Economics Theme 3 - Business Behaviour and Labour Flashcards
give three reasons why firms grow
1) Economies of scale - decrease cost of production leading to higher revenue and larger profit.
2) Profit - many firms are motivated by profit. Achieveing high levels or profit will allow a firm to reinvest for expansion
3) Diversification - opportunity to enter new markets as they are able to decrease risks through spreading across multiple products and markets. Eg. Samsung
Three reasons why firms remain small
1) Avoid diseconomies of scale - rapid growth can cause lack of control and may not meet an objective of a certain firm
2) Firms operate in niche markets - hindering ability to have sufficient demand for their goods and services required for growth.
3) Low barriers to entry - difficult for small firms to enter big markets that are dominated with large firms.
What causes Principal-agent problem?
Divergence of interests
As businesses grow there is a separation of ownership and control causing different aims such as profit maximisation vs own benefits and objectives between the shareholders ( principals ) and agents ( managers who run the business day to day ).
Stems from asymmetric information
How to overcome the Principal agent problem?
Place schemes like peformance based incentives or granting equity ownership to switch their objectives from sales maximisation to profit maximisation.
What’s the difference between Public and Private organisations?
Public: organisations run by government
Private: Private sectors firms run by private individuals and are motivated by profit
What’s the difference between Profit and Non-profit organisations:
Profit: maximising finianical benefits for shareholders as main aim and possibly maximising profits
Non profit: maximise social welfare and are excempt from certain taxes that profit organisations have to pay for.
What are the two main types of growth?
Organic and Integration
What is organic growth?
Expand internally rather than merging or taking over other businesses.
How do firms grow organically?
Increasing output or expanding into international markets
What is an example of a firm that grows organically?
LEGO - introduced new range of products and expanded customer base
What are advantages and disadvantages of organic growth?
+ keep control over business and reduces risk
+ avoids diseconomies of scale
-time consuming for those who wish to maximise salaries
- slow growth
What is integration?
A type of way for businesses to grow through merging or taking over another business.
What are the 3 types of integration?
1) Vertical
2) Horizontal
3) conglomerate
What is forward vertical integration and an example?
When a firm aquires or control businesses that a closer to the end-consumer/ dsitrubition side.
An example: In 2017, Amazon aquired Whole Foods market expanding its reach into the grocery industry
What is backwards vertical integration and an example?
When a firm aquires or takes control of businesses positioned earlier in the production or supply chain. Ensuring stable and reliable sources of raw materials.
An examples: Nike owns its factories, gaining more control over the production and distribution of its products
What are benefits of vertical integraion?
+ Increased market power as they gain more control over ensuring the quality of supplies and delivery is reliable. Reducing risks
+Increased potential for profit as they can capture a larger proportion of value chain
What are disadvantages of vertical integration?
-lose benefits of specialised expertise when they integrate
-causes problems of coordination and communication, potentially leading to diseconomies of scale
What is horizontal integraion?
- Taking over or merging of a firm at the same stage of production process and industry
What is an example of horizontal integration?
2019, Walt Disney aquired 21st Century Fox’s entertainment assets such as film and television studios.
What are advantages of horizontal integration?
+reduces competition by removing one or more key rivals
+diversification of products - creating opportunities for economies of scope
+exploit internal economies of scale - lower average costs can lead to increased profits
What are disadvantages of horizontal integration?
-Reduced flexibility -addition of more personnel and processes in the merged businesses means more legal accountability ( slowing down rate of business innovation )
-Risk of diseconomies of scale - from enlarged businesses if there’s a clash and costs increase
What is conglomerate integration?
Firms that takeover/merge with a business in another industry to what they’re in. Giving businesses the chance to expand into different markets which they may have struggled to compete in through organic growth.
What is an example conglomerate integration?
Samsung - the outh Korean electronics giant - makes military hardware, apartments, ships and also operates an amusement park
What are advantages of conglomerate integration?
+useful for firms where there may be no room for growth in the present market
+range of products reduces the risk of diseconomies of scale as it will allow for increased output and experience benefits that are derived from increased output such as lower borrowing costs
What are disadvantages of conglomerate integration?
- increases risk if lack of knowledge/expertise of the market and may result in making poor decisions and unable to attract new customers
What is demerger?
Business splits into seperate firms by selling one or more businesses it currently owns turning it into a seperate company
What is an example of a demerger?
In 2021, Johnson and Johnson announced its demerger plan involving its orthopedic business
Why do firms carry out demergers?
1) Allow focus on core business to cut average costs and improve profit margin
2) Reduce the risks of diseconomies of scale by reducing range of businesses and achieve lower management costs
3) Avoid investigation from authorities of monopoly power
What are the impacts of demerges
1) Job unceratinity as employees may feel uneasy about their job and positions may be duplicated or no longer needed - leading to potential layoffs
2) Brings opportunities and growth despite challenges as it creates new jobs and growth to companies
3) Disruption of services as customers may experiences delays or quality of services due to a disruption of services during the demergers process
4) Stock price changes - companies might experience changes as market adjusts to new organization
What are the main business objectives?
1) Profit maximisation
2) Sales revenue maximisation
3) Sales growth maximisation
4) Business survival
5) Public interest objectives
Where does profit maximization occur?
point where marginal cost = marginal revenue
what is marginal revenue?
change in total revenue from selling an extra unit
what is marginal cost?
change in total cost from producing an extra unit
if MR> MC what does that mean to profit
selling an extra unit will add to profit
what is the law of diminishing returns?
the additional output you get from adding one extra unit of factors of production will eventually diminish
Where does revenue maximisation occur
When MR = 0 and half way in demand curve
What is sales growth maximisation?
when a firm focuses on generating the highest possible level of sales within a given time period and occurs when price per unit = average cost
What is satisficing?
Combination of satisfaction and suffice and involves the shareholders setting minimum acceptable levels of achievement of revenue.
why is satisficing beneficial?
reduces and simplifies decision making
What is the difference between a “shareholder” and “stakeholder”?
Shareholder - owns a share in company’s stock
Stakeholder - are a broader group with diverse interests in the companies outcomes
Environmental and social obligations
1) reducing carbon emissions - many companies are setting targets to reduce their carbon emissions and become carbon neutral
what are some examples of stakeholders?
1) Shareholders
2) Managers
3) Employees
4) Suppliers
5) Government
6) Community
What are fixed costs?
expenses that do not vary depending on the level of output. costs remain the same whether the business produces high or low quantity of goods and services.
Do fixed costs change in the short run?
NO
What are some examples of fixed costs?
1) Fixed salary costs
2) insurance fee for business
3) Rent
4) research projects
What are variable costs?
Expenses that change directly depending on the level of output. Costs fluctuate and can vary significantly as business activity changes
Do variable costs change in the short run?
variable costs will rise as production expands
What is variable costs determined by?
marginal costs of extra units of output as more variable inputs are hired
What are examples of variable costs?
1) basic raw materials
2) packaging costs
3) component parts
4) part-time wages
What is the equation for marginal cost?
change in TC / change in output ( Q )
What is the equation for total cost?
TFC + TVC
What is the equation for Average Fixed Cost?
Fixed Cost (FC) / Quantity (Q
What is the equation for Average Variable Cost?
Variable Cost (VC) / Quantity (Q)
What is the equation for marginal cost?
Change in Total Cost / Change in Quantity
What is the difference economies and diseconomies of scale?
Economies of scale occurs when the average costs of a firm decrease due to increased output. On the other hand, diseconomies of scale occur when the average costs of a firm increase due to increased output.
What is the minimum efficient scale?
is the point at which the curve stops falling and levels off. this is the minimum point where the firm to full exploit economies of scale
What is an oligopoly market?
imperfectly competitive industry with high levels of market concentration
What are some industries that operate in the oligoply market?
1) Airlines
2) Fizzy drinks
3) Household goods
What are some characteristics of an oligopoly market?
1) High barrier to entry
2) Differentiated or homogeneous products
3) Mutual interdependance ( decisions by one firm affects other firms in the industry )
4) Small number of large firms dominating the industry
5) Non-price competition, eg. advertisement product, development, and customer service
Implications of mutual interdependance?
1) Startegic behaviour: firms actions are based on the expected actions and reactions of rivals
2) Conflicting incentives: collude or compete ( always uncertainty in this market structure )
what does the concentration ratio measure?
combined market share ( % ) of the largest N firms in the market. typically 3-5 firms
what is the typical conc ratio for an industry when it exists in an oligoply?
if combined 5 firm conc ratio > 60%
what is collusion in oligpoly?
anti-competitve behaviour: when two or more firms work together to set price or output levels
why do firms work together?
effectively set higher prices and limit output and reducing competition in the market as they set higher prices for consumers ( mutual benefit ) wha
what do countries do to prevent collusion?
government can set anti trust laws with penalties that prohibit firms from engaging in anti-competitive behaviour
what is the difference between collusion and cooperation?
collusion harms consumers and markets but cooperation is when firms work together to achieve mutual benefits that don’t harm market/consumers
what are the two different types of collusion?
tactical and collusive
what is tactical collusion?
( informal ) no formal agreements and firms behave based on implicit understanding. difficult to prove but can have significant negative effects on the market if unchecked.
what is a type of tactical collusion?
Price leadership - one firm sets/initates the dominant price and others follow the lead.
what are arguments against oligpoly?
-cartel behaviour leads to higher prices, causing a loss of allocative efficency
-high conc ratio limits consumer choices and barriers to entry may deter due to small firms unable to have a profitable entry
what are advantages of oligopoly?
-lead to price wars and increase consumer surplus
-high supernormal profits can be taxed
what is game theory?
mathematics that study strategic decision - making
when does nash equilibium occur?
when both firms follow their dominant strategies
what is dominant strategy in game theory?
where one single strategy is best for a player regardless of what strategy other players in the game chooses
what are some real world applications of game theory?
1) field of auctions - game theory can be used to moderate the bargaining process
what is the kinked demand curve used to represent?
model to represent price stability in an oligopoly
