Micro L1 & 3 Flashcards
Reasons why firms seek growth:
1) Higher profit
2) Lower unit costs
3) Greater market power
4) Diversification
5) Managerial objectives
How does a firm increasing in size lead to higher profit?
More production of goods and services leads to higher sales, revenue and profit
Market power:
Ability of a firm to raise prices and earn supernormal profit
Diversification:
Increasing range of products served by a business
What does the degree of diversification depend on?
How different the products are from the existing ones served by the business
How is diversification positive?
Reduces risk
How are managerial objectives a reason for growth?
Incentive to increase the size eg bonuses
Reasons why some firms remain small:
- Worried about experiencing diseconomies of scale
- Do not want the extra work and risks involved in expansion
- Legal requirements differ by firm size
When do diseconomies of scale occur?
When a business grows so large that costs per unit increase
Reasons why some firms are forced to remain small:
- Unable to finance expansion
- Operate in niche market w/ small customer base
- Skills and knowledge required may be lacking
- Lack resources to cope w/ additional regulations
What are the different sectors of an economy?
- Public
- Private
- Civil society
Private sector firm:
A firm that is not owned by gov
Who are private-sector firms owned by?
- Shareholders
- With a PLC
- Family ownerd
- Partner-owned (eg law firms)
- Sole proprietors
PLC:
- Public limited company
- Trading on stock market, where anyone can buy shares
Family owned firm:
Shares are not traded on stock market
Sole proprietor:
Owned and run by one person
Why may the government own certain businesses?
- Cannot survive without significant state funding
- Want to determine the direction of the business
Civil society:
Not for profit sector eg charities
Principal:
Shareholder/Owner of a business
Agent:
Person in charge of day-to-day running of the business
What is the principal-agent problem?
The agent can make decisions on behalf of the business, which may be incorrect due to asymmetric info. This could lead to their dismissal
What are the two types of growth?
- Organic
- Inorganic
Organic growth:
Growth based on the firm’s own resources
Advantages of organic growth:
- Lowest risk
- Positive for worker morale
Disadvantages of organic growth:
- Slow
- Lack of new ideas and innovation
Inorganic growth:
Growth involving merging with other firms
Advantage of inorganic growth:
- Instant access to increased economies of scale and market share
Disadvantages of inorganic growth:
- Increasing market share attracts regulator’s attention
Equity:
Issuing shares
Types of mergers:
- Horizontal merger
- Vertical merger –> forward and backward integration
- Conglomerate merger
Horizontal merger:
Merger between firms operating in SAME industry and SAME stage of production process eg two car assembly firms
What is the result of a horizontal merger known as?
Horizontal integration
Advantage of horizontal merger:
Affects degree of market concentration, as there are now fewer independent firms operating, which increases market power held by new firm
Backward integration:
Merging w/ firm involved in earlier stage of production process eg car company merging w/ component supplier
Forward integration:
Merging w/ firm involved in latter stage of production process eg car assembly plant merging w/ large distributor
Advantage of vertical integration:
- Greater control over supply chain
Conglomerate merger:
Merging of two firms operating in very different markets
Advantage of conglomerate merger:
Diversified portfolio of production leaves firm less vulnerable to recession
Disadvantage of conglomerate merger:
May be managerial diseconomies if management team doesn’t understand all aspects of new business
Disadvantages of mergers (general):
- Cost of integrating management may have been underestimated
- Production systems may not be compatible
- Corporate cultures may collide
Why may a firm decide to demerge?
- Experiencing diseconomies of scale –> higher long-run avg costs
- Reduce its monopoly power (for govs)
Possible advantages of demerger:
- More promotions available
- Lower prices and more choice for consumers
Possible disadvantages of demergers:
- If firms are more efficient, possible job losses
- Short-term issues for consumers
What is the short-run defined as?
The period when there is at least one fixed factor of production
What is the long run defined as?
The period over which all factors of production are variable
Give an example each for a variable and fixed factor:
Fixed: Capital, land
Variable: Labour
Hence, what is the only way to increase output in the short-run?
Increase labour
Law of diminishing returns:
If a firm increases input of variable factor whilst holding another factor constant, it will derive less additional output per unit of labour for each further increase
What assumption does the Law of Diminishing Returns make?
Capital is fixed
Why does the Law of Dimishing Returns state that output initially increases before falling?
Labour productivity increases due to:
- Specialisation is occurring
- Underutilisation of fixed factors eg capital
Why does the Law of Diminishing Returns state that output falls after an initial increase?
Labour productivity falls due to:
- Fixed factors of production constrains production
When marginal product is zero, what happens to total product?
TP is maximised
2 types of costs:
1) Explicit costs –> require payment
2) Implicit costs (opportunity cost)
What are the 2 types of explicit costs?
1) Fixed
2) Variable
Fixed costs:
Costs that do not vary w/ output
Examples of fixed costs:
- Rents
- Salaries
- Interest on loans
- Advertising
- Business rates
What is the difference between wages and salaries?
- Wages are paid hourly
- Salaries paid in fixed increments throughout year
Variable costs:
Costs that vary w/ output
Example of variable costs:
- Wages
- Utility bills
- Raw material costs
- Transport costs
Sunk costs (w/ example):
Costs that the firm cannot avoid paying even if it chooses to produce no output eg leasing machinery
Equation for total costs:
Total costs = total variable costs + total fixed costs
What does the total fixed cost curve look like?
Horizontal
What common assumption is made about total costs in the short-run?
At very low levels of output, total costs will rise at a lower rate than output, however total costs will accelerate as diminishing returns set in
Equation for avg fixed cost:
Avg fixed cost = Fixed costs/Output
Why does AFC fall as output increases?
Fixed cost is being spread across greater output
Avg variable cost equation:
Avg variable cost = Variable costs/Output
What does the average variable cost look like and why?
- Positive quadratic
- Due to Law of Diminishing Returns
Avg total cost equation: (2)
1) AFC + AVC
2) Total cost/Quantity produced
Marginal cost:
Change in total cost when one additional unit of output is produced
Equation for marginal cost:
- Gradient of total cost curve
- Change in TC/ Change in Quantity
What points does marginal cost curve always go through?
Minimum point of AVC and AC curve
Why does the gap between AC and AVC get smaller as output increases?
- AFC (the gap) falls as output rises
- AVC rises because of law of diminishing returns
Revenue:
Payments firms receive when they sell the goods and services they produce over a given time period
Total revenue equation:
TR = P x Q
Marginal revenue:
Additional revenue arising from the sale of an additional unit of output
Marginal revenue equation:
Change in total revenue/Change in quantity
Average revenue:
Revenue per unit of output sold
Average revenue equation:
Total revenue/Quantity
What is AR always equal to?
- Price
- Demand
What is the relationship between MR and AR?
MR is twice as steep as AR
Why does the analysis of revenues vary for different firms?
Dependent on whether or not the firm has any control over prices
What factor determines whether the firm has control over prices?
The amount of competition:
- firms under high (perfect) competition cannot influence prices
- firms under less competition can influence prices
Conditions of high (perfect) competition:
1) Many buyers and sellers
2) They are price-takers
3) Homogenous goods
4) No barriers to enter/exit market
5) Perfect information
6) They are profit maximisers (MC = MR)
Conditions of revenue where firm has some control over price (imperfect):
1) Few buyers and sellers
2) They are price-makers
3) Differentiated goods
4) High barriers to enter/exit market
5) Imperfect information
Conditions of revenue where firm has no control over price:
- P = MR = AR (horizontal curve)
- TR is fixed linear curve
Conditions of revenue where firm has some control over price:
- TR –> Quadratic curve
- Linear MR
- P = AR = D
What is the average revenue curve equivalent to?
D curve
When demand is price elastic, what happens to total revenue when price increases and decreases?
Opposite always happens:
- Price increase causes decrease in total revenue
- Price decrease causes increase in total revenue
When demand is price inelastic, what happens to total revenue when price increases and decreases?
Same thing happens:
- Price increase causes increase in total revenue
- Price decrease causes decrease in total revenue
What half of a graph is elastic and inelastic?
- Top half = Elastic
- Bottom half = Inelastic
