Strategy Byte - Week 35 Market & Price

Recap

During Week 34, we discussed fiscal policy which results in either

1. Fiscal Deficit or
2. Fiscal Surplus

The policy followed by Governments depends on

1. State of the Economy - If the economy is in recession, increase spending to prop up the economy results in higher deficits & conversely if the economy is in a bubble, decrease spending & increase revenue collection measures to cool down the economy. E.g., during Covid-19, Governments across the world increased spending to boost their economies severely affected by the pandemic.
2. Tax Policies - To increase efficiency of tax or revenue collection by increasing their tax base, Governments across the world have introduced new tax laws & policies with the objective to reduce their fiscal deficits. E.g., DMTT, VAT, CIT etc introduced by the GCC economies to create new revenue sources as well as diversify away from oil.
3. Subsidies, Military & Social spending - Increased spending on subsidies & social security along with military & police funding depending on population demographics & security situation respectively causes increased spending resulting in higher deficits.
4. Unexpected events - War, famine, natural calamities etc can cause deficits to skyrocket due to spending to get over the event & reconstruct a damaged economy.

Then we discussed types of fiscal policy which can be :

1. Expansionary or
2. Contractionary

We then explored National Debt which is the amount of money owed by a National Government.

National Debt is calculated as a % of GDP & we explored the top 10 countries with the highest debt to GDP ratio.

But why did we discuss some key macro-economic variables over the last several weeks & what do these variables have to do with Strategy?

Before we get into the explicit relationship between these variables & strategy, let us understand that the state of these variables & their importance at a point in time affects something known as Supply & Demand. What is Supply & Demand?

But before we get into Supply & Demand, let us understand two concepts :

1. Market
2. Price

Let us explore...

Market

A market is any place or venue where buyers & sellers can exchange goods & services.

A market may be

1. Physical - like a retail outlet (E.g., any physical outlet)
2. Virtual or online - like an online store (E.g., Amazon, E-bay)

(Source : here)

So, from the above definition, we can infer that :

1. A market is a place that enables buyers & sellers to exchange goods & services which means a market has two sides - buyers & sellers
2. There are markets for goods such as oranges, appliances, raw materials etc
3. There are markets for services such as online courses, haircuts, professional services etc.
4. Physical markets enable buyers & sellers to meet & conduct business
5. Virtual / online markets enable buyers & sellers who never meet or know little about each other to connect with each other online to conduct business

If we go to any market - physical or online, there are lots of buyers & sellers transacting at any point in time.

The energy surrounding a bazaar or as we call in this part of the world "Souk" is incredible. The haggling & negotiations are part of this energy. Buyers trying to reduce the price & sellers trying to sell at the maximum margin possible. With this in mind, let us now understand what is a Competitive Market.

Competitive Market

A competitive market is a market where there are a large number of buyers & sellers where no single buyer or seller can influence the price of goods being sold.

It is more of a theoretical concept than what exists in real life.

Imagine you are in a bazaar (like the ones above) where the sellers want to maximize their margins by selling their goods at the highest price possible. What would you as a buyer do if you feel the price is too high?

1. Negotiate with the seller to reduce the price or
2. Move on to another seller

But then, two questions arise - What is price? & the price is high compared to what?

Price

There are two kinds of prices in economics :

1. Money Price
2. Relative Price

The price of a good or service is the amount of currency that is given up in exchange for that good or service. This is known as Money Price.

However, life is not all that rosy or easy. There are constraints around us relating to

1. Resources - money available to spend
2. Supply of goods - the goods that we want may not be available in unlimited quantities.

So, we want to allocate those limited resources to something that we perceive to satisfy our needs best.

Consider we are grocery shopping & we reach the fruits section.

There are apples & oranges. Assume one apple costs $ 2.00 & an orange costs $ 4.00. So,

Cost of 1 orange = Cost of two apples

When we compare the price of one item with that of another, that price is called Relative Price.

Now, with limitation of resources (money), assume we can buy only one item - apples or oranges. If we decide to buy one orange, we sacrifice two apples. The two apples sacrificed is called the opportunity cost.

So, based on our preferences & resource constraints, there is a trade-off involved in our decisions to spend money or in other words - resource allocation.

Assume, there was a news flash that oranges have a special vitamin which helps in reducing muscle inflammation. Now, all health freaks would freak out on the oranges & demand would rise. What will happen then?

The demand for oranges will go up increasing their price. The price of apples would remain the same. So, the price of oranges would go up relative to apples which means the relative price of oranges would go up.

The consumers will buy either apples or oranges depending on their preferences at that point in time. If someone feels that oranges are too expensive, they will go for apples. This can also impact suppliers' decision to grow more oranges instead of apples.

Thus, the concept of relative pricing helps consumers & producers make informed decisions about resource allocation to spend or produce in line with their preferences.

With this understanding of market & relative prices, let us dive deep into Demand & Supply next week.