E- Theme 3

Principal Agent Problem

when the separation of ownership and control causes issues due to differing aims

Internal growth

expanding by reinvesting profits or loan finance in order to increase output

External growth

expanding by merging

vertical integration

merging with firms in the same industry at different parts of the supply/production chain

forwards vertical integration

to consumer

backwards vertical integration

to raw materials

horizontal integration

where firms at the same stage of production in the same industry merge

cost rationalisation

when a merged firms cuts costs eg firing workers

conglomerate integration

where firms in different industries with no obvious connections merge

joint venture

when firms join to pursue a common project but remain legally separate

demerger

when a firm decides to split into different firms

profit maximisation

maximised at output level where MR=MC

revenue maximisation

maximised at output level where MR=0

sales maximisation

largest output possible while earning at least normal profit, AR=AC

satisficing

owners setting minimum acceptable levels of achievement of profit or revenue, AR>AC

revenue

income generated from the sale of goods and services

average revenue

price per unit= total revenue/output

marginal revenue

change in revenue from selling one extra unit of output, change in TR/ change in Q sold

maximum TR occurs when

MR=0

total cost

fixed+variable costs

total fixed cost

costs that do not change with output & remain constant

total variable cost

costs that change directly with output

average total cost

total cost/output

average fixed cost

total fixed cost/output

marginal cost

extra cost of producing one extra unit of a good, change in TC/change in output

marginal product

additional output produced when an extra factor of production is employed

average product

total output/ number of factors of production employed

Law of Diminishing Marginal Returns

there is a point where each extra unit of production will produce less output than the previous unit, explains U shape of ATC and MC curves

economies of scale

the advantages of large scale production that enable a firm to produce at a lower cost than a small firm

diseconomies of scale

disadvantages that arise in large firms that reduce efficiency and cause AC to rise

increasing returns to scale

an increase in inputs by a certain % leads to a greater % rise in output

decreasing returns to scale

where output increases by a smaller % than inputs

constant returns to scale

input and output increase by the same %

Minimum Efficient Scale

minimum level of output needed for a business to fully exploit economies of scale

normal profit

minimum profit needed to keep factor inputs in their current use in the long run

includes opportunity cost,

AC=AR or TC=TR

supernormal profiy

in excess of normal profit

AR>AC or TC>TC

loss

less profit than normal

AR<AC or TR<TC

allocative efficiency

when social welfare is optimised

AR=MC or MSB=MSC

efficiency

making optimal use of scarce resources and operating at equilibrium

productive efficiency

when an economy is on its PPF or a firm is operating at the lowest point of the LRAC curve

bottom of LRAC, MC=AC or on PPF

dynamic efficiency

when firms meet changing needs and wants ie is innovative

X-inefficiency

when a firm uses more inputs than necessary for a given level of output

anywhere not on LRAC

oligopoly

when there are a few firms that dominate the market and hold most market share

CRM for perfect competition

0%

CRM for monopolistic competition

CRM for oligpoly

40-60%

CRM for monopoly

>90%

collusion

a situation where 2 or more firms jointly set their prices or output, divide the market among them or make other business decisions

cartel

when businesses agree to act together instead of competing with each other to drive up profits and maintain the image of competition

overt collusion

formal and explicit collusion

conditions for a cartel

agreement to collude

cheating must be preventable

potential competitors restricted

price leadership

when one firms has advantages due to its size or cost and becomes the dominant firm

tacit collusion

collusion without communication or formal agreement

non-price competition

an attempt by firms to differentiate their product by making it seem a less close substitute to competitors’ goods

game theory

explores the reactions of one player to changes in strategy of another

Nash equilibrium

when there is no incentive for players to deviate from their initial strategy

price wars

occur when non-price competition is weak and it is difficult to collude

predatory pricing

when a firm sets such a low price that other firms cannot make a profit and are driven out of the market

limit pricing

when firms set prices low to make at least normal profit but to discourage new entrants into the market

legal monopoly

over 25% market share

pure monopoly

100% market share

dominant monopoly

50-60% market share

natural monopoly

when MES is so high that it is efficient to have only one provider

third degree price discrimination

when monopolists charge different prices to different groups for the same product based on PED

monopsony

when a firm has buying power in their market

there is only one buyer with many sellers

contestability

when there is freedom of entry and exit into the market

sunk costs

an irrecoverable fixed costs if the firm leaves the market

demand for labour

the amount of workers firms are willing and able to employ at a given wage rate over a given time period

Marginal Physical Product

the extra output that an additional worker produces

Marginal Revenue Product

MRP=MR\*MPP

the extra revenue a firm gains from employing an extra worker

PED for labour

responsiveness of the quantity demanded of labour to the wage rate

market supply of labour

the number of workers willing and able to work in a given occupation or industry for a given wage at a given time period

individual supply of labour

the number of total hours that a worker is willing and able to supply at a given wage rate

labour force

the number of workers either in work or actively seeking paid employment and are available to start work

income effect

as wages rise, income rises, so people need less hours to maintain their income

substitution effect

as wages rise, opportunity cost of leisure time increases, so more hours may be worked

PES of labour

responsiveness of supply to a change in wage rates

geographical immobility of labour

the inability of workers to move around in search of work

occupational mobility of labour

the inability of workers to move between jobs due to a lack of appropriate skills or training

bilateral monopoly

both monopoly and monopsony in labour market