Growth and Objectives of Firms Flashcards
6 constraints on growth
- regulatory - under scrutiny
- financial - no equity as not listed, too risky for loans - cannot expand or market
- finding skilled staff (cost of pay, brain drain after training)
- disruptive tech - e.g. uber, airbnb
- size of potential market - niche
- diseconomies of scale
reaons for different sizes of firms
- size of market - e.g. niche cannot support large
- Personal services to allow for personal attention - hairdressers, lawyers
- barriers to growth - finance
- entrepreneurial objectives - maintaining control more important than profits
- tech advancements have made small businesses more efficient so can remain small while competing with larger firms
- skills needed - may require specialists in short supply
benefits of growing firm
- EOS lower LRAC, helping firm to cut prices without sacrificing profits and gain competitive edge –> productive efficiency
- dynamic efficiency - better tech and innovation benefits consumer welfare
- diversifying product range - spread risk of declining demand and exploit economies of scope
- producing more output helps to increase sales and market share and higher sales revenue - monopoly motive to increase LR SNP
*add specific example of EOS like marketing/technical and apply - technical could be Amazon warehouses, marketing could be Coco Cola global ad campaigns
cons of growing firm
- risk of DEOS because of _______which can increase LRAS - lower productive eff.
- principal-agent problem (divorce of ownership and control) leads to focus on revenue for bonuses and not productive efficiency to min costs and max profits
- monopoly power could lead to DWL - exploit consumers, lower allocative eff, lower productive eff. and possibly lower dynamic eff (quality and innovation)
*be specific - pick one example of a DEOS and explain how it creates inefficiencies and higher LRAC- e.g. coordination and communication
** do the monopoly DWL diagram and explain productive and allocative ineffiency
pros of small firms
- in perfect competition - AE and PE achieved in LR so can be efficient albeit less so than larger firms
- flexible personal services and attention - scope for higher profit margins
- may receive financial help from govt for contribution to jobs and growth
- not at risk of DEOS as communication and employee relationships are better
cons of small firms
- cannot exploit EOS so have higher LRAC - hard to compete with larger firms with prices
- less dynamic efficiency due to lower/no SNP (reference PC model)
- hard to access finance for growth - risk
why do mergers and takeovers fail?
Diseconomies of scale!!
- cannot pay debt used to fund takeover
- corporate culture clashes
- bad timing - during downturn/recession
- imcompatible systems - do not achieve synergies e.g. Skype and Ebay
- loss of customers and skilled labour - prefer smaller companies
- winner’s curse - takes over company for managerial prestige rather than potential for EOS and synergies - elon musk and X?
explain the principal-agent problem
arises from a conflict of objectives between principals and agents taking decisions on the principal’s behalf
occurs due to a divorce of ownership and control and asymmetric info - shareholders are not involved in day to run control of business so may not know what managers are doing
managers tend to have the objective to max revenue to increase bonuses rather than the shareholder’s objective of profit max
how to overcome the PA problem
- improve access to info - increase accountability to shareholders by monitoring managers (BUT cost and time)
- give managers incentives to align with principal objectives - e.g. bonus linked to profits instead of revenue; or employee share ownership schemes to increase motivation and commitment
how would you introduce the idea of different objectives of firms?
traditional economic theory suggests rational firms are concerned only with profit maximisation, but there are resons firms may have a different or additional key objectives
what are the different objectives of firms?
- profit max
- profit satisficing
- sales maximisation (volume)
- revenue maximisation (value)
- survival
- CSR
why do firms have profit max objective?
- retained profits used to fund reinvestment in expansion/R&D to improve efficiency, competitiveness and erect BTE to increase market power
- increase dividends to shareholds - reward for investment and retain interest
note that increased investment benefits macro economy by increasing actual and potential growth - employment, output - and intl. competitiveness
evaluate the profit max objective
- hard to know the true value of MR and MC at the profit maximising output, so may simply find ATC and add profit margin, which will not maximise profits
- higher SNP may attract regulatory intervention due to consumer exploitation - price caps, higher product standards, windfall taxes
- higher SNP will attract new rivals if BTE are low, reducing SNP in LT
- PA problem - managers want to revenue max, not profit max –> reducing prices will reduce profits)
- key stakeholders harmed - consumers, employees
- may not be best objective for current market conditions - e.g. economic downturn requires focus on survival, and higher competition requires focus on increasing sales
explain the profit max objective
firms produce at the level of output for which MR = MC.
This maximises profits because:
- at lower output levels, MR>MC, meaning a marginal profit still exists and it is rational for the firm to increase it production to continue adding to its total profit
- at higher outputs, MR<MC, so the firm is making a marginal loss and it is irrational to continue producing output
explain the profit satsifcing objective
making a satisfactory level of profit depending on the owner’s objectives, not necessarily maximising. It could help to satisfy both shareholders and other stakeholders, for e.g. lower prices increase CS, could increase wages, eco-friendly activities and CSR
