Microeconomics Theme 3 <3

1 niche market
2 diseconomies of scale
3 conflicting objectives (family business)

why firms stay small

1 higher profits
2 economies of scale
3 increased market share and price setting power

why firms grow big

1 internal growth (use profits to increase output)
2 external growth (merger or takeover)

how firms grow big

1 financial constraints
2 size of market
3 regulation
4 competition

what stops growth

combination of two or more companies into a single firm

merger

horizontal and vertical

2 types of mergers

a merger that occurs in the same stage of production

horizontal integration

a merger at different stages of the production away from the consumer

backward vertical integration

a merger at different stages of the production closer to the consumer

forward vertical integration

two completely different firms merging

conglomerate integration

1 reduce competition
2 economies of scale
3 monopoly power

advantages of horizontal integration

1 dis economies of scale
2 lack of synergy

disadvantages of horizontal integration

1 control of the supply chain
2 improved access to raw materials

advantages of vertical integration

1 no expertise in the industry
2 lack of synergy

disadvantage of vertical integration

1 reduced risk by diversitification
2 increased consumer base

advantage of conglomerate integration

1 lack of synergy
2 no expertise in the market

disadvantage of conglomerate integration

When a firm splits into two or more independent firms

demergers

1 reduce diseconomies of scale
2 new separate firms can specialise
3 a firm can sell one of its demerged divisions and its assets to increase SNP
4 reduce conflicts between different cultures within a firm

Reasons for demergers

business - in SR, there is cost of administration and in LR high returns so increases AC
workers - job losses, increase in managers
consumers - impact on price depends on scale of competiton

impacts of demergers

maximising profits

private sector

maximising welfare of citizens

public sector

An organisation whose main objective is not to make money e.g. charity

non profit organisation

price x quantity

total revenue

total revenue increases

elastic good price decreases

total revenue decreases

inelastic good price decreases

total revenue/quantity

average revenue formula

the revenue you receive per unit of output

average revenue

additional revenue received from one extra unit of output

marginal revenue

MC=MR

profit maximisation point

MR=0

revenue maximisation point

AR=AC

sales maximisation point

fixed costs + variable costs

total cost formula

total cost/quantity

average cost formula

(AR-AC) x quantity

profit formula

all factors of production is variable

long run average cost

at least one factor of production is fixed (usually capital)

short run cost curve

an additional factor of production will result in a smaller increase in output

the law of diminishing marginal returns

output increasing as cost per unit decreases

economies of scale

1 managerial
2 financial
3 commercial
4 technical
5 marketing

5 types of economies of scale

employ specialist managers
increase division of labour
increase efficiency
decrease LRAC

managerial EofS

bigger firms are perceived as less risky by financial institutions
lower interest rates when taking a loan
decrease lRAC

financial EofS

bulk buying decreases LRAC

commercial EofS

specialist capital decreases LRAC

technical EofS

lower unit cost for advertising as the firm expands

marketing EofS

output increases as cost per unit increase

diseconomies of scale

1 lack of motivation
2 loss of coordination
3 poor communication
4 organisational slack

4 types of diseconomies of scale

a firm with a lot of market share so they have price setting power

price maker

firms that accept the market price

price taker

1 no barriers to entry or exit
2 infinite amount of buyers and sellers
3 homogeneous good
4 perfect information

Characteristics of perfect competition

in the SR they make SNP
new firms enter the market as profits act as a signal
supply increases
in the LR firms make no SNP

price takers making profit in the short run

in the SR they make a loss
firms leave the market as loss acts as a signal
supply decreases
in the LR firms make no SNP

price takers making a loss in the short run

AR shifts with the dependants of demand PACIFIC

what shifts AR

AC shifts when fixed costs changes but MC does not
AC and MC shifts when variable costs shift

what shift AC

the production of any particular good in the least costly way (lowest point on the AC curve)

productive efficiency

(P=MC)

allocative efficiency

uses SNP to innovate

dynamic efficiency

(any point on the AC curve)

x efficiency

AVC is higher than AR then the firm leaves the market immediately

shut down point

1 low barriers to entry of exit
2 many buyers and sellers
3 slightly differentiated goods
4 firms aim to profit maximise

characteristics of monopolistic competition

SNP acts as a signal
new firms enter the market
increase in competition
increase in AC (marketing)
decrease in AR
no SNP

firms in monopolistic competition in the LR

1 5 firms have 60% market share
2 high barriers to entry and exit
3 slightly differentiated goods
4 firms aim to profit maximise
5 firms are interdependent

oligopoly characteristics

high concentration ratio in the market and the demand is inelastic

oligopoly

price rigidity
if a firm increases their price, then other firms will not (demand is elastic)
if a firm decreases their price, then other firms will decrease prices (demand is inelastic)

kinked demand curve

two existing firms with high market share engage in price fixing or quality fixing (illegal)

collusion

firms openly speak and cooperates on explicit price fixing

overt collusion

firms indirectly cooperates on price fixing

tacit collusion

1 small number of firms
2 demand is inelastic
3 firms output can be monitored easily
4 incomplete information

collusion characteristics

1 enforcement problems
2 falling market demand
3 successful entry of non cartel firms into the market
4 market regulators
5 whistle blowers

why collusion breaks down

the payoff firms get if they increase price or decrease price

pay off matrix

firms collude and set a high price to gain joint SNP

joint profit maximisation

while colluding a firm could decrease price and break the agreement to gain more SNP while the other firm gain less profit

first movers advantage

one firm supplying the only good or service dominating the market with 100% concentration

pure monopoly

one firm has 25% or more concentration ratio

legal monopoly

one firm has 40% concentration ratio

dominant monopoly

1 one firm in the market
2 high barriers to entry
3 firms aim to profit maximise
4 price setting OR quantity setting power but not both

monopoly characteristics

government - corporation tax, compete on international market
worker - increase job security, bonuses and perks
consumers - innovation in the market
other firms - secure outlet for suppliers, constant quality for firms

benefits of monopoly

government - often avoid tax
workers - low bargaining power, low job security (increase in capital)
consumers - less choice, higher prices, lower quality
other firms - monopsony set low prices for the supplier

costs of monopoly

sunk costs are high so economies of scale is constant

natural monopoly

monopolies can discriminate on price on different consumers who have different PED to increase their SNP

price discrimination

demand is inelastic
demand is irresponsive to a change in price
train firms charge higher prices

peak traveller (commuter)

demand is elastic
demand is responsive to a change in price
train firms charge lower prices

off peak travellers (leisure)

a firm which is the sole buyer of resources or supplies

pure monopsony

firms have some control over their supplier

monopsony power

supplier - secure revenue stream
monospony - increase bargaining power
consumer -

benefits of monopsony

supplier - reduced bargaining power
monopsony - suppliers may shut down
consumer -

costs of monopsony

ease of which firms enter or exit the market

contestability

1 low barriers to entry or exit
2 good information
3 low sunk costs

what affects contestability

1 limit pricing or predatory pricing
2 economies of scale and product differentiation
3 patents, copyrights and licensing requirements

types of barriers of entry or exit

1 no physical location
2 consumers can be reached easily
3 brand awareness reaches further
4 disrupting existing markets
this increases contestability

technology reducing contestability

the additional quantity of output produced by an additional unit of labour

marginal physical product of labour (MPPL)

the additional revenue received by a firm by using an additional unit of labour

marginal revenue product of labour (MRPL)

MPPL x MR

MRPL formula

each additional unit of labour, brings less additional productivity because capital is fixed

the law of diminishing marginal productivity

labour is homogenous

prefect information

perfect labour mobility

workers and firms are price takers and they must accept the industry wage rate

no barriers to entry or exit

perfectly competitive labour market

there is an inverse relationship between w/r and quantity of labour

how w/r affects demand for labour

when the w/r is low the capital will be substituted for labour as the labour is cheaper

labour substitution

when the w/r is high the labour will be substituted for capital as the capital is cheaper

capital substitution

capital becoming expensive

deregulation

PACIFIC

shifts in the demand for labour curve

the demand of labour is dependant on the demand of the good

derived demand

we cant workout individual productivity as people work in teams

criticism of the law diminishing marginal productivity