Theme 3 Flashcards
1
Q
What is theme 3 focused on?
A
The decisions that firms make
2
Q
What is average revenue?
A
Revenue per unit, it is equal to the price and the demand curve
3
Q
What is the formula for average revenue?
A
Total revenue / Quantity
4
Q
What is the formula for total revenue?
A
Price x quantity
5
Q
What is marginal revenue?
A
The change in total revenue from selling one extra unit of output, its gradient is usually twice as steep as the AR
6
Q
What is a price taking business?
A
A price taking business is a business that has to sell at the market price - it is found in perfect competition
7
Q
Why do price taking businesses have to sell at the market price?
A
Because they have no market power, they cannot reduce supply and charge a higher price
8
Q
What is a price making business?
A
Companies that can sell their products above the market price because they have greater market power.
9
Q
What properties make a business a price making business?
A
They must have greater market power; this is usually a monopoly or business with no market substitute
10
Q
What is revenue maximization?
A
It is equal to when marginal revenue = zero (MR=0)
11
Q
What is revenue synergy?
A
The ability to sell more products or services after a business merger
12
Q
What are some examples of revenue synergies?
A
Two merging firms may:
- do more marketing
- sell complementary products
- sell into a new consumer base
- share distribution channels
13
Q
What does a revenue schedule look like for a price taker?
A
Price/AR remains the same as the price is taken from the market, therefore MR also remains the same throughout. This assumes there is a perfect market, and the firms are acting rationally and cannot manipulate consumers.
14
Q
What is a revenue schedule for a price maker like?
A
As quantity increases Price/AR decreases with output as demand falls. The total revenue increases before it peaks and begins to decline again. The MR for each increase in output decreases until MR=0 (revenue maximization) and becomes negative and firms begin to make a loss.
15
Q
Where can Revenue maximisation be found on a graph?
A
At the point where MR = zero, at the midpoint of the downward sloping AR curve and at the highest point of the total revenue curve
16
Q
Why is the classic cost curve U shaped?
A
Due to the law of diminishing returns.
17
Q
What do firms need to do when costs start to rise again?
A
They need to make a long run decision when the SRAC begins to increase, creating a new SRAC curve
18
Q
Where does MC pass through ATC?
A
At it’s lowest point as once the marginal cost increase, the ATC will also increaase
19
Q
What happens to average fixed costs as output increases?
A
AFC decrease as output increases as the more output is occurring at the same fixed cost however, they will eventually begin to rise.
20
Q
When do AVC become relevant?
A
When trying to find the shutdown point.
21
Q
What is Normal profit?
A
The minimum profit needed to keep factor inputs in their current use in the long run - sustains the factors of production, Occurs when AC=AR or TC+TR
22
Q
What is total revenue?
A
The amount of money a firm receives, being quantity sold x price
23
Q
What happens to total revenue with a price taking firm?
A
TR increases linearly upwards as output increases as it is operating in a perfectly competitive market and must sell at the market determined price
24
Q
What happens to total revenue with a price making firm?
A
The TR will increase with output, before starting to fall, forming a parabola because as the price is cut the TR will start to rise at a slower rate causing the shape of the curve to dip
25
What is Average revenue?
The revenue a firm recieves per unit sold (equal to the price and demand) calculated by TR/Quantity.
26
What is the AR curve like for a price taker?
Perfectly horizontal line as the price will always remain the same in the assumed perfect market
27
What is the AR curve like for a price maker?
Downward sloping demand curve as AR is equal to demand and the demand will fall as the price rises
28
What is MR?
The change in total revenue received for selling one extra unit?
29
What is the MR curve like for a price taker?
A perfectly horizontal line as the product is always sold at the same price so no extra revenue is produced at any point
30
What is the MR curve like for a price maker?
The MR curve is also downward sloping but has 2x the gradient because cutting price means less additional revenue per item sold
31
What is the formula for price elasticity of demand?
PED = %change in quantity demand / %change in price
32
How is MR affected when demand is price elastic (demand doesn't change with an increase in price)?
Marginal revenue will be positive as a cut in price will increase total revenue. This means that demand is price elastic. a cut in price will generate revenue therfore MR will be positive
33
How is MR affected when demand is price inelastic (demand doesn't change with an increase in price)?
if a firm cuts price and marginal revenue is negative (total revenue falls) it implies that demand is price elastic. A cut in price will reduce revenue therefore MR is negative.
34
What does MR equal when there is unitary elasticity?
MR=0 When there is unitary elasticity
`
35
What is total cost?
Total cost = The cost of producing at a given level of output
36
What is the TFC?
Total fixed costs that do not change directly when there is an increase in output
37
What are TVC?
Costs that vary directly with output.
38
Write the formulas for the types of cost?
TC = TFC + TVC
TVC = TC - TFC
TFC = TC - TVC
39
What is average cost?
The cost per unit of output, = TC/Q
40
What is the marginal cost?
The cost to the firm of increasing one additional unit of output.
41
What is the formula for Marginal cost?
Change in total cost / change in output
42
What does the law of diminishing returns state?
The law of diminishing returns states that as more variables are added to fixed factors of production, the increase in output will eventually fall.
43
What are economies of scale?
Occur when an increase in the scale of production leads to a more than proportionate increase in output, causing a fall in the LRAC.
44
What are internal economies of scale?
Occurs when a firm benefits from lower LRAC as output expands
45
What are external economies of scale?
Occurs when a whole industry grows larger and all firms within that industry experience lower LRAC
46
What are 3 examples of External economies of scale?
- Improvements to transport
- When skilled labour moves to an area that has a reputation for a certain industry
- when new methods of production come about due to improving technology
47
What are the different types of economies of scale?
- Technical
- Managerial
- Marketing
- Commercial
- Financial
- Risk bearing
48
What are technical economies of scale?
Doubling the dimensions of an object increase its volume 8x, therefore a larger warehouse can hold disproportionately bigger number of workers/stocks
49
What are marketing economies of scale?
AS a firm grows bigger, cost of advertising is spread over a much larger number of potential customers e.g. for smaller firms advertising to a small number of people in a local newspaper is more effective.
50
What are commercial economies of scale?
Large firms can bulk buy from their suppliers, gaining discounts and better deals
51
What are managerial economies of scale?
Larger firms can bring in by employing higher skilled and more specialised managers that can increase productivity.
52
What are financial economies of scale?
Larger firms can issue shares on the stock market and can receive loans with lower levels of interest as they are deemed low risk by banks because they have lots of collateral.
53
What are risk bearing Economies of scale?
Large firms can spread risk by selling a wider range of products/ being in a wider range of industries.
54
What is the minimum efficiency scale?
The output at which a firms LRAC curve stops falling and begins to rise again. It can be viewed at the output at which internal economies of scale have been fully exploited
55
What is diseconomies of scale?
Occurs when LRAC starts to rise as output increases.
56
What are the 4 types of diseconomies of scale?
- X-inefficiency
- Poor communication
- Demotivation
- Poor coordination
57
How can X-inefficiency lead to diseconomies of scale?
AS firms increase in size costs can mean administration coasts increase disproportionately.
58
How can poor communication lead to diseconomies of scale?
The lines of communication between managers and employees can become complex, potentially leading to information delay or confusion with workers
59
How can demotivation lead to diseconomies of scale?
Large businesses tend to be more impersonal and employees feel less valued, this could lead to higher levels of absenteeism or lower staff retention, leading to reduced efficiency
60
How can poor coordination lead to diseconomies of scale?
Large companies can be difficult to manage as they operate with different languages, time zones and culture which could result in lower productivity.
61
What is profit?
The reward for risk taking - it is revenue - costs
62
What is profit maximisation?
When a firm cannot increase its profit, it is equal to the point where MR=MC (MR-MC=0) When the cost of making one unit is equal to the revenue of one unit.
63
What is normal profit?
The minimum necessary profit required to sustain the factors of production Occurs when TR=TC
64
What type of signal does normal profit act as?
It does not act as a signal for firms to enter the market, not does it signal for firms to leave the market
65
What does the size of normal profit depend on?
The level of risk involved and the other investment opportunities available
66
What is supernormal profit?
Any profit above the normal profit required to sustain the factors of production, it is the difference between TR-TC
67
What is a loss?
A loss occurs when firms TC exceed revenues (TC>TR) The average cost of production is more than the price per unit.
68
What is the break-even level of output?
Occurs when TC=TR, when a firms cost, and revenues are equal (they are making a normal profit)
69
Will a business always shut down if it is making a loss?
No, If a firm is covering its average variable costs, it will stay afloat in the long run
70
What is the Shutdown point?
The shutdown point is the point where TVC=AR and any price below that means the business will shut down as producing any good will result in a loss
71
What are the reasons a firm may keep producing if TVC>AR (the shutdown point)?
- There may be a temporary fall in demand (recession meaning demand will bounce back)
- A firm can gain access to a form of credit
- A firm may see AR return to its normal levels in the LR
72
Why may a firm not shut down even if AR>AVC?
The firm may be pessimistic about the growth of a particular market, and feel there is a high opportunity cost in staying in a declining market.
73
What is the profit maximisation position?
MC=MR
74
Why is MC=MR the profit maximising position?
Because it is the point before marginal revenue is exceeded by marginal costs.
75
What causes a change in supply?
- Productivity
- wage rises
- Energy/ production costs increasing
- Changes in exchange rates (depreciating pound means more expensive imported components and materials
- Advances in production technology
- The entry of new producers into the market
- Favorable weather
- Taxes, subsidies and regulation
76
What are the main Business objectives for firms?
- Profit maximisation
- Sales maximisation
- revenue maximisation
- Satisficing behaviour
- Social aims (enterprises)
77
What is satisficing behaviour?
Involves the owners of a business setting a minimum level of achievement in terms of revenue and profitability
78
What are social enterprises?
Businesses with profits that are reinvested for social aims
79
What are the 4 different reasons for differing business objectives?
- Managerial reasons (Revenue or sales growth instead of profit/ Satisfactory profit for shareholders)
- Information constraints (it can be hard to gain accurate info on MC and MR therefore cost-plus pricing is quite common
- Size of the business (small firms may be a 'lifestyle business'
- State owned corporations (can have a range of social and political objectives)
80
How do maximisers behave?
Believe in traditional economic theory and try to make the best possible choice from the available alternatives
81
How do Satisficers behave?
Examine only a limited set of alternatives and choose the best of them
- they use rules of thumb rather than complex pricing strategy
- They use simple cost-plus approaches rather than maximising profit
- Satisficers may be more concerned with increasing revenue or market share instead of profit maximisation.
82
What formula is for profit maximising?
MC=MR
83
What formula is for revenue maximising?
MR=0
84
What formula is for sales maximising?
ATC=AR
85
What is sales maximisation equal to?
Equal to normal profit, as they are trying to create the highest demand by charging the lowest price possible
86
Is perfect competition more or less competitive than a monopoly?
More competitive
87
What is perfect competition?
Perfect competition assumes there are many buyers and sellers within a market and neither can influence the price. Firms are price takers creating a horizontal demand curve of MC=MR
88
What does perfect competition imply?
- Goods sold are homogenous
- There are no barriers to entry/exit
- There is perfect information/knowledge
- All firms aim to maximise profits (MC=MR)
89
What happens in the short run of a perfect competition market?
The forces of supply and demand set the equilibrium level of output and firms will be making a supernormal profit
90
What happens in the long run of a perfect competition market?
The supernormal profit being made by firms acts as a signal for others to enter the market. Consequently, the supernormal profit being made will be competed away in the long run and the market price will fall. The fall in market price will mean individual firms will also want to reduce their output to make a normal profit.
91
Briefly summarise What happens in the long run of a perfect competition market?
new firms signalled to enter the market -> Profit is competed away -> forcing a lower market price -> TMT indivdual firms will reduce their output to make a normal profit (Supply for whole industry increases while individual firms lower supply)
92
What is monopolistic competition?
A form of imperfect competition where products are differentiated. Firms have control over their products and have some price setting power. The AR curve therefore slopes downward.
93
What are the assumptions of monopolistic competition?
- There are many producers and consumers
- Industry concentration is relatively low
- There is slight product differentiation, therefore non price competition is present with lots of consumer switching
- Producers have some price setting power
- Barriers to entry and exit are low
-
94
What are the profits of a firm operating under monopolistic competition in the SR?
They will be making supernormal profits.
95
What happens to the profits of a firm operating under monopolistic competition in the LR?
As more firms enter the market (with supernormal profits acting as a signal) The gradient of the AR curve decreases as elasticity with more firms enter the market. In the LR, the AR curve is tangential to AC meaning firms are making a normal profit.
96
What are the 6 barriers to entry?
- Brand loyalty
- Patents
- Vertical integration (no access to suppliers mean you cannot make any products)
- Being the 'first mover' (First to gain a strong position in the market)
- Geographical barriers
- Economies of scale
97
What is an oligopoly?
An imperfectively competitive market with a high concentration ratio. Examples are confectionary and supermarkets.
98
What are the assumptions of oligopolies?
- There are high barriers to entry and exit
- firms aim for profit maximization (MR=MC)
- Market is dominated by a few firms
- Each firm supplies branded products.
-Interdependency of firms (decisions by one firm impacts another greatly.
- Non price competition
99
What are some examples of non-price competition?
- Innovation
- Loyalty schemes
- sales promotions
-- free upgrades to product
- quality of service and after sales service
- branding
99
Why is there no change in profits made in the SR and LR in an oligopolistic market?
The entry barriers are too great, therefore there is no change in profit
100
Explain why there is inelastic demand below the market price in an oligopoly using the kinked demand curve theory?
In the short term, if a firm cuts price it would cause a big increase in demand and therefore would lead to a rise in revenue. However, other firms will respond by also cutting price to follow the first firm. The net effect is that if all firms cut price – the individual firm will only see a small increase in demand.
Because there is a ‘price war’ demand for a firm is price inelastic – there is a smaller percentage rise in demand.
If demand is inelastic and price falls, then revenue will fall.
101
Explain the layout of the kinked demand curve?
In an oligopoly, when a firms price is above the market price, there is elastic demand (demand changes lots in response to a change in price)
But once firms charge below the market price demand becomes inelastic as other firms will follow suit and lower prices too - TMT demand changes relatively little in comparison to price after this point.
102
What is Game Theory?
Game study is the study of strategic interaction where one player’s decision depends on what the other player does.
103
Explain game theory?
when prices are stable, if one firm cuts prices (starts price war) it will see profits rise. However, the other firm who keeps prices high will lose market share and get zero profits. Therefore, the firm who loses out will almost certainly retaliate and the outcome will move to with both firms just making a much smaller profit. Therefore, there is strong incentive to avoid price war.
104
What are the 4 'Game theory boxes'
HH, LH, HL -> LL
105
What is collusion?
Occurs when firms collaborate with other firms in the market. It mostly happens in oligopolistic markets because it enables firms to increase their profits by maintaining high prices and because oligopolies believe their collusion won't be identified by the regulator.
106
What are the reasons non-collusive behavior may occur in a market?
- There is no trust between firms in the market
- A possibility of new entrants entering the market
- High penalties if found guilty of collusion.
107
What is the main method of collusion?
Both firms make an agreement to raise and fix prices to reduce output and increase prices.
108
What are the two types of collusion?
Overt and Tacit collusion
109
What is overt collusion?
Any form of direct collusion between firms is known as overt or explicit collusion. There is a formal agreement among firms to control the market, fix prices, allocate customers or rigging bids for auctions. It is illegal and easier to detect than tacit collusion.
110
What is tacit collusion?
Results from situations where firms act individually but jointly exercise market power with other competitors. There is an unspoken/implicit agreement with no writing - this is also illegal but very difficult for authorities to control.
111
What is a cartel?
A form of overt/explicit collusion - it is a formal agreement between a group of producers to limit output in order to limit prices, they may also engage in collusive bidding for contracts and divide the market for all the firms involved.
112
What is price leadership?
In some markets, the dominant firms act to change prices and others will follow, if other firms retaliate it could lead to a price war which usually makes the largest firm the established leader.
113
What is game theory?
A form of diagrammatic analysis used to evaluate the actions of firms in an oligopoly - looks as the strategies firms use to makke decisions
114
What does the game theory payoff matrix look like?
Simple two firm, two outcome model with four boxes of HH,LH,HL,LL
115
What does the game theory payoff matrix explain?
Explains why firms are interested in collusion and why they want to avoid lowering prices - it is a reason why firms in an oligopoly compete on non price factors.
116
What are the types of price competition?
- Limit pricing
- Predatory pricing
- Price wars
117
What are price wars?
Cutting prices which leads other firms to cut prices - a chain reaction of price cuts.
118
What is predatory pricing?
Cutting prices below the cost of production (and sometimes variable cost) to force other firms to leave the market - letting them raise prices again. This is almost always illegal.
118
What is predatory pricing?
Cutting prices below the cost of production (and sometimes variable cost) to force other firms to leave the market - letting them raise prices again. This is almost always illegal.
119
What is limit pricing?
Cutting price to below the point that it deters new entrants into the market. It can also discourage incumbent firms (those already in the market) and is not necessarily illegal.
120
What is a pure monopoly?
When a single supplier dominates the entire market - has 100% of the market share - it is when the optimal number of firms in an industry is one
121
What is a legal monopoly?
ANy firm with greater than 25% of the total sales of the industry according to the CMA
122
What is a dominant firm?
Firm with higher than 40% market share
123
WHat are the charactersistics of a monopoly?
- Very high barriers to entry and exit which helps maintain supernormal profits
- Downward sloping demand curve
- Imperfect knwoledge assumed
- May not aim for profit max, instead for market share
124
Disadvantages of Monopolies?
- Prices are higher due to loss of allocative inefficiency
- Absences of competition may create x inefficencies
- Lower innovation
- lower quality
- Lower output
- Less choice for consumers and a loss of consumer surplus and welfare
- Diseconomies of scale
125
Advantages of monopolies?
- profits can be used to fund R=D
- Natural monopolies can create economies of scale
- Domestic monopolies can face foreign competition
- Monopolistic firms can be regulated
- better job security
126
What is allocative efficiency?
Occurs when marginal cost of production = price (MC=P) TMT people are paying the exact amount it costs to produce the last unit - There is an optimal distribution of goods.
his is because the price that consumers are willing to pay is equivalent to the marginal utility that they get. Therefore the optimal distribution is achieved when the marginal utility of the good equals the marginal cost.
127
What is productive efficiency?
Occurs when a firm operates at the lowest average cost (lowest point on the average cost curve. When price = lowest Average cost, consumers are enjoying it at the lowest price they can. there is little incentive for firms to operate at this level because here MC = AC
128
What is the difference between productive and allocative efficiency?
Productive efficiency is concerned with the optimal method of producing goods; producing goods at the lowest cost.
Allocative efficiency is concerned with the optimal distribution of goods and services.
129
What is dynamic efficiency?
Measures a firms ability to improve production over time e.g. through investment and innovation.
130
What is X-inefficiency?
Occurs when there is a rise in cost because there is a lack of competition. There is no incentive or reward for a company to be efficient and cut costs
131
What is price discrimination?
Involves charging different prices to different groups of people for the same good or service. e.g. peak time and off peak
132
What are the types of price discrimination?
First degree
Second degree (indirect)
Third degree (Group price discrimination)
133
What is first degree price discrimination?
Involves charging consumers the max price they are willing to pay (no consumer surplus)
134
What is second degree price discrimination?
Charging different prices based on the choices of the consumer e.g. quantity, time period coupons etc. Allowing them to 'choose what they pay'
135
What is third degree price discrimination?
Involves charging different prices to different groups of people e.g. student discount, peak and off travel (demand is more inelastic) etc.
136
Explain the other method firms use to discriminate consumers?
Product versioning - it is offering slightly different products as a way to discriminate between consumers ability to pay.
137
What are the conditions necessary for price discrimination?
- Price making firm
- Different markets to discriminate
- different groups with different elasticities of demand
- Low admin costs, as the cost to implement price discrimination can be fairly high
138
Advantages of price discrimination?
- Firms can increase revenue
- Increased investment from profits can benefit consumers from increased R+D and innovation
- Lower prices for some consumers
- Acts as a tool to manage demand to avoid overcrowding and spread-out demand
139
Disadvantages of price discrimination?
- Higher prices for some
- Decline in customer surplus
- Potentially unfair - lower income may have to pay more
- Administration costs associated with segmenting the markets
- profits from PD could be used to finance predatory pricing.
140
What is a pure monopsony?
A firm which is the sole buyer of resources of suppliers (they have complete power over suppliers) Many firms have various degrees of monopsony power
141
How can a monopsony affect its suppliers?
As they have power over their suppliers, they can demand higher quality - driving up the ATC of the suppliers which reduce their supernormal profits.
142
What is contestabillity?
The measure of a firm's ability to enter or exit a market. High barriers to entry make a market less contestable.
143
Signs of high levels of contestabillity?
- Low barriers to entry
- low levels of supernormal profits
- Low concentration ratios
- low sunk costs
144
What are sunk costs?
Unrecoverable costs firms can't back after it enters the market - high sunk costs reduce the contestabillity
145
What are the two factors that influence the demand for labour?
The marginal revenue product of Labour
Derived demand (derived from goods)
146
How does Marginal revenue product of Labour (MRPL) affect demand for labour?
MRPL = Marginal product (How much they produce) x Labour
This is the extra revenue a firm gains from employing an extra worker.
147
What are the issues with MRPL and how it affects demand for labour?
Hard to quantify the revenue Labour will generate
Hard to quantify what one person in a team contributes
148
What is derived demand and how does it affect demand for labour?
The demand for Labour is dependent on the demand for the final goods and services the products produce.
149
How does lower wages affect the demand for labour?
Lower wages means greater demand as it is cheaper
150
How does higher wages affect the supply of labour?
higher wages mean greater supply of labour as more are willing to work for greater monetary gain
151
What are the two reasons for low supply of labour?
- Geographical immobillity
- Occupational immobillity
152
HowWhat is geographical imobility?
Labour can't move to different places to seek work due to poor infrastructure, high house prices, cost of travel, family ties etc.
153
What is occupational imobillity?
When it is difficult to change jobs as they lack the appropriate skills or training e.g. the coal miners after Thatcher closed the pits.
154
How does a greater supply of labour affect the labour diagram?
More supply of labour shifts SOL to the right, creating greater employment and lower wages at a lower equilibrium.
155
How does a minimum wage affect the labour market?
A minimum wage higher than the equilibrium would cause demand for labour (firms) to reduce their output as they would have increased expenses. Whilst the supply of Labour (workers) would have a greater demand. This mismatch of demand and supply means there will be a period of unemployment (demand low supply high)
156
Whatr is the elasticity of supply of labour?
The responsiveness of the supply of labour to a change in wages.
157
Why Why may the supply of Labour be inelastic?
- high skills
- High qualifications
- high training time
158
Reasons for an elastic supply of Labour?
- low skills
- low qualifications
- low training time
159
What is the elasticity of demand for labour?
measures the responsiveness of labour demand (firms) to a change in the wage rate.
160
What factors affect the elasticity of demand for labour?
- Proportion of labour costs as a total cost of businesses (proportion of wages in comparison to total costs)
- Ease and cost of factor substitution
- Improving technologies and capital
161
What are the tpyes/ reasons for government intervention?
- To control mergers
- To control monopolies
- To promote competition and contestabillity
- To protect suppliers and employees
162
What is the CMA?
The Competition and Markets Authority (CMA) works to promote competition and benefit consumers by investigating mergers and breaches of UK/EU law.
163
What must occur for the CMA to investigate a proposed merger?
The CMA will investigate a proposed merger if the business being taken over has a UK annual turnover of £70 million or 20% of the market. IT can also force firms to demerge, Like Lloyds TSB in 2011
164
How does the government intervene in controlling monopolies?
- Price regulation e.g. OFWAT and OFGEM
- Profit regulation (gov can set a max % profit relative to a firms assets)
- Quality standards -> often offering a limited franchise period which will not be renewed if quality standards are not met
- Performance targets, like train punctuallity
165
How does governments intervene to promote competition and contestabillity?
- Promotion of small businesses: Start up loans, Venture capital shares, Tax relief.
- Deregulation
- Competitive tendering for government contracts ( when the private sector bid to build major public sector projects that force suppliers to compete to give consumer the best value for money)
- Privatisation
166
How does the government intervene to protect suppliers and employees>
- Restrictions on the monopsony power of firms - to ensure that suppliers are not exploited as they have only one buyer
- Nationalisation
167
what are the benefits of government intervention?
- Greater consumer prices and choice, increasing consumer surplus
- Less supernormal profits that are spent inefficiently
- Increased competition provides incentive for firms to reduce costs or be rid of waste practices.
- More competition encourages better quality designs.
168
Limitations of government intervention?
- Regulatory capture (When the regulated industries gain power over the regulators) means that regulators will act in favour of the industry rather than the consumers is a form of government failure.
- Asymmetric information can make it difficult for authorities to uncover anti competitive practices as those operating in the market will know more about the market than the regulators.
169
What are the 6 main reasons firms grow?
- Economies of scale/lower average unit costs
- build and sustain market power
- Improve shareholder return
- Reduce risk of hostile takeovers
- Pursuit of managerial objectives
- Synergy effects from having greater sales platforms
170
5 main motives for firms to grow?
- profit motive
- cost motive
- market power motive
- risk motive
- managerial motive
171
What is organic growth?
Growth from within the firm (profits reinvested into new products or markets)
172
What is inorganic / external growth?
Growth externally from mergers and takeovers
173
What is a takeover?
A method of external growth where one firm acrquires another by purchasing shares to take it over
174
What is a merger?
A combination of two previously separate businesses into a new business.
175
What is diversification?
Expanding into new markets with new products, diversification typically reduces risk.
176
What are the methods businesses grow?
- organic growth
- Backwards vertical integration
- Conglomerate integration
- Forward vertical integration
- Horizontal integration
177
What is backwards vertical integration?
Acquiring a business operating earlier in the supply chain e.g. a retailer buys a wholesaler, or a car manufacturer purchases a tyre supplier
178
What is forwards vertical integration?
Acquiring a business further in the supply chain e.g. a tyre manufacturer amalgamating with a car manufacturer. the businesses share the supply chain.
179
What is conglomerate integration?
A merger between firms that are involved in unrelated business activities
180
What is horizontal integration?
When companies from the same industry amalgamate - and they are at the same part of the production process.
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What is government regulation?
A set of rules normally imposed by government that seeks to determine behavior of firms, individuals or organizations usually to reduce/prevent market failure.
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What is government regulation?
A set of rules normally imposed by government that seeks to determine behavior of firms, individuals or organizations usually to reduce/prevent market failure.
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What is government regulation?
A set of rules normally imposed by government that seeks to determine behavior of firms, individuals or organizations usually to reduce/prevent market failure.
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What is a regulator?
an organisation, independent of the government that ensure government rules are followed.
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WHat is deregulation?
The process of removing rules and regulations from an industry to make it more contestable.
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What is a fine?
Money that must be paid if a law or regulation is broken, typically a financial penalty.
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What are the advantages of government regulation?
- Prevents consumers and workers being exploited
- Used in conjunction with other policies can alter behaviours
- Quick to implement usually
- Encourages or disourages goods with externalities
- Can increase or decrease consumer confidence
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Disadvantages of government regulation?
- bureaucracy can be costly and time consuming
- May lead to cheating of regulation or encourage illegal activities.
- Raises business costs to comply, reducing the competitiveness of certain industries
- Poor government information can mean that regulations are misguided and have a negative impact.
- There is a risk of regulatory capitre when regulations may suit the industries rather than achieving its intended goal.
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Impacts of regulatory capture?
- Regulators may fail to hold suppliers accountable and fail to enforce a minimum standard of service.
- Prices will be higher leading to regressive effects on households
- Damaging externalities and social impacts if regulators fail.
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What causes regulatory capture?
- Asymmetric information, regulator relying on information that is not true
- Under resourced regulatory agencies may not have efficient funding to effectively scrutinise an industry
- Information gaps - people working in regulatory agencies will not necessarily understand the complexity of an industry.
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Why is there a seperation of control in firms?
Firms are owned by their shareholders , who play no part in the day to day running
of the business.
The chief executive and senior managers work for the company and control day-to-day decision making.
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How do shareholders influence a company?
Shareholders are represented by a Board of Directors, who oversee the way the business is run. They are able to vote directors onto and off the Board of Directors at the (annual general meeting) AGM. However, this often makes little difference and shareholders have more
power through buying and selling shares
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Why does a seperation of ownership cause problems?
● The owners will want to maximise the returns on their investment so will want to short run profit maximise.
● However, directors and managers are unlikely to want the same thing: as employees, they will want to maximise their own benefits.
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What is the principle agent problem?
This is the principal agent problem, where one group, the agent, makes decisions on behalf of another group, the principal. In theory, the agent (directors and management) should maximise the benefits
for those whom they are looking after but in practice agents have the temptation to maximise their own benefits. It is for this reason that many firms are not run to
profit-maximise but to profit satisfice The issue could be
overcome by giving managers shares in the business or linking their bonuses to profits, this
will mean that they personally will gain from higher profits.
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What is the different between profit and not-for-profit organisations?
● Profit organisations: Almost all private sector organisations are run to make a profit and to maximise the
financial benefits for their shareholders . They may not necessarily profit-maximise, but their long term goal is to make money.
● Some private sector organisations are not-for-profit. Any profit they do make is used to support their aim of maximising social welfare and helping individuals and groups. These organisations include charities and smaller organisations who aren’t
large enough to be classified as charities.
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What are the 4 main constraints on business growth?
- Size of the market
- access to finance
- owner objectives
- Regulation
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Why does the size of the market constrain a business?
If a market is limited to a certain size not all businesses
are able to mass produce because their goods would not be bought by consumers.
This can happen no matter how big the market is, and there will always be limits on
growth. In particular, niche markets (specific products that few people want) and
markets for luxury items or restricted prestige markets make it difficult for businesses
to grow
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Why does access to finance constrain business growth?
Firms use two main ways to finance growth: retained profits and
loans. If firms do not make enough profit or have to give out too much to
shareholders, they will not be able to use retained profits to grow. Banks may be
unwilling to lend firms money, particularly smaller businesses that they see as high
risk. As a result, firms will be unable to grow as they can’t finance it.
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How does owner objectives constrain the size of a business?
Some owners may not want their business to grow any further as
they are happy with their current profits and do not want the extra risk or work that
comes with growth.
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What are the reasons for demergers?
- lack of synergies
- value of the company share/ price
- focused companies
- to avoid attention from the competition authorities
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Why is a lack of synergies a reason a company may want to demerge?
when the different parts of the company have no real
impact on each other and fail to make each other more efficient. Lack of synergy
means managers are splitting their time between areas which are so different it could
lead to managerial diseconomies of scale; firms may split in order to avoid these diseconomies
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Why is the value of company shares a reason a company may want to demerge?
Some companies demerge because the value
of the separate parts of the company is worth more than the company combined.
This is because some parts of the business are operating well and have potential to
grow but the overall value is brought down because of the lack of success or lack of
potential for growth of other parts of the business.
Value can be created by splitting up the companies.
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Why are focused companies a reason why a company may want to demerge?
ome people believe if the company and the management
are more focussed on individual markets they become more efficient and successful,
and make higher profits. Management have limited time and skills and there are
unable to spend the required time to make all areas of a huge diverse business
successful. By focusing on one area, managers can improve their skills and
knowledge and become more successful.
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What is the impact of demergers on workers?
Workers: Workers could gain or lose through a demerger. Separate firms may need
their own managers and leaders so people could get a promotion. However, the
goal of making the firm more efficient may result in job losses.
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What is the impact of demergers on a business?
businesses: Concentrating on a smaller core business may enable it to be more
efficient and concentration may lead to more innovation and surviving higher
competition. However, the smaller size of the business could lead to a loss of
economies of scale and reduce efficiency.
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What is the difference between the short run and long run?
SR = When one or more of the factors of the production is fixed
LR = when all the factors of production can be changed
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What is the minimum efficient scale?
The point where average costs are at a minimum, the point where long run average costs of production stop falling
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What does the MES determine?
Determines the number, size and distribution of firms in an industry and the concentration of them
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Provide an example of the MES?
E.g. if the Mes for the cars industry was 10,000 cars a week, and total industry demand was 40,000, the optimal number of firms Is 4
If there were more firms, the average costs would be much higher
