Theme 3: Business behaviour and the labour market Flashcards
What is business growth and organic growth (3.1) (2)
-Business growth is when the business reaches the point for expansion, and seeks additional options to generate more profit
-Organic growth is when a business grows internally either from reinvesting profits or borrowing from the bank
What are the key motivations for business growth (3.1) (7)
-Profit motives - increased growth can provide better returns to shareholders
-Cost motives - economies of scale help reduce average costs
-Market power motives - large firms can take advantage of large market share and gain from monopoly power
-Managerial motives - Managers may prioritise long run growth over short term profit maximisation
-Risk motives - Diversification can help reduce investor risk
-Reduces risk of hostile takeover
-Synergies - the idea that the valuation of 2 businesses combined is greater than both individually
Why might firms want to grow organically (3.1) (5)
-Increase market share
-Develop new, innovative products
-Find new markets to sell existing products
-Getting existing customers to buy more products through advertising
-Investing in new technology to expand production
What are the pros & cons of organic growth (3.1) (5,5)
-Can maintain current management style, culture, ethics
-Less risk financed with profit and expanding what they’re good at
-Easy to manage/control internal growth
-Less disruption = increased worker morale and productivity
-Able to keep a brand/name viewed positively by consumers
-Can take longer to grow internally
-Can take a while to adapt to big market changes
-Business ,ay miss out on opportunities for more ambitious growth
-If market not growing, business’ restricted to increased market share or new markets
-Market size not affected by organic growth
What are the pros/cons of horizontal integration (3.1) (5,4)
-Economies of scale attainable
-Spreading risk
-Reducing competition
-Increasing market share
-Easier to buy a brand than grow one
-Clash of cultures
-Diseconomies of scale
-Synergies not occuring may damage shareholder values
-Risk of attracting investigation from the CMA
What are the pros and cons of Vodafone and Threes merger (3.1) (5,5)
-Offered to freeze prices for UK consumers for 5 years
-Pledge to invest £11 billion into the UK
-Greater quality goods (5G)
-Pooled R&D can lead to greater innovation
-Increased economies of scale = lower AC = higher profits or lower prices
-Increased market share = increased prices (new company has 27 million userbase)
-Concerns of foreign joint ownership over a key national asset
-Hike peoples bills and cause job losses
-Diseconomies of scale
-Decreased choice
What are the types of business growth (3.1) (5)
-Organic growth - where a business grows internally by reinvesting (Subway, Iceland growing through adverts)
-Horizontal integration - when two businesses in the same stage of production merge (Vodafone and Threes proposed merger)
-Forwards vertical integration - when one firm integrates with a firm in a stage of production closer to the consumer (Pepsi buying KFC)
-Backwards vertical integration - when a business merges with another in a stage of production further from the consumer (Tesco buying a farm)
-Conglomerate integration - where two businesses in different industries merge (Amazon and Whole Foods)
What are some examples of horizontal integration (3.1) (3,3,3)
-Facebook and Instagram
-In 2012, Facebook bought Instagram for $1 billion, Instagram being valued at $100 billion in 2018
-Facebook bought Instagram to unlock new audiences and to reduce competition
-Disney and Pixar
-In 2006, Disney bought Pixar for $7.4 billion
-This integration allowed Disney access to Pixars high quality tech, a factor which is thought to have reanimated Disney
-Exxon Mobil
-In 1998, Exxon bought Mobil in a deal worth $75.3 billion, the largest merger in US history (then)
-This merger allowed the two to pool resources (sharing gas stations), as well as streamlining of resources and higher efficiency
What are some examples of vertical integration (3.1) (3,3,3)
-Ikea
-Ikea bought Romanian forestland in 2015, and Alabama forestland in 2018
-This allowed IKEA to control the production, manufacturing and final retail of their goods
-Netflix
-In 2013, Netflix entered the production business
-This allowed Netflix to differentiate from competitors and choose what shows to have on (Netflix originals)
-Zara
-Zara is vertically integrated with their designers and manufactorers
-This helps Zara increase efficiency in stock management as well as quickly reacting to trends
What are the pros and cons of vertical integration (3.1) (5,4)
+Greater reliability: Greater cooperation leads to quick deliveries, better service…
+Power of suppliers/buyers: Firms can dictate prices over who they own
+Economies of Scale: Firms can benefit from lower unit costs through higher output from suppliers
+Flexibility: Easy transmission of feedback allows both firms to act independent
+Lower consumer prices: assuming vertical integration leads to increased competitive advantage
-Higher costs: Financial, time and effort costs of purchasing/integrating a firm
-Management difficulties: People may not want to be dictated by someone with little experience in that field
-Loss of focus: Firms may lose focus on other parts of the business, focusing on integrating
-Reduced flexibilities: Firms may nor rely on a single supplier, instead of having multiple, making it harder to move production
What is the difference between an acquisition and a merger (3.1) (2)
-An acquisition is where one company buys another outright
-A merger is the combination of two firms, which subsequently form a new legal entity under the banner of one corporate name
What are the pros and cons of conglomerate merger (3.1) (5,4)
+Diversification: They can reduce risk by acting in different markets
+Synergies: Mergers may lead to a much higher stock market valuation
+Improved consumer base: Consumers from one firm may now check out/use the other
+Economies of Scale: Higher growth leads to economies of scale (However, different industries have different limits)
+Utilisation of human resources: Greater workforce, can pool together two firms labour
-No prior experience: A firm doesn’t know how the other industry works
-Shift in focus: May ignore other issues to focus on merging
-Complication: Can be complicated sharing resources/gaining EOS
-Government issues: regulators may dislike the mergers
What are constraints on business growth (3.1) (4)
-Size of the market - No firm can be bigger than the market they’re in
-Owner objectives - Short term profit or long term growth
-Limited access to finance - Not being able to take out loans may means firms have to grow via profit, which takes longer
-Regulators - Regulators may try to limit a firms growth, to stop them becoming too powerful
Who are the CMA (3.1) (3)
-The Competition and Markets Authority look into mergers
-They look into anti competitive behaviour by firms
-They work in the interest of workers, consumers and other stakeholders
What is the principle-agent problem (3.1) (3)
-The principal-agent problem is when the agent makes decisions for the principal, but acts in their own interests, rather than the principles
-A manager and a shareholder may have different objectives which may conflict, resulting in short term profit > long term dividends
-When a firms owner sells shares, they lose control they had over the firm, resulting in conflicting objectives between different stakeholders
What is a demerger, and what are the reasons for them (3.1) (2,6)
-A demerger is when a single business is broken into two or more businesses, to operate on their own, to be sold, or dissolved
-Paypal splitting from Ebay in 2014
Reasons:
-Lack of synergies - without synergies, firms are likely to demerge since they’d be worth more
-Growth - Faster growing sections may be split up from other parts of a firm with different growth rates
-Diseconomies of scale - If a firm is so large that average costs rise with output, they may split
-Focus - focusing on fewer markets could allow firms to grow faster than if they spread out
-Resources - a firm may sell of part of the firm if they haven’t got the resources to sustain production in all faucets
-Finance - Selling off parts of the firm can raise finance for more profitable parts
What are the impacts of demergers on businesses, workers and consumers (3.1) (4,2,3)
Businesses-
-Eliminate diseconomies of scale, through greater control and coordination
-Make a profit off part of a firm, which can be used as a source of finance for investment
-Dispose of underperforming/loss making parts
-New, demerged firm can focus on their unique market instead of having to spread
Workers-
-Potential job cuts
-Confusion as roles shift between demerged and parent firms
Consumers-
-Removal of diseconomies of scale = lower price
-Increased choice and competition, only if the two demerged firms are in the same industry
-Net welfare gain if the demerger leads to higher efficiency
Who are different people who could have control over a firms objectives (3.2) (6)
-Owners/shareholders
-Managers/directors
-Workers/unions
-State
-Consumers
-Pressure groups
What are the assumptions made about profit maximising, and what do firms gain by profit maximising (3.2) (3,5)
Assumptions:
-Neoclassical economists assume it is all firms’ sole objective to profit maximise
-The entepreneur is the owner/director
-That profit maximisation can be attained, through the marginalist principle of MR=MC
Benefits:
-Can invest in R&D, to increase the quality of technology
-Lower costs
-Can gain greater funds for reinvesting and expanding
-Pay out greater dividends to shareholders
-Reward enterpreneurship
What is profit maximisation, and how is it graphically represented (3.2) (3,1)
-Profit maximisation is when MR=MC
-If MR>MC, output can be further increased without increasing costs greater than revenue, so profit rises
-If MR<MC, total profits are reducing as costs are rising faster than revenue
-Find the point in the cost/revenue graphs where MR=MC, draw up from that to the AC and AR curves, than that square area is the supernormal profit
What is revenue maximisation, and how is it graphically represented (3.2) (3,1)
-Revenue maximisation is when MR = 0
-Revenue maximisation occurs at the top of the total revenue curve
-Revenue maximisation is a theoretical objective in which the goal is to maximise sales revenue
-You find the point where MR cuts the x axis and draw up to the AR and AC curves, achieving a higher quantity but lower price than the profit maximising point
What are the reasons for revenue maximisation, and how may you evaluate it (3.2) (4,3)
Reasons:
-Economies of scale -> Higher output = higher EOS = Lower AC’s
-Predatory pricing -> Firms could drive out competitors with lower prices
-Principle-agent problem -> Divorce between ownership and control could lead to managers settling for revenue maximisation, easier than profit max
-Brand loyalty -> Cut prices = increased exposure, loyalty and market share
Evaluate:
-Some firms (newspapers) are not profit motivated, but motivated by influence and exposure
-Revenue max can have greater costs and may lead to firms making a loss when they could make profits
-In theory, the Office of Fair Trading protects consumers from predatory pricing and firms seeking unfair competition (drive out competitors)
What are the reasons/evaluation for sales maximisation (3.2) (3,3)
Reasons:
-Economies of scale would lead to future profit
-Limit pricing, where at break even there’s no incentive for new firms to join the market
-To flood the market with a firms goods, increasing market share
Evaluation:
-Predatory pricing limited by the OFT
-Greater costs may lead to a loss
-Some firms are motivated by exposure, not profit (newspapers)
What is sales maximisation, and how can this be graphically represented (3.2) (2)
-Sales maximisation is supplying the largest output possible consistent with earning at least normal profits where AR=AC
-Sales maximisation on a graph is where AR=AC, a higher quantity than Qpm and a lower price than Ppm
What is profit satisficing (3.2) (3)
-Profit satisficing occurs where owners of a business set a minimum acceptable level of achievement in terms of profit/return
-This occurs when there is separation between ownership & management, and it is an acceptable rather than a perfect amount
-Firms may profit satisfice whilst setting other objectives
What is economic costs, imputed costs and opportunity costs of production (3.3) (3)
-Economic cost is the value that could’ve been generated had the resources been employed in their next best use (EC = Actual COP + Imputed COP)
-Imputed cost is the opportunity cost incurred during the period when an asset is employed for a particular use, rather than a different use
-The opportunity cost of production for financial capital is the income which could’ve been generated by investing elsewhere
What are fixed costs, variable costs and total costs (3.3) (4)
-Fixed costs are costs that do not vary with the level of output (AFC = FC/O)
-Variable costs are costs that do vary with the level of output (AVC = VC/O)
-Total costs are the costs of producing at a given level of output (AC = TC/O)
-AC = AFV + AVC = TC/O = P
How to show total costs and average costs on a diagram (3.3) (2)
-TVC and TC have an upwards wave-esque curved line, the difference between the two being TFC, a flat line
-AC and AVC are 2 quadratic-esque curves with positive coefficents, the difference between them being AFC, a curve closening to the x-axis
(TC/AC > TVC/AVC)
What are marginal costs and semi variable costs (3.3) (2)
-Marginal cost is the additional cost of producing one more unit of output
-Semi variable costs are costs which contain within them a fixed cost element and a variable cost element
What is the law of diminishing returns, average product, marginal product (3.3) (4)
-The law of diminishing returns states that in the short run, when variable factors of production (usually labour) are added to a stock of fixed factors of production, total/marginal product will initially rise then fall
-Average product = total product / input
-Marginal product = change in total product/change in input
-Firms may experience diminishing returns as firms are unable to increase their fixed factors of production, so variable FOP’s become the limiting factor
What does an AC + MC graph look like (3.3) (4)
-AFC is a downwards sloping curve
-AVC is an upwards sloping curve which initially falls
-AC is a U shaped curve
-MC initially falls then rises, and crosses through the lowest points of AVC and AC
What are some rules regarding the AC and MC curves (3.3) (5)
(first four also apply to AVC)
-AC>MC when AC is falling
-AC<MC when AC is rising
-AC=MC at all stages of production where AC is constant
-AC=MC at the lowest point of the AC curve
-Lowest pooint on the MC & AVC curves shows the law of diminishing marginal returns kick in
How does the AC/MC curves adapt to changes in costs (3.3) (2)
-When fixed costs rise, AC rises
-When variable costs rise, AC and MC rise
How do you draw a LRAC curve + its shifts (3.3) (1,2)
-LRAC is a U shaped curve, with a flat bottom, which is the productive efficiency, and the first Quantity at productive efficiency is the minimum efficient scale
-Higher FOP price = LRAC shifts up
-Lower FOP price = LRAC shifts down
What are economies of scale, internal economies of scale and external economies of scale (3.3) (3)
-Economies of scale are the long run average cost advantages a firm gains through increasing the scale of production, causing LRAC to fall
-Internal EOS are a result of the growth of the firm itself, leading to cost saving and a fall in LRAC’S
-External EOS occur when a whole industry grows larger, and firms benefit from lower average costs
What are technical, dimensional, purchasing and division of labour econommies of scale (3.3) (2,2,2,2)
-Technical economies of scale are when larger firms can buy better equipment, leading to greater efficiency and lower LRAC
-However, will these greater firms have the labour required to utilise the tech
-Dimensional economies of scale are when shipping (for example) dimensions are labelled, leading to a 4x price but an 8x volume, where the volume of what can be shipped has risen the most, reducing overall LRAC’s
-However, external factors (shipping limits) may limit how big these containers can be
-Purchasing economies of scale are when the more a firm purchases a specific raw material, the more negotiating power they have, allowing them to lower LRAC’s in the process
-However, this can be quite unethical, and can harm suppliers
-Division of labour economies of scale are when a greater sized firm can spread their labour out, allowing for specialisation, greater efficiency and lower LRAC’s
-However, if one part of the production process fails, specialised labour will be unable to fill this role
What are financial, managerial, marketing, risk bearing and R&D economies of scale (3.3) (2,2,2,2,2)
Financial:
-Banks more willing to give out better loans to bigger firms
-However, this depends on the state of the economy, willingness of bank to lend, and the increase cost of a higher loan
Managerial:
-Larger firms can employ specialist managers to maximise efficiency
-However, these managers can lead to less cohesion, less of a family feel and lower motivation to work
Marketing:
-Larger firms can spend more on adverts, and can offset more advertising costs
-However, there is no guarantee that the adverts will have the desired outcome on demand
Risk bearing:
-Larger firms are able to diversify, and take more risks, falling back on other parts of the firm if one fails
-However, a risk not paying off can lead to funds being diverted from more successful sections of the firm, increasing AC’s
R&D:
-Larger firms can afford entire R&D departments, to increase innovation
-However, there is no guarantee that these R&D departments will innovate anything
What are some examples of external economies of scale (3.3) (2,2,2,2)
Transport:
-Better transport will enable firms to reach a wider audience at lower costs
-However, this depends on what transport links firms already have, and what links they need
Education:
-Being close to a university/higher education will give firms a higher pool of skilled labour
-However, there is a time lag as the students go through the education, and it depend son what they do
Concentration:
-If more firms are concentrated in an area, it is more likely the supplier will move to the area, leading to lower delivery costs
-However, other firms may compete for the supplier
Reputation:
-If an area has a high reputation (silicon valley) is more likely to have workers go there
-However, reputation changes quickly
What are the advantages of firms growing in size for firms and consumers (3.3) (2,2)
-Efficiency in production makes firms more competitive in markets
-Firms can now gain higher profits, or lower prices to attract consumers and increase market share
-Consumers get lower prices
-Consumers get high quality/highly innovative goods
What are diseconomies of scale + types (3.3) (1,5)
-Diseconomies of scale are when the expansion of a firms output comes with increasing average costs
-Poor communication: in a large firm, it is harder to communicate an idea to everyone
-Alienation: in a highly specialised assembly line, workers may feel bored and lack motivation
-Lack of control: in a large firm there is greater separation between management and labour., meaning individual workers can get away with doing less
-Overcrowding: too many workers may mean some get in eachothers way, reducing efficiency
-Motivation: people feel less connected, and feel less of a personal incentive to work hard, decreasing productivity
How may firms be able to overcome diseconomies of scale (3.3) (5)
-Poor communication: divide the work process into separate groups, and get these groups to communicate within themselves
-Alienation: have incentives (worker of the month) to encourage people to work hard
-Lack of control: have separate managers for separate portions of the production process
-Overcrowding: let people work from home, or have multiple workplaces
-Motivation: have schemes (days out, pay incentives) to ensure people remain motivated
How do you draw an AR, MR and TR curve, assuming firms receive the same price per good (3.3) (1)
-AR = MR as a straight horizontal line, and TR is a upwards diagonal straight line, all 3 starting from the same point
(Revenue on Y axis, Q of sales on X axis)
How do you draw TR, AR and MR assuming firms recieve a lower price as Q of sales increases (3.3) (2)
-AR and MR are straight lines which fall diagonally, MR being twice as steep as AR
-TR is a negative curve, rising at first when demand is elastic, peaking when MR=0, then falling when demand is inelastic
What is revenue, TR, AR & MR (3.3) (2,2,2,2)
-Revenue is the money recieved from the sale of a good/service over time
-Firms usually calculate weekly, monthly … revenues
-Total revenue is the total money recieved from the sale of a good/service at a given level of output
-TR = P x Q
-Average revenue is the average revenue per unit of good/service sold
-AR = TR/Q = P = D
-Marginal revenue is the additional revenue gained from the sale of one more unit of output
-MR = change in TR/change in Q
