security or
unemployment benefits.

4. Balance of Represents the net of import and export value. If export is more than
payments import, the balance will be positive (favourable) and vice versa.

1.4: B. Determinant business activity – Others factors
• Defined as decline in a country’s GDP (features by job
Recession losses, plant closures).

• Increase level of customer confidence will result to higher
demand for product and services and thus greater
Confidence business activity within the economy.
• Low, interest rate, R&D, product innovation will attract
customer spending.

• Availability of capital resources (share capital or loan) will
Capital increase or reduce the business activity within the
economy.

• Strengthening currency will make export more expensive
and reduce demand for exports.
Exchange
• Imports on the other hand more cheaper (encourage
rate business activities for organization that rely on imported
resources).

1.4: B. Determinant business activity – Business cycles

1. Recession a. General definition of recession is declining in GDP rate for two
or more consecutive quarters.
b. In the recession phase, the country will suffer the decline in
consumer demand, low return on investment, closure
business operation, reduce inventory level, etc.
c. Government will usually adopt a budget deficit and reduce
the tax rates in order to boost aggregate demand.
2. Depression a. Severe economic downturn that will usually last several years
(long-term economic downturn).
b. Government policy (e.g. low interest rate) to reduce the
impact of recession was failed to achieve the objectives.
c. Depression are characterized by:
a. "unusual" increases in unemployment,
b. restriction of credit,
c. shrinking output and investment,
d. price deflation or hyperinflation, numerous bankruptcies,
e. reduced amounts of trade and commerce,
f. highly volatile/erratic relative currency value fluctuations,
mostly devaluations.

3. Recovery a. A period of growth after the economics recession and
depression.
b. The consumer confidence has returned to business which
leads increasing in production (demand increase), sale, profit
levels, employment, high investment in new capital
equipment and hence increase of GDP.
c. Usually followed by a series of good news.
4. Boom a. When the recovery continues, the output level will rise above
the general trend line, entering into the boom phase.
b. Capacity and labour become fully utilized leading to
increasing costs as competition for limited resources
intensifies or the demand is met through importing.
c. Increasing the sale prices may also be a result of trying to
control demand.
d. Households will have higher incomes due to higher salaries,
higher share of profits and higher dividends.
e. Demand level peaks, the expansion reaches and
unsustainable level and correction occurs within the economy
- trigger to short term of recession.

1.4: C. Impact of economises

1. Inflation
2. Unemployment
3. Stagnation
4. International payments disequilibrium

1.4: C. Impact of economises - Inflation
Definition: increase in aggregate and general price level in an
economy over a period of time (decline in the purchasing power and
real value of money)
Consequences of inflation:
- High inflation will follow by high interest rate as lenders know
that inflation will erode the value of their money, so they
increase the interest rate to compensate for the loss.
The Consumer
- Impact on standard of living and health (e.g. unable to
Prices Index purchase healthy food, obtain medical treatment) especially for
(CPI) is a those on low income.
common - Discourage saving as the purchasing power of investment may
method of be reduced with interest rate unable to compensate for
measuring inflation. E.g. the value of today will cost more for tomorrow.
inflation. - Economy's exports become more expensive and importer
cheaper that affect the balance of trade.
- Social unrest and revolts - inflation can lead to massive
demonstrations and revolutions.

1.4: C. Impact of economises - Unemployment
Overview: The amount of jobless in the economy. A person is generally unemployed
if they are willing and able to work but cannot find employment.
Measurement rate: No. of unemployed persons divided by the no. of people in the
labor force, where the labor force is the no. of unemployed persons plus the no. of
employed persons.
Fictional Seasonal –
Real wage unemployment Cyclical - economy
Due to the
unemployment – Temporary seasonal nature of Structural – is in recession and
–Trade unions unemployment. the job itself. No demand depression. When
and labor An individual is Certain industries available workers the employment
organization out of his will have different with particular rate moves in the
bargain for current job and demand for skill due to opposite direction
higher wages, looking for labour within the structural changes to the GDP rate
another job. seasons (e.g. within an industry. where GDP would
which leads to spring, summer, For example the be declining
strikes and The time period autumn and closure of coal during recession
lockouts and of shifting winter). The steel, technology and depression
result in the fall between two affected industries replacing manual but
in the demand jobs is known as would be farming, procedures, etc. unemployment
frictional tourism, winter increasing.
for labor.
unemployment. sports, etc.

1.4: C. Impact of economises - Stagnation
 Stagnation – relatively long period of very low or no economic growth, usually
accompanied by high unemployment.
– Under other definitions, growth less than 2-3% per year is a sign of stagnation.

 Stagnation should be differentiated with stagflation.
 stagflation is an economic situation where there is a coupling of sluggish economic
growth, high inflation rate and often unemployment (Stagflation occurs when the
economy isn't growing but prices are).

 Consequences of stagnation:
– The economy is unable to reduce existing unemployment levels.
– Lead to slow demand for goods and services, which adversely affect the
company’s profit and lead to recession

1.4: C. Impact of economises – International
payment disequilibrium
Overview: occurs when a country’s balance of payments (BOP) is negative (deficit).
BOP: Accounting record of all monetary transactions between a country and the
rest of the world.
BOP consist of: Current account, financial account & capital account.

Capital account:
The current account: Financial account : All international capital
transfers are recorded. This
Mark the inflow and outflow International refers to the acquisition or
of goods and services into a monetary flows disposal of non-financial assets
country. Earnings on related to (for example, a physical asset
investments, both public and investment in such as land) and non-produced
private, are also put into the business, real estate, assets, which are needed for
current account bonds and stocks are production but have not been
documented. produced, like a mine used for
the extraction of diamonds.

Long term trade deficits has to be financed.
Long term trade surplus can store up significant problem - inflation

1.4: D. Economic policy implemented by
government
1) Monetary policy:
 Government policy on money supply, the monetary system, interest rates,
exchange rates and the availability of credit for the purpose of promoting
economic growth and stability.
2) Fiscal policy:
 Government policy on expenditure and revenue collection (taxation) to
influence the economy (e.g. taxation, public spending and budget deficit or
surplus).
3) Supply side approach – kindly refer Note 2(1)
4) Taxation – kindly refer Note 2(1)
5) Privatisation – kindly refer Note 2(1)

1.5 - Micro-economic factors
1. Definition:
a. Supply & demand
b. Demand – demand curve, factors & substitute, complements goods
c. Supply – Supply curve, factors, short run supply
d. Equilibrium curve
e. Price regulation
2. Elasticity:
a) Elasticity of demand,
b) Arc elasticity,
c) Elastic & inelastic of demand,
d) Cross elasticity of demand &
e) Price elasticity of supply.
3. Market competition:
a) Perfect competition,
b) Imperfect competition
c) Pure oligopoly.

1.5: A. Micro-economic factors - Definition
1) Microeconomics :
 Branch of economics that studies the behaviour of individual households and firms
in making decisions on the allocation of limited resources.

2) The price mechanism:
 Term used to describe the means by which the many millions of decisions taken
each day by consumers and businesses interact to determine the allocation of
scarce resources between competing uses.

3) A market:
 Defined as a situation in which potential buyers and potential sellers (suppliers) of
a good or service come together for the purpose of exchange. Utility is the word
used to describe the pleasure or satisfaction or benefit derived by a person from
the consumption of goods.

4) Total utility:
 The total satisfaction that people derive from spending their income and
consuming goods.

5) Marginal utility:
 The satisfaction gained from consuming one additional unit of a good or the
satisfaction forgone by consuming one unit less

1.5: A. Micro-economic factors – Demand Curve
 The demand curve of a single consumer or household is derived by estimating
how much of the good the consumer or household would demand at various
hypothetical market prices.

Law of demand:
 Q demanded increases when price fall, and Q
demanded decreases when price rises, other things
held constants (ceteris paribus).

 Factors determining demand for a good.
• The price of the good
• The size of households' income (income effect)
• The price of other substitute goods (substitution effect)
• Tastes and fashion
• Expectations of future price changes
• The distribution of income among households – Normal goods &
inferior goods

 Substitute goods:
 Alternatives to each other, so that an increase in the demand for one is
likely to cause a decrease in the demand for another. E.g. Tea and coffee

 Complement goods:
 Tend to be bought and used together, so that an increase in the demand
for one is likely to cause an increase in the demand for the other. For
example bread and butter

Factors determining demand for a good continues:
• The distribution of income among households – Normal
goods & inferior goods. For example fresh vegetables
(normal goods) and frozen vegetables (inferior goods).

Normal goods:
 Demand rises as household income increases.
Q , Income

Inferior goods:
 Demand eventually falls as income rises. (Customers can
afford to switch demand to superior products).
Q , Income

Normal goods & Inferior goods

1.5: A. Micro-economic factors – Supply curve
 Supply refers to the quantity of a good that existing suppliers or
would-be suppliers would want to produce for the market at a
given price.


Law of Supply:
Q supplied increases when price increases, and Q supplied
decreases when price decreases, other things held constants
(ceteris paribus).

Factors influencing the supply quantity.
The costs of making the goods
The prices of other goods.
• Substitutes in supply:
An increase in the price would make the supply of another
good whose price does not rise (less attractive to suppliers).
• Joint supply or complements in production: When a
production process has two or more distinct and separate
outputs. E.g. Meat and hides. If the price of beef rises, more
will be supplied and there will be an accompanying increase
in the supply of cow hide.
Expectations of price changes
Changes in technology
Other factors - changes in the weather (for example, in the case
of agricultural goods), natural disasters or industrial disruption

1.5: A. Micro-economic factors – Short run supply curve
• Firm needs only to cover its variable costs, at Q1 below because:
– covering variable cost ensures than an output can be produced in the future. If variable
costs cannot be covered then no further output can be made.
• In the short run, the firm's supply curve is its MC curve above AVC (at B).
Below this point it will shut down. Hence the firm would be willing to supply
at P, but not at P1. At point B marginal revenue (P) is equal to marginal cost.
• Graph of short run curve:

• Dgjdgjjfdgjdgj

1.5: A. Micro-economic factors – Long run supply curve

• The supply curve was upward sloping in the short run because of diminishing
returns on the marginal cost. It will be downward sloping because of
benefits of economies of scale.
• Graph of short run curve:

• Dgjdgjjfdgjdgj

1.5: A. Micro-economic factors – Equilibrium price

• The equilibrium price for a good is the price at which the volume demanded
by consumers and the volume that firms would be willing to supply is the
same.

1.5: A. Micro-economic factors – Equilibrium price
• The equilibrium price for a good is the price at which the volume demanded
by consumers and the volume that firms would be willing to supply is the
same.
• Maximum price (or price ceiling) the maximum price a seller is allowed to
charge for a product or service.
• Minimum price (or price floor) lowest price that a government allows a good
to be sold for a good.

1.5: B. Micro-economic factors – Elasticity

1. Price elasticity of demand – elastic and
inelastic demand
2. Arc elasticity and point elasticity of
demand
3. Income elasticity of demand
4. Cross elasticity of demand
5. Price elasticity of supply.

1.5: B. Micro-economic factors – Elasticity of demand

1. Elasticity: Elasticity measures the responsiveness of
one variable following a change in another variable.

2. Price elasticity of demand (PED):
 Measure of the extent of change in the market
demand for a good in response to a change in its
price.


1. The coefficient of price elasticity of demand (PED):

• Elastic – luxury goods
• Inelastic – necessity goods


1. The coefficient of price elasticity of demand (PED):

1. Elasticity of demand: Greater than 1 @ (>1)

• If demand is elastic and the price goes up from $1 to $2, what happens to
TR?
• P=$1: TR = P x Q = $1 x 40 = $40
• P=$2: TR = P x Q = $2 x 10 = $20
It will decrease

1. Inelasticity of demand: Less than 1 @ (>1)

• If demand is inelastic and the price goes up from $1 to $4, what happens
to TR?
• P=$1: TR = P x Q = $1 x 20 = $20
• P=$4: TR = P x Q = $4 x 10 = $40
It will increase

1. Inelasticity of demand: Less than 1 @ (>1)

• If demand is unit elastic and the price goes up from $1 to $3, what
happens to TR?
• P=$1: TR = P x Q = $1 x 30 = $30
• P=$3: TR = P x Q = $3 x 10 = $30
It will not change


Factors influencing price elasticity of demand for a
good:
Percentage of income spent on the good
Availability of substitutes
Necessity
The time horizon
Competitor pricing
Habit

1.5: B. Micro-economic factors – Arc elasticity

Arc elasticity:
 Measures elasticity between two
points on the demand curve
(responsiveness of demand to a
large change in price).

1.5: B. Micro-economic factors – Elasticity of demand & Arc
elasticity
Question:
• Price increases from 10p to 12p.
• Quantity falls from 40 to 20.

Solutions:
• Arc elasticity of demand assumes that we should calculate using
the midpoint between 40 and 20 which equals 30
• The % change in quantity is 20/ 30 = - 0.667
• The % change in price is 2p / 11 = 0.18
• Therefore PED = -0.667 / 0.18 = -3.7 elastic since greater than 1
(Ignore the minus sign)

1.5: B. Micro-economic factors – Point elasticity of demand

 Point elasticity of demand:
Measure the responsiveness of demand at
one particular point in the demand curve
(assumed the demand curve is straight).

1.5: B. Micro-economic factors – Point elasticity of demand
Example: point elasticity of demand
The price of a good is $1.20 per unit and annual demand is 800,000. Market
research indicates that an increase in price of 10 cents per unit will result in a
fall in annual demand for the good of 70,000 units.

Required:
Calculate the elasticity of demand at the current price of $1.20.

Solution
We are asked to calculate the elasticity at a particular price. We assume that
the demand curve is a straight line. At a price of $1.20, annual demand is
800,000 units.

% change in demand=70,000/800,000 × 100% = 8.75% (fall)

% change in price= 10c/120c × 100% = 8.33% (rise)

Price elasticity of demand at price $1.20=(-8.75)/8.33 × 100% = -1.05%

1.5: B. Micro-economic factors – Income elasticity of demand
Income elasticity:
indicates the responsiveness of demand to changes in
household incomes.

1.5: B. Micro-economic factors – Cross elasticity of demand
 Cross elasticity of demand :
 the responsiveness of quantity demanded for one good following a change in
price of another good.

1.5: B. Micro-economic factors – Price elasticity of SUPPLY
 Price elasticity of supply:
 Responsiveness of supply to a change in price.

1.5: B. Micro-economic factors – Price elasticity of SUPPLY
 Factors influence price elasticity of supply:
Existence of inventories of finished goods
Availability of labour
Spare capacity
Availability of raw materials and components
Barriers to entry
The time scale:
• The short run
• Long run
• The secular period

1.5: C. Micro-economic factors – market competition
• Perfect competition
• Imperfect competition and
–Monopolistic competition;
–Oligopoly;
–Monopoly;
–Monopsony; and
–Oligopsony
• Pure monopoly

Definition: Markets such that no participants are
large enough to have the market power to set the
price of a homogeneous product.
Characteristics:

- Infinite buyers and sellers

Perfect - Zero entry and exit barriers
competition
- Perfect factor mobility

- Zero transaction costs

- Perfect information

- Profit maximization

- Homogeneous products

Definition: market situation where individual firms
have a measure of control over the price of the
commodity in an industry.
Arises when an industry's output is supplied only by
one, or a relatively small number of firms.
Consists of:
Imperfect
competition - Monopolistic competition

- Oligopoly

- Monopoly

- Monopsony

- Oligopsony

• Monopoly:
– which there is only one seller of a goods. Has complete control
over an industry, for example Meralco is sole distributor of
electric power in Metro Manila.
• Characteristics:
– Profit maximiser.
– Price maker: Decides the price of the good or product to be sold.
– High barriers to entry: Other sellers are unable to enter the
market of the monopoly.
– Single seller: In a monopoly there is one seller of the good which
produces all the output.
– Price discrimination:
• A monopolist can change the price and quality of the product.
• He sells more quantities charging less price for the product in a very
elastic market and sells less quantities charging high price in a less elastic
market.

• Oligopoly:
– Oligopoly, characterized by a small number of relatively large competitors
(dominated by a small number of sellers), each with substantial market control.
– Exhibit interdependent decision making - lead to intense competition among the
few and the motivation to cooperate through mergers and collusion.

– Profit maximisation conditions: An oligopoly maximises profits by producing where
marginal revenue equals marginal costs.
– Ability to set price.
– Entry and exit: Barriers to entry are high.
– Number of firms: There are so few firms that the actions of one firm can influence
the actions of the other firms.
– Long run profits: retain long run abnormal profits.
– Product differentiation: Product may be homogeneous (steel) or differentiated
(automobiles).
– Perfect knowledge: Assumptions about perfect knowledge vary but the knowledge
of various economic actors can be generally described as selective.
– Interdependence. Each firm is so large that its actions affect market conditions.

• Monopolistic competition:
– Many sellers producing highly differentiated goods.
– The output of each producer is a close but not identical substitute to
that of every other firm, which helps satisfy diverse consumer wants and
needs.
– Product differentiation. The cross price elasticity of demand between
goods in such a market is positive.
– Many firms.
– Free entry and exit in the long run. This assumption implies that there
are low start up costs, no sunk costs and no exit costs.
– Independent decision making.
– Market Power - firms have some degree of market power (firm has
control over the terms and conditions of exchange).
– Buyers and Sellers do not have perfect information (Imperfect
Information).

• Monopsony:
– There is only one buyer of a good.
• Oligopsony:
– There are few buyers of a good.


• Pure monopoly:
– A market in which only one firm has total control
over the entire market for a product due to some
sort of barrier to entry for other firms, often a patent
held by the controlling firm.

1.6 Social and demographic factors
 Social structure
 Demography
 Impact on organisation
 Government measures

1.7 Technological factors
 Business strategy
 Competitive advantage
 Organisational structure

1.8 Environmental factors

1.9 Competitive factors
 Porter’s five forces model
Generic strategies
Porter’s value chain

Chapter 1 F1 Accountant in Business

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