When we think of economics we think of supply and demand. What does that mean? W

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When we think of economics we think of supply and demand. What does that mean? While we know that if price goes up demand tends to go down. If for no other reason than we have limited resources and we slow or speed up our consuming as income increases or decreases. When the price goes up we have less money available to buy other things. Our cost of living goes up and our standard of living goes down. When price goes down we pay less for the product which frees up resources (consumer surplus) for other purchases. This raises our standard of living by reducing our cost of living.

But what about supply? If price goes up, supply tends to go up. If price goes down, supply tends to go down. As the cost of inputs---land, labor, capital and entrepreneurship--- goes up the per unit cost of production goes up and supply goes down to control costs. Anything that increases cost will increase the per unit production cost and reduce the production to bring costs back in line with sales and restore gross and net profits to their necessary level.

There are several costs to worry about with fixed and variable costs being the most important. Fixed costs are the costs that must be paid before you can even produce one unit of a product. They include, loans, the facilities used for production, utilities, all the manufacturing equipment, desks, computers, chairs, the salaries of senior management and staff. It's everything that must be in place before you can produce anything. These costs do not increase with inputs. They cannot be changed to any large degree without the passage of time. It can take years to change some of these costs because of long term contracts. These costs are called operating costs or over-heads.

This brings up an interesting thought. Retailers quite often talk about cutting out the middleman so they can reduce their prices. Who are these middlemen they are cutting out? The distributors. How then do the retailers get the products they sell if they do not get them from a distributor?

Then we have variable costs.These are the costs that vary with the inputs (factors of production). They are the only costs that can be controlled in the short-run. Sales of your product goes down this increases your costs per unit of production in manufacturing. In retail it increases your cost per square foot of display space and increases the need to sell more per square foot. You are not moving as much merchandise so your carrying costs (inventory costs) go up. You must control costs or you loose control of your business. The largest component of variable costs is labor. It makes up approximately 70% of variable costs. Sales go down and immediately you reduce your labor costs to conserve capital. You have to lay people off. You have no choice. It's the only cost that be immediately controlled. You cannot lose control of your costs or your business is gone.

If the price goes up, you immediately increase out-put. Why? If we assume, correctly I might add, that if we can increase out-put with a relatively small increase in production costs. We will therefore hire more people and immediately increase out-put. The result will be, in the short-run, increased our gross and net profits. No one knows that the increase in price added virtually little to your production costs. This allows selling it at a higher price which in turn will increase both gross and net profit. We will then be earning pure or economic profits---profits above accounting profits.

However, when the price goes down, demand will go up as will production costs compared to revenue. You have produced fewer goods over the same period of time. You now have a smaller output over which to spread your production costs.This means the difference between total costs (variable cost + fixed costs) will increase and reduce both your gross and our net profits. (Price minus Total Cost=Revenue) We will immediately reduce production and lay people off. This will allow us to restore our gross and net profits to an acceptable level.

Controlling costs is a constant battle. One which I fought, mostly with success, in my 4 years as a Production Operations Manager for the second largest pharmaceutical manufacturer in Europe. Production Operations is a good job but you must be able to work under great pressure and stress. If you can't handle stress or pressure you will end up as a chain-smoker, an alcoholic or you might also develop an ulcer and have to rely on a liquid diet. Unfortunately not the kind of liquids some people might desire. It' a great job if you like a challenge and have strong problem solving skills. I loved it! Of course, I did develop a small ulcer.

I almost forgot to mention that when drawing a supply schedule, if you must, it must always have a positive intercept on the vertical or Y axis. Nothing is free! There is no free lunch! There are costs associated with production. So it cannot start at zero. If you see, in a textbook, a supply schedule that starts at zero, throw the book away. They know not of what they speak!

What about equilibrium? It's real. However, once found it will shift almost as fast as you determine its location. Why? Because we have a dynamic economy. People's personal tastes and preferences change constantly. So do prices, primarily due to increased costs, taxes and regulations.

Let's look at the price of a gallon of milk, go to every store within two miles of your home and I'll guarantee you will find at least three different prices. So which one is the equilibrium price? Do we average them? If we do, and declare it the equilibrium price, will that price hold true in Tampa, New York, Chicago, San Francisco and Boston? No! Each market is totally unique and unrepeatable. As anyone in marketing I hope knows. Also equilibrium is a moving target. That's one of the reasons prices change. Producers and sellers are looking for the magic amount to produce in order to maximize their revenues. If you produce too much you have too much capital tied up in production costs and inventory which reduces cash flow. You must therefore reduce production and lay people off. It's a balancing act based on assumptions made as to how much should be produced and offered on the market to satisfy needs and wants. This is called demand analysis and is an important part of the firms strategic marketing plan.. Demand and prices rise and fall as sellers try to adjust their needs in a constantly changing market. We mustn't forget constantly changing money incomes which also has a major effect on demand. Prices change is not generally a result of a greedy businessman rather it is because of constantly changing resource prices, market forces and government regulations.

Before I forget, inflation is not a visitation from another planet. Something ET forgot too take home with him. Rather it is an increase in the money supply and the extension of credit. When government increases the money supply it is called sound monetary policy. When you or I do it, it's called counterfeiting.

Producer surplus is nothing more than a business who is perfectly willing to sell something at $30 but, because of market demand, are able to sell it for $50 which then gives them $20 of producer surplus better known as pure or economic profit. Something which businesses dream of attaining constantly.

Consumer surplus is nothing more than a customer willing to pay $50 for a pair of shoes but finds them for $30 dollars. They now have $20 in consumer surplus. This is what Wal Mart makes their living on. They sell a product at $30 dollars while their competition sells it at $50 or so. Where do they want you to spend this surplus? Think Wal Mart?

Economics is not brain surgery (my apologies to Ben Carson). Nor is it mathematics. It's wart removal! It's common stand-up, walking around sense. I had to have classes in philosophy and logic, as prerequisites, before I could take my first economics class. Now you may need calculus 1!

There are 10 embedded questions.

Do you believe that human activity can be predicted by mathematics?

Explanation / Answer

Well, Economics is concerned with the social science of distribution, consumption and production of goods and services. All economists try to do is study the statistics collected from the human behaviour over a period of time and study it to predict the future behaviour of the human sample so that a firm can keep making profits. After all, maximizing profits are the most important concern for a firm.

Economics and Mathematics (combined) are well equipped to predict human activity, but as you can see the key word here is "human". If we were talking about a specific individual, it would have been hard to keep track of his/her change in preferences but when we attempt to track the interests, preferences, tastes of a group of people then it surely helps. This might be not helpful for a particular person of the society but in the bigger picture it is quite useful for the consumers and producers, alike.

Your question about the fixed costs and why retailers ask the middlemen to be cut off is because they mostly increase the cost of production but they are not completely a part of fixed costs as they can be cut-off or employed in more numbers as per the situation of the firm.Thus, firing some middle-men brings the cost of production and the firm keeps making profits.

When these middlemen are fired, the retailers are required to either get their products from the firms themselves or the firms transports the product to them. As you can see, this can become a very difficult task for many firms, they are helpless and usually don't cut-off the middle-mens making them a part of their fixed cost. (firms can cut-off the middlemen in long-run).

Here I want to point a little mistake in your equation. the correct equation is (Total revenue-Total cost=economic profit).

Also, I completely agree that due to the dynamic markets we have, equilibirium prices have to change constantly but that is the job of economists to keep track of these changes because obviously the change in preferences , taste etc. of people won't happen instantly. thus, the firm can keep producing the quantity as suggested from the equilibirium price.

As you must already know that in an perfect competition if a firm is selling a product at higher price than other competing firms, people will stop purchasing from the firm charging higher price. Thus, walmart selling a product at $30 and not $50 is only making profit by selling a much higher quantity. We can agree that walmart has made profit by decreasing the market price and I am sure they are forming measures to get that $20 of consumer surplus out of the customer's pocket anyway. But in the end, customers are always in the profit as they are getting their product for by paying less than they are willing to. This is only one of the man amazing profits that economics provides us with.

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