Micro part 11- Growth of firms, market failure

Question 1

How do firms grow

Answer 1

1. They will usually grow to increase profits
2. Increasing EoS – grow to reach the MES where LRAC are minimised
3. Increase market share and reduce competition so gain some monopoly power so can set prices and make ANP

Question 2

What does internal growth mean

Answer 2

1. Internal growth means increasing the production scale
2. increase output, widen consumer base
3. most growth done by this since most firms are small
4. advantage is that firms can control exactly how growth goes and less risky. Business objectives are kept the same.

Question 3

What are disadvantages of internal growth

Answer 3

1. disadvantages are that it is a long term strategy since its slower than external, meaning competitors might increase their market share.
2. It is also limited by the growth of the market

Question 4

What is external growth

Answer 4

1. External growth means combining firms through a takeover (one firm buys another firm) or merger (when two firms join to make a new firm)
2. vertical/conglomerate less likely to yield economies to scale as unlikely to have any technical economies
3. can access market that is couldn’t otherwise e.g. into a different country

Question 5

What is horizontal integration

Answer 5

1. firms in the same industry at the same stage of production become one

Question 6

What are the advantages of horizontal integration

Answer 6

1. lower AC from internal EoS (firm + consumer)
2. reduce competition by reducing number of firms in market = increased market share and price making ability (firm)
3. more profit so greater dynamic efficiency

Question 7

What are the Disadvantages of horizontal integration

Answer 7

1. loss of jobs as no need for the same type of worker now it’s just one firm (consumer)
2. diseconomies of scale when objectives conflict (firm)
3. reduces choice (consumer)
4. reduction in competition could create higher prices (consumer) due to x-inefficiencies

Question 8

What is vertical integration

Answer 8

1. acquiring a business in the same industry but at a different stage of the supply chain,
2. it can be forward (closer to final consumer so further forward in production process)
3. or backward (closer to the raw material)

Question 9

What are the advantages of vertical integration

Answer 9

1. increase control over the supply chain which can reduce unit costs and improve quality by increasing coordination (reduce x-inefficiencies)
2. can control price and in what market it sells itself to

Question 10

What are the Disadvantages of vertical integration

Answer 10

1. high cost/over valued
2. many of the key workers in the firm being taken over may leave
3. may have little experience in new industry

Question 11

What is Conglomerate integration

Answer 11

1. combining firms which are in completely different markets

Question 12

What are the advantages of Conglomerate integration

Answer 12

1. lower risk since if one fails then there’s a back up (risk-bearing economies of scale)

Question 13

What are the disadvantages of Conglomerate integration

Answer 13

1. may lack experience in the new sector, which reduces product quality

Question 14

What constraints business growth

Answer 14

1. Size of the market
2. Finance
3. Regulation

Question 15

How does the size of the market constrain business growth

Answer 15

1. limit growth because a limited consumer market has limited demand so there are limited opportunities to expand output so EoS can’t be exploited

Question 16

How do finances constrain business growth

Answer 16

1. hard for small businesses to get loans as they are perceived as riskier.
2. Need to use profit that has been saved up

Question 17

How does regulations constrain business growth

Answer 17

1. gov. may block a merger if it leads to substantial lessening of competitive pressure in a market.

Question 18

When does market failure occur

Answer 18

1. occurs when the functioning free market fails to allocate resources efficiently and in the best interests of society.
2. Occurs when the market prices do not accurately reflect the costs/benefits to society

Question 19

When does social optimum occur

Answer 19

1. Social optimum occurs when social costs = social benefits

Question 20

What are the causes of market failure

Answer 20

1. Externalities – these are the effects of production/consumption on 3rd parties not involved in an economic transaction
2. Under provision of public goods
3. Imperfect information leading to misallocation of resources

Question 21

What are Externalities

Answer 21

1. these are the effects of production/consumption on 3rd parties not involved in an economic transaction

Question 22

What is negative externality of consumption

Answer 22

1. consumers overvalue the good by ignoring its externalities causing it to be overconsumed
2. SB

Question 23

What is positive externality of consumption

Answer 23

1. consumers do not take into account all the benefits to society when purchasing the good so it is undervalued and underconsumed
2. SB>PB

Question 24

What is negative externality of production

Answer 24

1. The cost to society is higher than the cost being paid by firms.
2. Hence at any given output the cost of supply is higher than in a free market where firms are free to pollute.
3. The welfare loss is the difference between the MSC and the MPB
4. SC>PC

Question 25

What is positive externality of production

Answer 25

1. production is below the social optimum | 2. SC

Question 26

Why does market failure occur

Answer 26

1. Market failure occurs because in a free market the price mechanism only takes into account the private costs/benefits but not external 2. therefore MPC is supply curve and MPB is demand curve 3. social optimum occurs when MSC = MSB

Question 27

How is education an example of the principal agent problem

Answer 27

1. the principal is the individual/group (child/student) that benefits whilst the agent (gov.) makes decisions on behalf of the principal 2. student has asymmetric information causing them to underestimate the benefits e.g. only consider the benefits to themselves (higher-paid job) without considering the externalities (increasing the productivity of the workforce and the potential output of an economy, reducing unemployment and raising incomes) 3. this means the student acts in ways that reduces the long term benefits (e.g. not working hard in school) which means the student may devote too few resources to education therefore misallocation of resources

Question 28

Problems for healthcare in free market

Answer 28

1. in the free market the consumers/providers of healthcare only consider private costs/benefits 2. but there are positive externalities e.g. healthy population is more productive and has less time of work due to sickness which increases output 3. with legal drugs, the producers of alcohol are more likely to be aware of the social costs but choose to not explicitly disclose these as it may reduce demand for their product and profits