Chapter 3 - Microeconomic decision makers Flashcards
What are the four functions of modern currency (money)?
Modern currency (money) is a medium of exchange, a measure of value, a store of value and a method of deferred payment.
How does money act as a medium of exchange?
A medium of exchange: Without money, it becomes necessary for buyers & sellers to barter (exchange goods). Bartering is problematic as it requires two people to want each other’s goods (double co-incidence of wants). Money easily facilitates the exchange of goods as no double co-incidence of wants is necessary
How does money act as a measure of value?
A measure of value: Money provides a means of ascribing value to different goods and services. Knowing the price of a good in terms of money allows both consumers and producers to make decisions in their best interests. Without this measure it is difficult for buyers & sellers to arrange an agreeable exchange
How does money act as a store of value?
A store of value: Money holds its value over time (of course inflation means that is not always true). This means that money can be saved. It remains valuable in exchange over long periods of time
How does money act as a method of deferred payment?
A method of deferred payment: Money is an acceptable way to arrange terms of credit (loans) & to settle any future debts. This allows producers & consumers to acquire goods in the present & pay for them in the future
What are the six characteristics of money?
Divisible, acceptable, durable, scarce, uniform and portable
Why is money divisible?
Divisibility: to be a valued medium of exchange, currency must be divisible. €50 notes can be exchanged for €10 euro notes or €1 coins
Why is money acceptable?
Acceptability: the currency must be valued & widely accepted by society as a valid way to pay for goods/services.
Why is money durable?
Durability: the currency must be robust, not easily defaced/destroyed & last for a long period of time.
Why is money scarce?
Scarcity: the supply of the currency should be such that it remains desirable & retains its value in the market. Oversupply would decrease its worth.
Why is money uniform?
Uniformity: in order to be a valid measure of value each denomination must be exactly the same e.g. every $50 note must be exactly the same.
Why is money portable?
Portability: good currency is easy to carry/conceal.
What are the four functions of the central bank?
Central banks are the lender of last resort, implementation of monetary policy, governments bank and regulate the banking industry.
Why is the central bank a lender of last resort?
Lender of last resort: commercial banks are able to borrow from the central bank when they run into short term liquidity issues. Without this help, they might go bankrupt leading to instability in the financial system.
How does the central bank implement monetary policy?
Implementation of monetary policy: the central banks implements monetary policy by adjusting interest rates and controlling the money supply.
How does the central bank bank to the government?
Banker to the government: the government sets the annual budget, but it is the central bank that manages the tax receipts and payments.
How does the central bank regulate the banking industry?
Regulation of the banking industry: the high level of asymmetric information in financial markets requires that commercial banks are regulated in order to protect consumers.
What are the five functions of commercial banks?
Commercial banks facilitate saving, lend to businesses and individuals, facilitate the exchange of goods and services, they provide forward markets in currencies and commodities, and they provide a market for equities.
How do commercial banks facilitate saving?
They facilitate saving: storing money for future use is essential for households & firms. It also provides a pool of money that financial institutions can lend i.e. one person’s savings is another person’s borrowing.
Why do commercial banks lend to businesses and individuals?
They lend to businesses and individuals: access to credit is a key requirement for economic growth & development. Being able to borrow money speeds up consumption by households & investment by firms. It also allows households or firms to purchase assets & pay them off over an extended period of time e.g. mortgages on home purchases.
Why do commercial banks facilitate the exchange of goods and services?
They facilitate the exchange of goods and services: each purchase of goods/services requires the movement of money between at least two parties. Commercial Banks provide multiple ways for this exchange to happen including phone apps (e.g. Google Pay), debit cards, credit cards & bank transfers.
How do commercial banks provide forward markets in currencies and commodities?
They provide forward markets in currencies and commodities: forward markets are also called futures markets. They provide some price stability in commodity markets & enable investors to make a profit by speculating on future prices.
How do commercial banks provide a market for equities?
They provide a market for equities: equities are shares in public companies that are listed on stock exchanges around the world. Commercial Banks facilitate both long term investment & speculation by providing platforms which connect buyers & sellers.
How can spending, saving and borrowing levels change in households?
Changes to income, changes to interest rates and changes to confidence levels influence spending, saving and borrowing.
How do changes to income influence household spending and consumption?
Changes to income: Disposable income is the money that households have left over from their salary/wages after they have paid their taxes & have received any transfer payments/benefits from the government. Consumption increases as disposable income increases & decreases as disposable income decreases.
How do changes to interest rates influence household spending and consumption?
Changes to interest rates: Interest rates are set by the government’s Central Bank. Changes to the base rate cause commercial banks to change the lending rates they offer customers. If interest rates increase, then the cost of borrowing increases. Higher borrowing costs = less consumption. If interest rates increase, the monthly repayment on any existing loan increases. Higher loan repayments = less consumption.
How do changes to confidence levels influence household spending and consumption?
Changes to confidence levels: The stronger the economy, the higher consumer confidence. Consumers feel secure in their jobs & are confident of receiving regular salary payments. Therefore, consumption increases. In a weakening or recessionary economy, consumer confidence falls. Consumers feel less secure in their jobs & consumption decreases.
How do changes to income influence household saving?
Changes to income: When disposable income increases, the proportion saved depends on the overall income level of the household. Low-income households will spend any additional income on necessities or a few basic luxuries - little additional saving occurs. Medium income households will increase both consumption & savings. High income households will usually increase their savings (or asset purchases) significantly.
How do changes to interest rates influence household saving?
Changes to interest rates: Changes to the base rate cause commercial banks to change the savings rate they offer customers. An increase in the savings rate offered by commercial banks incentivises households to save more. A decrease in the savings rate offered by commercial banks disincentivises households from saving & encourages consumption.
How do changes to confidence levels influence household saving?
Changes to confidence levels: Households tend to save when they are more fearful of the future. The stronger the economy, the higher the consumer confidence & the lower the level of household saving. The weaker the economy, the lower the consumer confidence & the higher the level of household saving.
How do changes to income influence household borrowing?
Changes to income: When disposable income increases, household borrowing often increases due to the ability to make additional monthly payments. Low-income households find it difficult to access commercial bank loans & if they need to borrow money, they face higher interest rate charges (e.g. payday loans or “buy now, pay later” schemes) - or they turn to money lenders. Medium income households will increase borrowing as income rises. High income households often receive preferential interest rates & obtain large loans to fund asset purchases e.g. luxury properties.
How do changes to interest rates influence household borrowing?
Changes to interest rates: If interest rates decrease, medium & high-income households may decide to borrow more money from commercial banks, as it is now cheaper to repay. There will likely be an increase in personal loans to fund travel, car purchases & home improvements. Low-income households are usually unable to access borrowing from commercial banks, even when interest rates fall & continue to borrow from sources that charge high interest rates.
How do changes to confidence levels influence household borrowing?
Changes to confidence levels: When the economy is booming, confidence is high resulting in more borrowing & consumption. When the economy slows down or stagnates, confidence falls resulting in less borrowing & consumption.
What are wage factors?
Wage factors are financial payments that workers receive for their labour. They include wages, salary, commission, bonus, piece rate pay, performance related pay, share options and fringe benefits.
What are non-wage factors?
Non-wage factors incorporates a range of influences that are meaningful to a worker. They include length of training or level of education required, job security, job satisfaction, career prospects, level of challenge and status.
What are four factors that influence the demand for labour?
The price of the product being produced, the demand for the final product, the ability to substitute capital for labour and the productivity of labour
How does the price of the product being produced influence the demand for labour?
If the selling price of the product increases, then the firm will be incentivised to supply more & the firm’s demand for labour will increase.
How does the demand for the final product influence the demand for labour?
As demand for labour is a derived demand, when an economy is booming then demand for most goods/services will be high - & the demand for labour will be high. When an economy is in a recession demand for most goods/services will be lower - & the demand for labour will be lower.
How does the productivity of labour influence the demand for labour?
If the productivity of labour increases (possibly through training) this will lower average costs & firms will likely demand more labour.
How does the ability to substitute capital for labour influence the demand for labour?
Firms will constantly evaluate if it will be possible & more cost effective to switch production from using labour to capital (machinery). If it is more cost effective, then demand for labour will fall.
What are the eight factors that influence the supply of labour?
Training period, wages in other occupations, changes in migration policy, income tax levels, working conditions, trade union power, level of welfare benefits and social trends.
How does the training period influence the supply of labour?
Long training periods (& their cost) act as a barrier to entry & exclude many households from offering labour in certain markets.
How do wages in other occupations influence the supply of labour?
Comparative wage rates in substitute labour markets strongly influence the supply of labour e.g. it is getting harder to recruit economics teachers as the private sector offers higher wages for their skills.
How does changes in migration policies influence the supply of labour?
Policies that increase the net migration rate increase the supply of labour to certain industries e.g. in 2022, 36% of Singapore’s labour force were migrants.
How do income tax levels influence the supply of labour?
At a certain level, income taxes become a disincentive to households offering their labour. The assumption is that as income tax increases, labour supply decreases - and vice versa.
How do working conditions influence the supply of labour?
The working conditions & non-wage benefits can act as strong incentive in certain industries e.g. tech companies are well known for their laid-back work environment & wide range of benefits e.g. on-site childcare & restaurants.
How does trade union power influence the supply of labour?
Trade unions can increase the supply of labour to certain industries as workers consider the benefits of belonging to the union e.g higher wages & a safer working environment.
How does the level of welfare benefits influence the supply of labour?
The higher the level of welfare benefits, the lower the incentive for low-skilled labour to offer their labour - and vice versa.
How do social trends influence the supply of labour?
Social trends include any major changes within society & can influence the supply of labour to certain industries e.g. work from home during Covid resulted in significant changes to the labour market & not all workers returned to work when economies opened up again.
What are four factors that influence workers bargaining power?
Membership of a trade union, age and experience, level of education and current supply conditions.
How does membership of a trade union influence workers bargaining power?
Membership of a trade union: trade unions represent the interests of the workers in negotiations with employers & members frequently enjoy higher wages than non-union members.
How does age and experience influence workers bargaining power?
Age and experience: young, inexperienced workers have less bargaining power then older, more experienced workers. As workers grow older their age often begins to count against them & this reduces bargaining power.
How does level of education influence workers bargaining power?
Level of education: education provides higher levels of skill & specialisation to a worker. This increases their bargaining power relative to unskilled workers.
How does current supply conditions influence workers bargaining power?
Current supply conditions: the supply of labour in many industries can change due to socio-political conditions.
Why do governments set a minimum wage?
Governments often intervene in the labour market by setting a minimum wage. They do this in order to improve equity and avoid the exploitation of workers.
Why do wage differentials occur?
Workers are paid in different amounts (wage differentials) due to a number of factors including gender pay differences, industrial pay sector pay differences, private and public sector pay differences and differences in pay between skilled and unskilled workers.
What are the reasons for wage differentials between men and women?
Men usually work full-time whereas women often work part-time in order to meet the demands of motherhood/childcare.
Men usually have an uninterrupted career journey whereas women often take time away from work (motherhood/family) & so miss opportunities for advancement.
Women are more likely to accept a job below their skill or quantification level if it fits in with the needs of looking after their children.
The gender pay gap is a form of discrimination & occurs when a women is paid less than a man who is doing exactly the same job.
What are the reasons for wage differentials between the primary, secondary and tertiary sector?
Primary sector workers are usually paid low wages due to the unskilled nature of the job & the fact that raw materials often generate the lowest profits in the production chain.
Secondary sector workers add value to the raw materials & these products sell for higher profits. Therefore, wages tend to be higher than primary sector wages.
Tertiary sector workers are paid the highest. Their jobs often require highly valued skills that take years to acquire & the products they sell or services they provide can be complex & expensive e.g. artificial intelligence coders.
What are the reasons for wage differentials between the private and public sector?
Private sector organisations are owned and controlled by private individuals and firms. Salaries can be extremely high, especially if the value of goods or services offered is high & the workers are productive. Some salaries can also be very low as firms seek to cut costs & maximise profits e.g. garment sector worker in Bangladesh get paid very little for the work they do. Many wage benefits tend to be better than those provided by the public sector e.g. bonuses or share options
Public sector organisations are owned and controlled by the government. Wages will reach a maximum ceiling that is often below what the private sector may offer e.g. public-school teachers are paid less than private school teachers. Wages often do not fall as low as some private sector jobs as many public sector workers belong to trade unions. Job security is high resulting in long careers with defined pathways for promotion. Pensions are often very good but are limited in comparison to private sector pensions.
What are the reasons for wage differentials between skilled and unskilled workers?
Many economies have a high supply of unskilled labour. This means that employers can push wages down as there is always someone willing to work for less (take it or leave it approach to wages).
To become skilled takes time & money which means that there is a more limited supply of specific skillsets. In recognition of these factors, wages for skilled workers are higher.
What is division of labour?
The division of labour is when a task is broken up into several component tasks. This allows workers to specialise by focusing on one (or a few) of the components that make up the production process and thereby gain significant skill in doing it. This results in higher output per worker and so increases productivity
What are the advantages towards workers of the division of labour and specialisation?
Workers can acquire the single skill required relatively quickly.
Workers gain recognition & status for performing their skill well.
What are the disadvantages towards workers of the division of labour and specialisation?
The work can be repetitive & boring.
There is limited opportunity to gain additional skills.
If the firm replaces labour with capital, the worker may find it difficult to find employment elsewhere due to their limited skill base.
What are the advantages towards firms of the division of labour and specialisation?
Time spent training new workers is relatively short.
Increased output allows firms to generate more sales & profit.
Higher labour productivity lowers cost/unit for firms, which makes their goods more competitive internationally (exports).
What are the disadvantages towards firms of the division of labour and specialisation?
Worker productivity can fall due to the boredom/ decreased motivation experienced.
Staff turnover may be high as workers seek new, interesting opportunities elsewhere.
International trade is beneficial for the firms that can compete globally. However, some firms will be unable to compete and will go out of business.
Entire industries may close leading to structural unemployment.
What are the advantages towards the economy of the division of labour and specialisation?
Increased exports can result in economic growth for the nation.
Economic growth usually leads to higher income and a better standard of living.
Income gained from exports can be used to purchase other goods from around the world (imports). This increases the variety of goods available in a country.
What are the disadvantages towards the economy of the division of labour and specialisation?
Specialisation may create over-dependency on other countries’ resources. This may cause problems if conflict arises (E.g, Europe’s reliance on Russian natural gas during the Ukraine crisis).
Specialisation using a country’s own resources will lead to resource depletion. Specialisation increases the rate of resource depletion.
What is a trade union?
Trade union is an organisation that represents the interests of its workers in negotiations with a firm’s management or owners.
What are the four interests of workers?
The interests of workers include wage and non-wage benefits, health and safety and the reduction of discrimination and worker exploitation.
What are the four types of trade unions?
General union, industrial union, craft union and white collar union
What is a general union?
These represents skilled and unskilled workers in any industry e.g. truck drivers, football referees, musicians and gardeners
What is an industrial union?
These represents workers in the same industry. Anyone in the industry can join, irrespective of skill level or seniority e.g. The Fire Brigades Union in the United Kingdom
What is a craft union?
These represent skilled workers with a specific trade e.g. painters, electricians
What is a white collar union?
These represent professional office-based (‘white-collar’) workers e.g. financial advisors, teachers, architects, designers
What are the three roles of trade unions in an economy?
Collective bargaining power on wages, working conditions and contractual terms, protecting the employment of their workers and influencing government policy
How do trade unions increase collective bargaining power on wages, working conditions and contractual terms within an economy?
Collective bargaining on wages, working conditions and contractual terms: Negotiating for acceptable wage level which are often well above minimum wage, negotiating for increased wages when comparative industries receive pay increases, negotiating for inflation-linked pay rises, negotiating for higher wages when firms are making higher profits, negotiating standard weekly working hours and overtime payments and negotiating for improvements to working conditions and equipment’s.
How do trade unions protect the employment of their workers within an economy?
Protecting the employment of their workers: Negotiates for the retention and redeployment of workers when machinery (capital) replaces labour, negotiates resettlement packages when firms relocate from one region to another and redundancy terms for those unable to relocate, negotiates to minimise job losses when machinery (capital) replaces labour and negotiates on a fair termination process when firms are struggling in an economic downturn.
How do trade unions influence government policy within an economy?
Influencing government policy: Negotiates with government on the creation/maintenance of minimum wage levels, aims to influence policy through member action such as strikes, negotiates to minimise job losses when machinery (capital) replaces labour and negotiates on a fair termination process when firms are struggling in an economic downturn.
How does the percentage of workers from a firm influence the collective bargaining power with the employers?
The higher the percentage of workers from a firm that belong to a trade union, the greater the collective bargaining power of that union with the employers
How does the percentage of workers from an economy influence the collective bargaining power with the government?
The higher percentage of workers from an economy that belong to trade unions, the greater the collective bargaining power of the unions with the government.
What seven factors influence the strength of trade unions?
The unemployment level, wage levels as a proportion of total costs, swapping labour for capital, the level of profits, state of the economy, overall size of the trade union and the productivity of labour.
How does the unemployment level influence the strength of a trade union?
The unemployment level: the higher the unemployment level, the weaker the bargaining power as firms can more easily replace existing workers.
How does wage levels as proportion of total costs influence the strength of a trade union?
Wage levels as proportion of total costs: the lower the percentage of total costs that a firms’ wages represent, the higher the bargaining power.
How does swapping labour for capital influence the strength of a trade union?
Swapping labour for capital: the nearer the replacement cost of capital for labour to meeting the increased costs demanded by the union, the weaker the bargaining power.
How does the level of profits influence the strength of a trade union?
The level of profits: higher profits strengthen the unions demands for higher wages.
How does the productivity of labour influence the strength of a trade union?
The productivity of labour: if the workers are extremely productive, generating high levels of output from low levels of input, they are more valuable to the firm and the union has stronger bargaining power.
How does the overall size of the trade union influence the strength of a trade union?
Overall size of the trade union: the larger the union, the stronger their bargaining power.
How does the state of the economy influence the strength of a trade union?
State of the economy: less bargaining power in a recession and more when the economy is booming.
What are the advantages of trade unions for workers?
Workers no longer need to negotiate with management on their own as they benefit from collective bargaining
Workers receive better pay than non-unionised workers
Workers enjoy better working conditions than non-unionised workers
Workers enjoy better non-wage benefits such as guaranteed lunch breaks
Workers receive specialised job training & free legal advice from the union
What are the disadvantages of trade unions for firms?
Including unions in decision-making increases the time period taken to implement changes which can be detrimental to effective competition
Management styles have to be more inclusive & less authoritarian which some managers find difficult to accept
Meeting union demands increases costs of production, which may reduce output & profits
What are the advantages of trade unions for the government and the economy?
Trade unions help create a more equal & prosperous society
A prosperous society is the basis of strong consumption in an economy & this helps to drive economic growth
If firms’ profits increase due to increased productivity, governments receive more corporation tax
Higher wages mean that the workers’ pay more income tax to the government, which can be used to further fund public & merit goods
What are the disadvantages of trade unions for workers?
Industrial action is stressful as it is a conflict between workers & management
Workers do not get paid while on strike
Strike action disrupts economic activity & can upset other people in the economy
Individual workers may not agree with specific demands made by the trade union on behalf of all the workers, & yet they are pressured to support the collective action
Some union members continue to work through a strike (they may need the money) & receive abuse & intimidation from the other striking union members
What are the disadvantages of trade unions for the government and the economy?
Industrial action reduces output, lowers firms’ profits, thereby lowering the potential corporation tax collected by the government
Strike action is often very disruptive to many people’s lives, especially when it occurs in essential industries such as rail networks
Governments may find it harder to attract multinational corporations (MNCs) to invest if industrial action occurs regularly
MNCs may be more reluctant to invest in strongly unionised economies as the costs of production will be higher
What are the advantages of trade unions for firms?
Training from the trade union increases worker productivity which decreases costs
Empowerment in the workplace improves employee motivation, which usually results in fewer sick days, higher productivity & greater output for the firm
What is a firm?
A firm is a business organisation which sells or produces a good or a service. All firms require factors of production as inputs. They add value to these inputs in producing a good or a service. They sell the good or service, ideally at a price higher than the cost of production.
How can you classify firms?
You can classify firms by the sector of the economy in which they operate, publicly (government) or privately (owned) and their relative size.
What is the primary sector?
The primary sector includes firms involved in the production or extraction of raw materials e.g. fishing, farming and mining
What is the secondary sector?
The secondary sector includes firms that process raw materials in order to manufacture goods e.g. car manufacturing
What is the tertiary sector?
The tertiary sector include firms which provide services e.g. car sales, banking and travel bookings
How do economies measure what proportion of firms are active in each sector?
Economies usually measure what proportion of firms are active in each sector. This can be done by the % of workers employed in each sector of the % of gross domestic product which each sector generates.
What are public sector firms?
Public sector firms are owned and controlled by the government
What are private sector firms?
Private sector firms are owned and controlled by other firms and private individuals such as entrepreneurs and shareholders
What is privatisation?
Privatisation occurs when government-owned firms are sold to the private sector
What is the main goal of public sector firms?
Their main goal is usually to provide a service
Public sector firms can operate on a local, regional or national government level
E.g. Transport for London (local); Agricultural State Service in India (regional); Caribbean Airlines (national)
What is the main goal of private sector firms?
The objective of most private sector organisations is profit maximisation
This often causes the private sector to be more efficient than the public sector with higher levels of productivity
Types of business ownership vary from sole trader to partnerships to company shareholders
What four factors influence the relative size of firms?
The number of employees
The % of market share in an industry
The size of profits
Market capitalisation
What are six reasons why small firms exist?
Personalised service, loans, niche market, mass markets, diseconomies of scale and the firms objective.
Why do small firms exist for personalised service?
Personalised service as they offer a more personalised service and focus on building relationships with their customers
Why do small firms exist for loans?
Loans as small firms are often unable to access finance for expansion
Why do small firms exist for mass markets?
Mass markets as many first operate in mass markers with low barriers to entry
Why do small firms exist for niche markets?
Niche market as they provide a product that is in a niche market, smaller market size but can be very profitable
Why do small firms exist for diseconomies of scale?
Diseconomies of scale as rapid growth can cause diseconomies of scale which can be difficult to deal with and so many owners choose to avoid these
Why do small firms exist for the firms objective?
The firms’ objective as an owner’s goal is not profit maximisation but rather an acceptable quality of life
What are some advantages of small firms?
They often provide highly customised goods/services e.g. pet grooming in the customer’s home
They often create personal relationships with their customers which helps to generate customer loyalty & word-of-mouth advertising
They often provide very unique products which are sold in small quantities at high prices - this can be very profitable
Smaller firms can respond quickly to changing market conditions
What are some disadvantages of small firms?
More susceptible to changes in the wider economy than large firms, especially during recessions
Less financial resources available to them, including access to larger bank loans - some smaller firms are unable to access any loans at all
It is harder to recruit/retain staff as the wage & non-wage benefits are less competitive than those offered by bigger firms
Owners may struggle to take a holiday/sick leave as revenue slows/stops coming in when they stop working
Small firms struggle to generate economies of scale as the volume of output is significantly lower than that of larger firms resulting in lower profit margins
What are the two types of growth of firms?
The growth of firms can be organic (internal) or inorganic (external)
What is organic (internal) growth?
Organic growth (internal) is usually generated by gaining greater market share, product diversification, opening a new store, international expansion or investing in new technology/product machinery.
What is inorganic (external) growth?
Inorganic growth (external) usually takes place when firms merge in one of three ways. Vertical integration (forwards or backwards), horizontal integration or conglomerate integration.
What is forward vertical integration?
Forward vertical integration involves a merger or takeover with a firm further in the supply chain e.g. a dairy farmer merges with an ice cream manufacturer
What is backward vertical integration?
Backward vertical integration involves a merger or takeover with a firm further backward in the supply chain e.g. an ice cream retailer takes over an ice cream manufacturer
What is horizontal integration?
Horizontal integration involves a merger or takeover with a firm producing the same product at the same stage of production
What is conglomerate integration?
Conglomerate integration involves a merger or takeover with a firm producing a different product from a different industry
What are the advantages of organic growth?
The pace of growth is manageable
Less risky as growth is financed by profits & there is expertise in the industry
Avoids diseconomies of scale
The management know & understand every part of the business
What are the disadvantages of organic growth?
The pace of growth can be slow & frustrating
Not necessarily able to benefit from economies of scale
Access to finance may be limited
What are the advantages of vertical integration?
Reduces the cost of production as middleman profits are eliminated
Lower costs make the firm more competitive
Greater control over the supply chain reduces risk as access to raw materials is more certain
Quality of raw materials can be controlled
Forward integration adds additional profit as the profits from the next stage of production are assimilated
Forward integration can increase brand visibility
What are the advantages of horizontal integration?
Rapid increase of market share
Reductions in the cost per unit due to economies of scale
Reduces competition
Existing knowledge of the industry means the merger is more likely to be successful
Firm may gain new knowledge or expertise
What are the disadvantages of vertical integration?
Diseconomies of scale occur as costs increase e.g. unnecessary duplication of management roles
There can be a culture clash between the two firms that have merged
Possibly little expertise in running the new firm results in inefficiencies
The price paid for the new firm may take a long time to recoup
What are the disadvantages of horizontal integration?
Diseconomies of scale may occur as costs increase e.g. unnecessary duplication of management roles
There can be a culture clash between the two firms that have merged
What are the advantages of conglomerate integration?
Reduces overall risk of business failure
Increased size & connections in new industries opens up new opportunities for growth
Parts of the new business may be sold for profit as they are duplicated in other parts of the conglomerate
What are the disadvantages of conglomerate integration?
Possible lack of expertise in new products/industries
Diseconomies of scale can quickly develop
Usually results in job losses
Worker dissatisfaction due to unhappiness at the takeover can reduce productivity
What are economies of scale?
Economies of scale occur when as a firm grows, it is able to increase its scale of output generating efficiencies that lower its average costs of production. Economies of scale help large firms to lower their costs of production beyond what small firms are able to achieve.
What are diseconomies of scale?
Diseconomies of scale occur as firms continue to increase its scale of output, it will reach a point where its average costs will start to increase.
What are internal economies of scale?
Internal economies of scale occur as a result of the growth in the scale of production within the firm.
What are external economies of scale?
External economies of scale occur when there is an increase in the size of the industry in which the firm operates in.
Diagram of economies and diseconomies of scale
What is the demand for the factors of production by firms influenced by?
The demand by firms for the factors of production is influenced by the demand for goods and services, the price of different factors of production and the availability and productivity of the factors.
How does the demand for goods and services influence the demand for the factors of production?
The demand for goods and services is a derived demand. E.g. if a tyre manufacturer benefits from increased demand for their tyres, they will require more rubber to meet the demand. They may also require more labour and possibly more capital (machinery) to manufacture the tyres.
How does the price for different factors of production influence the demand for the factors of production?
The price for different factors of production are constantly monitored by firms in order to ensure that they are maximising profits. The price of installing new and efficient machinery (capital) will be monitored against the cost of hiring more workers (labour)
How does the availability of the factors of production influence the demand for the factors of production?
The availability of the factors of production can change rapidly in factor markets. Many firms responded by searching for substitute factors of productions so that they could continue producing goods and services. In some cases, this meant switching demand from cheaper foreign imports to more expensive locally produced raw materials.
How does the productivity of the factors of production influence the demand for the factors of production?
If the productivity of a factor is high (or increasing) then the demand for that factor will also increase.
What two types of intensive can a firm be?
A firm can either be labour intensive or capital intensive
What is labour intensive?
Labour intensive means that the proportion of labour costs are higher than the other factors if production
What is capital intensive?
Capital intensive means that the proportion of machinery costs are higher than any of the other factors of production
What are the advantages of labour-intensive production?
The firm can adjust the number of workers hired as demand for its goods/services fluctuate
Depending on the industry, workers can build meaningful connections with customers which helps to create customer loyalty e.g. restaurant waiters versus iPad ordering
Workers can generate new ideas & offer suggestions on how processes can be improved
What are the disadvantages of labour-intensive production?
There may be periods where worker productivity is low
The firm may find it difficult to recruit workers when needed & letting go of staff when they are not required is unpopular
The more skilled the labour required, the higher the wage bill for the firm will be
Each worker requires both wage & non-wage benefits, which can prove expensive for the firm
Workers can get ill & then are unavailable for work
What are the advantages of capital-intensive production?
Production can continue 24/7 with only short breaks so as to allow for machinery maintenance
Machinery cuts down on human error & product quality remains consistent
Absenteeism or a shortage of skilled workers are non-issues with capital-intensive production
The firm can reduce average costs as it benefits from technical economies of scale
What are the advantages of capital-intensive production?
The cost of purchasing & installing new machinery can be very high (but is often financed with a bank loan & paid off over a period of years)
Most machinery cannot improve processes, although artificial intelligence innovation is changing this
Switching capital for labour negatively impacts both the workers who lose their job & also the morale of the workers left behind
Once the machinery is installed, it can be difficult for the firm to respond to changing customer tastes/fashions which require product changes
What is production?
Production is the act of adding value to the factors of production to create goods and services. It is the process of factor conversion into goods and services, and it is a measure of output.
What is productivity?
Productivity is a measure of efficiency that calculates the amount of outputs produced per unit of input. It calculates how efficiently resources are being used in the creation of goods and services and provides a metric for comparison.
What are some influences on production?
Influences on production: during a recession production falls and during a boom period production increases, demand for goods and services and supply of the factors of production.
What are some influences on productivity?
Influences on productivity: process innovation, product innovation, increasing expenditure on capital, investment into machinery, training, competition and encouraging small businesses.
Why is higher productivity important for a firm?
Higher productivity is important for a firm and an economy because it lowers costs, improves a firms national and international ability to compete, increases output, increases economies of scale, generate higher profits, increased government revenue from tax and economic growth
What are total costs?
Total costs (TC) are the sum of the fixed + total variable costs. The total cost is the sum of the variable & fixed costs. The total costs cannot be 0 as all firms have some level of fixed costs
What are average total costs?
Average total costs (ATC) is the total cost per unit of output. As a firm grows, it is able to increases its scale of output generating efficiencies that lower its average total costs (AC) of production
These efficiencies are called economies of scale
As a firm continues increasing its scale of output, it will reach a point where its average total costs (AC) will start to increase. The reasons for the increase in the average costs are called diseconomies of scale
What are fixed costs?
Fixed costs (FC) are costs that do not change as the level of output changes. The firm has to pay its fixed costs which do not change, irrespective if the output is 0 or 100,000 units. The fixed costs for this firm are $4,000.
What are variable costs?
Variable costs (VC) are costs that vary directly with output. The variable costs initially rise proportionally with output, as shown in the diagram. At some point the firm will benefit from a purchasing economy of scale and the rise will no longer be proportional.
What are average fixed costs?
Average fixed costs (AFC) is the fixed cost per unit of output. If the fixed costs of a firm are $1,000 & it produces 1 unit of output, then its AFC is $1,000 ($1,000/1). If the firm increases its output to 1000 units, then the AFC is $1 per unit ($1000/1,000). The more units a firm produces, the lower its AFC will be. This is one reasons why large levels of output help to increase the profit per unit
What are average variable costs?
Average variable costs (AVC) is the total variable cost per unit of output.
How do you calculate total cost?
Total cost (TC) = total fixed costs (TFC) + total variable costs (TVC)
How do you calculate average total cost?
Average total cost (ATC) = total cost (TC) / quantity (Q)
How do you calculate total variable cost?
Total variable cost (TVC) = variable cost (VC) x quantity (Q)
How do you calculate average fixed costs?
Average fixed cost (AFC) = total fixed costs (TFC) / quantity (Q)
How do you calculate average variable cost?
Average variable cost (AVC) = total variable costs (TVC) / quantity (Q)
How do you calculate total revenue?
Total revenue (TR) is the total value of all sales in a firm. Total revenue (TR) = selling price (P) x quantity sold (Q)
How do you calculate average revenue?
Average revenue (AR) is the overall revenue per output. Average revenue (AR) = total revenue (TR) / quantity sold (Q)
What are four objectives of firms?
Profit maximisation, growth, survival and social welfare
Why do firms aim for profit maximisation?
Profit maximisation by increasing sales revenue or decreasing their costs. Profit = total revenue (TR) – total costs (TC). Firms continuously analyse their costs to see if they can reduce them so that profit can be maximised.
Why do firms aim for growth?
Growth can be achieved by focusing on their sales revenue or market share. Firms will also maximise revenue in order to increase output and benefit from economies of scale.
Why do firms aim for survival?
Survival is focused on in the short term for many new firms.
Why do firms aim for social welfare?
Social welfare include focusing on climate action and addressing poverty or inequality.
What are the five characteristics of market structure?
Characteristics of market structure: number of sellers, type of information, firms price setting behaviour, type of product, barriers to entry and number of buyers.
What are the four characteristics of competitive markets?
Characteristics of competitive markets: there are many buyers and sellers, there are no barriers to entry or exit meaning firms can start up or leave the industry with relative ease which increase the level of competition, buyers and sellers possess perfect knowledge of prices and the products sold by competing firms are identical and indistinguishable from each other meaning that firms are unable to build brand loyalty as perfect substitutes exist.
What are the advantages of competitive markets?
Lower prices: competition causes firms to lower prices for consumers in an attempt to gain market share.
Better quality: firms innovate & continuously seek to improve their quality of their goods/services in order to become recognised in a crowded market.
More choice: more sellers equals more choice for consumers.
What are the disadvantages of competitive markets?
Worse quality: in a bid to lower prices, product quality may actually deteriorate over time
Too much choice: consumers may be overwhelmed & not explore the full range of market offerings, instead sticking to what they know
Worker welfare: the greater the competition the greater the need to cut costs, often resulting in low wages & poor working environments.
What is a monopoly?
A monopoly is a market structure in which there is a single seller, there are no substitute products, the firm has complete market power and high barriers to entry exist.
What are the advantages of monopoly power for firms?
Large profits generate money for continued investment in technology & product innovation.
Market power enables the firm to increase its global competitiveness.
Economies of scale can increase thereby lowering the average cost.
Price discrimination: the firm can charge consumers different prices based on the different price elasticity of demand for the product e.g. peak (inelastic) & off-peak (elastic) travel on trains.
What are the advantages of monopoly power for employees?
Large profits often result in higher wages.
What are the disadvantages of monopoly power for firms?
Due to a lack of competition, there is a reduced incentive to be efficient.
Cross subsidisation can create inefficiencies.
Monopolies lead to a misallocation of resources as they limit supply in order to increase price.
Due to a lack of competition, innovation sometimes lacks effectiveness .
What are the disadvantages of monopoly power for employees?
Having only one supplier in the industry limits the opportunity to change employers.
What are the advantages of monopoly power for consumers?
Product innovation due to the firm’s large profits may result in a better-quality product.
Cross subsidisation can lower prices on some products that the firm provides.
Prices may fall If firms pass on their cost savings to consumers (due to economies of scale) in the form of lower product prices.
What are the disadvantages of monopoly power for consumers?
A lack of competition is likely to result in higher prices as no substitute goods are available.
A lack of competition may result in no product innovation & worse product quality over time.
May experience worse customer service as the incentive to improve it is limited.
Cross subsidisation is likely to increase prices on some products offered by the firm.
What are the advantages of monopoly power for suppliers?
Increased sales volume for some suppliers as they are able to supply products that are distributed nationally or internationally.
What are the disadvantages of monopoly power for suppliers?
There is less competition for their products & a monopoly often has the power to dictate what price they will pay to suppliers.
