Firms and Decisions Part 2 Flashcards

Question

Pricing Strategies

Answer 1

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

Answer 2

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

Answer 3

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 1. Market power - Need to have market power to choose its price 2. 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 3. 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

Answer 4

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 1. Customer characteristics (age, nationality, student, where PED is diff) 2. Location (lack of accessibility or lack of knowledge by charging different prices in difference locations) 3. 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)

Answer 5

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

Answer 6

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

Answer 7

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

Answer 8

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

Answer 9

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

Answer 10

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

Answer 11

1. Attracts new customers to buy its products but also retains existing customers 2. Increases desirability of product to customers and lower degree of substitutability of products sold by firms, in turn increasing opportunity cost of switching 3. Deepens degree of brand loyalty by convincing consumers that product is different from rivals 4. 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

Answer 12

1. Differences in design, packaging, shapes and flavours 2. Advertising campaigns 3. Free gift with purchase while stocks last 4. Customer loyalty 5. Research and development leading to product innovation 6. Green marketing (social and environment concerns)

Answer 13

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

Answer 14

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

Answer 15

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

Answer 16

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

Answer 17

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

Answer 18

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

Answer 19

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

Answer 20

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

Answer 21

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)

Answer 22

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

Answer 23

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

Answer 24

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

Answer 25

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

Answer 26

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

Answer 27

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

Answer 28

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

Answer 29

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

Answer 30

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

Answer 31

- 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

Answer 32

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

Answer 33

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

Answer 34

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

Answer 35

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

Answer 36

PC markets do not offer consumers choices as goods are homogeneous

Answer 37

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

Answer 38

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