Some Principles of Microeconomics

Small businesses are feeling the economic pinch. Many have already shut down, before government orders to curb lending. In the mean time, it is still possible that many small companies will need to shut down over the next few weeks. Small businesses have a number of advantages, though. They can weather temporary lean periods and improve efficiency through cost-cutting.

A few months ago, there was an outbreak of swine flu in the business sector. Some small businesses were forced to close down. It is natural for smaller businesses to consider these things, as pandemic outbreaks are common in any industry.

There is no direct relation between the current crisis and the economic health of small businesses. However, as the economy improves, small business will likely experience some benefits. The economic recession has been a boon for consumers. This has been especially so in the US, where consumers have enjoyed substantial wage increases. A better economy should increase spending.

Unfortunately, economics also considers the opportunity cost. The more money a person or family spends, the more opportunities they lose to earn additional income. One economic principle related to cost per action, or CPE, can help explain why people react so negatively when confronted with losing an opportunity.

According to this economic principle, if a person or family loses an opportunity, they will not look at similar opportunities next time. The loss of potential income is considered a “pulse loss.” It is much harder to recover from a loss of future income than it is to recover from a loss of current income. The current crisis is obviously much worse for small businesses than it is for large corporations. Small business owners must take into account how difficult it will be to recover from a small business recession.

Consider a situation in which all of the previously mentioned factors are applied: unemployment is at an all-time high, unemployment is rising, interest rates are near record lows, inflation is above pre-recession levels, etc. Obviously, businesses will suffer more losses than they would on other occasions in which these factors did not apply. Many economically rational people think that the current recession will result in dire consequences for small businesses. In truth, the recent economic chaos may actually be an opportunity for small businesses.

According to another of economics’s most widely used theories, the theory of elasticity, there is one price that cannot be set, and businesses must continually adjust for the subsequent effects. The elasticity of prices, therefore, means that businesses do not gain a benefit from changing their prices and must instead wait until the effects have been fully realized. A similar economic theory, called Say’s Law, also shows that some items will always be priced at a particular value, because supply and demand always maintain the same price. One of the most influential of modern economists, Hyman M. Lerner, Ph.D., suggests that small businesses should not attempt to compete with larger firms when all other factors are equal. Since the competition between small enterprises is based on certain minimum standards, the smaller enterprise may be forced to adjust its prices to remain within that price range. Although the theory of elasticity makes the process of pricing more complicated, it also indicates that a small business does not need to charge the same prices as its larger competitors in order to be successful.

In addition to Say’s Law and the Carnavale-Hubbell principles, another of modern economics’s most prominent principles is the implicit opportunity cost. According to this principle, a firm has an opportunity cost if it fails to take advantage of that opportunity cost; if it does not spend that potential benefit on a particular activity, then it can easily be replaced by a more profitable activity. The implicit opportunity cost of a firm therefore reflects not only the firm’s direct expenses but also those costs which it could or would avoid by pursuing a different activity. Although this principle has received a great deal of attention in recent years, the Carnavale-Hubbell method has received even more focus. Both Carnavale and Hubbell were developed by economists with a specialization in business firm decision making.

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