Consumer Sovereignty: What are its Benefits and Limitations?

4-3-12Man is a social animal, but with individual likes and interests. Everyone has their own perspective. How would you feel if someone imposes their choices on you, or tells you this is best for you? No one wants that, unless you deliberately ask someone to make a choice for you. From food, liquor, to fashion, clothing and accessories, we all want something that is of our choice. In olden times, consumers has fewer choices, since they had fewer options. Today, if you flip through your remote control, you’ll notice that the number of television channels have multiplied by leaps and bounds, and you’re presented with a wide variety to choose from. To add to your ease, there is Internet shopping, which has made the world a smaller market. Trade facilities between different nations have improved, and it is easier to import or export goods today.

With the changes in technology and production, it is easier produce a variety of products, Thus, from caveat emptor (let the buyer beware) to caveat venditor (let the seller beware), there is a paradigm shift in the production system. Today, what the consumer wants is considered as the need of the hour. He gets to decide what should be produced in the market. Sellers vie to grab the attention of the consumers and get the desired output.
What is Consumer Sovereignty?
Consumer Sovereignty Definition: It is simply the power of the consumer to manipulate and influence the forces of the market. They determine what should be produced in the market. It means that the choices and preferences of the consumers determine whether the product should be produced in the market or not. Thus, a lot depends on the psychology of the consumers. Consumer sovereignty has been typically associated with being prevalent in a free market economy, due to more privatization and lesser or no government intervention. The famous economist Adam Smith was one of the strong advocates of consumer sovereignty.
Consumer Sovereignty Examples
A classic example of consumer sovereignty can be where a well-established entrepreneur decides to take up the production of a new product. ‘X’ is an entrepreneur who has a business of beverages. He has retail outlets which sell his products, and his brand is a local household name with goodwill established over the years. This year, he decides to start a new flavored beverage. However, before he considers investment in starting this new production, he needs to understand the market, and whether it is willing to accept a new product. Accordingly, he produced samples and distributed them at the outlets, and asked storekeepers to distribute free samples. Thus, in this case, ‘X’ has to take into account the consumer’s choices before taking up any production, or he may run into huge losses. After the sample distribution, the review was that consumers still preferred the old flavors over the new one, and hence, ‘X’ decided to discard the idea.
Limitations of Consumer Sovereignty
Advertisement and Marketing
Consumers can be fooled into buying a particular product. Advertisement and marketing is a classic way to lure consumers into buying some products. For example, a young teen sees his icon endorsing a bike in an advertisement, and he wishes to emulate him, and will end up buying that bike.
Transferring Responsibility of Choosing
In another case, the consumer may seek expert opinion or delegate the responsibility of making a choice to another person. Thus, there is no complete consumer sovereignty. For instance, before making investments, ‘Y’ may seek help of an investment banker to make all investing decisions on his behalf.
Fashion Trends
All consumers like to observe the fashion trends of any economy. It can be manipulated by sellers and others. Often, it is influenced by other factors. For example, a certain movie creates ripples in the market, and turns out to be a blockbuster. Thus, everyone wants to dress up like the protagonists. The clothing and fashion industry will exploit this opportunity and give the consumer something that will sell like hot cakes. Once word has spread, more and more consumers get enticed to buy that product.
Government Regulation
In a mixed economy, there is some degree of government regulation, where the freedom of the consumer to choose can be curtailed. One such example is the electricity department which is not privatized in all nations. In such a government-owned sector, the consumer has little choice but to accept the given product or service. Thus, not everything is at the consumer’s discretion. In such cases, you cannot say that the consumer is the king of the market.
Element of Irrationality and Other Restrictions
It is not possible for the consumer to be completely rational while taking decisions. He is bound to be influenced by his own emotions and other parameters that might not be completely rational.
Levy of Taxes
Taxes vacuum out some portion of the money of consumers, thus creating a limitation on the buying capacity of individuals. Thus, automatically, the freedom to choice is curbed.
Though everyone has their own choices, production takes place as per the choice of the masses. Thus, for a select few who have an off-beat choice, there might be a very small market, or no market at all, serving as a limitation.

Whatever the case may be, today, for the consumer, there is a lot of freedom to choose, and the market is expanding day-by-day due to globalization. As consumers, we have good reason to rejoice.

Continue reading Consumer Sovereignty: What are its Benefits and Limitations?

Understanding Excess Capacity in Different Arenas With Examples

4-3-11Did You Know?
Currently, the Chinese economy is facing the problem of excessive capacity.
Capacity is the ‘ability’ to do something. In business and economics, capacity means the ability to produce. Thus, the definition of excess capacity is the ability to produce more than there is demand. Similar to manufacturing, it also applies to the service industry. If you see idle human resources, it implies that the firm has excess capacity; however, the demand is comparatively lesser.
Excess capacity = Potential Output – Actual Output

As mentioned above, we see news reports that China’s industry is facing the problem of excess capacity. Many industries no longer require any capital for expansion plans, and have to bear the increasing labor costs too. Thus, having overcapacity can prove harmful to the economy.
In business, excess capacity means a firm has more capacity to supply than its demand. A very common phenomenon observed is at some restaurants, where you find empty chairs and the staff being idle. What does this indicate? It indicates that the restaurant has capacity to accommodate more guests. However, the demand is not equivalent to its capacity.
What is Excess Capacity in Microeconomics?
A situation of excess capacity arises usually in the scenario of a monopolistic competition.

Monopolistic competition: It is that market, wherein, all manufacturers are selling products that are unique and not perfect substitutes of one another. In this market, any new firm is freely able to enter the fray. They tend to have excess capacity in order to provide for future growth in demand. It implies that a firm is operating at a level that is below that level of output where cost is minimum.
There is excess capacity always in a monopolistic competition, in the long run. Efficient sale is achieved at a point where ‘Marginal Cost’ is equal to ‘Actual Cost’. Profit maximization occurs when ‘Marginal Revenue’ is equal to ‘Marginal Cost’, implying that there is an excess capacity left at the disposal of the firm. Thus, the difference between both the quantity levels is the excess capacity. The AC curve is downward sloping, which gives the firm an opportunity to produce more output at the same level than the actual production.
Monopolistic competition: graph indicating excess capacity
Excess capacity
MC = Marginal Cost Curve
AC = Average Cost Curve
AR = Average Revenue or Demand Curve
MR = Marginal Revenue Curve
Profit maximization is the level at which Marginal Cost = Marginal Revenue. Thus, the firm produces OQ level of output. However, the cost-minimization level is at OQ1. Hence, there is excess capacity. Thus, the difference between OQ and OQ1 is the excess capacity of the firm.
What is Excess Capacity in Business?
This means that the capacity to supply is more than the demand. If there is too much excess capacity, it may lead to the industry or factory getting converted into a sick unit.

Continue reading Understanding Excess Capacity in Different Arenas With Examples

Simple Examples That Show How to Solve the Equation for Profit

4-3-10Did You Know?
Every business enterprise invests some capital in order to succeed. Profit is thus termed as ‘ROI’ or ‘return on investment’. Conjugally, higher the ROI, higher is the investment.
The success of any business or organization depends solely on its profits. The higher the profits, the greater the efficiency of the firm. Profit is a reward for any commodity sold or any transaction done in business. These commodities could be any product or service.

The price at which a commodity is bought by the business is the cost price. The price at which a commodity is sold in the market is the selling price. Profit mainly depends on the cost price and the selling price. For any business or entity to make profit, the selling price must be greater than the cost price, i.e., the price at which a commodity is sold must be greater than the price at which it was bought.
Profit Equation in Economics
In order to understand the profit equation, let us first understand what a function is. A function f(x) is a mathematical relation which takes x as the input and generates an output which is a discrete value.

Consider the equation given below:

Continue reading Simple Examples That Show How to Solve the Equation for Profit

The Applications of Zero-sum Game Explained With Apt Examples

4-3-9“Even with a receptive audience, dominance is a zero-sum game: the more power and authority I have, the less you have.”― Adam M. Grant, Give and Take: A Revolutionary Approach to Success
‘Zero-sum Game’ is a situation where the loss of one person is another person’s gain. There can be more than two players in a zero-sum game. As against a win-win situation, where you negotiate with the opposite party to create equal gains for both, in a zero-sum game, the total of all wins of all the person(s) in a group is equal to the loss suffered by others in the group. You might have come across this situation many times in every day life.
For example, if you have a dispute with your friend over the choice of restaurant, you either lose or win. If you end up going to the place you like, you win, and your friend loses. In a case where there are more than two people involved, the total of all the gains must match the total of all the people around.

Continue reading The Applications of Zero-sum Game Explained With Apt Examples

Things You Should Know About Reaganomics and Its Consequences

4-3-8As is well-known, every government in the world today tries its best to have an equilibrium between the economic wants and needs of the country, the government revenue, and the government expenditure. Experts put forward several theories relating to how to go about this task, how to achieve and maintain that equilibrium and experience economic progress at the same time, and so, we can say that Reaganomics tried to do the same in the 1980s in America.

Simply put, Reaganomics can be explained as the economic policies that were introduced during the administration of President Ronald Reagan in the 1980s. Advocates of Reaganomics highly praised the effects of these policies on the American economy, and called them components of a ‘free-market’ economy, while opponents, which included several important personalities of the time, severely and intensely criticized them. Reaganomics was infamously also known as Voodoo Economics by opponents of the Reagan administration.

❑ The American Economy before the Reagan Administration

Continue reading Things You Should Know About Reaganomics and Its Consequences