Responds to these two posts in 200 words each

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Week Four Discussion: Chapters 11-12

Amanda Kelly

Robert W. Plaster Graduate School for Business, University of the Cumberlands

BADM 535: Managerial Economics

Dr. Chris Phillip

Mar. 23, 2020

Many previous terms and concepts compound and evolve in this week’s reading as simplicity changes to complexity. Dealing with more realistic and complex pricing, one gains a better understanding for the art of pricing (Froeb et al. 2018). And the laws of supply and demand also impact exchange rates, growing the scope of supply and demand beyond a microeconomic level.

Foreign exchange shows how a market brings demand and supply for one type of currency, such as American dollars, together at an exchange rate. Exchange rates are another form of price equilibrium, in which the supply curve meets the demand curve (Froeb et al 2018). When a country wants invest in another country, they sell their currency to buy that other country’s currency (Froeb et al. 2018). It’s important, as Froeb et al. (2018) demonstrates, to keep the frame of reference in the forefront to understand what the supply is, what the demand is and what is being appreciated or depreciated in relation to one another. By investing in Icelandic exports, British investors sell their pounds to buy Icelandic krona. The investment increases demand of krona, leading to its appreciation relative to the British pound. As noted by Froeb at al. (2018), British investors pulled out of Icelandic investments, selling the krona to buy British pounds and bring their money home. This caused an increase in demand for British pounds, creating a depreciation for Icelandic krona. The application of currency devaluation shows the real world impact of foreign exchange. By selling one currency to buy another currency as part of a larger investment in a country, effects on suppliers and demanders, both foreign and domestic, come into play. “Currency devaluation helps domestic suppliers and foreign consumers but hurts domestic consumers and foreign suppliers,” (Froeb et al., 2018, p. 141). Froeb et al. (2018) notes the demand increase in fish exports from Iceland benefited Icelandic suppliers but hurt local consumers.

People and their expectation play a major role pricing, as Froeb et al. (2018) points out in both chapters this week. Bubbles develop due to complex pricing and price equilibrium. As people set a price expectation, a bubble can form around that item, causing the expectation to become true (Froeb et al. 2018). The authors point out three characteristics apparent in bubbles: Bubbles develop as enough investors disagree about the “importance of a big economic event,” bubbles “involve large increases in trading volume,” and bubbles may continue to develop even when suspected and won’t pop unless enough people act at the same time (Froeb et al., 2018, p. 143). The controversial concept explains, partially, the burst in the housing market last decade. The burst, as Froeb et al. notes (2018), is unpredictable still, which is important to understand because an economist may only be able to recognize a bubble and work to avoid it instead of predicting when it will pop. It may be hindsight, but common sense tells this economist loaning massive amounts of money to unqualified applicants does not goes as planned. Earning money is a goal, but not at the risk of taxpayers who bailed out the markets a decade ago. Prospect theory shares the same concepts as bubbles because price expectations are just as important to manage as actual prices. In fact, the price expectation, as Froeb et al. (2018) notes, is “self-fulfilling,” (p. 142).

The concept of complex pricing was simple to expand upon as Froeb et al. (2018) explains. Raising prices when commonly-owned substitutes are owned by the same firm to avoid stealing profits from one another and lowering prices to entice an increase demand for complements owned by the same company was an easy second step to take. Focusing on long-run marginal revenue and costs help business people map out long-term ventures. It is important to take capacity into account if capacity can be capped. If the goal is to turn a profit, it’s better to look at if marginal revenue is larger than marginal cost. Previous concepts on marginal revenue compared to marginal cost, even in the short run, show it is better to in the long run to overcharge for a hotel room if the loss is lower than to undercharge and fill to capacity. Making money in the short run and recalculating marginal analysis can lead to long-run profits for businesses with limited capacity. As always, it is crucial to know the demand to make the best decision possible.

References

Froeb, L. M., McCann, B. T., Shor, M., & Ward, M. R. (2018). Managerial Economics: A Problem Solving Approach (5th ed.). Boston: Cengage Learning.