Chapter 5 - Businesses In The Market Economy

What is a business firm

An organisation using entrepreneurial skills to combine factors of production to produce a good or service for sale

What is an industry

An industry consists of firms involved in making a similar range of items that usually compete with each other

Business firms are the ………….. in our economy

major production units

Business firms size, behaviour and performance influence

overall productive capacity

Several factors may influence the decisions of investors and entrepreneurs

• The skills and experience of the business operator

• Industries where there is a strong consumer demand

• Specific business opportunities

• The amount of capital required to start the business

How do businesses decide how much to produce

Based on its assessment of the level of consumer demand and its ability to convert that demand into sales

How do businesses decide how to produce

The production process involves combining a range of resources (inputs) to create goods and services (outputs)

What is the sharing economy

A socio-economic ecosystem built around the sharing of human, physical and intellectual resources

What does the sharing economy include

Creation, production, distribution, trade and consumption of goods and services by different people and organisations

Businesses can also contribute to regional development

What are the benefits of regional development?

Better regional infrastructure

Improved liveability

Population attraction and retention

Growth in individual businesses also increases an economy’s

productive capacity

Increasing a nation’s productive capacity results in

greater economic output

greater competitive pressures, which leads to lower inflation and translated into improved living standards

Goals of a business firm

• Maximising profits

• Meeting the expectation of shareholders

• Increasing market share

• Maximising growth

• Satisfying behaviour

What is productivity

Refers to how much we produce with a given quantity of resources, per unit of time

An increase in productivity can be defined as

an increase in output per factor of production

What is the formula for productivity

Total output/ Total input

What is production

Refers to the total amount of goods and services produced

How can we increase production

Increasing the amount of resources we use, or working those resources for a longer period of time

How can we increase productivity

Increase production proportionately more than the increase in input of resources

What are the benefits to an economy when firms use resources more efficiently

Increase in living standards

Productivity contributes to an improvement in our standard of living in several ways:

• Less wastage of scarce resources

• Lower production costs and higher profits for the business firms

• Lower inflation rate

• Higher incomes

• Improved international competitiveness of Australia’s industries

One of the major ways business firms can increase their productivity is

specialisation

What is specialisation

Where factors of production are used more intensely for a smaller number of production processes

What is the specialisation of labour

Division of labour

What is division of labour and give an example

Occurs when businesses break down their production process into a number of sub-processes, allowing labour to specialise in a particular part of the process, and thus avoiding the time and effort of moving from one process to another

eg. assembly line for car production

What is the specialisation of land (natural resources)

Location of industry

What is location of industry and give an example

Occurs when a large number of businesses that produce similar goods and services congregate in the same area to reduce production costs by sharing common infrastructure requirements

Eg. concentration of advanced technology industries in Macquarie Park Industrial Area

What is the specialisation of capital

Large scale production

What is large scale production and give an example

Occurs when businesses grow so large they can use highly specialised capital equipment in their production process

Eg. large wine producer that uses specialised machines to bottle, cap and label wines

Firms are able to reduce their per-unit costs of production as

their output increases

What is internal economies of scale

Concept that a firm needs to achieve a large scale production in order to minimise costs

Economies of scale occur when (in relation to graph)

a firm’s output level is below the technical optimum

Economies of scale are experienced when average costs per unit of production fall as

the size of output grows

Average cost is

the per-unit cost of production:

total cost of producing a certain level of output / the total quantity produced

The manufacturer will continue to expand the business, while the firm can lower per-unit costs because

this will increase the firm’s overall profitability

As a firm continues to lower per-unit costs of production, there will eventually reach a point where

the costs of production will start to rise because of certain disadvantages of being too big

When the costs of production will start to rise because of certain disadvantages of being too big, this is known as

internal diseconomies of scale

Most of the factors that cause diseconomies of scale are related to

management problems

How can management cause internal diseconomies of scale

Management may not be able to:

• Efficiently organise all areas of the business

• Creating organisational congestion/lack of communication

• Slowing down the production process and increasing costs

What are the cost-saving advantages of internal economies of scale (6)

• By becoming bigger, the firm can specialise their labour

• A large firm can invest in more efficient capital equipment

• A large firm can buy its raw materials in bulk (generally reduces the per-unit cost of these inputs)

• A large firm can generally find a market for its by-products instead of discarding them as waste

• A large firm can put resources into research which can lead to improved production techniques and investing in human capital, improving the labour force by training

• Larger firms find it easier and cheaper to raise finance for business expansion

What are the disadvantages of internal diseconomies of scale (4)

• Management can lose touch with the running of the firm and inefficiency can increase due to a lack of communication in a big firm

• Larger size of the firm can lead to duplication and paperwork

• Problems arise in workplace relations because management no longer knows the staff and leads to misunderstandings and disputes

• Decrease in managerial and administrative efficiency, overshadows the advantages of being large and leads to increasing per-unit production costs

What does the long-run average cost curve show

Shows the relationship between production costs and internal economies and diseconomies of scale

Point X is the technical optimum.

What does this represent

Most efficient level of production for the firm

What is a benefit of continuously repeating production processes

A firm can become more efficient at completing the same tasks in production processes over time

How is ‘learning by doing’ represented as a curve?

Results in a downward shift of the firm’s long-run average cost-curve meaning lower per-unit production costs at each level of output

What are external economies and diseconomies of scale

Other cost advantages and disadvantages that can affect a business that exists completely outside its control and occur regardless of a firm’s level of production

What are external economies of scale

Cost saving advantages that occur to a firm because of outside influences, are not the result of the firm changing its own scale of operations

What are three examples of external economies of scale that could benefit a business?

1. Increasing localisation of industry means that all firms in a certain region would enjoy certain cost-advantages like locating in area of skilled labour, plentiful inputs and major consumer market

2. As an industry grows, all firms in that industry derive some extra benefits like government funding to promote special research

3. A growing and competitive market would be of benefit to all firms as it could provide cheaper investment funds from a variety of sources

What are external diseconomies of scale

Result from the growth of the industry in which the firm is operating, but they can also result from rapid growth across the entire economy

What are three examples of external diseconomies of scale that would disadvantage a business?

1. The growth of industry causes increased pollution, which contributes to illness, premature deaths and occasional closures of factories

2. Increasing the concentration of industry and people in existing urban areas increases transport costs of all firms and causes transport bottlenecks

3. As an industry grows, the cost of a firm’s new materials can rise, as the increasing demand for materials increases relative to the demand and supply

The modern business environment is highly competitive and dynamic.

Thus businesses leader need to be alert to

trends and new technologies

Improved technological innovations enable a business to

improve their efficiency and increase their output using existing resources

Businesses that invest in technology have generally experienced

lower production costs

increased efficiency

reduction in the size of the workforce

Larger production runs

Why has online shopping reduced the profit margins of firms

Consumers have more options to compare prices, especially with overseas firms

What is a negative of technological change for individuals

Can lead to the redundancy of many jobs

In order to compete globally, manufacturing and other labour work has been

outsourced overseas

Businesses that invest in technology are able to

offer better quality products at a lower price

better able to respond to changes in the market demand

provide goods tailored for their customers

What is a negative of investing in technology

Not all technology performs to expectations

What does environmental sustainability refer to

Minimising pollution and waste, preserving the natural environment and using renewable energy

Businesses may change their activities because of (3)

Government regulations

Consumer demands

Ethical commitment