Notes eco

Introduction to Tourism Economics

UNIT 1:
INTRODUCTION TO TOURISM ECONOMICS

Chapter objectives
• Understand the characteristics of economic standardized measures including GDP, FDI
and BOP
• Explore the general concept of economic trends such as recession and inflation, standards
of living, as well as import and export activities

The Development of an Economic Society

It is a process of change that is focused on the betterment of the community, state and nation.
Economic is viewed as the foundation for building a prosperous society. Thus, economic
development is one of the goals for the successful country, state or city.

Standardized measures of an economic development are used to identify the status of one country,
state or local community. Standardized measures include:
• GDP (Gross Domestic Product)
• FDI (Foreign Domestic Investment)
• BOP (Balance of Payments)
• And others

Gross Domestic Products (GDP)

Gross domestic product (GDP) refers to the market value of all final goods and services produced
within a country in a given period. GDP per capita is often considered an indicator of a country's
standard of living; GDP per capita is not a measure of personal income.

It is not to be confused with Gross National Product (GNP) which allocates production based on
ownership - Gross domestic product is related to national accounts, a subject in macroeconomics.
A basic measurement of a country’s economic performance and is the market value of all final
goods and services made within the borders and a nation in a year.

GDP can be measured as:
• The sum of value added by all producers
• The sum of income claims generated in producing goods and services
• The spending of final goods and services produced

Determining GDP

GDP can be determined in three ways, all of which should, in principle, give the same result. They
are the product (or output) approach, the income approach, and the expenditure approach. The most
direct of the three is the product approach, which sums the outputs of every class of enterprise to
arrive at the total.

The expenditure approach works on the principle that all of the product must be bought by
somebody, therefore the value of the total product must be equal to people's total expenditures in
buying things. The income approach works on the principle that the incomes of the productive

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factors ("producers," colloquially) must be equal to the value of their product, and determines GDP
by finding the sum of all producers' incomes
Example: the expenditure method:
GDP = private consumption + gross investment + government spending + (exports − imports)

Note: "Gross" means that GDP measures production regardless of the various uses to which that
production can be put. Production can be used for immediate consumption, for investment in new
fixed assets or inventories, or for replacing depreciated fixed assets. "Domestic" means that GDP
measures production that takes place within the country's borders. In the expenditure-method
equation given above, the exports-minus-imports term is necessary in order to null out expenditures
on things not produced in the country (imports) and add in things produced but not sold in the
country (exports).

Economists (since Keynes) have preferred to split the general consumption term into two parts;
private consumption, and public sector (or government) spending.

Two advantages of dividing total consumption this way in theoretical macroeconomics are:
• Private consumption is a central concern of welfare economics. The private investment and
trade portions of the economy are ultimately directed (in mainstream economic models) to
increases in long-term private consumption.
• If separated from endogenous private consumption, government consumption can be
treated as exogenous, so that different government spending levels can be considered within
a meaningful macroeconomic framework.

1. Production approach
"Market value of all final goods and services calculated during 1 year." The production
approach is also called as Net Product or Value added method. This method consists of three
stages:
• Estimating the Gross Value of domestic Output in various economic activities;
• Determining the intermediate consumption, i.e., the cost of material, supplies and
services used to produce final goods or services; and finally
• Deducting intermediate consumption from Gross Value to obtain the Net Value of
Domestic Output.
Symbolically,
Gross Value Added = Value of output – Value of Intermediate Consumption.
Value of Output = Value of the total sales of goods and services + Value of changes in the
inventories.

The sum of Gross Value Added in various economic activities is known as GDP at factor
cost. GDP at factor cost plus indirect taxes less subsidies on products is GDP at Producer
Price.

For measuring gross output of domestic product, economic activities (i.e. industries) are
classified into various sectors. After classifying economic activities, the gross output of each
sector is calculated by any of the following two methods:
• By multiplying the output of each sector by their respective market price and adding
them together and
• By collecting data on gross sales and inventories from the records of companies and
adding them together.



Subtracting each sector's intermediate consumption from gross output, we get sectoral Gross
Value Added (GVA) at factor cost. We, then add gross value of all sectors to get GDP at
factor cost. Adding indirect tax less subsidies in GDP at factor cost, we get GDP at Producer
Prices.

2. Income approach
"sum total of incomes of individual living in a country during 1 year." If GDP is calculated this
way it is sometimes called Gross Domestic Income (GDI), or GDP(I). GDI should provide the
same amount as the expenditure method described above.

This method measures GDP by adding incomes that firms pay households for factors of
production they hire- wages for labour, interest for capital, rent for land and profits for
entrepreneurship. The US "National Income and Expenditure Accounts" divide incomes into
five categories:
• Wages, salaries, and supplementary labour income
• Corporate profits
• Interest and miscellaneous investment income
• Farmers’ income
• Income from non-farm unincorporated businesses

Two adjustments must be made to get GDP:
• Indirect taxes minus subsidies are added to get from factor cost to market prices.
• Depreciation (or Capital Consumption Allowance) is added to get from net domestic
product to gross domestic product.

Total income can be subdivided according to various schemes, leading to various formulae for
GDP measured by the income approach. A common one is:
GDP = compensation of employees + gross operating surplus + gross mixed income + taxes
less subsidies on production and imports
GDP = COE + GOS + GMI + TP & M – SP & M
• Compensation of employees (COE) measures the total remuneration to employees for
work done. It includes wages and salaries, as well as employer contributions to social
security and other such programs.
• Gross operating surplus (GOS) is the surplus due to owners of incorporated businesses.
Often called profits, although only a subset of total costs are subtracted from gross output
to calculate GOS.
• Gross mixed income (GMI) is the same measure as GOS, but for unincorporated
businesses. This often includes most small businesses.

3. Expenditure approach
"All expenditure incurred by individual during 1 year." In economics, most things produced
are produced for sale, and sold. Therefore, measuring the total expenditure of money used to
buy things is a way of measuring production - This is known as the expenditure method of
calculating GDP.

Sweater-knitting is a small part of the economy, but if one counts some major activities such as
child-rearing (generally unpaid) as production, GDP ceases to be an accurate indicator of
production.

Similarly, if there is a long term shift from non-market provision of services (for example
cooking, cleaning, child rearing, do-it yourself repairs) to market provision of services, then



this trend toward increased market provision of services may mask a dramatic decrease in
actual domestic production, resulting in overly optimistic and inflated reported GDP.

This is particularly a problem for economies which have shifted from production economies to
service economies.

Components of GDP by expenditure

Components of U.S. GDP
GDP (Y) is a sum of Consumption (C), Investment (I), Government Spending (G) and Net
Exports (X – M).
Y = C + I + G + (X − M)

Here is a description of each GDP component:
• C (consumption) is normally the largest GDP component in the economy, consisting of
private (household final consumption expenditure) in the economy.
• I (investment) includes business investment in equipments for example and does not include
exchanges of existing assets. Spending by households (not government) on new houses is also
included in Investment.
• G (government spending) is the sum of government expenditures on final goods and services.
• X (exports) represents gross exports. GDP captures the amount a country produces, including
goods and services produced for other nations' consumption, therefore exports are added.
• M (imports) represents gross imports. Imports are subtracted since imported goods will be
included in the terms G, I, or C, and must be deducted to avoid counting foreign supply as
domestic.

Foreign Domestic Investment

FDI is defined as a company from one country making a physical investment into building a factory
in another country – thus, it is a measure of foreign ownership of productive assets, such as
factories, mines and land.

Foreign direct investment (FDI) refers to the net inflows of investment to acquire a lasting
management interest (10 percent or more of voting stock) in an enterprise operating in an economy
other than that of the investor. It is the sum of equity capital,other long-term capital, and short-term
capital as shown in the balance of payments.

It usually involves participation in management, joint-venture, transfer of technology and expertise.
There are two types of FDI: inward foreign direct investment and outward foreign direct
investment, resulting in a net FDI inflow (positive or negative) and "stock of foreign direct
investment", which is the cumulative number for a given period.

Direct investment excludes investment through purchase of shares. FDI is one example of
international factor movements. FDIs require a business relationship between a parent company and
its foreign subsidiary. Foreign direct business relationships give rise to multinational corporations.

The foreign direct investor may acquire voting power of an enterprise in an economy through any of
the following methods:
• by incorporating a wholly owned subsidiary or company
• by acquiring shares in an associated enterprise
• through a merger or an acquisition of an unrelated enterprise



• participating in an equity joint venture with another investor or enterprise

Foreign direct investment incentives may take the following forms:
• low corporate tax and individual income tax rates
• tax holidays
• other types of tax concessions
• preferential tariffs
• special economic zones
• EPZ – Export Processing Zones
• Bonded Warehouses
• investment financial subsidies
• soft loan or loan guarantees
• free land or land subsidies
• relocation & expatriation subsidies
• job training & employment subsidies
• infrastructure subsidies
• R&D support
• derogation from regulations (usually for very large projects)

Balance of Payments

Balance of payments (BOP) accounts are an accounting record of all monetary transactions
between a country and the rest of the world. These transactions include payments for the country's
exports and imports of goods, services, financial capital, and financial transfers.

The BoP accounts summarize international transactions for a specific period, usually a year, and are
prepared in a single currency, typically the domestic currency for the country concerned. Sources of
funds for a nation, such as exports or the receipts of loans and investments, are recorded as positive
or surplus items. Uses of funds, such as for imports or to invest in foreign countries, are recorded as
negative or deficit items. When all components of the BOP accounts are included they must sum to
zero with no overall surplus or deficit.

For example, if a country is importing more than it exports, its trade balance will be in deficit, but
the shortfall will have to be counter-balanced in other ways – such as by funds earned from its
foreign investments, by running down central bank reserves or by receiving loans from other
countries. While the overall BOP accounts will always balance when all types of payments are
included, imbalances are possible on individual elements of the BOP, such as the current account,
the capital account excluding the central bank's reserve account, or the sum of the two.

Imbalances in the latter sum can result in surplus countries accumulating wealth, while deficit
nations become increasingly indebted. The term "balance of payments" often refers to this sum: a
country's balance of payments is said to be in surplus (equivalently, the balance of payments is
positive) by a certain amount if sources of funds (such as export goods sold and bonds sold) exceed
uses of funds (such as paying for imported goods and paying for foreign bonds purchased) by that
amount.

Recession and Inflations

Recession



In economics, a recession is a business cycle contraction, a general slowdown in economic activity.
During recessions, many macroeconomic indicators vary in a similar way. Production, as measured
by gross domestic product (GDP), employment, investment spending, capacity utilization,
household incomes, business profits, and inflation all fall, while bankruptcies and the
unemployment rate rise.
Recessions generally occur when there is a widespread drop in spending, often following an adverse
supply shock or the bursting of an economic bubble. Governments usually respond to recessions by
adopting expansionary macroeconomic policies, such as increasing money supply, increasing
government spending and decreasing taxation. A recession has many attributes that can occur
simultaneously and includes declines in component measures of economic activity (GDP) such as
consumption, investment, government spending, and net export activity.

These summary measures reflect underlying drivers such as employment levels and skills,
household savings rates, corporate investment decisions, interest rates, demographics, and
government policies.

Economist Richard C. Koo wrote that under ideal conditions, a country's economy should have the
household sector as net savers and the corporate sector as net borrowers, with the government
budget nearly balanced and net exports near zero. When these relationships become imbalanced,
recession can develop within the country or create pressure for recession in another country. Policy
responses are often designed to drive the economy back towards this ideal state of balance. A severe
(GDP down by 10%) or prolonged (three or four years) recession is referred to as an economic
depression, although some argue that their causes and cures can be different.

Inflation

In economics, inflation is a rise in the general level of prices of goods and services in an economy
over a period of time. When the general price level rises, each unit of currency buys fewer goods
and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a
loss of real value in the internal medium of exchange and unit of account in the economy.

A chief measure of price inflation is the inflation rate, the annualized percentage change in a
general price index (normally the Consumer Price Index) over time.
Inflation's effects on an economy are various and can be simultaneously positive and negative.

Negative effects of inflation include a decrease in the real value of only money held and only other
monetary items only when they are not inflation-adjusted daily in terms of a Daily Consumer Price
Index over time; e.g. all government inflation-indexed bonds in many countries are inflation-
adjusted daily (they trade daily) in terms of a Daily CPI which is a lagged, daily interpolation of the
monthly published Consumer Price Index.

Uncertainty over future inflation may discourage investment and savings, and high inflation may
lead to shortages of goods if consumers begin hoarding out of concern that prices will increase in
the future.

Inflation-adjusting the entire money supply (excluding bank notes and coins which generally make
up about seven per cent of the money supply in an advanced economy) would result in zero cost of
inflation (not zero inflation) in the entire economy (excluding in bank notes and coins) under
complete co-ordination.

Positive effects include ensuring central banks can adjust nominal interest rates (intended to
mitigate recessions), and encouraging investment in non-monetary capital projects.



Today, most economists favor a low, steady rate of inflation.

Low (as opposed to zero or negative) inflation reduces the severity of economic recessions by
enabling the labor market to adjust more quickly in a downturn, and reduces the risk that a liquidity
trap prevents monetary policy from stabilizing the economy.

The task of keeping the rate of inflation low and stable is usually given to monetary authorities.
Generally, these monetary authorities are the central banks that control monetary policy through the
setting of interest rates, through open market operations, and through the setting of banking reserve
requirements.

Standards of Living

Standard of living is generally measured by standards such as real (i.e. inflation adjusted) income
per person and poverty rate. A more realistic measure is the number of people who have access to
free subsistence land. Other measures such as access and quality of health care, income growth
inequality and educational standards are also used. Examples are access to certain goods (such as
number of refrigerators per 1000 people), or measures of health such as life expectancy.

It is the ease by which people living in a time or place are able to satisfy their needs and/or wants.
Standard of living refers to the level of wealth, comfort, material goods and necessities available to
a certain socioeconomic class in a certain geographic area. The standard of living includes factors
such as income, quality and availability of employment, class disparity, poverty rate, quality and
affordability of housing, hours of work required to purchase necessities, gross domestic product,
inflation rate, number of vacation days per year, affordable (or free) access to quality healthcare,
quality and availability of education, life expectancy, incidence of disease, cost of goods and
services, infrastructure, national economic growth, economic and political stability, political and
religious freedom, environmental quality, climate and safety.

The standard of living is closely related to quality of life. The idea of a 'standard' may be contrasted
with the quality of life, which takes into account not only the material standard of living, but also
other more intangible aspects that make up human life, such as leisure, safety, cultural resources,
social life, physical health, environmental quality issues etc. More complex means of measuring
well-being must be employed to make such judgements, and these are very often political, thus
controversial.

Even between two nations or societies that have similar material standards of living, quality of life
factors may in fact make one of these places more attractive to a given individual or group.
However, there can be problems even with just using numerical averages to compare material
standards of living, as opposed to, for instance, a Pareto index (a measure of the breadth of income
or wealth distribution). Standards of living are perhaps inherently subjective.

As an example, countries with a very small, very rich upper class and a very large, very poor lower
class may have a high mean level of income, even though the majority of people have a low
"standard of living". This mirrors the problem of poverty measurement, which also tends towards
the relative. This illustrates how distribution of income can disguise the actual standard of living.

Likewise Country A, a perfectly socialist country with a planned economy with very low average
per capita income would receive a higher score for having lower income inequality than Country B
with a higher income inequality, even if the bottom of Country B's population distribution had a
higher per capita income than Country A.



Real examples of this include former East Germany compared to former West Germany or North
Korea compared to South Korea. In each case, the socialist country has a low income discrepancy
(and therefore would score high in that regard), but lower per capita incomes than a large majority
of their neighboring counterpart. This can be avoided by using the measure of income at various
percentiles of the population rather than a highly relative and controversial overall income
inequality measure.

Import and Export

Import

The term import is derived from the conceptual meaning as to bring in the goods and services into
the port of a country. The buyer of such goods and services is referred to an "importer" who is
based in the country of import whereas the overseas based seller is referred to as an "exporter".

Thus an import is any good (e.g. a commodity) or service brought in from one country to another
country in a legitimate fashion, typically for use in trade. It is a good that is brought in from another
country for sale. Import goods or services are provided to domestic consumers by foreign
producers.

"Imports" consist of transactions in goods and services (sales, barter, gifts or grants) from non-
residents residents to residents. - The exact definition of imports in national accounts includes and
excludes specific "borderline" cases.

A general delimitation of imports in national accounts is given below:
• An import of a good occurs when there is a change of ownership from a non-resident to a
resident; this does not necessarily imply that the good in question physically crosses the
frontier. However, in specific cases national accounts impute changes of ownership even
though in legal terms no change of ownership takes place (e.g. cross border financial
leasing, cross border deliveries between affiliates of the same enterprise, goods crossing the
border for significant processing to order or repair). Also smuggled goods must be
included in the import measurement.
• Imports of services consist of all services rendered by non-residents to residents. In national
accounts any direct purchases by residents outside the economic territory of a country are
recorded as imports of services; therefore all expenditure by tourists in the economic
territory of another country are considered as part of the imports of services. Also
international flows of illegal services must be included.

There are two basic types of import:
• Industrial and consumer goods
• Intermediate goods and services

Companies import goods and services to supply to the domestic market at a cheaper price and better
quality than competing goods manufactured in the domestic market. Companies import products
that are not available in the local market. There are three broad types of importers:
• Looking for any product around the world to import and sell.
• Looking for foreign sourcing to get their products at the cheapest price.
• Using foreign sourcing as part of their global supply chain.

Export



This term export is derived from the conceptual meaning as to ship the goods and services out of
the port of a country. The seller of such goods and services is referred to as an "exporter" who is
based in the country of export whereas the overseas based buyer is referred to as an "importer".

In International Trade, "exports" refers to selling goods and services produced in home country to
other markets. Any good or commodity, transported from one country to another country in a
legitimate fashion, typically for use in trade. Export goods or services are provided to foreign
consumers by domestic producers
In national accounts "exports" consist of transactions in goods and services (sales, barter, gifts or
grants) from residents to non-residents.

A general delimitation of exports in national accounts is given below:
• An export of a good occurs when there is a change of ownership from a resident to a non-
resident; this does not necessarily imply that the good in question physically crosses the
frontier. However, in specific cases national accounts impute changes of ownership even
though in legal terms no change of ownership takes place (e.g. cross border financial
leasing, cross border deliveries between affiliates of the same enterprise, goods crossing the
border for significant processing to order or repair). Also smuggled goods must be
included in the export measurement.
• Export of services consist of all services rendered by residents to non-residents. In national
accounts any direct purchases by non-residents in the economic territory of a country are
recorded as exports of services; therefore all expenditure by foreign tourists in the economic
territory of a country is considered as part of the exports of services of that country. Also
international flows of illegal services must be included.



UNIT 2:
PATTERNS OF DEMAND FOR TOURISM

Chapter objectives
• Discuss the historical trends in tourism economics: economic, social and infrastructural
development, as well as industrialization, cross-border movement and government
regulations
• Understand the regional dimensions and European popularity in tourism economics
• Explore seasonality aspects and its application in tourism economics
• Identify the lifestyle and lifecycle determinants that may impact the tourism economics

Historical trends

Historical Trend Analysis (HTA) is a geomorphologic tool which utilizes the analysis of data
relating to a particular physical process or morphologic feature from different time periods, in order
to identify directional trends, and if quantifiable, rates of changes in that process or feature. An
overview of tourism’s historical development is required in order to fully appreciate today’s modern
tourism environment and to understand the challenges of the globalized economy.

The history of tourism cannot be easily traced; back in the ancient years, as ancient world empires
grew in Africa, Asia and the Middle East, the infrastructure necessary for travel such as land routes
and water ways was created and vehicles and other means for travel were developed. Most
historians of tourism have tended to focus on Europe, from the Greeks and Romans, to the railway
and Thomas Cook in the UK.

Thomas Cook has been the so called “father of the tourist trade”, since, on July 5th 1841, he
arranged to take a group of about 500 members of his local “Temperance Society” from Leicester
London Road railway station to a rally in Loughborough, eleven miles away, having arranged with
the rail company to charge one shilling per person that included rail tickets and food for this train
journey.

When industrialization across Europe gave rise to an affluent middle class with an increasing
amount of free time, tourism began to take shape as an international industry.
However, for the most part of the 19th century it has been expensive and limited to a small number
of destinations. When in the 1960’s a growing number of people had disposable incomes and the
desire for “something new”, reasonably priced commercial aircrafts airplanes made international
travel easier; mass tourism had arrived.

Economic Development

Economic development generally refers to the sustained, concerted actions of policymakers and
communities that promote the standard of living and economic health of a specific area. Such
actions can involve multiple areas including development of human capital, critical infrastructure,



regional competitiveness, environmental sustainability, social inclusion, health, safety, literacy, and
other initiatives.

Economic development typically involves improvements in a variety of indicators such as literacy
rates, life expectancy, and poverty rates. Essentially, a country's economic development is related to
its human development, which encompasses, among other things, health and education. These
factors are, however, closely related to economic growth so that development and growth often go
together.

Social Development

Social development can be summarily described as the process of organizing human energies and
activities at higher levels to achieve greater results. Development increases the utilization of human
potential. Social development consists of two interrelated aspects – learning and application.

Society discovers better ways to fulfill its aspirations and it develops organizational mechanisms to
express that knowledge to achieve its social and economic goals.
• The process of discovery expands human consciousness.
• The process of application enhances social organization.

Society develops in response to the contact and interaction between human beings and their
material, social and intellectual environment.

Infrastructural Development

Infrastructure development contributes to poverty reduction by spurring economic growth,
stimulating enterprise opportunities, generating employment and providing poor people with access
to basic needs.

Example: Australia’s approach to infrastructure will centre on four pillars:
• Delivering sustainable transport infrastructure
• Facilitating increased access to basic water and sanitation infrastructure services
• Creating reliable energy services and supporting information and communication
technologies
• Supporting urban infrastructure planning and development.

The development and maintenance of essential public infrastructure is an important ingredient for
sustained economic growth and poverty reduction. Health, education, and efficient water and
sanitation services help lay the groundwork for a more productive, healthy population capable of
contributing to sustained economic growth - Likewise transport infrastructure improves access to
services and markets in rural areas.

Industrialization

Industrialization (or industrialization) is the process of social and economic change that
transforms a human group from an agrarian society into an industrial one. It is a part of a wider
modernization process, where social change and economic development are closely related with
technological innovation, particularly with the development of large-scale energy and metallurgy
production. It is the extensive organization of an economy for the purpose of manufacturing.



Industrialization also introduces a form of philosophical change where people obtain a different
attitude towards their perception of nature, and a sociological process of ubiquitous rationalization.
The first country to industrialize was the United Kingdom during the Industrial Revolution
commencing in the eighteenth century. By the end of the 20th century, East Asia had become one of
the most recently industrialized regions of the world

Cross-border Movement

Also known as economic globalization - Economic globalization refers to increasing economic
interdependence of national economies across the world through a rapid increase in cross-border
movement of goods, service, technology and capital.

Whereas globalization is centered around the diminution of international trade regulations as well as
tariffs, taxes, and other impediments that suppresses global trade, economic globalization is the
process of increasing economic integration between countries, leading to the emergence of a global
marketplace or a single world market.

Depending on the paradigm, economic globalization can be viewed as either a positive or a negative
phenomenon. Economic globalization comprises the globalization of production, markets,
competition, technology, and corporations and industries.

Governmental Regulations

Regulation is administrative legislation that constitutes or constrains rights and allocates
responsibilities. It can be distinguished from primary legislation (by Parliament or elected
legislative body) on the one hand and judge-made law on the other.

Regulation mandated by a state attempts to produce outcomes which might not otherwise occur,
produce or prevent outcomes in different places to what might otherwise occur, or produce or
prevent outcomes in different timescales than would otherwise occur. In this way, regulations can
be seen as implementation artifacts of policy statements.

Common examples of regulation include controls on market entries, prices, wages, development
approvals, pollution effects, employment for certain people in certain industries, standards of
production for certain goods, the military forces and services. The economics of imposing or
removing regulations relating to markets is analyzed in regulatory economics.

Regional dimensions

Regional development is fundamentally about economic development and reforms that allow
markets to work and individuals and communities to enhance their wellbeing. Regional trade
integration can serve as a powerful catalyst to economic growth. Regional trade agreements
continue to proliferate despite being economically inferior from a global perspective to
nondiscriminatory trade liberalization on a most-favored-nation (MFN) basis.

Multilateral liberalization and regional integration will continue to coexist in the future. The role of
regional development policy ought to be to support regions to grow while ensuring that individuals
are able to best manage their transition to a more diversified economic base - to other centres that
are growing with new employment and lifestyle opportunities.



The choice of forming a customs union first and then acceding to the WTO (World Trade
Organization) could increase the overall level of trade protection of customs union members
compared to their level of protection prior to the customs union. The larger the customs union the
more the collective monopoly power it has in commanding a high level of protection. The incentive
to protect is particularly strong if there is a country with greater bargaining power within the region
and higher external tariff rates.

The reason is that, in the case of heterogeneous countries, the higher external tariff of the dominant
country is likely to prevail as a Common External Tariff (CET) for the group. In this case,
implementation of the customs union implies that the more liberal countries will eventually
converge toward the higher rates.

By entering first into a regional agreement, a country may increase its bargaining power in
multilateral negotiations by having a common (regional) position toward sensitive issues (e.g.,
textile and agriculture), where developed countries still maintain a protectionist stance, although it
is not obvious, a priori, that the outcome would reflect the preferences of custom unions’ smaller
members.

Example:
On September 19, 2003 Belarus, Kazakhstan, the Russian Federation, and Ukraine met in Yalta to
sign a draft agreement to create a CES over 5–7 years.
The process involves three stages:
• the coordination of customs duties and harmonization of trade and custom regulations;
• the lifting of current trade barriers and creation of the customs union; and
• the liquidation of internal customs boundaries to be replaced by a common customs
boundary and the creation of a supra-national regulating institution.

European popularity

The history and theory of popular culture in Western Europe - Different regions, ethnicities and
racial identities were represented in and by popular culture. The culture of Europe might better be
described as a series of multiple cultures.

Whether it is a question of North as opposed to South; West as opposed to East; Orthodoxism as
opposed to Protestantism as opposed to Catholicism as opposed to Secularism; many have claimed
to identify cultural fault lines across the continent.

There are many cultural innovations and movements, often at odds with each other, such as
Christian proselytism or Humanism. Thus the question of "common culture" or "common values" is
far more complex then it seems to be.

The foundation of European culture was laid by the Greeks, strengthened by the Romans, stabilized
by Christianity, reformed and modernized by the fifteenth-century Renaissance and Reformation
and globalized by successive European empires between the sixteenth and twentieth centuries.

Thus the European Culture developed into a very complex phenomenon of wider range of
philosophy, Christian and secular humanism, rational way of life and logical thinking developed
through a long age of change and formation with the experiments of enlightenment, naturalism,
romanticism, science, democracy, and socialism. Because of its global connection, the European
culture grew with an all-inclusive urge to adopt, adapt and ultimately influence other trends of
culture. Examples of popular culture are like art, music, literature, cuisine, etc.



Seasonality

In statistics, many time series exhibit cyclic variation known as seasonality, periodic variation, or
periodic fluctuations. This variation can be either regular or semi regular and very common in
economic time series. Example: retail sales tend to peak during holiday season and then decline
after the holidays.
Seasonal variation is a component of a time series which is defined as the repetitive and predictable
movement around the trend line in one year or less. It is detected by measuring the quantity of
interest for small time intervals, such as days, weeks, months or quarters. Organizations affected by
seasonal variation need to identify and measure this seasonality to help with planning for temporary
increases or decreases in labor requirements, inventory, training, periodic maintenance, and so
forth.

There are several main reasons for studying seasonal variation
• The description of the seasonal effect provides a better understanding of the impact this
component has upon a particular series.
• After establishing the seasonal pattern, methods can be implemented to eliminate it from the
time-series to study the effect of other components such as cyclical and irregular variations.
This elimination of the seasonal effect is referred to as deseasonalizing or seasonal
adjustment of data.
• To project the past patterns into the future knowledge of the seasonal variations is a must for
the prediction of the future trends.

A decision maker or analyst can make one of the following assumptions when treating the seasonal
component:
• The impact of the seasonal component is constant from year to year.
• The seasonal effect is changing slightly from year to year.
• The impact of the seasonal influence is changing dramatically.

Lifestyle determinants

Lifestyle is a term to describe the way a person or an animal lives. A set of behaviors, and the
senses of self and belonging which these behaviors represent, are collectively used to define a given
lifestyle. The term is defined more broadly when used in politics, marketing, and publishing.

A lifestyle is a characteristic bundle of behaviors that makes sense to both others and oneself in a
given time and place, including social relations, consumption, entertainment, and dress. The
behaviors and practices within lifestyles are a mixture of habits, conventional ways of doing things,
and reasoned actions. The lifestyle determinants include: culture, economic, income, political
environments, social, and demography

Culture

Culture and lifestyle are the major factors affecting how we talk, dress, relate with and treat people,
how we eat and live. Lifestyle affects culture and culture affects lifestyles in the society. Culture
can be known as a complex whole which includes knowledge, belief, art, law, moral, customs and
any other capabilities and habits acquired by man as a member of a society.

Culture is a term that has many different inter-related meanings. As mention above, the word
"culture" is most commonly used in three basic senses:
• Excellence of taste in the fine arts and humanities, also known as high culture



• An integrated pattern of human knowledge, belief, and behavior that depends upon the
capacity for symbolic thought and social learning
• The set of shared attitudes, values, goals, and practices that characterizes an institution,
organization, or group

Economic

Economics is the social science that analyzes the production, distribution, and consumption of
goods and services. A focus of the subject is how economic agents behave or interact and how
economies work.

Microeconomics examines the behavior of basic elements in the economy, including individual
agents (such as households and firms or as buyers and sellers) and markets, and their interactions.
Macroeconomics analyzes the entire economy and issues affecting it, including unemployment,
inflation, economic growth, and monetary and fiscal policy.

Economic analysis may be applied throughout society, as in business, finance, health care, and
government, but also to such diverse subjects as crime, education, the family, law, politics, religion,
social institutions, war, and science.

Income

Income is the consumption and savings opportunity gained by an entity within a specified time
frame, which is generally expressed in monetary terms. However, for households and individuals,
"income is the sum of all the wages, salaries, profits, interests payments, rents and other forms of
earnings received... in a given period of time."

For firms, income generally refers to net-profit: what remains of revenue after expenses have been
subtracted. In the field of public economics, it may refer to the accumulation of both monetary and
non-monetary consumption ability, the former being used as a proxy for total income. National
income, measured by statistics such as the Net National Income (NNI), measures the total income
of individuals, corporations, and government in the economy.

Politic

The term lifestyle in politics can often be used in conveying the idea that society be accepting of a
variety of different ways of life—from the perspective that differences among ways of living are
superficial, rather than existential.

Lifestyle is also sometimes used pejoratively, to mark out some ways of living as elective or
voluntary as opposed to others that are considered mainstream, unremarkable, or normative. Politic
consists of “social relations involving authority or power” and refers to the regulation of a political
unit, and to the methods an dtactics used to formulate and apply policy. From a historical
perspective, societies in need of government have moved from the primitive to the patriarchal state
and finally to the military, the real politics of modern times

Social



The term social refers to a characteristic of living organisms as applied to populations humans and
other animals. It always refers to the interaction of organisms with other organisms and to their
collective co-existence, irrespective of whether they are aware of it or not, and irrespective of
whether the interaction is voluntary or involuntary.

• The term "social" is used in many different senses, referring among other things to:
• Attitudes, orientations, or behaviors which take the interests, intentions, or needs of other
people into account (in contrast to anti-social behaviour) has played some role in defining
the idea or the principle.
• For instance terms like social realism, social justice, social constructivism, social
psychology and social capital imply that there is some social process involved or considered,
a process that is not there in regular, "non-social" realism, justice, constructivism,
psychology, or capital.

Demographic

Demographics are the characteristics of a human population as used in the government, marketing
or opinion research. Commonly used data are sex, race, age, income, disabilities, mobility (in terms
of travel time to work or number of vehicles available), educational attainment, home ownership,
employment status and even location.

A demographic trend describes in a population over time i.e. the average age of a population may
increase or decrease over time. Certain restrictions may be set in place i.e. the one child policy in
China.

Marketers typically combine several variables to define a demographic profile. A demographic
profile provides enough information about the typical member of this group to create a mental
picture of this hypothetical aggregate.

Life cycle determinants

The concept of the life cycle is widely used in social sciences - However, its meanings and
applications are diverse. Additionally, for denoting temporality in a general sense, the terms life
cycle, life span or life course are often regarded as interchangeable (O’Rand and Krecker, 1990).

By considering an individuals life as a chronological sequence of stages, the life cycle can be
characterized by the occurrence of events and the length of the resulting life cycle stages. The
development of longevity and the timing of retirement are important factors shaping the life cycle.
In addition to adjustments of the life cycle caused by health or disability, constraints and incentives
of the pension system are of particular importance for the evolution of life cycles; e.g., decisions on
retirement age are strongly dependent and influenced by institutional factors.

The design of the social security system, social policies as well as structural changes in an economy
influence the life cycle adjustments additively to demographic changes. The additional life time
offers opportunities to increase the length of the working life, to invest further time in education or
to enjoy more time in leisure

As governmental social transfer arrangements have partially overtaken individual financial security
functions, policy makers have to be conscious of life cycle dynamics arising from increasing life
expectancy and varying retirement ages. In economic, life-cycle decisions depend on:
• The cost-effectiveness of the banking sector;



• Individual income uncertainty;
• The persistence of an individual productivity process;
• The generosity of the social security system.

The effects of higher productivity process persistence on the economy are as follows: An increase
in the persistence raises expected life-time earnings of high-productivity individuals and diminishes
expected income of low-productivity individuals. The former are therefore reducing their
precautionary savings, whereas the latter are less interested in taking loans. The overall impact on
the capital-output ratio is negative, which leads to an increase in the real interest rate.

UNIT 3:
MACRO DETERMINANTS OF TOURISM DEMAND

Chapter objectives
• Identify, explore and discuss the macro-determinants of tourism demands: disposable
income, educational levels, seasonality, household size, demographics variables, the buyer
decision process and travel buying behavior

Macro determinants of tourism demand

Determinants of tourism demand include the following:
• Disposable income
• Educational levels
• Seasonality
• Household size
• Demographic variables
• The buyer decision process
• Travel buying behavior

Disposable Income

Disposable income is total personal income minus personal current taxes. In national accounts
definitions, personal income, minus personal current taxes equals disposable personal income.
Subtracting personal outlays (which includes the major category of personal (or, private)
consumption expenditure) yields personal (or, private) savings.

Restated, consumption expenditure plus savings equals disposable income after accounting for
transfers such as payments to children in school or elderly parents’ living arrangements. The
marginal propensity to consume (MPC) is the fraction of a change in disposable income that is
consumed.

For example, if disposable income rises by $100, and $65 of that $100 is consumed, the MPC is
65%. Restated, the marginal propensity to save is 35%.

Discretionary income is money remaining after all bills are paid off. It is income after subtracting
taxes and normal expenses (such as rent or mortgage, utilities, insurance, medical, transportation,
property maintenance, child support, inflation, food and sundries, etc.) to maintain a certain



standard of living. It is the amount of an individual's income available for spending after the
essentials (such as food, clothing, and shelter) have been taken care of:

Discretionary income = Gross income - taxes - necessities

Despite the definitions above, disposable income is often incorrectly used to denote discretionary
income. Commonly, disposable income is the amount of "play money" left to spend or save. The
Consumer Leverage Ratio is the expression of the ratio of Total Household Debt to Disposable
Income

Use of discretionary income in high-income loan applications

When applying for a loan (mortgage, consumer loan), lenders may take into consideration a high-
income applicant's discretionary income in order to assess the loan repayment capacity of the
applicant.

Discretionary income provides the lender with more information on the applicant's capacity to repay
than the debt-to-income ratio in the case where the applicant has a lot of debt, but also a lot of
income, such that the percent of available income may be smaller than normal standards would
allow, but the actual amount of money is still large

Educational Levels

Education in its broadest, general sense is the means through which the aims and habits of a group
of people lives on from one generation to the next. Education can be defined as any act or
experience that has a formative effect on the mind, character or physical ability of an individual.
Education is the process by which society deliberately transmits its accumulated knowledge, skills
and values from one generation to another – it controls decision making, lifestyle, needs, wants and
etc

A right to education has been created and recognized by some jurisdictions: Since 1952, Article 2 of
the first Protocol to the European Convention on Human Rights obliges all signatory parties to
guarantee the right to education. At the global level, the United Nations' International Covenant on
Economic, Social and Cultural Rights of 1966 guarantees this right under its Article 13.

Economics and education

It has been argued that high rates of education are essential for countries to be able to achieve high
levels of economic growth. Empirical analyses tend to support the theoretical prediction that poor
countries should grow faster than rich countries because they can adopt cutting edge technologies
already tried and tested by rich countries.

However, technology transfer requires knowledgeable managers and engineers who are able to
operate new machines or production practices borrowed from the leader in order to close the gap
through imitation. Therefore, a country's ability to learn from the leader is a function of its stock of
"human capital".

Recent study of the determinants of aggregate economic growth have stressed the importance of
fundamental economic institutions and the role of cognitive skills. If more education leads to faster
economic growth, then investments in education could pay for themselves in the long run, and



could also play a role in reducing poverty. Such reasoning could be crucial in bolstering political
support for education investments and ensuring their sustainability.

The following findings are highlighted:
• educational quality directly affects individual earnings
• early analyses have emphasised the role of quantity of schooling for economic growth
• the quality of education matters even more for economic growth
• improving educational quality requires a focus on institutions and efficient education
spending, not just additional resources
• the need to alter institutions fundamentally is inescapable

Mobility Levels

Is the state of being in motion. There are many types of mobility, including:
• Academic mobility – the possibility for students and teachers to move between different
institutions
• Economic mobility - the ability of an individual, family or some other group to improve (or
lower) their economic status - usually measured in income
• Social mobility – the ability of individuals within a society to move between different social
levels
• Population mobility – migration within a population

Economic mobility

Economic mobility is often measured by movement between income quintiles. Economic mobility
may be considered a type of social mobility, which is often measured in change in income. Mobility
may be between generations ("inter-generational") or within a person or groups lifetime ("intra-
generational"). - It may be "absolute" or "relative".

• Inter-generational mobility compares a person’s (or group's) income to that of her/his/their
parents.
• Intra-generational mobility, in contrast, refers to movement up or down over the course of a
working career.

Absolute mobility involves widespread economic growth and answers the question “To what extent
do families improve their incomes over a generation?” Relative mobility is specific to individuals or
groups and occurs without relation to the economy as a whole. It answers the question, "how
closely are the economic fortunes of children tied to that of their parents?" - Relative mobility is a
zero-sum game, absolute is not.

Seasonality

In statistics, many time series exhibit cyclic variation known as seasonality, periodic variation, or
periodic fluctuations. This variation can be either regular or semi regular and very common in
economic time series. Example: retail sales tend to peak during holiday season and then decline
after the holidays

Seasonal variation is a component of a time series which is defined as the repetitive and predictable
movement around the trend line in one year or less. It is detected by measuring the quantity of
interest for small time intervals, such as days, weeks, months or quarters. Organizations affected by



seasonal variation need to identify and measure this seasonality to help with planning for temporary
increases or decreases in labor requirements, inventory, training, periodic maintenance, and so
forth.

There are several main reasons for studying seasonal variation
• The description of the seasonal effect provides a better understanding of the impact this
component has upon a particular series.
• After establishing the seasonal pattern, methods can be implemented to eliminate it from the
time-series to study the effect of other components such as cyclical and irregular variations.
This elimination of the seasonal effect is referred to as deseasonalizing or seasonal
adjustment of data.
• To project the past patterns into the future knowledge of the seasonal variations is a must for
the prediction of the future trends.
A decision maker or analyst can make one of the following assumptions when treating the seasonal
component:
• The impact of the seasonal component is constant from year to year.
• The seasonal effect is changing slightly from year to year.
• The impact of the seasonal influence is changing dramatically.

Household Size

Households consisting of individuals, families, community groups, business organizations, or state.
Their role in economic activity are as follows:

1. As the owners of factors of production.
Factors of production or production resources are owned and provided by the household.
Production factors include natural resources or land, or land, labor, capital, and expertise or
entrepreneurship. Production factors is a necessary component of the company in producing
certain goods and services.

2. Get a reward or remuneration of factors of production they provide.
As the owners of factors of production that provides paroduksi factors, the household is
entitled to remuneration from the company. Remuneration will be the income for households.
Fringe benefits may include salary or wages for the owners of labor, interest for the owners of
capital, rent for land owners, and entrepreneurial profit for the owner.

3. Acting as a consumer.
Households requiring goods and services to meet their needs. This action causes them to act as
consumers who make the consumption of goods and services produced by the company.

4. Paying taxes to the government.
Taxes paid to the government from some of the income received by households. In this case,
households have an obligation to the government to pay taxes in accordance with applicable
regulations, and the government have the full right to demand payment of taxes from
households. Household taxes paid to the government will later be used for the benefit of the
general public. Thus, an indirect tax payments by households to the government benefits will
be felt again by the household.

Demographic Variables



Demographics are the characteristics of a human population as used in the government, marketing
or opinion research. Commonly used data are sex, race, age, income, disabilities, mobility (in terms
of travel time to work or number of vehicles available), educational attainment, home ownership,
employment status and even location

A demographic trend describes in a population over time i.e. the average age of a population may
increase or decrease over time. Certain restrictions may be set in place i.e. the one child policy in
China. Marketers typically combine several variables to define a demographic profile.

A demographic profile provides enough information about the typical member of this group to
create a mental picture of this hypothetical aggregate. Increased life expectancy and consequently
the average age of population are the results of an accelerated economic growth in the modern
period. It has been proven that as a general long-term trend, when GDP per capita increases due to
better living, the average lifespan of the population and life expectancy increase too.

The relationship between GDP and life expectancy may be analysed also in a reverse way. Namely,
along with increased quality of life and life expectancy, we get an increase of the active life on
population; thus resulting an increase in the overall productive capacity of a country and therefore
of GDP per capita

The Buyer Decision Process

Buyer decision processes are the decision making processes undertaken by consumers in regard to
a potential market transaction before, during, and after the purchase of a product or service. More
generally, decision making is the cognitive process of selecting a course of action from among
multiple alternatives. - Common examples include shopping and deciding what to eat.

A general model of the buyer decision process consists of the following steps:

Need Information Evaluation of Purchase Post-purchase
Recognition Search Alternatives Decision Behavior

Problem recognition
The buying process starts when the buyer recognizes a problem or need
Information search
An aroused consumer may or may not search for more information. How much searching a
consumer does will depend on the strength of the drive, the amount of initial information, the ease
of obtaining more information, the value placed on additional information and the satisfaction one
gets from searching.
Evaluations of alternatives
Unfortunately, there is no simple and single evaluation process used by all consumers or even by
one consumer in all buying situations. There are several evaluation processes:



Attitude of
Others
Evaluation of
Purchase Purchase
Alternatives
Intention Decision
Unexpected
Situational
Factors

Purchase decision
In the evaluation stage, the consumer ranks brands in the choice set and forms purchase intentions.
Generally, the consumer will buy the most preferred brand
Post-purchase behavior
The marketer’s job does not end when the customer buys a product. Following a purchase, the
consumer will be satisfied and dissatisfied and will engage in post-purchase actions of significant
interest to the marketer.

Travel Buying Behavior

Travel industry is undergoing massive structural reorganization – loyalty schemes, price and brand
in their buying decisions. Level of Involvement in purchase decision also increasing – importance
and intensity of interest in a product in a particular situation. Buyer’s level of involvement
determines why he/she is motivated to seek information about a certain products and brands but
virtually ignores others

Information Travel Travel Travel
Felt need/ collection and decision preparation satisfaction
travel desire evaluation (choice and travel outcome and
image between experiences evaluation
alternatives)

The model suggests that there are two levels of factors that have an effect on the consumer.
• The first level of influences is close to the person and includes psychological influence such
as perception and learning.
• The second level of influences includes those, which have been developed during the
socialization process and include reference groups and family influences.

All these models that have been adapted for tourism offer some into the consumer behavior process
involved during the purchase post-purchase decision stages.

Consumer Decision-Making Framework



Socio-
economic Cultural
influences influences

Motivation or Perception
energizers

Consumer or
Decision-maker

Personality/
attitude Learning

Reference group Family
influences influences

In conclusion, consumer making a purchase decision will be affected by the following three (3)
factors:
• Personal - Unique to a particular person. Often according to demographic factors such as
sex, race, age and etc
• Psychological - Motive is an internal energizing force that orients a person’s activities
toward satisfying a need or achieving a goal
• Social - Consumer wants, learning, motives and etc are influenced by opinion leaders,
person’s family, reference groups, social class and culture

UNIT 4:
MARKET STRUCTURE

Chapter objectives
• Describe and understand the market general concept and its structures
• Identify and explore the competitive market: monopoly, oligopoly, and perfect competition
• Discuss the definition and explanation on entrepreneurship and joint-ventures

Market

A market is one of many varieties of systems, institutions, procedures, social relations and
infrastructures whereby parties engage in exchange. While parties may exchange goods and
services by barter, most markets rely on sellers offering their goods or services (including labor) in
exchange for money from buyers. It can be said that a market is the process in which the prices of
goods and services are established.



In mainstream economics, the concept of a market is any structure that allows buyers and sellers to
exchange any type of goods, services and information. The exchange of goods or services for
money is a transaction. Market participants consist of all the buyers and sellers of a good who
influence its price.

Markets vary in form, scale (volume and geographic reach), location, and types of participants, as
well as the types of goods and services traded. Examples include:
• Physical retail markets, such as local farmers' markets (which are usually held in town
squares or parking lots on an ongoing or occasional basis), shopping centers and shopping
malls
• (Non-physical) internet markets (see electronic commerce)
• Ad hoc auction markets
• Markets for intermediate goods used in production of other goods and services
• Labor markets
• International currency and commodity markets
• Stock markets, for the exchange of shares in corporations
• Artificial markets created by regulation to exchange rights for derivatives that have been
designed to ameliorate externalities, such as pollution permits (see carbon trading)
• Illegal markets such as the market for illicit drugs, arms or pirated products

There are two roles in markets, buyers and sellers. The market facilitates trade and enables the
distribution and allocation of resources in a society. Markets allow any tradable item to be evaluated
and priced. A market emerges more or less spontaneously or is constructed deliberately by human
interaction in order to enable the exchange of rights (cf. ownership) of services and goods.

Historically, markets originated in physical marketplaces which would often develop into — or
from — small communities, towns and cities

Market structure

Market structure is best defined as the organisational and other characteristics of a market.
Traditionally, the most important features of market structure are:
• The number of firms (including the scale and extent of foreign competition)
• The market share of the largest firms (measured by the concentration ratio – see below)
• The nature of costs (including the potential for firms to exploit economies of scale and also
the presence of sunk costs which affects market contestability in the long term)
• The degree to which the industry is vertically integrated - vertical integration explains
the process by which different stages in production and distribution of a product are under
the ownership and control of a single enterprise. A good example of vertical integration is
the oil industry, where the major oil companies own the rights to extract from oilfields, they
run a fleet of tankers, operate refineries and have control of sales at their own filling
stations.
• The extent of product differentiation (which affects cross-price elasticity of demand)
• The structure of buyers in the industry (including the possibility of monopsony power)
• The turnover of customers (sometimes known as “market churn”) – i.e. how many
customers are prepared to switch their supplier over a given time period when market



conditions change. The rate of customer churn is affected by the degree of consumer or
brand loyalty and the influence of persuasive advertising and marketing

In economics, market structure (also known as the number of firms producing identical products).
• Monopolistic competition, also called competitive market, where there are a large number of
firms, each having a small proportion of the market share and slightly differentiated
products.
• Oligopoly, in which a market is dominated by a small number of firms that together control
the majority of the market share.
• Duopoly, a special case of an oligopoly with two firms.
• Oligopsony, a market where many sellers can be present but meet only a few buyers.
• Monopoly, where there is only one provider of a product or service.
• Natural monopoly, a monopoly in which economies of scale cause efficiency to increase
continuously with the size of the firm. A firm is a natural monopoly if it is able to serve the
entire market demand at a lower cost than any combination of two or more smaller, more
specialized firms.
• Monopsony, when there is only one buyer in a market.
• Perfect competition is a theoretical market structure that features unlimited contestability (or
no barriers to entry), an unlimited number of producers and consumers, and a perfectly
elastic demand curve.

Competitive market

Monopolistic competition is a type of imperfect competition such that competing producers sell
products that are differentiated from one another as good but not perfect substitutes (such as from
branding, quality, or location).

In monopolistic competition, a firm takes the prices charged by its rivals as given and ignores the
impact of its own prices on the prices of other firms. In a monopolistically competitive market,
firms can behave like monopolies in the short run, including by using market power to generate
profit. In the long run, however, other firms enter the market and the benefits of differentiation
decrease with competition; the market becomes more like a perfectly competitive one where firms
cannot gain economic profit.
In practice, however, if consumer rationality/innovativeness is low and heuristics are preferred,
monopolistic competition can fall into natural monopoly, even in the complete absence of
government intervention.

Monopolistically competitive markets have the following characteristics:
• There are many producers and many consumers in the market, and no business has total
control over the market price.
• Consumers perceive that there are non-price differences among the competitors' products.
• There are few barriers to entry and exit.
• Producers have a degree of control over price.

There are six characteristics of monopolistic competition (MC):
• Product differentiation
• Many firms
• Free entry and exit in the long run
• Independent decision making
• Market Power



• Buyers and Sellers do not have perfect information (Imperfect Information)

Market power

MC firms have some degree of market power. Market power means that the firm has control over
the terms and conditions of exchange. An MC firm can raise it prices without losing all its
customers. The firm can also lower prices without triggering a potentially ruinous price war with
competitors.

The source of an MC firm's market power is not barriers to entry since they are low. Rather, an MC
firm has market power because it has relatively few competitors, those competitors do not engage in
strategic decision making and the firms sells differentiated product. Market power also means that
an MC firm faces a downward sloping demand curve - The demand curve is highly elastic although
not "flat"

Monopoly

A monopoly (from Greek monos μόνος (alone or single) + polein πωλεῖν (to sell) exists when a
specific person or enterprise is the only supplier of a particular commodity. Monopolies are thus
characterized by a lack of economic competition to produce the good or service and a lack of viable
substitute goods. The verb "monopolise" refers to the process by which a company gains much
greater market share than what is expected with perfect competition.

A monopoly is distinguished from a monopsony, in which there is only one buyer of a product or
service ; a monopoly may also have monopsony control of a sector of a market. Likewise, a
monopoly should be distinguished from a cartel (a form of oligopoly), in which several providers
act together to coordinate services, prices or sale of goods. When not coerced legally to do
otherwise, monopolies typically maximize their profit by producing fewer goods and selling them at
higher prices than would be the case for perfect competition.

Sometimes governments decide legally that a given company is a monopoly that doesn't serve the
best interests of the market and/or consumers. Governments may force such companies to divide
into smaller independent corporations as was the case of United States v. AT&T, or alter its
behavior as was the case of United States v. Microsoft, to protect consumers. Monopolies can be
established by a government, form naturally, or form by mergers.
A monopoly is said to be coercive when the monopoly actively prohibits competitors by using
practices (such as underselling) which derive from its market or political influence. There is often
debate of whether market restrictions are in the best long-term interest of present and future
consumers.

Characteristics
• Profit Maximiser: Maximizes profits.
• Price Maker: Decides the price of the good or product to be sold.
• High Barriers to Entry: Other sellers are unable to enter the market of the monopoly.
• Single seller: In a monopoly there is one seller of the good which produces all the output.
Therefore, the whole market is being served by a single company, and for practical purposes,
the company is the same as the industry.
• Price Discrimination: A monopolist can change the price and quality of the product. He sells
more quantities charging less price for the product in a very elastic market and sells less
quantities charging high price in a less elastic market.



Sources of monopoly power
Monopolies derive their market power from barriers to entry – circumstances that prevent or greatly
impede a potential competitor's ability to compete in a market.

There are three major types of barriers to entry; economic, legal and deliberate.

• Economic barriers: Economic barriers include economies of scale, capital requirements, cost
advantages and technological superiority.
o Economies of scale: Monopolies are characterised by decreasing costs for a
relatively large range of production. Decreasing costs coupled with large initial costs
give monopolies an advantage over would-be competitors.
o Capital requirements: Production processes that require large investments of
capital, or large research and development costs or substantial sunk costs limit the
number of companies in an industry
o Technological superiority: A monopoly may be better able to acquire, integrate and
use the best possible technology in producing its goods while entrants do not have
the size or finances to use the best available technology
o No substitute goods: A monopoly sells a good for which there is no close substitute.
The absence of substitutes makes the demand for the good relatively inelastic
enabling monopolies to extract positive profits.
o Control of natural resources: A prime source of monopoly power is the control of
resources that are critical to the production of a final good.
o Network externalities: The use of a product by a person can affect the value of that
product to other people. This is the network effect. There is a direct relationship
between the proportion of people using a product and the demand for that product.

• Legal barriers: Legal rights can provide opportunity to monopolise the market of a good.
Intellectual property rights, including patents and copyrights, give a monopolist exclusive
control of the production and selling of certain goods. Property rights may give a company
exclusive control of the materials necessary to produce a good.

• Deliberate actions: A company wanting to monopolise a market may engage in various
types of deliberate action to exclude competitors or eliminate competition. Such actions
include collusion, lobbying governmental authorities, and force

Oligopoly

An oligopoly is a market form in which a market or industry is dominated by a small number of
sellers (oligopolists). The word is derived, by analogy with "monopoly", from the Greek ὀλίγοι
(oligoi) "few" + πωλεῖν (polein) "to sell". Because there are few sellers, each oligopolist is likely to
be aware of the actions of the others. The decisions of one firm influence, and are influenced by, the
decisions of other firms.

Strategic planning by oligopolists needs to take into account the likely responses of the other market
participants. Oligopolistic competition can give rise to a wide range of different outcomes - In some
situations, the firms may employ restrictive trade practices (collusion, market sharing etc.) to raise
prices and restrict production in much the same way as a monopoly.

Where there is a formal agreement for such collusion, this is known as a cartel - A primary example
of such a cartel is OPEC which has a profound influence on the international price of oil. Firms



often collude in an attempt to stabilize unstable markets, so as to reduce the risks inherent in these
markets for investment and product development.

There are legal restrictions on such collusion in most countries. There does not have to be a formal
agreement for collusion to take place (although for the act to be illegal there must be actual
communication between companies)–for example, in some industries there may be an
acknowledged market leader which informally sets prices to which other producers respond, known
as price leadership.

In other situations, competition between sellers in an oligopoly can be fierce, with relatively low
prices and high production. This could lead to an efficient outcome approaching perfect
competition.
The competition in an oligopoly can be greater than when there are more firms in an industry if, for
example, the firms were only regionally based and did not compete directly with each other.

Characteristics
• Profit maximisation conditions: An oligopoly maximises profits by producing where
marginal revenue equals marginal costs.
• Ability to set price: Oligopolies are price setters rather than price takers.
• Entry and exit: Barriers to entry are high. The most important barriers are economies of
scale, patents, access to expensive and complex technology, and strategic actions by
incumbent firms designed to discourage or destroy nascent firms. Additional sources of
barriers to entry often result from government regulation favoring existing firms making it
difficult for new firms to enter the market.
• Number of firms: "Few" – a "handful" of sellers. There are so few firms that the actions of
one firm can influence the actions of the other firms.
• Long run profits: Oligopolies can retain long run abnormal profits. High barriers of entry
prevent sideline firms from entering market to capture excess profits.
• Product differentiation: Product may be homogeneous (steel) or differentiated
(automobiles).
• Perfect knowledge: Assumptions about perfect knowledge vary but the knowledge of
various economic actors can be generally described as selective. Oligopolies have perfect
knowledge of their own cost and demand functions but their inter-firm information may be
incomplete. Buyers have only imperfect knowledge as to price, cost and product quality.
• Interdependence: The distinctive feature of an oligopoly is interdependence. Oligopolies are
typically composed of a few large firms. Each firm is so large that its actions affect market
conditions. Therefore the competing firms will be aware of a firm's market actions and will
respond appropriately. This means that in contemplating a market action, a firm must take
into consideration the possible reactions of all competing firms and the firm's countermoves.

Perfect Competition

In economic theory, perfect competition describes markets such that no participants are large
enough to have the market power to set the price of a homogeneous product. Because the conditions
for perfect competition are strict, there are few if any perfectly competitive markets. Still, buyers
and sellers in some auction-type markets, say for commodities or some financial assets, may
approximate the concept.

Perfect competition serves as a benchmark against which to measure real-life and imperfectly
competitive markets. Generally, a perfectly competitive market exists when every participant is a
"price taker", and no participant influences the price of the product it buys or sells.



Specific characteristics may include:
• Infinite buyers and sellers – Infinite consumers with the willingness and ability to buy the
product at a certain price, and infinite producers with the willingness and ability to supply
the product at a certain price.
• Zero entry and exit barriers – It is relatively easy for a business to enter or exit in a perfectly
competitive market.
• Perfect factor mobility - In the long run factors of production are perfectly mobile allowing
free long term adjustments to changing market conditions.
• Perfect information - Prices and quality of products are assumed to be known to all
consumers and producers.
• Zero transaction costs - Buyers and sellers incur no costs in making an exchange (perfect
mobility).
• Profit maximization - Firms aim to sell where marginal costs meet marginal revenue, where
they generate the most profit.
• Homogeneous products – The characteristics of any given market good or service do not
vary across suppliers.
• Non-increasing returns to scale - Non-increasing returns to scale ensure that there are
sufficient firms in the industry.

In the short term, perfectly-competitive markets are not productively efficient as output will not
occur where marginal cost is equal to average cost, but allocatively efficient, as output will always
occur where marginal cost is equal to marginal revenue, and therefore where marginal cost equals
average revenue. In the long term, such markets are both allocatively and productively efficient.
Under perfect competition, any profit-maximizing producer faces a market price equal to its
marginal cost.

This implies that a factor's price equals the factor's marginal revenue product. This allows for
derivation of the supply curve on which the neoclassical approach is based. (This is also the reason
why "a monopoly does not have a supply curve.") The abandonment of price taking creates
considerable difficulties to the demonstration of existence of a general equilibrium except under
other, very specific conditions such as that of monopolistic competition.

Entrepreneurship

Entrepreneurship is the act of being an entrepreneur, which can be defined as "one who
undertakes innovations, finance and business acumen in an effort to transform innovations into
economic goods".

This may result in new organizations or may be part of revitalizing mature organizations in
response to a perceived opportunity. The most obvious form of entrepreneurship is that of starting
new businesses (referred as Startup Company); however, in recent years, the term has been
extended to include social and political forms of entrepreneurial activity.

When entrepreneurship is describing activities within a firm or large organization it is referred to as
intra-preneurship and may include corporate venturing, when large entities spin-off organizations .



Entrepreneurial activities are substantially different depending on the type of organization and
creativity involved. Entrepreneurship ranges in scale from solo projects (even involving the
entrepreneur only part-time) to major undertakings creating many job opportunities.

Many "high value" entrepreneurial ventures seek venture capital or angel funding (seed money) in
order to raise capital to build the business. Angel investors generally seek annualized returns of 20-
30% and more, as well as extensive involvement in the business. Many kinds of organizations now
exist to support would-be entrepreneurs including specialized government agencies, business
incubators, science parks, and some NGOs.

Joint-ventures

A joint venture (JV) is a business agreement in which parties agree to develop, for a finite time, a
new entity and new assets by contributing equity. They exercise control over the enterprise and
consequently share revenues, expenses and assets. There are other types of companies such as JV
limited by guarantee, joint ventures limited by guarantee with partners holding shares.

With individuals, when two or more persons come together to form a temporary partnership for
the purpose of carrying out a particular project, such partnership can also be called a joint venture
where the parties are "co-venturers". The venture can be for one specific project only - when the JV
is referred to more correctly as a consortium (as the building of the Channel Tunnel) - or a
continuing business relationship. The consortium JV (also known as a cooperative agreement) is
formed where one party seeks technological expertise or technical service
arrangements, franchise and brand use agreements, management contracts, rental agreements, for
one-time contracts. The JV is dissolved when that goal is reached.

A joint venture takes place when two parties come together to take on one project. In a joint
venture, both parties are equally invested in the project in terms of money, time, and effort to build
on the original concept. While joint ventures are generally small projects, major corporations also
use this method in order to diversify. A joint venture can ensure the success of smaller projects for
those that are just starting in the business world or for established corporations. Since the cost of
starting new projects is generally high, a joint venture allows both parties to share the burden of the
project, as well as the resulting profits.

Since money is involved in a joint venture, it is necessary to have a strategic plan in place. In short,
both parties must be committed to focusing on the future of the partnership, rather than just the
immediate returns. Ultimately, short term and long term successes are both important. In order to
achieve this success, honesty, integrity, and communication within the joint venture are necessary.

Partner selection

While the following offers some insight to the process of joining up with a committed partner to
form a JV, it is often difficult to determine whether the commitments come from a known and
distinguishable party or an intermediary. This is particularly so when the language barrier exists and
one is unfamiliar with local customs, especially in approaches to government, often the deciding
body for the formation of a JV or dispute settlement.

The ideal process of selecting a JV partner emerges from:
• screening of prospective partners
• short listing a set of prospective partners and some sort of ranking
• due diligence – checking the credentials of the other party
• availability of appreciated or depreciated property contributed to the joint venture


• the most appropriate structure and invitation/bid
• foreign investor buying an interest in a local company

Companies are also called JVs in cases where there are dominant partners together with
participation of the public. There may also be cases where the public shareholding is substantial but
the founding partners retain their identity. These companies may be 'public' or 'private' companies.
Further consideration relates to starting a new legal entity ground up. Such an enterprise is
sometimes called 'an incorporated JV', one 'packaged' with technology contracts (knowhow, patents,
trademarks and copyright), technical services and assisted-supply arrangements.

The consortium JV (also known as a cooperative agreement) is formed where one party seeks
technological expertise or technical service arrangements, franchise and brand use agreements,
management contracts, rental agreements, for 'one-time' contracts, e.g., for construction projects.
They dissolve the JV when that goal is reached.

Company incorporation

A JV can be brought about in the following major ways:
• Foreign investor buying an interest in a local company
• Local firm acquiring an interest in an existing foreign firm
• Both the foreign and local entrepreneurs jointly forming a new enterprise
• Together with public capital and/or bank debt

UNIT 5:
THE THEORY OF PRICE DETERMINATION

Chapter objectives
• Outline the definition of pricing and understand about price sensitivity
• Identify and explain the different types of pricing strategies
• Discuss about the different types of pricing methods and price discounting measurements
• Explore the demand and supply model: demand and supply curve, as well as demand and
supply price elasticity



Pricing

Pricing is the process of determining what a company will receive in exchange for its products.
Pricing factors are manufacturing cost, market place, competition, market condition, and quality of
product. Pricing is also a key variable in microeconomic price allocation theory.

Price is the only revenue generating element amongst the four Ps, the rest being cost centers.
Pricing is the manual or automatic process of applying prices to purchase and sales orders, based on
factors such as: a fixed amount, quantity break, promotion or sales campaign, specific vendor quote,
price prevailing on entry, shipment or invoice date, combination of multiple orders or lines, and
many others.

The needs of the consumer can be converted into demand only if the consumer has the willingness
and capacity to buy the product. Thus pricing is very important in marketing.

What a price should do?

A well chosen price should do three things:
• achieve the financial goals of the company (e.g., profitability)
• fit the realities of the marketplace (Will customers buy at that price?)
• support a product's positioning and be consistent with the other variables in the marketing
mix
o price is influenced by the type of distribution channel used, the type of promotions
used, and the quality of the product
o price will usually need to be relatively high if manufacturing is expensive,
distribution is exclusive, and the product is supported by extensive advertising and
promotional campaigns
o a low price can be a viable substitute for product quality, effective promotions, or an
energetic selling effort by distributors

From the marketer's point of view, an efficient price is a price that is very close to the maximum
that customers are prepared to pay.

Nine Laws of Price Sensitivity & Consumer Psychology

• Reference Price Effect
Buyer’s price sensitivity for a given product increases the higher the product’s price relative
to perceived alternatives. Perceived alternatives can vary by buyer segment, by occasion,
and other factors.
• Difficult Comparison Effect
Buyers are less sensitive to the price of a known / more reputable product when they have
difficulty comparing it to potential alternatives.

• Switching Costs Effect
The higher the product-specific investment a buyer must make to switch suppliers, the less
price sensitive that buyer is when choosing between alternatives.

• Price-Quality Effect
Buyers are less sensitive to price the more that higher prices signal higher quality. Products
for which this effect is particularly relevant include: image products, exclusive products, and
products with minimal cues for quality.


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