Microeconomics Theories and Businesses and Markets Behaviour - Article Example

Microeconomics Theories and Businesses & Markets Behaviour The body of economic literature can be categorised into two kinds of theories including macroeconomics theories and microeconomics theories. Conventional microeconomic theories are the basic theories, which explain the economic markets. According to Samuelson (1986, pg. 1), the disappointing economic performance of the world is insisting the economists to re-examine the macroeconomics theories, however, it can be expected that microeconomics theories are facing a relatively a little tranquillity. Samuelson (1986, pg. 2) argues that potential failure of conventional microeconomic theories does not occur when these theories are falsified in real world setting but because answers given by theories do not have counterparts in economy. In this report, I would evaluate the behaviour of businesses and markets in consideration to conventional microeconomic theories such as law of supply and demand, price control, market structure etc. It is very interesting to note that conventional microeconomic theories do not only find their implications in market behaviour but also in businesses. Most of the decisions of a company are affected by such theories because these theories give us models to make predictions. It is evident from an example of expected merger between Deutsche Telekom and France Telekom. European Commission has recently granted them clearance to start their proposed merger in the UK. Mergers and acquisitions are usually discouraged in economies because a competitive market offers more benefits to consumers as compared to monopolies. According to conventional microeconomic theories when mergers and acquisitions are increased, the market structure start transforming from competitive to monopolistic structure. In such case, barriers to entry increases and power of the firm to regulate prices also increase. Therefore, to ensure competitive market structure, commissions introduce some rules and policies. For example, in this case, European commission ensured that the merger of Deutsche Telekom and France Telecom would not have negative impact on customers and overall business synergies (Newsroom Orange, 2010). Another similar example is the merger of Britannia Building Society and Cooperative bank. Britannia has become a part of Co-operative Bank, as a result, the new organisation has become more strong in its mortgage and savings products, personal and corporate banking and in insurance & investment. The same above mentioned theory of market structure has its implications in this case. Another real world case, which is showing contradiction to demand and supply curve is the case of India. In July, India bought about 22 tonnes of Gold and just after one month, India bought 100 tonnes of Gold. During this period, the surge in the demand of gold was also noticed in Dubai, however, rather than increase in price of Gold as a result of boosting demand, the prices declined (Kim, 2008). This example shows that many times, the predictions based on the conventional microeconomic theories are not correct, because the market behaves differently. Another example, which contradicts law of demand and supply, is the latest trends in the prices of oil. It is evident form the given graph that during 2008, the prices of crude oil declined too sharply. Before this period, the prices of crude oil were at their peak however, the demand of crude oil in the world was very high. Although such a high demand should not let the prices to decline so sharply, however, they did decline. In a competitive market structure, reservation pricing strategies are commonly used because the companies end up in price wars. The case of Ryanair Airlines can be explained in this scenario.The airlines was reducing its prices very aggressively not only by compromising on its profits but through cost innovation and stripping out extra charged such as checked baggage etc. With time the gap between the fares of Ryanair and other airlines widened. The other airlines felt the risk of losing customers therefore; they also started reducing their fares. The customers started to think whether they are getting value for their money or not. Gradually, even the premium customer started travelling in low cost airlines and profits of Ryanair showed a significant increase between 2007 and 2008 (IMD, 2009). Although this phenomenon shows that reservation pricing concept has been introduced to save the interest of consumers and the suppliers, however, it also shows that consumer awareness has increased nowadays. Consumers do not only want low prices but they ask for true value for their money. Conventional microeconomic theories provide us theoretical knowledge of a real world phenomenon. Although there are various factors, which may influence the businesses and markets, thereby, making their behaviour different from the behaviour defined by these theories, however, these theories still have a very important role in our economy. States make most of their decisions in considerations to theories implications. For example, if a company devalues its currency, the demand of its exports boost in the international market because the goods become cheaper for foreigners and they find the prices lower. Therefore, countries sometimes artificially regulate their currencies to increase to decrease the demand of their products. One of the important concepts in microeconomics is price control. In 1930s, the United State government brought parity prices for some farm products. The idea of this price parity was that if market price went below parity price, the government would pay farmers the difference to buy the unsold crops. As a result surpluses were noticed and government stored the crops. To finish the surpluses, government introduced acreage controls through which farmers were being paid to take land out of production. The surprising results were seen because even a 20 percent decline in wheat acreage, did not reduce the production of wheat therefore, sometimes official prices create surprising results. Brent barrel petroleum spot prices, May 1987 – March 2009. Source: Wikipedia According to Dean (1981, pp. 362-367), conventional microeconomic theories have ignored the inflation transmission process. He also explained that general equilibrium micro theory does not highlight transmission process because the concepts of equilibrium and disequilibrium are out of its scope. Therefore, ignorance of inflation transmission process is because of lack adequacies in microeconomic theories. There are various cases, in which the conventional microeconomic theories do represent the behavior of market forces. For example, in New Zealand agriculture, the increase in output per unit of labour was noticed, when a continuing trend towards substitution of capital for labour was followed. Meanwhile, the decline in the prices of products was also observed therefore, it was expected that demand curve would shift left (farmer’s labour on farm) and the same thing happened. Based on such trends that are explained by supply and demand, the important decisions of on-farm investment and off-farm investments are made in New Zealand agriculture. There are various economies which are enjoying great benefits by taking conventional economies theories into consideration. For example, Japanese capitalists are generating profits because they have long term plan for economic development and they take more interest in the development of commodities in which they are lacking and unlike other economies, they do not play monopolies with their savings. It is evident from the fact that Japanese capitalists have 50 percent interest in all mines. China is also attempting to follow the same strategy. Basically, capital moves from one field of production to the other depending on where the demand is high and this fluctuation results in prices changes and created capital scarcity when there is a glut. Conventional microeconomics theories do have some assumptions, which need to be considered very carefully before evaluating the implications of this theory. For example, nowadays, the pump prices are increasing, so do the consumption of gas. Now, one can surely ask the question why it does not reduce consumption. In fact, the simultaneous increase of price and demand are not contradicting the law of supply and demand because law of demand clearly states that in case of Giffen Goods, the supply and demand curve has opposite interpretations. The house prices in Britain rose by more than £11,000 during 2009 and according to a housing economist, Martin Ellis (2009) the demand has increased because of the low interest rates and decline in property prices. The decline in property prices enhanced the confidence of consumers thereby, increasing the demand of property. The conventional microeconomic theory also supports this example because the decrease in price is followed by increase in demand (Elliott, 2009). Therefore, from all of the above mentioned examples, it can be argued that there are many cases when markets and business contradicts the conventional microeconomic theories however; they generally behave in the manner predicted by such theories. The contradictions to theories can be explained by considering the assumptions of theories very carefully. A huge research work has been done in this area however; there is a need to know how the implications of the conventional microeconomics theories can be used to improve the businesses and market performance. In this way, we can surely get great benefits from these useful theories. References Cooperative Bank. (2009) The Co-operative Financial Services and Britannia merge to create a new, powerful force in financial services. [Online] Available from: http://www.co-operativebank.co.uk/servlet/Satellite/1224053763488,CFSweb/Page/Bank-CustomerServices [Accessed 3rd March 2010]. Dean. (1981) The American Economic Review. Papers and Proceedings of the Ninety-Third Annual Meeting of the American Economic Association [Online] 71 (2), 362-367. Elliott. (2009) Halifax: House prices up £11,000 since spring trough. [Online] Available from: http://www.guardian.co.uk/business/2009/nov/03/halifax-house-prices [Accessed 3rd March 2010]. IMD. (2009) RESPONDING TO CUT-PRICE RIVALS IN A DOWNTURN. [Online] Available from: http://www.imd.ch/research/publications/upload/PFM170_LR_Ryans.pdf [Accessed 3rd March 2010]. Kim, S .S . (2008) Law of Demand and Supply is Dead for Gold and Silver. [Online] Available from: http://seekingalpha.com/article/95496-law-of-supply-demand-is-dead-for-gold-silver [Accessed 3rd March 2010]. MAF. (n.d.) The implications of a demand & supply framework for off-farm income. [Online] Available from: http://www.maf.govt.nz/mafnet/rural-nz/profitability-and-economics/employment/off-farm-income-theory-and-practice/ofincth4.htm [Accessed 3rd March 2010]. Newsroom Orange Website. (2010) Merger of T-Mobile UK and Orange UK cleared by EU Commission. [Online] Available from: http://newsroom.orange.co.uk/2010/03/01/merger-of-t-mobile-uk-and-orange-uk-cleared-by-eu-commission/ [Accessed 3rd March 2010]. Salterre. (n.d.) Competition in the Market and Law of supply &demand. [Online] Available from: http://www.salterre.org/Mchptr9b.html [Accessed 3rd March 2010]. Samuelson, L. E. (1986) Microeconomic Theory. [Online] Springer. Available from: http://books.google.com.pk/books?id=MY3xOYst5RsC&dq=conentional+microeconomic+theory&source=gbs_navlinks_s [Accessed 3rd March 2010]. Wikipedia. (n.d.) Prices of Petroleum. [Online] Available from: http://en.wikipedia.org/wiki/Price_of_petroleum [Accessed 3rd March 2010]. Read More