Schedule H - Market Strucutres - Overview

Question 1

What do we refer to when we talk about market structure?

Answer 1

The term market structure refers to the number and size of firms within a market for a particular good or service

Question 2

What are the names of the types of competition on the spectrum of competition?

Answer 2

Perfect competition — Monopolistic competition — Oligopoly — Duopoly — Pure Monopoly

Question 3

What objective is assumed in analysis about market structure?

Answer 3

The models that comprise the traditional theory of the firm are based upon the assumption that firms aim to maximise profit

Question 4

What is the profit maximising rule?

Answer 4

MC=MR

Question 5

Explain why profits are maximised when MC=MR

Answer 5

If MR>MC, the firm could increase profit by raising output (from the left, towards mc=mr)
If MR<MC, the marginal profit is negative. It would be better to decrease output (from the right, towards mc=mr)

Question 6

Why do we assume that firms aim to profit maximise?

Answer 6

Because profit maximisation enables firms to:
1. Pay higher dividends to shareholders, which may encourage more people to buy shares in the company or help boost the share price
2. Employees may gain if some of their pay is linked to the profitability of the business
3. Higher profits may lead to increased capital investment spending - benefits industries like construction and engineering
4. May choose to ‘plough back’ profits into R&D - dynamic efficiency, better products - gain more customers
5. Profits are the reward for entrepreneurship

Question 7

What are the possible disadvantages of profit max?

Answer 7

1. Higher prices for final consumers which reduces their real incomes/purchasing power and means a lower level of consumer surplus
2. Higher profits may incentivise new entrants which in longer term might reduce returns to shareholders as competition intensifies
3. Overly profit focused companies may lose sight of social/ethical/environmental aspects of business - negative externalities for local communities
4. If costs are cut to maximise profits, this could negatively impact quality

Question 8

Which economist developed the idea of maximising Revenue instead of profits?

Answer 8

William Baumol

Question 9

At which point on the diagram is revenue maximised?

Answer 9

Total revenue is maximised at a price and output where MR=0

Question 10

What did William Baumol’s research on revenue max and how can this mean that firms can choose to revenue maximise?

Answer 10

Baumol’s research found that salaries and rewards for managers were closely linked to sales revenue rather than profits. This might mean that managers will not choose to profit maximise but will revenue maximise to secure perks and benefits for themselves.

Question 11

Why might a business choose to revenue maximise?

Answer 11

A business might aim to maximise revenue rather than profits because:
1. It can get Economies of scale benefits.
2. Predatory pricing - it might wish to deter the profitable entry of new firms / rivals to Ian industry and therefore maintain more market power
3. Principal-agent problem/ Divorce of ownership and control -go to shareholders leverage for greater perks and bonuses (Baumol theory)

Question 12

What is a possible disadvantage of aiming to revenue maximise?

Answer 12

A reduction in the price of the firm’s shares since operating profit is likely to be lower.

Question 13

What does it mean for a business to maximise sales volume?

Answer 13

The sales maximising output is when a business maximises output without making an economic loss.

Question 14

At what point in the diagram is sales volume maximised?

Answer 14

At the point where AR=AC

Question 15

What type of profits are made at the sales maximising output?

Answer 15

Normal profits are made at AR=AC

Question 16

What objective does sales maximisation coincide with (what else can it be know as)?

Answer 16

It coincides which growth maximisation / market share maximisation

Question 17

Why might a firm want to maximise sales?

Answer 17

1. Benefit from Economies of scale
2. Limit pricing - break-even price takes away the incentive for new firms to enter the market.
3. Principle agent problem (managers can use this as leverage to go for greater perks)
4. Flood the market - lots of consumers become aware of the product and develop brand loyalty; later, the firm can switch objective.

Question 18

Explain why a firm can choose survival as their objective?

Answer 18

A large proportion of businesses fail in the first few years of operation. In its early stages, a firm might choose to survive the critical period, even if it is making losses, establish a customer base and make sure consumers are aware of their product. They can then start to try to make profit.
“Survival may be a short term objective in hyper competitive markets.”

Question 19

What might a firm choose to produce at the output where P=MC?

Answer 19

They might have the objective of maximising societal welfare. This is common with Public Sector Organisations. This output is allocatively efficient - where Price (D) = Marginal Cost (S)

Question 20

Give an example of a firm that focuses on corporate social responsibility (CSRs)?

Answer 20

The Body Shop do not test their products on animals, only in laboratories. They have an ethical focus.

Question 21

What is the range on the diagram between which profit satisficing occurs?

Answer 21

It can occur at any output between profit maximisation and sales maximisation

Question 22

What type of behavioural bias can we say the principal agent problem is an example of? Explain your answer

Answer 22

The principal-agent problem is an asymmetric information problem. The owners of a firm cannot observe directly the day-to-day decisions of management. Decisions and performance of the agent are difficult to monitor.

Question 23

Simply put, what is the meaning of the divorce between ownership and control?

Answer 23

The owners of a business (shareholders) may not be the same people as those who are taking key day-to-day decisions (managers)

Question 24

Give 3 ways in which we might try to resolve the principal agent problem

Answer 24

• Employee share ownership schemes
• Long term employment contracts for senior management
• Long term stock commitment

Question 25

How might employee share ownership schemes be a bad idea?

Answer 25

Stock options might lead to perverse behaviour - eg deliberate attempts to hike up share prices through illegal action as in the case of ENRON

Question 26

Give an example of how long term stock commitment works

Answer 26

Apple’s policy requires senior executives at Apple to hold 3 times their annual base salary in stock, and executives have to keep this salary in stock for a minimum of five years to satisfy the requirement