Micro 3

factors influencing the size of the firm (why some stay small and why other grow)

market size

potential for economies of scale

the principal agent problem

when there is a conflict between the objectives of the owners (principal) and the managers (agents) who run the company

define profit satisficing

where managers produce just enough profit to keep the owners content even though this may not be the maximum profit the firm could make

define x inefficiency

when managers let costs rise unnecessarily due to the lack of incentive to minimise them

alternative objectives of managers

be largest company in market (sales max)

maximise perks (pensions, company cars, etc.)

prestige (maximise number of workers under them)

define public sector

organisations which are state owned and funded and run in the public interest

define private sector

organisations which are privately owned and funded

define profit

what is left from revenue after the firm has covered all its costs of production

functions of profit

reward for entrepreneurs

provides funds that can be reinvested in R&D

signals to other entrepreneurs whether to enter market. efficient allocation of resources in society

biggest merger in history example

2015 hj heinz and kraft foods 100bil dollars

greatest acquisitions examples

instagram by facebook

youtube by google

android by google

marvel by disney

define organic growth

growth of firms by either reinvesting profits or raising finance through share issues and borrowing

define external growth

growth of a firm by merger or takeover

types of growth of a firm

organic

horizontal integration

forward vertical integration

backward vertical integration

conglomerate integration

define horizontal integration

merges with a firm in the same industry and at the same stage of production

define forward vertical integration

merges with a firm in the same industry and at a later stage of production

define backward vertical integration

merges with a firm in the same industry and at an earlier stage of production

define conglomerate integration

merges with a firm in a completely unrelated industry

advantage of organic growth

lower levels of risk as the expansion of the firm is gradual and remains in a familiar industry

disadvantage of organic growth

growth can be slow especially if funded by retained profits and borrowing

advantages of horizontal integration

increased market share - economies of scale

greater market power to set prices

disadvantage of horizontal integration

diseconomies of scale e.g. cultural clashes

advantages of forward vertical integration

control of outlets so easier to coordinate production and distribution. increased efficiency

cut out “middle man” thus lowering costs and capture profits

cost savings and coordination benefits across the stages of production

disadvantages of forward vertical integration

diseconomies of scale e.g. coordination

firm may lack expertise in the next stage of production - inefficiencies

advantages of backward vertical integration

gain control of inputs thus guaranteeing supply

cuts out “middle man” thus lowering costs and capturing profits

disadvantages of backward vertical integration

diseconomies of scale e.g. coordination

lack of expertise in the previous stage of the production process - inefficiencies

advantage of conglomerate integration

diversification, risk bearing economies

disadvantages of conglomerate integration

high risk. lack of expertise in new market leads to inefficiencies

if it fails, risk damaging the brand and thus ability to compete in other markets

constraints on business growth

size of market - avoid inefficiencies

access to finance - business confidence, interest rates, etc.

owner objectives

regulation - competition and markets authority

define demerger

when a firm either sells off its subsidiaries or divides itself into multiple firms

why would a firm demerge

raise finance

improve managerial control

reduce/avoid diseconomies of scale

increase profitability

example of forced demerger

lloydstsb in 2013. now competitors

impact of demerger on consumers

greater competition - lower prices, more choice, maybe better quality

greater consumer welfare

impact of demerger on businesses

reduction in revenue and profits short term

but increased efficiency so greater profits long term

may become better at responding to changes in demand, especially in fast moving markets

impact of demerger on workers

flatter and less hierarchical organisational structure

job losses

uncertainty and demotivation

reduced career prospects

main business objectives

profit max

revenue max

sales max

satisficing

motive for profit max

profits can be distributed to shareholders in form of dividend payments

profits can be reinvested to fund further growth and expansion

motive for revenue max

prestige

motive for sales max

increase market share

motive for satisficing

performing to a satisfactory level but not necessarily the maximum level

why mr curve cut halfway to ar

because when the firm cuts the price of its product to sell more, it has to cut the price for all products

although it is selling a higher quantity, addition to tr begins to decline as the price for all the goods it sells is now lower

why is revenue max when mr = 0

when mr is positive, each unit sold adds something to tr

when mr is negative, each unit decreases tr and pulls the curve towards 0

revenue maximisation and elasticity of demand

when mr is positive, demand is elastic so lower price = higher revenue

when mr is negative, demand is inelastic so lower price = lower revenue

revenue curves when demand is perfectly elastic

mr=ar=d

straight upward sloping tr because each unit sold adds same amount to tr

define fixed costs + examples

production expenses which are independent of level of output, e.g. rent and insurance

define variable costs + example

production expenses which are dependent upon the level of output e.g. raw materials

define total costs

the amount spent on producing a given level of output

the sum of fixed and variable costs

labour costs fixed or variable?

salaries are fixed

overtime or piece work payment is variable

however depends on nature of work

define average costs

the cost of producing a single unit of output 

define marginal cost

the addition to total costs of producing one additional unit of output

define the short run in terms of production

the period of time when at least one factor of production (usually capital) remains fixed

all production takes place in the short run

define the long run in terms of production

when all factors of production are variable

planning takes place in the long run

define total physical product / TPP

the quantity of output produced by a given number of inputs over a period of time

define marginal physical product / MPP

the addition to total output from one extra unit of the variable factor

define diminishing marginal returns

when the output of an additional factor adds less to total output than the last additional factor

why do diminishing marginal returns occur

because the gains from specialisation and the division of labour have been used up

if u keep adding variable factors of production to a fixed factor, productivity will start to decline

relationship between mc and ac

when mc < ac, cost of producing an extra unit is less than the average cost of production. each additional unit reduces average costs, so they fall

when mc > ac, cost of producing extra unit is greater than average cost of production. each additional unit adds to average costs, so they rise

define economies of scale

when the LRAC falls as output increases

define the minimum efficient scale

the first point of output on the LRAC curve where long run average costs are lowest

why do internal economies of scale occur

due to an increase in the scale of production

irl example of technical economies of scale

coca cola bottling plant in london

runs non-stop

labour just checks that machines are working properly

irl example of marketing economies

nestle produced kitkat and has launched multiple versions of the brand due to the success of the original

describe financial economies of scale

large firms can take out larger loans, negotiate better interest rates

plcs can issue new shares and bonds on capital markets to raise money cheaply

irl example of risk bearing economies of scale

virgin has airlines, trains, banking, mobile phones, etc.

define external economies of scale

the result of growth within the industry in which a firm operates

define diseconomies of scale

when the LRAC rises as output increases

reasons for internal diseconomies of scale

management problems of control, coordination and communication

poor motivation

example of diseconomies of scale

nokia and kodak respond slowly to changing market conditions

kodak bankrupt

nokia struggling to re-establish

define external diseconomies of scale

where factors outside the firm cause average costs to rise

example of external diseconomies of scale

government taxation policy

define marginal profit and formula

the addition to total profit a firm receives from selling one additional unit of output

change in total profit / change in output

define normal profit

the minimum amount of profit the firm must receive to carry on producing

define supernormal profit

any profit greater than normal profit

profit maximisation on diagrams

where the gap between tr and tc is the greatest

mc=mr

when mr > mc, revenue from each unit exceeds cost so marginal profit is positive

when mc > mr, cost of producing each unit exceeds revenue, so marginal profit is negative

shut down point on diagram

long run - ar = ac

short run ar = avc

why firm operate below long run shut down point but above short run shut down point

any amount of revenue earned above avc will make a contribution towards fixed costs

may not want to leave immediately due to investments and opportunity costs made by going into business

also would still have to pay fixed costs when leaving industry

types of efficiency

allocative

productive

dynamic

define allocative efficiency and where on diagram and why

the extent to which the allocation of resources matches consumer preferences

ar=mc

because mc acts as supply curve and ar acts as demand curve

define productive efficiency and where

when a firm minimises its average cost of production

lowest point on ac curve so mc=ac

define static efficiency

considers efficiency at a point in time and ignores the fact that change occurs over time e.g. tech changes

define dynamic efficiency

considers efficiency over a period of time and the impact of tech change in terms of delivering efficiency gains

define + describe a natural monopoly

industries where start-up costs are so high that they can only really support one firm in the market

must have large output to spread high fixed costs

sunk costs are so high that average costs are always falling

define a perfectly competitive firm

one that is such a small part of the total industry in which it operates that it cannot significantly affect the price of the product in question

price taker

define a perfectly competitive market

a market in which buyers and sellers cannot affect the market price

efficiency of firms in perfect competition

in long run, they are both allocatively and productively efficient

in short run, may not be productively efficient but always allocatively efficient

define monopolistic competition

market structure where each firm is a small part of the total industry in which it operates

define oligopoly

an industry or market that is dominated by a few firms

define concentration ratio

measures the percentage of output or sales of a group of firms in a given industry

example of concentrated market

2008 uk four firm concentration ratio of 76.2%

tesco asda sainsbury’s morrisons

define collusive oligopoly

where firms work together through collusive agreements to increase producer welfare at the expense of consumer welfare

formal/overt collusion

firms sign an agreement fixing either price or output or both or agreeing advertising revenues

avoids danger of any firm price cutting

form a cartel which effectively acts as a single supplier e.g. OPEC

covert collusion

where firms meet secretly and agree to set prices or output levels

define tacit collusion

where there is no formal agreement to keep prices stable but firms operate in a manner that suggests collusion

define predatory pricing

when a firm sells a good or service below the avc of production in order to remove a competitor from the industry

illegal

often done through cross-subsidising

define limit pricing

setting a price below the ac of new entrants to deter new entrants from entering the industry

define monopoly

a single supplier that constitutes the entire industry

legally: a firm that has 25% or more of the market share for a particular industry

define third degree price discrimination

charging different groups of consumers different prices for the same good or service

benefits of third degree price discrimination

increased revenue for firm

capture consumer surplus and convert to producer surplus

can benefit lower income customers

cost of third degree price discrimination

difficult to prevent leakage between markets, especially with e-commerce

define monopsony

a single buyer in a market