Theme 3 Flashcards
The size of firms in the UK?
Although production in the UK is dominate by large firms, there are many industries where small and medium-sized enterprises play a significant role.
Why do large firms exist?
Economies of scale and barriers to entry
Why might the costs of production for a large scale producer be higher than for a small company?
- It could be due to productive inefficiency - a large firm operating within its average cost curve boundary e.g. may be poorly organised in what they see as small unimportant segments of the market (called market niches)
- Or X-inefficiency may be present
- Average cost curve of a large producer may be higher in certain markets than for a small producer
How businesses grow?
Organically or internal growth
- firms increasing their output - increased investment or labour force
External growth through merger, amalgamation or takeover
- A merger or amalgamation is the joining together of two or more firms under common ownership
- A takeover implies that one company wishes to buy another company. May lead to hostile takeover when needs more than 50% of shares to win and the control.
Reasons for growth?
Profit maximising companies are motivated to grow in size for a number of reasons:
- may be able to exploit EOS
- more able to control its markets. Reduce competition and exploit market better
- be able to take more risk
5 different types of mergers?
Horizontal integration - merger of two firms in same industry at same stage of production
Vertical integration - in same industry but at different stages of production
Forward production integration - involves a supplier merging with one of its buyers
Backward vertical integration - involves a purchases buying one of its suppliers
Conglomerate integration - is the merging of two firms with no common interest
Whats a social enterprise?
Profits reinvested for social purposes
Whats a small - medium enterprise (SME)
Fewer than 250 employees - 99% of UK businesses
Whats a PLC?
A private sector business that trades it shares publicly on stock exchange with a minimum share capital of £50000
Whats a Ltd?
Shares are held privately and are not traded on the Stockmarket. Limited means that the amount investors have in share capital are only liable for the value of it.
Whats a partnership?
A business structure where partners share responsibility for the business (2-20)
Why small firms are likely to survive?
- Subcontracted by larger firms
- Provide niche goods and services that are highly price inelastic in demand, leading to high profits
- Can avoid diseconomies of scale
- Lifestyle enterprises - not profit maximising but profit satisfying (“enough”)
- Can be innovative and flexible in responding to changes in the market.
- Easy to sell online, eBay Etsy and amazon without incurring costs of having physical stores.
5 reasons why a firm may want to expand and grow?
- EOS (lower long run unit costs)
- Build and sustain your market power
- Improve shareholder returns from higher operation profits
- Reduce the risk of a hostile takeover
- Pursuit of managerial objectives
Whats a demerger?
why?
When a firm decides to split into separate firms
- Reduce risk of diseconomies of scale
- Raise money for shareholders
- Focus on streamline costs and improve profit margins
- diversify risk - focus on markets
What is profit maximising?
Profits are maximised at an output where marginal cost = marginal revenue
What is revenue maximisation?
Revenues are maximised at an output where marginal revenue = zero
What is sales maximisation?
Producing the largest amount possible consistent with earning normal profits
Whats satisfying behaviour?
Satisfying behaviour involves the owners of a business (shareholders) setting minimum acceptance levels of achievement in terms of revenue and profitability.
What is total revenue?
This is the total income a firm receives. Price x quantity
What is average revenue (AR)?
TR/Q
Marginal revenue (MR)?
The extra revenue gained from selling an extra unit of a good
Profit?
Total revenue (TR) - total costs (TC)
or
(AR-AC) x Q
Whats fixed costs?
The costs which don’t vary with changing output. Fixed costs stay the same even with relation to output.
What are variable costs?
Costs which depend on the output produced
What are total costs?
Fixed + variable costs
What are marginal costs?
marginal cost is the cost of producing an extra unit.
What are sunk costs?
Costs that have been incurred and cannot be recouped. e.g advertising after leaving the industry
ATC=
Average total cost = total cost / quantity
AVC=
Average variable cost = variable cost / quantity
MC=
Marginal cost
AFC=
Average fixed cost = fixed cost / quantity
TC=
variable costs + fixed costs
Why are short run cost curves u-shaped?
Why in the short run does marginal cost increase.
because of diminishing marginal returns
As capital is fixed, after a certain point, increasing extra workers leads to a declining productivity. Therefore, as you employ more workers the marginal cost increases.
What happens in long run costs curves and with consideration of EOS and DOS?
Due to EOS and DOS. if a firm has high fixed costs, increasing output will lead to lower average costs.
However, after a certain output, a firm may experience diseconomies of scale. This occurs where increased output leads to higher average costs. e.g communication in big-firms coordinate workers
What is the minimum efficient scale?
The minimum efficient scale is the scale of output where internal economies of scale have been fully exploited. The minimum point of output necessary to achieve the lowest A.C. on the LRAC. Productive efficiency achieved.
What is external economies of scale?
Occurs when a whole industry grows larger and firms benefit from lower long-run average costs. (positive external benefits of industrial expansion)
- supportive legislation
- transport links
- attract more labour
What is internal economies of scale?
Refers to how a firm gains lower average cost - from the increase in size of that particular firm
- technical
- specialisation
- bulk-buying
- financial economies
What is perfect competition?
Is a market structure where many firms offer a homogenous product. Because there is freedom of entry and exit and perfect information, firms will make normal profits and prices will be kept low by competitive pressures.
What are the 5 features of perfect competition?
- Many firms
- Freedom of entry and exit, this requires low sunk costs
- All firms produce an identical or homogenous product
- All firms are price takers, therefore the firms demand curve is perfectly elastic
- There is perfect information and knowledge
What are the 8 characteristics used to define a market ?
- Number and size of firms
- Barriers to entry and exit
- Sell a product or service - either homogenous or differentiated
- Short run or long run
- Price setting power (price takers or price makers)
- Knowledge - perfect or imperfect
- Profits - normal, abnormal and subnormal
- Scope for economies of scale
What is supernormal profit?
All excess profit a firm makes above the minimum return necessary to keep a firm in business
Total revenue - total costs and AR>AC
What are normal profits?
Firm makes sufficient revenue to cover its total costs and remain competitive in an industry
include opportunity cost when calculating
AR=AC
What are sub-normal profits?
Any profit less than where price is lower than average costs. If its making an economic loss than its likely to leave the market in the long run in search of higher expected returns. AR
What are the underlining assumptions in classical economics?
Firms seek to maximise profits (profit maximisers)
- MR=MC
- occurs at the biggest gap between total revenue and total costs
What is monopolistic competition?
Combines elements of monopoly and competitive markets. Is one with freedom of entry and exit, but firms can differentiate their products. Therefore they have an inelastic demand curve and so they can set price. However, because there is freedom of entry, supernormal profits will encourage more firms to enter the market leading to normal profits in the long run.
What are the characteristic of monopolistic competition?
- Many firms
- Freedom of entry and exit
- Firms produce differentiated products
- Firms have price inelastic demand; they are price makers because the good is highly differentiated
- Firms make normal profit in the long run but could make supernormal profits in the short run.
- Firms are allocatively efficient and productively efficient