Shifting the demand curve to increase social welfare% Telefónica

In the field of regulation and competition, the ultimate political goal must be to maximize social welfare. The previous article in this series explained the basic economic logic behind the concept of well-being. It has been shown that the social well-being created by an activity depends on the units of the related product or service used and the utility that consumers derive from that use. It was also explained that prices distribute wealth between producers and consumers and affect both the level of consumption and investment incentives.

Therefore, regulators and politicians use prices to increase social well-being in the short term, jeopardizing their future sustainability. Finally, it was concluded that the best way to improve social welfare seems to be to shift the demand curve to the right. This article will explain how this process works and the role that producer profits play in it.

Value grows with utility

Remember that the basis for calculating wealth is the demand curve. This curve represents the value that consumers give to each unit of product or service consumed, measured by their willingness to pay. Figure 1 shows that if the demand curve shifts to the right, social welfare increases for equal use. This is because users derive more utility for each unit used.

The shift in demand may be exogenous to the market and not due to the actions of producers. For example, during a particularly hot summer, the usefulness of air conditioning for consumers is likely to increase. This will shift your search curve to the right. From a political point of view, endogenous changes that can be caused by manufacturers who find new applications for their products or generally improve them with features that allow them to better meet consumer preferences are much more interesting.

For this to happen, the product must change or a successful innovation must be born. How is this process carried out?

Competition as a process of market opening

To understand this, it is a good idea to describe the competitive process as a market discovery process. [1]. Figure 2 shows the process graphically.

Competitive flow as a process of market discovery led by an entrepreneur


We assume that information about consumer preferences is distributed among people and must be found in some way. Thus, the market is understood as a dynamic discovery process generated by entrepreneurs who are constantly looking for opportunities for profit. This identification is done by calculating the market, with which they receive estimates that guide their decisions. In this context, prices act as signals of entrepreneurial activity.

Opening a business opportunity is equivalent to discovering more valuable use for a commodity. [1]. The entrepreneur who decides to act must acquire such a commodity and combine it with other commodities in the production process, which always leads to a certain duration. Once this is done, you need to sell the resulting product at a price that allows you to recoup the entire investment, along with the interest rate over time (interest rate over time). If you benefit after the whole process, it will mean that your assessment was correct and that the product is more valuable in the new use than it was in the alternative. On the contrary, the occurrence of losses would mean improper use of the asset, sending a clear signal that it should be returned to its original use.

If there is a benefit, more than good should be directed to this new use. This will be done by the successful entrepreneur himself, who is logically in a privileged position to continue to take advantage of his discovery, or by new entrepreneurs attracted by the benefit. The process of imitation continues until the benefit is exhausted due to an increase in the stock of goods received or an increase in the prices of the initially undervalued goods. This increase, in turn, will act as a signal of profit, activating new competitive processes such as that described in other markets.

The pillars that underlie the competition process

Business opportunities depend on the differences between current prices of goods and expected prices for them. Therefore, changes in prices create business opportunities: an increase in the price signals an increase in the relative deficit of the commodity, either due to an increase in its value for individuals (for example due to new use), or due to a decrease in available stocks. The decrease in the price signals the opposite.

In this way, the market can be described as seeking the greatest value in the context of uncertainty and its functioning can be summarized around four key pillars [2].

1.- competition: understood as competing activities of market agents in search of information on how best to meet the needs of consumers.

2.- knowledge and discovery: The competitive process not only mobilizes existing knowledge, but also raises awareness of opportunities whose very existence has been unknown.

3.- Benefits and incentives: profits do not simply consist of subtracting known costs from known revenues, but rather are incentives to localize the differences between costs and revenues. In other words, the benefits are a signal that certain goods are more valuable in new uses than in current ones.

4.- Market prices: at all times, prices represent the exchange rates agreed between market participants; they provide information to entrepreneurs about the ongoing valuation of assets and therefore about business opportunities.

The role of producer profits in changing demand

From what has just been said, it is clear that shifting demand to the right and the subsequent increase in social welfare is not a simple process. On the contrary, it is a process subject to a high degree of risk and uncertainty. [3]as improvements to a product that consumers value are not known in advance.

In addition, the entrepreneur must invest in the necessary goods to be able to test his idea, he can not do it without spending. In short, entrepreneurs face trial and error as the only way to increase consumer utility, a procedure that requires resources but very often ends in failure.

Although success is not guaranteed, the more tests an entrepreneur can do, the better his chances of finding a better product and shifting the demand curve to the right.

The search for how to achieve a more valuable product for consumers is at the heart of many modern business management practices, such as the method “Lean start”By Eric Rice, who explores how to effectively use a limited budget for innovation. Here, the discovery process is compared to taking off an airplane with two possible outcomes: success or failure.

Tracking (runway) left until launch, ie “the amount of time left at start-up to start or fail ” usually measuredwith the money in the bank divided by the monthly expense or net draining of the balance on the specified account ” [4]. This applies both to start-ups and to any established company, due to the changing and uncertain nature of consumer preferences. In fact, Rice goes so far as to say that “the real measure for the track is the number of turns the startup has left” [5]in view of the resources at your disposal.

In financial terms, this means that capital expenditure (CAPEX) is needed to move the demand curve to the right. The more capital costs are invested, the more ideas can be put to trial and error. And they increase the chances of hitting when moving the curve.

Similarly, the capital costs that a company can devote to the discovery are directly related to the part of the profit that the manufacturer can keep. The reason is that this advantage will be directly available for the acquisition of new goods, which allow restarting the discovery process.

In any case, there should be an increase in social welfare as a result of invested capital expenditures and with a certain delay compared to the time of investment; in addition, a higher increase should be observed at higher CAPEX.

conclusion

1.- Producers can increase social welfare by shifting the demand curve to the right. That is, finding new applications or improving goods.

2.- The way in which it is achieved can be explained by the understanding of competition as a process of market opening.

3.- In the process of opening the market, entrepreneurs anticipate (invest) resources in a trial and error process. They do it to learn about consumer preferences. Most of the time, their ideas fail, but when they succeed, the demand curve shifts to the right. Consequently, social welfare increases, often drastically.

4.- The expected resources correspond to the financial concept of CAPEX. The greater the manufacturer’s profit, the more CAPEX will be able to invest and the more likely they will be able to find new valuable applications for their products, thus increasing social welfare.

In the next entry in this series on social care, we will apply the methodology explained in this and the previous publication to measuring the social well-being provided in the telecommunications market, both in the European Union and in the United States. We will also check whether the link between CAPEX and welfare, which has just been described, is valid in this case. Interesting? Stay informed and subscribe to our weekly newsletter to keep up to date with all the news.


Footnotes:

[1] In economic theory, a distinction is made between first-class goods (ready-to-use goods) and higher-order goods (factors of production). In general, the activity of producers consists in combining production factors to obtain a product. This product may or may not be a first-class product, but the analysis is not the same.

[2] Kirzner IM (1985). The dangers of regulation: a market process approach. In RM Ebeling (1991): Austrian Economics: reader. Hillsdale, MI: Hillsdale College Press. See pages 629-633.

[3] As can be seen from any statistics on business failures or products released and then abandoned.

[4] “The amount of time remaining during which the start-up must either achieve an increase or fail“”through the remaining money in the bank divided by the monthly percentage of burning or net draining of the balance on this account”(Own translation). See Ries E. (2011). Lean Startup. Crown Publishing, Chapter 8. This same book introduces the concept of “Minimally Viable Product” (MVP, for its acronym in English), so widespread today.

[5] “The real measure for the track is how many spins are left for the start-up company”(Own translation). About Rhys a “pivot”Is a change in strategy, but the concept is directly summarized to“ research ideas ”.

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