Sample Economic Essay on Price vs. Total Expenditure

Price vs. Total Expenditure

Duffman’s assumption that the total amount of money spent on purchasing beer in Springfield will fall due to a fall in the unit price of beer is incorrect. In a business context, the law of demand states that all other factors being constant, the price of a commodity varies inversely with its demand (Krugman & Wells, 2005). The law simply states that in a business environment, price relates to demand through a function known as the demand curve. This function presupposes that the quantity of a product demanded varies with price along a downhill slope, that is, the quantity demanded by consumers will increase with a decrease in the price of the commodity. Conversely, the demand will fall with a subsequent increase in price. Therefore, a fall in the beer price will result in high demand and as a result, large quantities of beer will be sold. This translates into an increase in the total amount spent on beer.

Alternatively, the total expenditure on a product depends on the price elasticity of demand. Price elasticity of demand informs one of the decreases in quantity demanded (Rissel, 2011). An elastic demand implies that consumers are highly price-sensitive, thus changes in the commodity’s pricing would significantly affect its demand and consequently the total expenditure. Beer has an inelastic demand implying that its consumers are less sensitive to an increase in price. Based on this account, it may be argued that a decrease in the price of beer will stir an increased consumption and thus an increased expenditure as the total expenditure is calculated as price multiplied by quantity. Furthermore, beer has fewer substitutes and a change in its pricing is unlikely to affect its demand.

Fixed Costs in the Short Run

Profit maximization is essentially the principal objective of every business organization. In order to achieve this objective, decisions have to be made. An organization’s decisions are made within two main time frames: short-run and long-run. The short-run is a period whereby at least one quantity of the organization’s factors of production is fixed (Hirschey, 2009). A fixed cost refers to any cost that is independent of the firm’s level of output, it is incurred regardless of whether the firm is producing or not. Fixed costs are sometimes referred to as sunk costs as they cannot be changed. Sunk costs are insignificant to a firm’s short-run decisions and should therefore be ignored when making output and pricing decisions.

Fixed costs occur in form of the organization’s capital or existing plant size and have no significant impact on the short-run decisions. An organization’s short-run profits are affected by only variable costs and revenues.  A firm’s variable costs are those costs that have a direct proportionality variation to the output. An organization’s fixed costs do not change with output and thus the total fixed cost is constant at every production level (Hough, 1993). The average fixed cost, which is the quotient of the sum of all fixed costs and the total quantity produced, diminishes as the output swells. For this reason, fixed cost should not be considered when making output and pricing decisions in the short run, but rather focus should be put on variable costs and revenues. Since fixed costs can neither be changed nor recovered, they do not affect the output. Therefore, an organization should increase its production level in order to spread them.

References

Hirschey, M. (2009). Fundamentals of managerial economics. Mason, OH: South-Western/Cengage Learning.

Hough, P. G. (1993). Are all costs variable? (Or how to handle fixed costs in unit cost resourcing). The Armed Forces Comptroller, 38(1), 14. Retrieved from http://search.proquest.com/docview/194759440?accountid=1611

Krugman, P. R., & Wells, R. (2005). Chapter 3: Supply and Demand. In P. R. Krugman, & R. Wells, Microeconomics (pp. 45-62). New York: Worth.

Rissel, B. (2011). Price elasticity of demand. Credit Union Management, 34(10), 22-23. Retrieved from http://search.proquest.com/docview/902758503?accountid=1611