Theme 3 Flashcards
Why do firms of different sizes exist? (2)
- Economies of scale
2. Barriers to entry
Define the principal-agent problem
The way in which the actual owners of firms have become distances from those who are physically controlling and running the firm
3 types of mergers + short explanations
- Horizontal merger - between two firms in the same industry at the same stage of production
- Vertical merger - merger between two firms at different production stages in the same industry
(forward production integration involves a supplier merging with one of its buyers & backward vertical integration involves a purchaser buying one of its suppliers) - Conglomerate merger - merging of two firms with no common interest.
Reasons for growth (4)
- larger company may be able to exploit economics of scale more fully
- larger company may be more able to control its markets, hence reducing competition
- conglomerate merger can reduce the risk for owners by reducing susceptibility to shocks in individual markets
- if firms grown in size, this may come with higher bonuses and salaries for managers, thereby incentivising them
+/- of organic growth
+ easier than external growth & less risk
- may be more difficult in certain cases when the size of its markets are limited by geography & organic growth can be slow
+/- of vertical mergers
+ may be costs savings & may reduce risk and dependence, giving a firm more control over its supply chain
- firm may have little experience on managing this aspect of the supply chain & issues with competition authorities may arise
+/- of horizontal mergers
+ lower AC due to E of S & reduced competition & allows one single firm to own a unique asset (which has perhaps been created by another company) & success is more likely as the firm already has experience in this market
- firms may over-pay & risk of X-ineffiency
+/- of conglomerate mergers
+ reduces risk & and can be used for asset spreading -> keeping/selling specific parts of the acquired company
- firms will not have experience in the new market & asset striping will locally result in unemployment and potentially derelict buildings.
Reasons for demergers (3)
Lack of synergies (one part of the firm is having no impact on the more efficient and profitable running of the other part of the firm), price (price of the split firms may be higher than that of the original firm), focussed companies (has become more fashionable to create more specialised firms/more profitable)
Constraints on business growth (4)
Size of the market, access to finance, owner objectives, regulation
At what point is a normal profit made?
AC=AR
Chain of reasoning as to why firms will continue in production in the short run, even if they are making a loss, so long as they cover their variable costs.
Say the fixed costs are 20, the firm will always have to pay these, even if it shuts down. As long as it is not making a loss greater than the size of its fixed costs, then it should continue to operate.
Barriers to entry (+ small explanation) (8)
- Capital costs - this will make it harder for those entering the market who have fewer resources.
- Sunk costs - costs which are unrecoverable
- Scale economies - depending on the specific market, these can result in a natural number of firms in a market
- Natural cost advantage - to do with natural location
- Legal barriers - nationalised industries can be made monopolies & patent laws
- Marketing barriers - brand image
- Limit pricing - incumbent firms earn normal profits to deter new firms from entering the market
- Anti-competitive practices - not selling to a retailer that stocks another firm’s products/predatory pricing
Barriers to exit (4)
Employment laws
Contract with suppliers
Paying lease
Characteristics/assumptions of monopolistic markets
- competition is imperfect because goods are generally non-homogeneous
- large number of buyers and seller sin the market, each of which his relatively small and acts independently
- no barriers to entry and exit
- firms are short run profit maximisers
- > firms can produce differentiated goods, firms have certain levels of market power
e. g. hotel trade, coach travel, furniture production
Types of price competition (3) and explanation
- Price wars - occur in markets where non-price competition is weak, drive down prices to levels where firms are often making losses, forcing some firms to leave the market in the long run
- Predatory pricing - when an established firm in a market is threatened by a new entrant, an incumbent firm sets a low price so that new firms cannot make a profit, driving them out of the market
- Limit pricing - when firms set a low enough price to deter new entrants from coming into the market by charging a lower price, they can gain market share and still make at least normal profits, while being low enough to deter new firms from entering.
Types of price competition (3) and explanation
- Price wars - occur in markets where non-price competition is weak, drive down prices to levels where firms are often making losses, forcing some firms to leave the market in the long run
- Predatory pricing - when an established firm in a market is threatened by a new entrant, an incumbent firm sets a low price so that new firms cannot make a profit, driving them out of the market
- Limit pricing - when firms set a low enough price to deter new entrants from coming into the market by charging a lower price, they can gain market share and still make at least normal profits, while being low enough to deter new firms from entering.
How can price discrimination be achieved and what is required for it
Time - different prices are charged at different times e.g. electricity distribution companies or rail companies.
Place - same car can be bought at different prices in different EU nations
=> it requires separate groups of people in a market to have different elasticities of demand, hence a firm can change the prices it charges per group in order to maximise its profits.
+/- for producers from price discrimination
+ increases their profit by appropriating some producer surplus what would otherwise be consumer surplus
- costs of production may be higher due to price discrimination
+/- for consumers from price discrimination
- likely to lose out because many will pay higher prices, losing some of their consumer surplus to producers
+ consumers with more elastic demand curve will gain because they will be charged a lower price and it may expand the market
+ consumers may benefit through the firm being able to stay in business by price discriminating
Degrees of discrimination, and what they all mean
1st degree - when a firm is able to charge each customer a different price e.g. asking people what they would be prepared to pay
2nd degree - when a consumer pays less the more they buy e.g. bulk buying
3rd degree - when the market is split and different prices are charged to these groups
Why is there no supply curve in a monopoly
A supply curve is only relevant for price takers, who’s price is determined by the market equilibrium of S and D, whereas a monopoly is a price maker, meaning that it a supply curve is irrelevant to its quantity produced.
+/- of a monopsony for consumers
+ part of the lower costs for the monopsonist may be passed on to customers in lower prices (depends)
- the amount supplied may change, which depends on the price elasticity of supply of the product
