Firms and Decisions Part 2 Flashcards
Market Structure
4 types of market structure, which vary accordingly to degree of competition in terms of number and size of firms relative to market
Perfect Competition characteristics
Large number of buyers and sellers
- Each firm has no significant share of total market output, acts independently in deciding its own output level
No barriers to entry and exit
- No restrictions when they enter market, absence of financial, technical and government imposed barriers
- Accounts for large number of firms and why they can only make normal profits in long run
Homogeneous product
- Product is identical to rivals, perfect substitutes
- No non-price competition, no variety, no preference for product of any one firm
- Unable to determine price of its own product, sell it at market price
- Firm is PRICE TAKER
Perfect Knowledge
- Everyone knows prices and production costs of rivals, market costs and available production technology
- Complete information about each and every seller’s price and their quality and availability of products
Pricing decisions of PC
Price taker, no control over price of product, sell its product at prevailing market price
- If selling above market price, quantity demanded for firm’s product falls to 0 because consumers will purchase product from any other firm since products are perfect substitutes
- No incentive to reduce price below market equilibrium price because it can sell all it wants at prevailing market price
Graph of PC Firms
Perfectly price-elastic because firms is price-taker, every unit of output is sold at market price
Price = average revenue = marginal revenue
Output decisions of PC
Produce the level of output that maximises total profit, when MR = MC and MC is rising
When MR > MC, addition to total revenue from last unit of output is greater than additional cost incurred in producing, firm can increase profits if production is increased
When MC > MR, cost more to produce the last unit than what firm gains in revenue, producing the last unit caused a fall in total profits
Profit is only maximised when last unit of output produced adds as much to total revenue as total cost
When MR = MC but MC is falling, continue to produce as additional output will add more to total revenue than to total cost
PC Profitability in SR and LR
In SR, firm can make supernormal, normal or subnormal profits
In LR, firm only can make normal profits.
- Due to perfect info, presence of supernormal profits attracts new firms to enter market/ presence of subnormal profits will cause firms to shut down and leave the market
- Lack of entry/ exit barriers increase/ decrease number of firms, leading to a increase/ decrease in quantity supplied at every price level, and a rise/ drop in market supply
- Price rises/ falls, and since PC firms are price-takers, they have to sell at that lower/ higher price
- Assuming no change in cost conditions, supernormal profits are eroded/ losses of PC firms who survived is reduced.
- Firms still in the market would make only normal profits.
Monopoly Characteristics
Only seller of the good, price setter
Unique product, Lack of close substitute, demand for output is less price elastic
Imperfect Knowledge- not fully aware of costs and production of product, technology used is closely guarded, increasing price-setting ability
Complete barriers to entry and exit- new firms cannot enter industry, firms can charge relatively high price above MC and retain supernormal profits, barriers to entry are temporary as potential firms develop new technologies and devise price strategies to break into market
Monopoly Artificial barriers to entry
- Strategic barriers (strategic entry deterrence)
= Intensive advertising to boost demand for its products, persuade customers of lack of substitutes and induces customer loyalty and make it harder for potential entrants to break into market
= Gaining control over supplies of essential raw materials, ensure small amount of supply in the market, keeping prices high
= Hostile takeovers and acquisitions, dominant company buys up a rival firm
= Use supernormal profits to finance research and development to develop new products or improve on production to cut costs - Statutory barriers
= Given by force of law, regulation of intellectual property rights (patents and copy rights)
= Keep demand high and less price elastic
Monopoly Natural barriers to entry
Differences in production and costs between existing firm and potential entrant
Capacity expansions results in lower unit costs of production through exploiting more fully available internal economies of scale, helping firm to be more cost efficient and lower LRAC and more price competitive than potential entrant which operates on smaller scale
Monopoly Barriers to exit
Sunk costs are costs which cannot be recovered and cannot be diverted to other uses such as
- Capital inputs specific to an industry
- Money spent on advertising marketing research and development projects
- Money spent on building expensive and complex IT systems that are unworkable
Graph of Monopoly firm
Constrained by market demand- cannot increase both price and output at the same time
Demand/ AR and MR curve is downward sloping, but AR would be greater than MR at any output (other than first one)
- Has to lower price on all units to sell an extra unit, assuming he chargers uniform price, hence MR is the price he receives from sale of last additional unit minus loss of revenue from sale of all other units at lower price
Monopoly profit maximising condition
Produce at MR = MC
If MR > MC, each additional output unit adds more revenue than cost, increasing firm’s profits, should expand output
If MR < MC, each additional unit sold adds more to cost than revenue, so additional unit reduces profits of firm
Monopoly Profitability in SR and LR
No guarantee that monopolist makes supernormal profits in short run
Possible for monopolist to retain supernormal profits in long run by erecting high barriers to entry
Natural monopoly
Market demand is large enough to support only one large firm operating at or near its minimum efficient scale of production
Firm may have to incur overhead costs that are prohibitively high compared to variable costs, so firm can spraed overhead costs more widely over larger output level and exploit technical economies of scale more fully, achieving a lower long run cost per unit
Can reduce price of product to ward off potential entrants, new entrants cannot compete effectivily, discouraging them from entering
Monppolistic competition characteristics
Large number of small buyers and sellers relative to market size
- Relative small share of total market
- Acts independently of others as it is impossible to take into account the reaction of so many rivals, retaliation is less likely to occur as their gains in sales revenue would be spread thinly over many rivals, so the extent to which they suffer due to other firms is negligible
- Engage in non-pricing competition to differentiate products from rivals to maintain customer loyalty providing firm with certain degree of market power
Low barriers to entry and exit
- Low start-up costs, relatively easy to copy technology and relatively mobile factors of productions
- Rental and licensing costs are low
Differentiated products
- Real physical differences
* Goods are altered in a way that they differ in minor ways (materials/ workmanship)
- Imaginary differences
*Differentiated by design, branding and promotion methods
* Non-price competitive techniques increase demand for firm’s products and make demand less price elastic
- Differences in conditions of sale
*Location of shops and quality of service
Imperfect knowledge
- Dont have complete information regarding production methods and consumers dont have complete information of all available prices
MPC Profitability in SR and LR
Can make subnormal supernormal and normal profits
Makes only normal profits due to low barriers of entry
- Ease of entry allows new firms to enter industry and sell products that can be potential substitutes to those sold by existing firms, consumers have wider range of products to choose from
- (same as PC)
- Inability to retain supernormal profits in long run restricts ability of firms to engage in large-scale advertising or invest huge sums of money in research and development so products are slightly differentiated, but the presence of many rivals make product differentiation necessary
Oligopoly Characteristics
Few dominant firms relative to market size
- Firms command large proportion of market share and have relatively high market power, ability to set price and price setters
- High degree of interdependence or rival consciousness exists amongst firms
- Rival’s actions cannot be ignored as they are likely to result in significant effects, must keep an eye on competitors
High barriers to entry
- Artificial barriers to entry
*Strategic barriers
= Limit and predatory pricing where prices are deliberately set very low (lower than profit maximising price) by dominant competitor to prevent rivals from entering market because entrants cannot match price of incumbent firm without incurring losses, or to drive out existing competitors
= Advertising and branding establishes brand loyalty, making it hard for poetntial firms to break into market
*Statutory barriers are same as Monopoly
- Natural barriers
= Firms enjoy substantial internal economies of scale, new entrant cannot produce at scale of production that matches incumbent, AC of potential new firms is higher than incumbent firms AC harder for them to compete
Homogenous or differentiated products
Homogeneous products means perfect oligopoly as each firm has control over their pricing policy and each firm is a price setter
Differentiated products mean oligopoly is imperfect as there is less fear of immediate reaction from rivals
Imperfect knowledge
Sellers and buyers have incomplete info about production methods and prices, serving also as barrier to entry, icnrease price-setting ability of oligopoly
Short run shut down condition
- Firm can only reduce variable costs to zero by stopping production and shutting down
- Will not be able to avoid losses incurred from paying for fixed factors of production even if it produces a quantity of zero
- Consider whether total revenue can cover variable costs
a. If revenue earned is more than variable costs as surplus generated can be used to offset part of its fixed costs
b. If revenue earned is less, firm should shut down so losses are limited to only fixed costs instead of making losses by continuing production and incurring both fixed and variable costs - Continue production as long as TR > TVC
Cooperative model- collusive oligopoly and types of collusions
Firms work together to reduce uncertainty and increase predictability of rival’s reactions.
Agree to limit competition through agreed output quotas or fixed prices, or limits of product promotion/ development or agreements not to poach each other’s markets
Cartels and price leadership model
Cartels strategy
Increase market power to determine jointly level of output and price, behaving like a monopolist
If they sell homogenous product, their demand curve would be horizontal at market price, but if they form a cartel, will jointly face a downward sloping market demand curve, where the marginal cost curve is horizontal sum of individual members’ marginal cost curves
Can choose to produce less output and charge higher price, to maximise joint profits, each firm will have a production quota
Limitations of cartels
- Incentive to not follow production quota to increase individual profits
-> Firms are unable to produce at their profit maximising level of output for joint profits to be maximised
-> Producing more but continuing to sell at the same price would increase its individual profits
-> Other members would follow suit and produce beyond quota to maximise individual profits
-> Market supply of good increases driving down prices
-> Collusive agreement will break down, every member earns profit that is below joint profits
-> If dominated by many smaller firms monitoring members would be harder
-> Hard to formulate policy that meets the needs of every single member, make it harder to monitor perfectly and detect cheating, easier for firms to pursue own priorities
-> Smaller the no. of firms the better, so barriers to entry must be high to limit no. - Product is less standardised more unique, harder to reach agreement on price and production quotas
-> Coordination is harder when firms have different cost structure as it is more difficult to synchronise prices - Government efforts to curb collusion
-> Goes against backbone of political democracy as cartels go against free and fair competition
-> Monetary penalty requiring convicted firm to pay money after an offense has been committed
-> Possibly can significantly reduce firm’s profits, must penalising through fines may not be effective for multi-billion-dollar corporations that have alot of money to spare - Market demand is variable
-> Difficult to make agreements due to difficulties in predicting and due to need to make frequent amendments to agreements
Price leadership model
- Barometric model
-> Firm that is more adept at identifying changes in market conditions and can respond more efficiently will be market leader
-> Other producers follow its lead under assumption that price leader is aware of something they have yet to realise - Dominant firm model
-> Firm controls vast majority of market share within an industry. enjoys lowest average cost of production
-> As dominant firm adjusts prices, any smaller firms within segment must follow
Informal for firms to determine price and avoid undercutting each other
Price set by market leader in tacit collusion is accepted as market price by other firms, prices tend to be stable, when leader initiates a change other firms will follow
Pricing Strategies
Firm’s plan for setting price of its product, accepting it will sell the quantity demanded which corresponds to the price as indicated by the firm’s demand curve
Uniform pricing
Firm sells all units of its output at same price and charge all its customers the same price for the same good
To maximise profits, set price qty where MR = MC, and price at corresponding point on AR curve
To profit satisfice, make enough profit to keep shareholders happy, occurs when ownership and control is separated
To maximise revenue, set qty where MR =0 and set price at corresponding point on AR curve
To increase market share (means the firm makes normal profits), produce where AC = AR
Price discrimination and 3 conditions for this to happen
Occurs when producer sells same good at different prices whereby price difference does not reflect differences in cost of supplying customer, capture consumer surplus earn higher total revenue and hence higher total profits
- Market power
- Need to have market power to choose its price - Identify and segment market according to differences in price elasticity of demand
- Buyers with lower PED is charged higher prices, while buyers with higher PED is charged lower prices - Prevent resale and arbitrage
- Prevent reselling otherwise low-price consumers can make profit on resale while high-price consumers can buy product at lower price than what is charged, firm eventually can only sell to those who want to buy it at the lowest price
Third degree price discrimination
Firm charges different price to different groups of customers buying the same product by segmenting the market according to differences in price elasticities of demand between these groups
- Customer characteristics (age, nationality, student, where PED is diff)
- Location (lack of accessibility or lack of knowledge by charging different prices in difference locations)
- Past purchase behaviour (discount new customers, because existing customers are relatively less price elastic as they are unwilling to spend time and effort to search for better deals)
Benefits and limitations of third degree price discrimination
Benefits
- Increase firm’s profits via increasing total revenue through capturing consumer surplus of group of customers that is relatively less price elastic
- Increase sales volume to group of customers that is more price elastic, as more price sensitive consumers can enter market, firms can benefit from lower unit cost of production and exploit internal economies of scale
- Cost of providing a good/ service cannot be covered by low revenue generated, firms can continue to provide good or service through cross subsidisation
Limitation
- Only effective is firms are successful in segmenting the market and preventing resale, firms need to spend on costly monitoring and enforcement systems, adding to operational costs and negatively affecting profitability
- Technological advancement mean consumers have greater access to information that reduces effectiveness of price discrimination
Predatory pricing
Drive competitors out of market and scare off potential entrance by selling below average variable costs in short run, may lead to price war
Result in significant losses for predator, predator must expect losses made in current period to be offset by future gains arising from lesser competition, so must have sufficient past supernormal profits to cover losses
Used as a short term strategy and unsustainable in the long run, hurt brand image as it causes consumers to perceive the product as cheap or poor quality, only attract bargain hunters and lack customer loyalty
Price Wars
Suppliers attempt to undercut one another’s prices to achieve greater share of market and/ or to increase total revenue and profits in long run.
Price competition leads to price wars, which are harmful and unsustainable as firms need to make at least normal profit in long run to survive in industry
Price cuts also does not lead to higher revenues for firms and depends heavily on reactions of rivals in response to price cut
Price wars occur when firms get rid of their old stocks or during festive occasions where firms want to make greater sales
Likely to be initiated by firms with largest minimum efficient scale as rivals that operates on smaller scales have to shut down by stopping production temporarily in short run
Winner of price war will gain larger market share with lesser competition, firm has greater market power, raising ability to charge a higher price and earn higher profits
Limit pricing
Set price below profit maximising price but above competitive level
Short run departure from profit maximisation to prevent entry so potential entrants decide that risks of entering industry are too high as they make sizeable loss
More effective in industries with high sunk costs, as incumbents have first mover advantages, hence enjoy significantly lower average cost of production compared to new entrant
Large and established firm may want to enter new product market to diversify even if it is unprofitable in the short run, able to cross subsidise and absorb losses using profits generated in other markets
Discounts
Reduce prices to increase sales volume, increase chances that product is perceived as lower in quality, which unintentionally may cause demand to fall, and may even trigger a price war
Non price strategies
Strategies used to differentiate its product from competing products to increase demand for good and reduce price elasticity of demand by reducing availability of substitutes without changing price
Product differentiation refers to variations within a product class that consumers view as substitutes
Can be real differentiation where physical changes is made by adding features or modifying features, or differences in performance and quality, superior location and distribution channels
Imaginary differentiation through packaging advertising and branding
Service differentiation where unusual way to serve customers
Benefits of product differentiation
- Attracts new customers to buy its products but also retains existing customers
- Increases desirability of product to customers and lower degree of substitutability of products sold by firms, in turn increasing opportunity cost of switching
- Deepens degree of brand loyalty by convincing consumers that product is different from rivals
- Ceteris paribus, demand for firm’s product increases and price elasticity of demand of product falls, increasing profit-maximising price and output, in turn increasing total revenue profits
Types of product differentation
- Differences in design, packaging, shapes and flavours
- Advertising campaigns
- Free gift with purchase while stocks last
- Customer loyalty
- Research and development leading to product innovation
- Green marketing (social and environment concerns)
Differences in design, packaging, shapes and flavours
Benefits and Limitations
Keep in mind most salient features of products, because consumers tend to fixate on information that is distinctive while ignoring anything that does not stand out
Salience can be strategically achieved by keeping designs and packaging simple or through customisation of service (let consumers associate their design with them easily)
Product differentiation may not increase its profits because it increases its costs of production
- Increase in marketing research costs lead to increase in fixed costs as such costs are independent of level of output
- Firm’s profits will fall ceteris paribus
- Successful requires increase in total revenue to be more than increase in total costs for profits to increase
Having more options is not always better for consumer as choosing from more options increase choice difficulty according to paradox of choice
- Choice overload causes consumers more stress, when consumers are overwhelmed they choose not to choose and dont buy anything at all
- Reduces demand for the firm’s product rather than increase, reducing the firm’s total revenue and profits ceteris paribus
- Consumers may also be less satisfied with their selection
Saliency bias leads to irrational decision making resulting in suboptimal outcomes for consumers
- Tendency for people to focus on info that is more prominent and over other less prominent but equally relevant pieces of information
- Undesirable to consumers as it prevents them from weighing all the pros and cons of their purchase in an objective manner, resulting in them making a less than ideal purchase
Advertising Benefits and Limitations
Benefits
- Explain to its target audience that products of its firm are differentiated
- Reduce search costs for consumers and make consumers more aware of a product
- Build preference for that product over its competitors by highlighting to consumers the uniqueness of firm’s product and by creating perceived differences between product and rivals’ one
- Creates brands that consumers aspire to own, perceive cost of switching to rivals’ products to be higher as strong branding creates loyalty that locks in existing customers
Limitations
Costs of advertising may outweigh its benefits
- Revenue from advertising may only be materialised in long run as it takes time to change consumers’ taste and preference hence choices
- Firms must have sufficient retained profits to fund its advertising campaign before they become successful
Advertising outcomes may not always be successful in increasing demand and profits but instead result in wastage of resources
- May backfire and generate negative feedback from consumers
Firms that engage in expensive advertising have become victims of sunk cost fallacy
- Firms who spent heavily on advertising may continue even though it does not result in increase in demand as they invested considerable time, energy and resources in advertisement campaign
- Firms who are loss averse more likely to continue spending to avoid negative feelings of loss/ guilt. wastefulness
Saliency bias leads to irrational decision making resulting in suboptimal outcomes for consumers
Free Gift with purchase while stocks last
Benefits
Consumers more likely to buy more items to hit the minimum amount that makes them eligible for promotion, even though it is not needed
- Signal scarcity and urgency prompting customers to take advantage of offers as soon as possible
- Foster customer loyalty gives impression that firm is thoughtful and caring towards customers
Limitations
Limited in increasing firm’s profits as costs of having promotion may outweigh benefits
- Incur variable costs because greater qty of output greater qty of free gifts
- Incur opportunity cost by putting strain on firm’s tight budget that could be used elsewhere to market firm’s product or service
Loss aversion bias, tendency to prefer avoiding losses to acquiring equivalent gains
- Feel like they are missing out on an opportunity
- Lead to irrational decision making resulting suboptimal outcomes for consumers
Customer Loyalty Rewards Programs benefits and limitations
Benefits
Increase switching barriers to foster customer retention
- Increasing customers’ perception of switching cost because it involves forgoing points, expending effort and time in signing up for new program and learning how to redeem rewards
Limitations
Unintended perverse effects
- Ending reward program may negatively impact or anger most valued customers, causing them to switch to competitors, leading to fall in demand and revenue and profits
Loss aversion bias
Research and development leading to product innovation benefits and limitations
Benefits
Introduce good or service that is new or significantly improved
- Research market and needs of customers, developing new and improved products to meet them
- Increase demand and reduce substitutability for innovative firm’s products enable it to capture larger share of market since competitors need time to respond
Limitations
Effective in increasing profits temporarily, as other firms can include similar features
- Increase in demand for products may only be in short run
- Constantly innovate and differentiate products to retain existing customers and attract new ones
Sunk cost fallacy
Green and ethical marketing benefits and limitations
Consumers increasingly influenced by ethical aspects of food production and are more concerned about economic, environmental and social potential impacts of production techniques, consumption and disposal of products after use
Limitations
Trade off between environmental sustainability and profits in short term
- Cost reductions in energy savings gained by going green is insufficient to offset initial upfront conversion costs
- Long run firms may see increase in profits if trend towards sustainability continues
Impact of non-pricing strategy
MR and AR curve pivots (with right end as pivot) upwards, demand will increase and become less price elastic
Extent to which these strategies are employed depends on market structure
- MPC firms have limited ability to engage in non-price strategies but have incentive
- DO not earn supernormal profits in long run due to low barrier to entry so advertising and promotion is relatively small
- Oligopoly and monopoly have high barriers to entry so firms can retain supernormal profits in long run, substantial funds to do campaigns
- Degree and pace of non-price strategies is highest for oligopolies because they have incentive to do so as actual competition exists in oligopolies
Cost Reducing strategies
Reduce variable cost by sourcing for cheaper inputs
- Drop in variable cost decreases AC and MC
Increase scale of production, more fully exploit available internal economies of scale
- Movement along LRAC curve towards minimum efficient scale
Band together to set up jointly owned enterprises to source for raw materials
- Enjoy many internal economies of scale enjoyed by larger firms
Cluster in together so they can enjoy economies of concentration
- Downward shift of firm’s LRAC curve
Develop existing and new business processes (process innovation), automate certain aspect of production processes, reduce use of resources to run operations
- Reduce average and marginal cost of providing service, reflected by downward shift of AC and MC curve
- Costly and hurt demand for products that thrive on buyer-seller relationship
- Lead to huge costs since they are complex machines
Offshoring/ outsourcing various stages of production to country that produce respective stage for lowest cost
- Lower average costs
- Hard to control quality of service, may be of poor quality because of communication barriers
- Increase risks associated with data sensitivity and loss of confidentiality to external parties
Growth strategies
Internal growth when firms grow within framework of its existing management and control structure
External growth occurs through merger (when firm combines with other existing firms to form entirely new enterprise) and acquisition (when organisation buys another firm without creating new organisation)
Horizontal integration (merger and acquisition)
Firm combines with or take over similar firm at same stage of production to form a single entity
- Lower long run unit costs of production as expands scale of production towards its minimum efficient scale
- Able to more fully exploit available internal economies of scale
- Market share dominance, reduction in competition and increase in demand in its products demand , increase in revenue and profits
- Reduce duplication to lower costs
- Merge with company with expertise in new market to break into new market
Vertical integration
Firms combines with or takeover another firm at different stage of production but in same industry
- Achieve new sources of revenue
- Spread risks as losses incurred for one product can be offset by profits earned from another
- Secure access to production inputs/ retail markets
- Further benefit from reduced risks and greater economies of scope
Forward integration
Firm moves into succeeding stages of production, gains ownership over other companies that were once customers
Lower uncertainty to access to markets, improving supply chain coordination
- More control over the way product is presented and distributed, and at what price
- Crucial for companies that operate in industries that lack qualified distributors which affect demand for its product (and revenue and profits)
Lower costs
- Reduce/ remove transportation, transaction and business-to-business marketing costs
- Cut out middlemen costs, improving profitability
More control over delivery timings
- Control over distribution channels ensure strategic independence of company from third parties
Set itself apart from competitors
- diversify from traditional product space and venture into new markets can offset loss in revenue from traditional product space by creating new revenue stream
Backward integration
One firm merges with another firm involved in previous/ earlier stage of production (increase ownership over companies that were once its suppliers)
- Lower uncertainty with regards to securing factors of production and improve supply chain coordination
- Greater control over quantity and quality of scarce factors of production
- Ensure that it would not be hurt by suppliers providing materials of inferior quality which can lead to fall in demand and fall in revenue and profits
- Wont be hurt by suppliers holding out for higher prices which can lead to higher costs of production and in turn a fall in profits
- Entry deterrence to keep potential entrants out of market
- Restrict availability of supplies of critical factors of production to potential competitor
- Prevent demand for its product and hence revenue and profits from falling
- Avoid suppliers with high market power and experience reduction in costs and hence profits
- Acquire factors of production at cost price, reduce overall costs
- Prevent slowdown in production caused by negotiations or other aspects external to company
- Risky and heavy investments in acquiring factories
- Lack of supplier competition results in fall in X-efficiency
Limitations of integrations
Internal diseconomies of scale if merged firm expands beyond firm’;s minimum efficient scale
- Management decisions become more complex and time-inconsistent
- Less responsive to changes in market conditions, since decision-making goes through several channels before making final decision
- More difficult to monitor workers and coordinate activities due to lower morale
- Monitoring cost increases as firm needs to hire more workers
- Higher average cost, adversely affecting firms’ profitability
Different companies have different work culture and objective
Conglomeration
One very large firm consisting of many smaller firms that formed through either merger or acquisitions, selling a variety of goods and services that are not directly related to one another through subsidiaries
Diversification
- Reduce uncertainty and risks
- Less subject to unpredictability of specific markets
Rising cost due to added layers of management and corporate culture issues
May not have necessary skills and expertise to support newly acquired subsidiaries
Continue to hold on to poor performing subsidiaries for purpose of diversification
- Hurt performance of more profitable subsidiareis
- Average cost continues to increase and average revenue declines, affecting overall profitability
Franchising
Sell the right to use a firm’s successful business model and brand for a period of time (brand proliferation)
- Expand while avoiding risk of investing significant amounts of capital
- Build brand presence, reduce search costs for consumers and increasing revenue by collecting fees
- Reap marketing economies, spread significant advertising cost across many franchises, bargaining for lower prices for factor inputs
- Does not maintain standard of quality and service likelihood that it will negatively impact reputation of franchise
- Communication with franchisees located globally is costly, as well as high cost of training
- Lack freedom to operate independently as they have to adhere to instructions and communications even though it may be unsuitable
- Unprofitable as they have to make payment of royalties that are significantly high even when demand and revenue is low
Mark-up pricing
Retailer knows with some certainty what gross profit margin of each sale is
- Set a price that takes into account all relevant costs of production including fixed and variable costs, mark it up by certain number of times the costs of production
- Know that all its costs are covered
Technological Disruptions and benefits
Displaces an established technology and shakes up industry of ground-breaking product that creates completely new industry
- Changes the way buyers and sellers communicate, conduct transactions and firms operate
- Replaces well-established systems, products or even habits
- Acceleration in adoption of disruptive technologies can be driven by economic shocks
Spurs new demand and encourage creation of new products
- Increase demand for goods with ease and convenience, increases total revenue and profits
- Enables firm to differentiation products significantly, reduce degree of substitutability of products, increasing market power and limiting competition
Emergence of larger number of innovation and technological startups
Cut costs
- Increase competitiveness of existing industries
- Improve efficiency of supply chains
- Tighten supply chains to avoid accumulating inventories and minimise losses
Risks for disruptive technologies
- Reliance of labour likely to decline
- In developing countries barriers to digital connectivity slows adoption of them, expected rise in overall demand and revenue may be overestimated as digital divide may be significant across globe
- Increase cybersecurity risks as more digital use increases exposure to cyberattacks
- Smaller firms with fewer resources are able to enter and compete in segments that have been neglected by main industry players
- Reduce exit costs significantly as they dont need to spend significantly on set-up cost
- Minimal entry and exit costs increases contestability, removes barriers to entry, weakening position of established players and giving new firms space to grow
- Phase out firms that are slow to respond to disruptive technology or leverage on it
Allocative efficiency in PC
Overall welfare is maximised, when price of the good is equal to marginal cost of producing that good (assuming absence of externalities and public goods)
If MB > MC, society values the last unit of good more than opportunity cost of producing that unit, society will benefit if more units of good was produced, under-production of good leads to deadweight welfare loss
If MC > MB, price is less than marginal cost of producing that additional unit. Society values last unit of good less than opportunity cost of producing that unit, society will benefit if fewer units of good was produced, over-production leads to deadweight welfare loss
Productive efficiency in PC
All resources are fully and efficiently utilised
- Macro: Resources are used to max capacity, all points on production possibility curve are productively efficient
- Micro:
Society: Firm’s long run average cost is at minimum, firm operating at minimum efficient scale, as all internal economies of scale have been exploited
Firms: All points on LRAC are productively efficient as all points represent the lowest possible average cost of producing each given level of output
ATTAINED WHEN it is operating at MES
- Produces at minimum long run average cost, fully exploited all internal economies of scale
- Being a price-taker, firm has to be as cost-efficient as possible to maximise profits
Dynamic Efficiency in PC
Firms are technologically progressive to reduce average cost of production and meet changing wants and needs of consumers over time
Improvement in level of technology resulting in more and better quality output, brings about new products/ new production methods to reduce average costs
Lead to fall in unit cost at every level of output as well as expand the product range of firm
Increase society’s welfare with wider range of better quality products and increase quantities consumed
IN PC, no dynamic efficiency as no incentive or ability for research and development because:
- Assumption of perfect information: Innovations are quickly replicated by competitor firms or new firms, discouraging research and development as innovating firm cannot reap fruits of innovation
- Long-run normal profits, limits firm ability to undertake research and development due to its high expenditure
- Assumption of homogenous products make innovation irrelevant
Equity in PC
Fairness in distribution
PC tend to spread opportunities and wealth widely and more evenly, without barriers to entry, profits are spread amongst many small firms, consumer surplus is maximised at P=MC
MONOpoly able to earn and retain large supernormal profits, consumers suffer due to exploitative pricing
Consumer choice in PC
PC markets do not offer consumers choices as goods are homogeneous
Allocative efficiency under imperfect competition
Downward sloping demand curve as it is price setter, has to lower price of every single unit of good to sell one more good
- AR (price) is greater than MR
- At profit-maximising output level where MR = MC, AR > MC/ MR, so firm is allocatively inefficient
- Firm would have underproduced , as benefit to society from consuming additional unit of good is greater than opportunity cost of producing it, society would be better off if additional units of good were produced
- Result in deadweightloss
- Greater price-setting ability, less price elastic demand curve, steeper AR curve, hence extent to which price exceeds its MC would be greater
Productive efficiency in imperfect comp
MPC
Firms POV: Productively efficient as they have to operate at a point on LRAC due to long-run normal profits, only way to maximise profits is to be as cost-efficient as possible
Societys POV: Productive inefficiency arises because they are not producing at minimum point of LRAC
- Firms have small market share, demand not large enough to support producing at MES
- Firm is yet to exploit all internal economies of scale
O and M
Firms POV: Can afford to be productively inefficienct as firm could incur a cost above point C as they can retain supernormal profits into long run due to presence of high barriers to entry, allowing them to continue to exist in industry without minimising cost, represents wastage of resources to society
Societys POV: Firm may be more productively efficient from society’s point of view as it is large enough to reap significant internal economies of scale than smaller firms, so it may produce closer to MES
- Can also reduce duplication of resources
- Firms may engage in large-scale adveritsing, whcih is veiwed as wasteful because resources expended could be sued to produce more goods or improve quality
- Resources could have been put to more productive use and be allocative inefficient
- However, if can provide better consumer information which moves market to perfect info, and educate consumers on its benefits, differences and how to buy them
