The class of 2006

First "real" academic class in Warwick, The Basics of Economics.
Ok is not like if the "Introduccion to accounting" was a bad one, in fact I didn't know how to put the rigth figures in a balance sheet before, but I can see that the economics one is gonna be really interesting, and the professor (Ben Knight) was really cool (ok, having and Irish mother with spanish surname has also influenced me a bit ;-).

Since I want to improve my english writting skills and at the same time consolidate the few concepts explained today I'm afraid I'm gonna bored any single lector that accidentaly came to my blog, but eh! guess what? at lest you don't have to pay the 25.000 pounds of the MBA.
I'm even thinking about do it in a weekly basis if I have time, let's see what happens.

Let's start saying that managers have little influence in the success of their companies because of the so called "Economic Determinism" quoting Warren Buffet.
Because Macroeconomy and Microeconomy forces managers' job should be to simply pray for good times.
In accordance with Ben, economics explains Cycles and Trends in the Financial Performance of Business by assessing:

• Vulnerability of the individual business to external forces
• Exposure in its Market
• Exposure to the Global Macroeconomy

My guess was that the professor just wanted to make his subject relevant but let's go deep inside...

Vulnerability has to be with "The Short Run Average Cost Curve". Economists assume that capital is fixed in the short run therefore they consider only fixed and variable costs as Total Cost. On the other hand they consider the Output of a business the what the costumer pays for it minus the value of the "bought in" inputs.
Basically we have a function called "Average Total Costs" equal to "Total Cost" divide by "Output" and if we draw this function depending on the Output we have the following curve:

Point B is called "Minimum Efficient Scale" and it tells you things like the amount of production that you should have to maximize efficiency.
I know what are you thinking, why the heck is called minimum if in fact is maximizing, first of all economist are not so optimistic as engineers are and second they put the average cost in the y-axis when it clearly is a function of the price, so, what could you expect from them?

Anyway, with this curve is really important because depending in which industry you are,
it will be more like a Champagne Flute in which case you'll be more vulnerable to external Economics changes or like a saucer like manufacturing industries in which case your variable cost is bigger than the fixed one and you aren't so vulnerable, therefore The Slope matters!


Market Exposure is even easier to understand. Usually when you reduce the price of your product, more people buy it because the real incomen of the customer also increase or because of the substitution effect, like when DVD players were cheaper than VHS everyone subsituted it for the new one.

This is represented in the next graphic, but what is really interesting, is when you compare the slope of two different industries.

The blue one is less exposed to changes in the market because a change in price doesn't affect (as much) the quantity of products sold, like the oil, where an increase of 1% in price only rebounds in a 0.003% decrease in demand. Whereas the green one is more elastic and exposed to market changes.

Just to mention that the dream of any company is to reverse the slope of the function and make it in a way that when you increase price more people buy your product.

Another Market Exposure can be seen from the customer's income point of view, the so called the Income Elasticity of Demand (IED). This is equal to the % change in demand divide per % change in buyer's income.
For Normal Goods this figure is positive and demand increases when the income increases
For Inferior Goods the IED is negative meaning that if the income rises the demand drops.
For Luxury Goods where a 1% income increase increases the demand in more than 1% the IED is bigger than 1.
If products are strongly inferior then an increase in price will reduce real income and hence strongly increase demand offsetting the substitution effect so the demand curve is positively sloped.

So far so good, we haven't yet spoken about the Macroeconomic Exposure, but this almost is self explanatory.

One of the key concepts is the Gross Domestic Product (GPD), which is the sum of value added by each and every producer of goods and services.
This small acronim determines the Disposable income, which determines the Aggregate ie Total Demand, which determines the Market Demand and Prices, in a way that if the GPD increases all the rest increases and the other way around.
Giving us another powerfull mesure unit called "GDP Respone Elasticity", which is the "% change in Market Demand" divide per "% change in GDP".
With this we also have industries with more elasticity like steel or leisure and others with less like water or food.

There are more important macro exposures like Exchange rate and Interest rate but I think we had enough for today.

Ok managers of the world, now you see how little you can influence to the success or fail of your companies, but instead of just sit and pray just try to AVOID being vulnerable and exposed asking your marketing team to discommoditise your product and differentiating it from the rest; or asking your law team to put barriers to entry to the competitors; or just start rigth now to buy suppliers and distribution chains to be able toapply vertical restraints.
Yeah, I now these are just minutes compared with the power of politicians, but by the way, who wants to study politics and give the power to the people (at least once every four years) ?? ;-)