microeconomics and business basics

Microeconomics and Business Basics

Revenues (sales), the total amount you sell to customers

= number of Units x Price

Revenues

• Sell 3 ice cream bars

• Each ice cream bar has a price of $2.50

• Revenues = $7.50

Costs

• What you spent to make the good that you sold

• For the ice cream bar, the cost of all the ingredients + what it cost to make the bar

Profit or Loss

• Profit – When revenues are more than total costs

• Loss – When revenues are less than total costs

Types of Costs

Fixed Costs

Expenses that don't change based on production or sales volumes.

Toyota Example – Fixed Costs

• Toyota must have an entire factory all ready to make just one car

• To have a factory ready, you need to pay all the workers, pay the electricity costs, pay the salaries of management, pay insurance, pay accountants, rent, cleaning of the factory after the shift is over, etc..

Burger King Example, Fixed Costs

• If Burger King is open from 1130am to 1130pm, it is possible that they could have only one customer during those 12 hours

• But BK still has to have a cashier, cook, person that cleans, pay electricity for the day, and pay the salary of the CEO in Miami, etc…

Variable Costs

Variable Costs are expenses that vary based on production volumes. They include materials and delivery costs

Toyota example – Variable Costs

• The amount of the following materials that you need will depend on the number or cars manufactured!

• Metal, tires, plastic, car radios, engines, brakes, paint, GPS systems, leather, car batteries, etc..

• Also the more cars you sell, the more it costs you to deliver them to customers (delivery costs)

Burger King´s Variable Costs?

• Hamburger meat, buns, tomatoes, lettuce

• The more hamburgers they make in one day, the higher the costs of these things are

Total Costs

Total Costs = Fixed Costs + Variable Costs

Profit = Revenues – Total Costs

For the ice cream bar example:

Revenues $7.50Total costs $3.00Profit $4.50

Average Total Costs per unit

• The total costs divided by the number of units

Example: 1 unit (1 Nestle ice cream bar)Fixed Costs $10,000Variable Costs $1 per unit

$10,000 + $1 = $10,001 = $10,001 ATC per unit 1 unit

Economies of Scale

Spreading your fixed costs over a larger base

It will be cheaper PER ice cream bar for Nestle to make 30,000 ice cream bars than to make one ice cream bar (or even 20,000)

Economies of Scale!

Example: 5,000 unitsFixed Costs $10,000Variable Costs $1 per unit

10,000 + $5,000 = $15,000 = $3 ATC per unit 5,000 units

Economies of Scale!

Example: 10,000 unitsFixed Costs $10,000Variable Costs $1 per unit

$10,000 + $10,000 = $20,000 = $2 ATC per unit 10,000 units

Economies of Scale!

Example: 30,000 unitsFixed Costs $10,000Variable Costs $1 per unit

$10,000 + $30,000 = $40,000 = $1.33 ATC per unit 30,000 units

Average Revenues (AR)

The price you charge

Simple case, only one product (Nestle ice cream bar)

FACTORS OF PRODUCTION

• LAND

• LABOUR

• CAPITAL

• ENTERPRISE

South American countries´ rankings for

market Freedom

Source for reasons that some rank low

2011 Investment Climate Statement (BUREAU OF ECONOMIC, ENERGY AND BUSINESS AFFAIRS, US GOVERNMENT)

Why Does Economic Freedom Matter?

Economic freedom is a crucial component of liberty.

It empowers people to work, produce, consume, own, trade, and invest according to their personal choices.

Pink tide countries rank low on the market freedom list – Why?

• Countries that rank low: Their overall investment climates

remain uncertain as economic, commercial and investment policies continue to evolve

Lower ranking countries

• Various legal changes negatively impact private sector

• Some governments have terminated investments by MEDCs in their countries

Low ranking countries

• In general, the legal complexity resulting from the inconsistent application of investment laws

• Means risks of doing business in these countries

Low ranking countries

• Government officials and private businesses have used regulatory schemes and questionable legal maneuvers to affect foreign company operations in the country

• Companies have sometimes been confronted with requirements of additional payments not negotiated in original agreements.

Low ranking countries

• Sometines property, jointly owned by several persons or companies, can be seized by courts through judgments or seizure orders

• Resolution and compensation typically require many years and significant legal costs

Low ranking countries

• The judiciary systems in some of the continues operate slowly

• Enforcement against intellectual property infringement remains a serious problem

Low ranking countries

•Weakness in the judicial system and its susceptibility to political or economic pressures (slow and/or corrupt)

Low ranking countries

• Criminal complaints and arrest warrants against foreign company officials have been used to pressure companies involved in commercial disputes

Low ranking countries

• There is a widespread local trade in pirated audio and video recordings, computer software, and counterfeit activity regarding brand name clothing

Low ranking countries

There are sometimes no antitrust laws and industry is fairly concentrated

Low ranking countries

• Inconsistency: ministries and regional and municipal governments all impose their own requirements and regulations on commercial activity

Low ranking countries

• Customs procedures (for imports arriving) are sometimes too complicated and slow

• Regulators sometimes provide little or no opportunity for public comment on newly proposed laws and regulations

Low ranking countries

• Capital markets are not developed

• Corruption sometimes

• Labor laws that do not protect employees adequataley (or are not inforced)

Good news, some progress

• In many of these countries the central governments and are exploring ways to support current investment and encourage the entry of new investment

• and also lower the bureaucratic hurdles (RED TAPE) mentioned

Where do South American countries rank?

• Rankings of the 10 countries of South America in the Forbes Magazine ¨Best Countries for Business¨ in 2011

• The Rankings are based on 11 different factors, and evaluated 134 different countries:

Forbes List

• Property rights

• Innovation

• Taxes

Forbes List

• Technology

• Corruption

• Freedom (personal, trade and monetary)

Forbes List

• Red tape (having to fill out forms, go through different steps, etc..)

• Investor protection

• Stock market performance

Forbes List

• Canada is number one in the world

• MEDCs rated higher than LEDCs

• South America: #24 is Chile

Forbes List

• #42 is Perú – Case of Mr. Humala and observations of Mr. Simons, 2006 to 2011 (next slide)

• #61 is Uruguay

• #62 is Colombia

Regarding Perú and Humala

• Not elected in 2006, was too extreme, too aligned with Chavez

• Elected in 2011 on a more balance promise (to be more in the center, less on the left)

Forbes List

• #73 is Brazil

• # 85 is Paraguay

• #95 is Argentina

Forbes List (at the bottom)

• #114 is Ecuador

• #123 is Bolivia

• #130 is Venezuela

Types of economies

• Market, command, mixed

• But, we find that virtually all economies are mixed

Types of economies

• A market economy (we also use the word capitalism) is an economy in which decisions regarding investment, production and distribution are based on supply and demand.

• The prices of goods and services are determined in a free price system

Command economy

• Also called a ¨planned economy¨ is on that is completely controlled by the government. The word socialism is used to describe this, BUT MANY CAPITALIST ECONOMIES HAVE PUBLIC OWNERSHIP OF CERTAIN PARTS TOO (so we have to refer to mixed economy)

• Not common in the world

• Examples: former Soviet Union, Cuba, Libya, North Korea

Mixed economy

• Most mixed economies can be described as market economies with strong regulatory oversight, in addition to having a variety of government-sponsored aspects

• The USA has been called a mixed economy and so have welfare states (Sweden and Norway, where the government plays are large role in the protection of the well being of its citizens)

Mixed economies

• Cuba has even been labled a mixed economy, so it gets confusing

• So we can say that mixed economies is the most common type of economy.

Mixed economies

• In USA for example, there is the Central Bank, the Post office, many of the railroads were owned by the government, public television stations, and many, many government agencies

• And much regulatory oversight and things like minimum wages, and trade barriers

But the US is closer to pure capitalist than many others

• POOR SAFETY NET COMPARED TO MANY OTHER DEVELOPED COUNTRIES

• Some developing countries that also have poor safety nets might also be considered close to being puer capitalist

• Compare this to the UK, Sweden or Germany

Mixed economies – Democratic Socialism

• Using this terminology, we might put Venezuela in center left. Its government is also called democratic socialism

• And we also might put the other countries that have elected to more ¨left thinking leaders¨ in the last 15 years (pink tide)

What about Communism?• It is a political system that began in the 20th century with

the ideas of Karl Marx (German philospher) in the late 1800s, then was used by Vladmir Lenin in the early 1900s to lead a revolution in Russia (and the communist Soviet Union was formed)

• Communism is associated with the command, planned economy we talked about. Communisim believes that the all workers should be treated the same, and does not like some profiting more than others, so it is anti-capitalism

Leaders of Latin America that we can call center ¨left¨

• And we can add that they tend to be center left (like China or Cuba) or center right (like USA, UK, Colombia, Mexico and many, many others)

Red Tide

Today

The Pink Tide 1980 – Chavez - Pink Tide begins

The Pink Tide – 2000 to present

• Mixed economies, democracies, but the leaders are center left

• A number of Latin American administrations that are committed to moderate economic reform – Brazil, Chile, best examples

Democratic Socialism – In some countries, 2000 to present

• For Chavez and Morales (Ven and Bolivia, the

most radical of the Pink tide) it is a more extreme backlash against the Washington Consensus

The Washington Consensus

• A set of liberal economic policies that Washington-based institutions urged Latin American countries to follow, including privatization, trade liberalization and fiscal discipline

- And of course, democracy

The Pink Tide – 1998-2010 1998: Hugo Chavez, Venezuela1999: Ricardo Lagos, Chile2002: Luis Inacio Lula da Silva, Brazil2003: Nestor Kirchner, Argentina2004: Tabare Vasquez, Uruguay2005: Evo Morales, Bolivia2006: Michelle Bachelet, Chile2006: Rafael Correa, Ecuador2006: Manuel Zelaya, Honduras2006: Daniel Ortega, Nicaragua2007: Cristina Kirchner, Argentina2008: Fernando Lugo, Paraguay (impeached June 2012)2009: Jose Mujica, Uruguay2009: Mauricio Funes, El Salvador2010: Dilma Rousseff, Brazil2011: Ollanta Humala, Peru MANY EXPERTS WOULD AGREE THAT IT DOES NOT BELONG IN THE

LIST

STUDY GUIDE, WEEK 5 ASESSMENT ALL MULTIPE CHOICE Qs, some simple math

calculations for Profit/Loss Qs, bring calculators1- Video, Meltdown, US housing bubble and recession2 - Factors of Production3 - Types of economies, economic/political map, Pink

Tide, and ECU and VEN case studies4 - Economic Freedom Index5 - Fixed Costs, Variable Costs, ATC, Profit/Loss, and

Economies of scale, 6 - Financial Intermediation

Case Study of the Pink Tide

Ecuador

Ecuador

• DEMOCRATIC SOCIALISM, Mixed Economy, Pink Tide Left Center

• Rafael Correa has made the economic freedom ranking worsen with his policies, but has also had tremendous success with his model (which Venezuela has not), Why?

Introduction – Ecuador (Rafael Correa, PhD in Economics, University of Illinois)• The keys: rich natural resources, A SMALL COUNTRY

(small consumption of oil), and super high oil prices

• Increased government spending on infrastructue with the money from oil that now goes to Ecuador instead of foreigners

• This social spending is aimed at helping everyone, but ESPECIALLY THE POOR

Keys to Ecuador –took back oil from foreign companies

• Before, 80% of the oil profits went to foreign companies, N0W OVER 80% go to the Ecuadorian government

• He took the oil investments from foreign companies, hurting economic freedom tremendously (now one of the worst in the world), FDI is very low

Ecuador - Socialism• Has increased government spending (3 times

more than past Ecuadorian governments), which is good for job creation and infrastructure, but bad if he is borrowing for the funds

• The government gets more money when the price of oil is high, giving him more money to spend, so he is benefitting from the high price of oil, as are other oil exporting nations

Which Venezuela has failed to do

• At least we can say that Ecuador has taken advantage of its rich natural resources and high oil prices, and has avoided inflation crises as the currency in Ecuador is the US dollar

• Compare to Venezuela, 49% inflation, terrible crime, poor people given handouts instead of being part of infrastructure building, and public sector jobs, etc.., shortages of medicines

Ecuador - Price of Oil – per barrel

• Wide fluctuations:

• Was as low as $11 per barrel in the early 2000s

• Reached $140 in 2008

• Now at around $100 (vs. 20s range for much of the 80s and 90s)

So, Ecuador has huge inflows of cash from its rich oil resources

• Produces 500,000 barrels a day

• Only 15 million population, only need 150,000 barrels a day for its people

• EXPORTING 350,000 barrels a day, this is the key to Correa being able to manage the country in a left center way and not suffer consquences yet

Chart – 2007 to 2012 - Price of oil

•

WTI Crude Oil$87.01 ▼0.65 0.74% 12:39 PM EDT - 2012.07.04

Determinants of Oil Price

• Supply of oil (discoveries, extraction, reserves)

• Demand for oil (consumption determined by economic growth)

• Political instability in oil producing nations (Iran, Iraq, Afghanistan, Venezuela, Israel, Syria, all the chaos in the world…)

Ecuador - is there a cost to this?

• In addition to seizing foreign investments, Ecuador also didn´t pay some international debts it owed, also hurting its reputation

• In 2010 FDI was $164 million, compared to $7.3 billion in Peru and the same amount in Colombia

Ecuador - (Correa´s) policies

• Negatives: of a lot of government spending is keeping it´s country risk rating the second highest of Latin America after Venezuela

Ecuador – What they do with the money = Socialism

• Guaranteeing health insurance for all citizens – 2008 constitution

• Spending on internal programs to help the people – HIGHEST RATE OF INVESTMENT ON SOCIAL PROGRAMS (10% OF GDP) OF ANY LATIN AMERICAN COUNTRY

Other public areas getting attention

• Healthcare

• Sanitation

• Housing for the poor

• Education (Ecuador does need to improve it´s university system a lot!, Correa is aware of this)

This socialism is good in the short term

• But Ecuador will fall behind other Latin American economies if it does not invest in the country and let foreigners invest

• Risks if price of oil goes down, also it is a non-renewable source (Geography class)

Also, depending on one single export - dangerous

• From Geography (Blue Book), a page is dedicated to countries with high percentage of exports in just one product (dangerous)

Ecuador - (Correa´s) policiesEcuador`s NON-OIL trade deficit reached a record 13% of GDP in 2010, SO ECUADOR IS A SMALL NATION HAVING A LOT OF OIL FOR ITS SIZE (key to success)

Compare to US trade deficit 2.5% of its GDP

What is the Price of having lower FDI in Ecuador

Does it hurt you in the long term? Yes, country develops slower or not at all, less job creation, not benefitting from foreign money and expertise

• What if the oil price declines significantly, how will Ecuador maintain this spending?

• How will Correa or the next President deal with increased debt?

Summary, Ecuador, the good things about Socialism

• HELPING THE POOR IS WHAT THE PINK TIDE IS ALL ABOUT………..Correa wants the best for his people, but is this PhD doing it the right way?

Ecuador (Correa) - Summary• Climate for Ecuadorian businesses and foreign

businesses still operating in ECU is stable, but FDI has decreased significantly, which is bad for Ecuador´s future

• Economic numbers are good, growth continues. He has many people applauding him, the evaluation of his policies is ongoing as it is for ANY PRESIDENT OF ANY COUNTRY

Ecuador Summary

• We can say that Ecuador is benefitting from the high price of oil, but if the price of oil were significantly lower, there might be more challenges for Mr. Correa to deal with

• All similar to Maduro´s (Ven) situation (which Chavez created). But to this point, Correa is managing Ecuador far superior than Maduro in VEN

Case Study – Venezuela November 2013

Near Highest inflation in the world (49.5%)Low GDP growth and Devaluation of the currency (5 times in 9 years)

Venezuela – What is a devaluation?

• There is an official government exchange rate (was 4.3 Bolivares per US dollar before the 2013 devaluation), now it is 6.3 Bolivares per dollar (after the 5th devaluation recently)

• And there is an unofficial Black Market Rate (is as high as 30x the official government rate!)

Devaluation

Before ….. 1 dollar = 4.3 Bolivares Now …… 1 dollar = 6.3 Bolivares

• Dollar is stronger, Bolivar weaker So exports up, imports down

Venezuela• Why devalue?

-Can export more of its oil

-It uses the new exchange rate to value its debt to other countries and like a magician it has less debt! Example 100,000 Bolivares of debt at 4 exchange rate = $25,000 of debt

Now devalue the currency to 6, and the amount of debt has reduced to $16,000

Venezuela, Official government exchange rate

• Very few dollars available to exchange at the ARTIFICIALLY LOW OFFICAL RATE. Maduro just announced that he will make $900 million dollars available to importers, they will buy them in an auction (highest bidders get the dollars)

• If you could get 1 dollar for 4.3 Bolivares it would be good, but you cannot, so everyone ends up exchanging at the black market rate, which was as high as B37 to $1, now is around B25 to $1.

To review – everyone in Ven wants dollars

• You get to Caracas airport with dollars, everyone wants dollars, you can get 25 Bolivares for 1 dollar (instead of official 6 rate)

• If you are a Venezuelan and want dollars, you would rather pay the official 6x rate (than 25, the black market rate) but noy many dollars are available at that rate, so you pay the black market rate

Venezuela, and why do Venezuelans want dollars?

• To be able to import things (number one reason)

• To be able to travel outside of Venzuela, and some are fleeing Venezuela to live in other countries!

Venezuela – Black Market Rate

• Black market rate is what the exchange rate would be if the currency did not have an official exchange rate, it reflects the true value of the currency

Venezuela – Black market rate is the real rate

• This is the reason that it appears the Mcdonald´s is charging $16.27 for a Big Mac in Caracas. The price is 70 Bolivares

• 70/4.3 = $16.72 using the official exchange rate!

Venezuela

• But since almost anyone going to Mcdonald´s has exchanged their dollars at the black market rate of approximately 25 Bolivares per dollar, the price for the Big Mac is actually $2.80

Venezuela

• 3. THERE IS HIGH INFLATION, MORE MONEY IS CHASING GOODS THAN BEFORE

• 4. LOSE CREDIBILITY WITH OTHER COUNTRIES (ECONOMIC FREEDOM)

Venezuela

• What are the negatives? There are many…

• 1. PURCHASING POWER OF THE BOLIVAR GOES DOWN

• 2. IMPORTERS CANNOT BUY AS MANY FOREIGN GOODS

One exception for the devaluation

• Medicinces have a capped price (a limit to how much they can charge) so that Venezuelans can still get the medicine they need

• But this is at the expense of profits of the pharmaceutical companies importing the medicines, and they have to have dollars at the lower, official exchange rate

What Experts say about Venezuela

CANNOT RUN A COUNTRY SUCCESSFULLY BY SIMPLY PRINTING MORE AND MORE MONEY AND GIVING IT TO THE PEOPLE

Should encourage invesment (including FDI) and focus on training people and creating jobs, not just handing out money…