Theme 3 - : Business behaviour and the labour market

Question 1

Define economies of scale

Answer 1

When a firm can produce goods and services more efficiently as it increases its scale of production

Question 2

To revenue maximise, firms would need to produce at where…

Answer 2

MR = 0

Question 3

What is revenue maximisation?

Answer 3

Theoretical objective of a firm which attempts to sell at a price that achieves the greatest sales revenue - increase market share

• William Baumol suggested that managers are interested in their level of revenue as thats what their salary depend on
• A fall in revenue would be negative as this could lead to a downward spiral for the company
• Most firms aim to revenue maximise as long as some profit is provided for the owners

Question 4

Distinction between profit maximisation and revenue maximisation

Answer 4

Profit maximisation is when firms focus on maximising profit even at the expense of revenue

Revenue maximisation is when firms focus on increasing its sales in order to benefit company and managers, even if it means sacrificing some profit

Question 5

Sales maximisation

Answer 5

AC = AR

Firms maximise its sales without making a loss

Question 6

What are the 6 types of internal economies of scale?

Answer 6

• risk bearing
• managerial
• financial
• purchasing
• technical
• marketing

richards mum flies past the moon

Question 7

3 types of internal diseconomies of scale

Answer 7

• alienation
• bureaucracy
• communication

Question 8

Reasons for a firm expanding vs staying small

Answer 8

growing:
- more sales and profit - monopoly power
- increase market share
- internal economies of scale
- diversify and enjoy risk bearing economies
- owners objectives

staying small:
- niche markets
- lacks finance to expand
- regulation restricts growth
- profit satisfice
- diseconomies of scale

Question 9

As firms grow bigger, they might experience…

Answer 9

Divorce of ownership and control – leads to the The principal-agent problem which is when the agent (e.g. the manager who runs and controls the business) pursues different objectives to the principal (e.g. the shareholders who own the business)

Question 10

Distinction between types of firms

Answer 10

• private vs public sector
• for-profit or non-profit

Question 11

What is allocative efficiency? and where is allocative efficiency on the diagram?

Answer 11

It is when resources are used to produce goods and services which consumers want and value most highly, maximising social welfare and utility.

It occurs when the value to society from consumption is equal to the marginal cost of production, where P=MC.

Question 12

What is productive effciency?

Answer 12

It occurs when a firm produces products at the lowest average cost, using the fewest resources to produce each product. This can only exist if firms produce at the bottom of the AC curve, where MC=AC.

Question 13

Define diseconomies of scale

Answer 13

Increases in the unit (average) costs of supply due to decreasing returns to scale

A business has moved beyond their optimum size in the long run - suffering from productive inefficiency due to organisational slack

Question 13

What is organisational slack?

Answer 13

When a business fails to minimise its average costs at a given level of output - it is X-inefficient (type of productive inefficiency)

Question 14

What is the main purpose of the Competition and Markets Authority (CMA)?

Answer 14

To promote competition for the benefit of consumers

Question 15

What types of cases does the CMA investigate?

Answer 15

investigates mergers and breaches of UK and EU competition law

Question 16

What enforcement powers does the CMA have?

Answer 16

• impose financial penalties, prevent mergers, force businesses’ to reverse decisions already made

Question 17

In addition to competition law, what other laws does the CMA enforce?

Answer 17

Consumer protection law

Question 18

What actions can the CMA take against individuals who participate in cartels?

Answer 18

Can bring criminal cases against individuals who partake in cartels

Question 19

Define regulatory capture

Answer 19

A form of government failure whereby the regulators operate in the interest of producers, due to impartial information, rather than the interest of the consumers

Question 20

How are mergers assessed in the UK by the Competition and Markets Authority (CMA)?

Answer 20

considering whether there will be a substantial lessening of competition (SLC)

Question 21

What criteria does the CMA use to determine whether a merger will be approved?

Answer 21

Whether the potential benefits outweigh the costs + evaluates the likely competitive situation if the merger goes ahead or not

Question 22

When is a merger investigated?

Answer 22

if it will result in a market share greater than 25% or if it meets the turnover test of a combined turnover of £70 million or more.

Question 23

Why does the CMA aim to prevent two large companies from merging?

Answer 23

• prevent exploiting customers by raising prices, offering poor quality products, limiting choice, preventing firms from gaining monopoly power

Question 24

What are the 4 types of government intervention for monopolies

Answer 24

• price regulation
• profit regulation
• quality standards
• performance targets

Question 25

What is the aim of government intervention: price regulation

Answer 25

Regulators set price controls that force monopolists to set a price below their profit maximising price

• to ensure efficiency gains are passed onto the consumer

Question 26

What formula do regulators use to set price controls to force monopolists to charge a price below profit-maximizing price?

Answer 26

RPI + X , where X = the expected efficency gain

Question 27

What is the alternative formula for regualtors to set to price regualte monopolies instead of rpi-k

Answer 27

RPI-X + K(investment)

Question 28

Define profit regulations as a form of government intervention

Answer 28

Profit regulation is to set prices to allow firms to cover the costs of running their business

Question 29

Pros and cons of profit regulation

Answer 29

Profit regulation is to set prices to allow firms to cover the costs of running their business e.g. rate of return - giving them a fair rate of return on their investments

Pros

• encourages investment

cons
- over investment of capital
- difficult to predict what price to set

Question 29

What is a type of performance target (gov intervention)

Answer 29

• yardstick competition - operate efficiently e.g. times for trains

Question 30

Policies of government intervention promoting competition

Answer 30

• promoting small busines, incumbent firms will no longer be x-inefficient

Question 31

How do we calculate the level of profit

Answer 31

compare average revenue to average costs

Question 32

Difference between organic and inorganic growth

Answer 32

Organic- when a firm grows by investing in itself to increase output

Inorganic - when a firm grows by merging with or acquiring another firm

Question 33

Name the 4 types of inorganic growth

Answer 33

• Forward vertical integration
• Backwards vertical integration
• Horizontal integration
• Conglomerate integration

Question 34

Define the 4 types of inorganic growth

Answer 34

Forward vertical integration - when a firm integrates with another firm, closer to the consumer, in the at different stage in same production process

Backward integration is when a firm integrates with another firm, further away from the consumer, at different stage in the same production process

Horizontal integration is when a firm integrates with another firm, in the same stage in the production process

Conglomerate integration is when a firm integrates with a firm in an unrelated industry

Question 35

Pros and Cons of organic growth

Answer 35

• low risk as investing into own business means good knwolege of business
• owner keeps control and ownership - using bank loan or reinvesting, keeps most profit

cons

• can lose control and ownership if it grows organically by selling lots of shares or setting up lots of franchises
• slow process relative to inorganic growth

Question 35

Pros and cons of vertical integration

Answer 35

• decreased intermediary costs
• control of supply chain
• increased access to consumers and raw materials

cons

• costs may increase due to diseconomies of scale
• lack of expertise
• increased regulation

Question 35

Pros and cons of horizontal integration

Answer 35

pros
- economies of scale
- decreased competition
rationalisation - no duplicate costs

cons
- internal diseconomies of scale
- rationalisation leads to job losses
- brand duilty if brands are different