What Does Interdependence Mean?

Interdependence is a connection between subjects where one subject’s needs can be fulfilled by the other subject’s resources and these transfer of resources works both ways. That means both subjects need each other to fulfill their needs. These kinds of relationships can be found almost everywhere since, as humans, we need other people’s help to survive and strive. In the business field, organizations depend on each other in many different levels.

Depending on the nature of the relationship, the degree of interdependence can be so high that the disappearance of one party might cause the other party to disappear too. Interdependence can be found in client-supplier relationships when it comes to raw materials. The supplier needs the client to pay for his goods but the client also needs the supplier in order to produce its own goods.

On the other hand, there’s also interdependence between business and financial companies. The latter needs to loan money to be financially profitable and the former needs to borrow money to leverage itself in order to grow.

Example

A business called City Wheels Co. is a bike rental venture that serves the city of Los Angeles. The company leases bikes to individuals for given periods of time and they have locations all around the city to pick-up and deliver the bikes. From the perspective of interdependence we can identify at least two essential interdependent relationships between the business and other parties.

First of all, City Wheels and its clients are interdependent since these individuals need the bikes for transportation and the company also depends on them to earn the revenues they need to remain operational. And second of all, there’s also interdependence with bike mechanics and bike suppliers, since in both cases these suppliers depend on the company to keep their business running and City Wheels depends on them to keep its business well equipped to serve its clients.

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What Does Microeconomics Mean?

Microeconomics, as opposed to macroeconomics, is focused on explaining the decision making processes of market participants individually. These participants are sometimes considered individuals even if they are a group, e.g. a household or a company. By studying the way economic decisions are made an economist can understand how scarce resources are allocated throughout the economic system. These interactions are normally explained in an under-normal-circumstances scenario, this means that there might be variations and departures from theorized behaviors proposed by microeconomics if the environment acts differently than what is expected.

The most widely known theories and concepts of microeconomics are the laws of supply and demand, the economic factors of production and the labor market economic dynamics. For example, the law of supply and demand says that the interaction between each of these forces will reach an equilibrium price at which supplied goods will match demanded goods. On the other hand, it also says that if the price of a given good increases, the quantity of goods demanded will decrease, under normal circumstances.

Here’s an illustration of how this works in practice.

Example

Fast Tires Co. is a company that manufactures different set of tires for regular automobiles. The company is currently restructuring its finances and as part of this effort they identified a weakness in the current price setting procedure. By analyzing the net margin of each product they concluded that in order to increase profitability they must increase prices by 30%. How could a study of the microeconomics involved in this operation help the company?

As we conceptualized previously, microeconomics is concerned with the dynamics of individual entities interacting between each other. By analyzing the behavior of the company’s clients an economist can evaluate the impact of this increase in the overall sales volume of the company. A microeconomics’ concept called elasticity of demand and the laws of supply and demand can be used to study the degree in which the current quantity demanded will be reduced by this increase and how this will affect the company’s financial structure.

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What Does Mutual Agency Mean?

Mutual agency only exists for partners acting within the scope of normal business operations and dealings. For example, a retailer apparel partner with agency would not be able to contract the other partners into a deal to purchase a piece of investment real estate because this would be outside the normal operations of the business.

One of the retail partners can, on the other hand, purchase goods from a vendor and require the partnership pay for the goods. This transaction is within the normal course of operations of the business.

Example

Mutual agency has several advantages and disadvantages for the partnership. It’s advantageous to have multiple partners with agency because they are authorized to make deals and transactions for the partnership. This arrangement splits up the duties and responsibilities among multiple partners, so the company can expand and grow.

The main disadvantage of having multiple agents is that all the partners can be encumbered and legally contracted by the actions of one partner. This means that if one partner makes a few bad business decisions, all of the partners will have to pay for it.

Mutual agency is a risk that partners have to weight before starting the company. The contracts entered into by agents are binding to the partnership and the third party that has knowledge of the agency. This is why the partners have the option to negotiate different levels of agency for each partner and even restrict authorization powers to select individuals for the protection of the company.

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What Does Economies of Scale Mean?

What is the definition of economies of scale? This is evident in all areas of production because as more units are produced, the fixed costs get spread among more units making each unit less expensive to produce. There are also number synergies and efficiencies realized as the production level increases. Bulk orders and shipments save time and money while batch production saves labor hours and machine time. Thus, as more units are produced, the cost per unit decreases. Other operational efficiencies can also lower the variable costs per unit as production increases as well.

This is one reason why large companies are able to sell their products for significantly less than their smaller competitors. They take advantage of their scale and produce each unit much cheaper than their smaller competitors are capable of producing their products.

Let’s look at an example.

Example

Alex is the CEO of a fast growing startup, one that has found a new, more efficient way to manufacture computer hardware. However, since this company is creating a product with a variety of components and sources, the per-unit costs can be as high as 90% of the final price.

The company has not been able to make a profit for the past few years. However, once the company starts producing over 2,000 units per day, it suddenly finds itself with per-unit costs at only 40% of total cost.

This is due to an ordering contract that takes affect once the company starts producing over 2,000 units per day. Bulk order discounts are one of the many ways EOS can help lower the per-unit cost of producing a product.

Economies of Scale, in the case of Alex’s company, helped his company become profitable once it achieved a certain production figure. This is the advantage that many large companies enjoy with their suppliers. Although overall costs may be increasing, per-unit costs decrease, which leaves more room for profit and the success of the company.

Summary Definition

Define Economies of Scale: Economy of scale means a company’s ability to make products more efficiently and less expensive as production increases and like operations are combined.

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What Does Diseconomies of Scale Mean?

What is the definition of diseconomies of scale? DoS are related to a range of factors that pertain to a company’s performance. The increase in the output that a firm produces may lead to an increase in the marginal cost of production, thereby creating a diseconomy of scale. Reasons for the marginal cost to increase as the output increases may include a difficulty to control complex projects (managerial inefficiency,) bureaucracy, ineffective maintenance of equipment, lack of employee motivation (labor inefficiency), and ineffective mechanisms of cost control.

All of these lead to the firm’s inadequacy to efficiently use its resources. As a result, rather than decreasing the costs and increasing the output, the firm experiences a higher marginal cost as the output increases.

Diseconomy of scale is the opposite of an economy of scale. Take a look at the graph of each below.

Let’s look at an example.

Example

As the firm increases its output, it seeks to lower its marginal cost, i.e. the cost for each additional unit produced. In doing so, it will increase efficiency by utilizing its resources in the best possible way. Improved efficiency will lead to increased profits per unit. However, when there is a diseconomy of scale, the marginal cost rises instead of decreasing.

For a quantity equals 4, the marginal cost (MC) starts to increase. At this point, the economies of scale become diseconomies of scale as shown in the graph below. Also, note that for a quantity equals 5, the variable cost increases, thereby increasing the total cost. The marginal cost is Change in TC / Change in Q, therefore as the total cost increases, the marginal cost increases too.

At this point, the company must reconsider its cost policies and restructure its operations as it becomes an easy target for competitive companies that can acquire a larger market share or even buy out the company. Furthermore, the company should use an efficient technology that can improve the costs while increasing the output.

Summary Definition

Define Diseconomies of Scale: Diseconomy of scale means a point in production where an increase in a production process does not lower the marginal costs of the next unit produced.

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What Does Diminishing Marginal Utility Mean?

What is the definition of diminishing marginal utility? The marginal utility of consumption of equal successive units of a commodity will decrease as the consumption increases. The question is: for whom is marginal utility higher with the use of one extra dollar? For a poor man who has only $100 or for a rich man who has $100,000? The law of diminishing marginal utility says that the extra dollar for the rich person will have less value than 1/100,000 and the extra dollar for the poor person will have less value than 1/250.

People seek to equalize their marginal utilities per currency unit. For example, if a person has greater utility / $ in good A than in good B, he will buy more units of good A and less units of good B. The analysis of marginal utility can be used to display the law of demand, which stipulates that the price and quantity demanded are inversely correlated, ceteris paribus.

Let’s look at an example.

Example

Barry goes out with his friends to celebrate his college graduation. He buys beers for everybody, and he has his first beer for $10. After the first round, his best friend John buys beers for everybody for $13. So, Barry has a marginal utility of $3. In the third beer, the marginal utility drops to $1 because Barry starts to feel a bit dizzy. So, upon consuming the second and third beer, Barry’s willingness to go on drinking declines. In the fourth beer, his marginal utility becomes -$2, indicating that Barry does not want to drink anymore. The fifth beer remains untouched.

Summary Definition

Define Diminishing Marginal Utility: DMU means a consumer’s reduced amount of satisfaction from each additional unit of a good or service consumed.

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What Does Competition Mean?

In microeconomics, though, it is classified into the perfect competition that forces commercial companies to expand their product line and offer consumers a greater selection of first-rate products and the imperfect competition.

Perfect competition assumes:

• the existence of many companies that sell a homogenous product
• the existence of many buyers
• the existence of informed consumers and suppliers
• no barriers to entry / exit
• no price intervention
• no government intervention
• free movement of factors of production
• companies seeking for profit maximization

Although competition ensures the best allocation of resources in view of the income distribution, it does not ensure that the goods are produced and distributed in accordance with the needs of society, due to large income disparities.

Let’s look at an example.

Example

When perfect competition exists in a sector or an industry, the price of a product is determined by the total demand and supply for this product. In long-term, the price of a product tends to be equal to the minimum average cost. In the short-term, the price of the product is determined only by the market and it is equal to the marginal cost.

Since the company X operates in the perfect competition, it cannot influence the price of the product. Given that each company seeks to maximize its profit, how can the company X determine the level of production that will ensure either profit maximization or losses minimization?

The first way is to calculate the total costs and the total revenues by multiplying the quantity by the price of the product.

The second way is to compare the marginal costs with the marginal revenues for different levels of production and to select the level of production that equates the two, thereby maximizing profits or minimizing losses.

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