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Flashcards in Theme 3 Deck (59):

Why do firms of different sizes exist? (2)

1. Economies of scale
2. Barriers to entry


Define the principal-agent problem

The way in which the actual owners of firms have become distances from those who are physically controlling and running the firm


3 types of mergers + short explanations

1. Horizontal merger - between two firms in the same industry at the same stage of production
2. Vertical merger - merger between two firms at different production stages in the same industry
(forward production integration involves a supplier merging with one of its buyers & backward vertical integration involves a purchaser buying one of its suppliers)
3. Conglomerate merger - merging of two firms with no common interest.


Reasons for growth (4)

- larger company may be able to exploit economics of scale more fully
- larger company may be more able to control its markets, hence reducing competition
- conglomerate merger can reduce the risk for owners by reducing susceptibility to shocks in individual markets
- if firms grown in size, this may come with higher bonuses and salaries for managers, thereby incentivising them


+/- of organic growth

+ easier than external growth & less risk
- may be more difficult in certain cases when the size of its markets are limited by geography & organic growth can be slow


+/- of vertical mergers

+ may be costs savings & may reduce risk and dependence, giving a firm more control over its supply chain
- firm may have little experience on managing this aspect of the supply chain & issues with competition authorities may arise


+/- of horizontal mergers

+ lower AC due to E of S & reduced competition & allows one single firm to own a unique asset (which has perhaps been created by another company) & success is more likely as the firm already has experience in this market
- firms may over-pay & risk of X-ineffiency


+/- of conglomerate mergers

+ reduces risk & and can be used for asset spreading -> keeping/selling specific parts of the acquired company
- firms will not have experience in the new market & asset striping will locally result in unemployment and potentially derelict buildings.


Reasons for demergers (3)

Lack of synergies (one part of the firm is having no impact on the more efficient and profitable running of the other part of the firm), price (price of the split firms may be higher than that of the original firm), focussed companies (has become more fashionable to create more specialised firms/more profitable)


Constraints on business growth (4)

Size of the market, access to finance, owner objectives, regulation


At what point is a normal profit made?



Chain of reasoning as to why firms will continue in production in the short run, even if they are making a loss, so long as they cover their variable costs.

Say the fixed costs are 20, the firm will always have to pay these, even if it shuts down. As long as it is not making a loss greater than the size of its fixed costs, then it should continue to operate.


Barriers to entry (+ small explanation) (8)

1. Capital costs - this will make it harder for those entering the market who have fewer resources.
2. Sunk costs - costs which are unrecoverable
3. Scale economies - depending on the specific market, these can result in a natural number of firms in a market
4. Natural cost advantage - to do with natural location
5. Legal barriers - nationalised industries can be made monopolies & patent laws
6. Marketing barriers - brand image
7. Limit pricing - incumbent firms earn normal profits to deter new firms from entering the market
8. Anti-competitive practices - not selling to a retailer that stocks another firm's products/predatory pricing


Barriers to exit (4)

Employment laws
Contract with suppliers
Paying lease


Characteristics/assumptions of monopolistic markets

- competition is imperfect because goods are generally non-homogeneous
- large number of buyers and seller sin the market, each of which his relatively small and acts independently
- no barriers to entry and exit
- firms are short run profit maximisers
-> firms can produce differentiated goods, firms have certain levels of market power
e.g. hotel trade, coach travel, furniture production


Types of price competition (3) and explanation

1. Price wars - occur in markets where non-price competition is weak, drive down prices to levels where firms are often making losses, forcing some firms to leave the market in the long run
2. Predatory pricing - when an established firm in a market is threatened by a new entrant, an incumbent firm sets a low price so that new firms cannot make a profit, driving them out of the market
3. Limit pricing - when firms set a low enough price to deter new entrants from coming into the market by charging a lower price, they can gain market share and still make at least normal profits, while being low enough to deter new firms from entering.


Types of price competition (3) and explanation

1. Price wars - occur in markets where non-price competition is weak, drive down prices to levels where firms are often making losses, forcing some firms to leave the market in the long run
2. Predatory pricing - when an established firm in a market is threatened by a new entrant, an incumbent firm sets a low price so that new firms cannot make a profit, driving them out of the market
3. Limit pricing - when firms set a low enough price to deter new entrants from coming into the market by charging a lower price, they can gain market share and still make at least normal profits, while being low enough to deter new firms from entering.


How can price discrimination be achieved and what is required for it

Time - different prices are charged at different times e.g. electricity distribution companies or rail companies.
Place - same car can be bought at different prices in different EU nations
=> it requires separate groups of people in a market to have different elasticities of demand, hence a firm can change the prices it charges per group in order to maximise its profits.


+/- for producers from price discrimination

+ increases their profit by appropriating some producer surplus what would otherwise be consumer surplus
- costs of production may be higher due to price discrimination


+/- for consumers from price discrimination

- likely to lose out because many will pay higher prices, losing some of their consumer surplus to producers
+ consumers with more elastic demand curve will gain because they will be charged a lower price and it may expand the market
+ consumers may benefit through the firm being able to stay in business by price discriminating


Degrees of discrimination, and what they all mean

1st degree - when a firm is able to charge each customer a different price e.g. asking people what they would be prepared to pay
2nd degree - when a consumer pays less the more they buy e.g. bulk buying
3rd degree - when the market is split and different prices are charged to these groups


Why is there no supply curve in a monopoly

A supply curve is only relevant for price takers, who's price is determined by the market equilibrium of S and D, whereas a monopoly is a price maker, meaning that it a supply curve is irrelevant to its quantity produced.


+/- of a monopsony for consumers

+ part of the lower costs for the monopsonist may be passed on to customers in lower prices (depends)
- the amount supplied may change, which depends on the price elasticity of supply of the product


Monopsony power definition

When a firm is a large enough buyer in the market to be able to change the price at which they buy from suppliers


Contestable markets assumptions

> no. of firms in the market can vary
> freedom of entry and exist from the market
> firms compete (profit maximiser) and do not collude
> firms may produce homogeneous or non-homogeneous goods
> perfect knowledge


What is hit and run competition and when may this occur

It is when new firms can enter a market for a short space time, undercutting incumbent firms whilst still making some level of supernormal profits, and then leaving the market when other firms match their prices.
It is made possible in natural monopolies for instance by the absence of sunk costs and unrecoverable capital costs for instance.


How do the different 'stakeholders' of a firm influence the decision-making processes

1. The owners - plays a reducing role as the size of the firm increases (when there are managers, can only influence their decision making by sacking them) & votes may be carried out
2. Directors/managers - they are pressured to maintain a high share price and perhaps incentivised by sales/revenue over profit
3. Workers - can have a strong influence over certain parts of the firms like wages and safety regulations, particularly through trade unions
4. Government - can enforce certain levels of legislation
5. Consumers - can partially influence companies to change their policy through organisations like the Consumers' Association for example


What are the potential business objectives?

1. Profit satisficing - making enough profit, but not maximising profits, after which directors and managers are then free to maximise their own rewards from the company
2. Revenue maximisation (MR=0) - the larger the sales revenue of the firm, the higher is likely the pay and prestige of senior managers -> justifies their high reward (subject to profit satisfying constraint)
3. Sales maximisation (AC=AR) - greatest quantity which still holds the profit satisficing assumption


Explain static efficiency

Static efficiency exists at a point in time - productive and allocative efficiency are both static concepts of efficiency
e.g. whether a firm could produce one million cars a year more cheaply by using more labour and less capital.


Explain dynamic efficiency

Concerned with how resources are allocated over a period of time e.g would there be greater efficiency if a firm distributed less profit over time to its shareholders and used the money to finance more investment
i.e. when resources are allocated efficiently over time (e.g. investment in R&D)


Productive efficiency

When production is achieved at lowest cost


Technical efficiency

If a given quantity of output is produced with the minimum number of inputs.


Explain x-inefficiency

When a firm is operating within the AC boundary as is is not producing at the lowest possible cost for a given level of output.


Explain allocative efficiency

Measures whether resources are allocated to those goods and services demanded by consumers. Occurs when P=MC, because at this point, the marginal cost of production is equal to the marginal benefit received from consumption - demand curve shows the value that consumers place on the last unit bought of a product and the marginal cost curve shows the cost t firms of producing an extra unit of the good.


What things do firms compete on

Price, design, quality, reliability, customer service, availability, promotions (advertising)


Evaluation of different markets with regards to efficiency

Perfect comp.: trade off between static and dynamic efficiency (will not have dynamic efficiency in the LR)
Imperfect comp.: although there is static inefficiency, there are some dynamic efficiencies
=> question is whether the benefits to society from innovation are worth the cost of abnormal profits being earned by the firm, leading to higher prices


For what 3 reasons do natural monopolies arise?

No single producer can fully exploit the potential E of S (one producer will always be able to undercut another)
More competition would result in a loss of productive efficiency.
No firm in this industry would produce at the electively efficient level of production.


Why is the demand curve for labour downward sloping in the long run

The higher the wage rate, the more likely it is that firms will substitute machines for workers and hence lower the demand for labour


Why is the demand curve for labour downward in the long run

Law of diminishing marginal returns


What does the marginal revenue product curve show

It shows the number of workers the firm will employ at any given wage rate = demand curve
N.B. also falls for imperfectly competitive firms because the average revenue of the product falls as output expands


What three things may result in a shift in demand for labour curve

1. If the physical productivity of labour changes
2. The price of what is produced may change
3. Price of capital increases/decreases


Determinants of the elasticity of demand for labour

1. Time: the longer the time period, the easier it is to substitute labour for other factors of production
2. Availability of substitutes: the better the substitutes, the higher the elasticity
3. Elasticity of demand for product: labour is a derived demand
4. The proportion of labour cost to total cost: a rise in unit labour costs will reduce the supply of a product - if labour costs only make up as a small proportion of total costs, then this increase in labour costs will only result in a small shift in the quantity of labour demanded


Supply curve for individual worker - chain of reasoning

Backward bending supply curve
- initially part time worker
- if there firm is willing to double her wages, she is most likely to want to work full time
- eventually, it is likely that increases in wage rates will make her want to reduce her working week or increase her holidays. She will value increased leisure time more than extra money to spend
Therefore, she is choosing to buy leisure time by foregoing the wages she could otherwise have earned and the goods she could otherwise have bought.
=> work is arguably an inferior good; the higher the income, the fewer hours individuals will wish to work


Balance of substitution and income effects

Initially, the positive substitution effect outweighs the negative income effect, but accessing the much higher wage rates, the negative income effect starts to outweigh the positive substitution effect


What non-monetary conditions affect the supply of labour

Job satisfaction, location, friends and family involvement, commuting


What kind of supply curves of labour do perfectly competitive vs imperfectly competitive firms face

Horizontal vs upward sloping


What is the elasticity of the supply of labour affected by

1) Availability of suitable labour from other industries - transferrable skills
2) Time
3) Extent of underemployment and unemployment: higher unemployment, higher elasticity


What are the two types of labour immobility

1. Geographical immobility of labour
2. Occupational immobility


Supply curve might shift if...

1. There is an increase in the number of workers in the population as a whole
2. Wages or conditions of work deteriorate in other indsutries


Why do wage rates differ

1: Labour is not homogeneous
2: Workers do not necessarily seek to maximise wages
3: Labour is not perfectly mobile


A monopoly buyer of labour

The marginal cost of employing an extra unit of labour is higher for the monopsonist than the average cost or wage because the firm has to raise wage rates to attract extra labour into the industry *diagram


Monopoly supplier of labour

Trade unions attempt to fix a minimum price for the supply of labour, producing a kinked supply curve *diagram


Bilateral monopoly for labour (why does monopsonist buy more labour at a higher wage rate from a union that it would otherwise)*

Because it can be seen that the marginal cost of labour is lower at a certain point when labour is unionised - it is the MC of labour which determines the level of employment


What determines the power of trade unions

1. Trade union membership
2. Demand curve for labour is relatively inelastic. A rise in wages will have less of a negative effect on employment
3. Profitability of the employer - trade unions stronger when employer is making supernormal profits


What effects do trade unions have on economic efficiency

- a trade union facing a monopsonist will redress the balance of power in the industry and lead to a level of employment and a wage rate which will be nearer to the free market price of labour
- may increase efficiency of decision-making as the whole group of workers can be treated as one
- lead to inefficiency in competitive industries


Wage inequality facts

1975-2013, full time workers
95th percentile, pay rise of 150%
13th and 14th percentile, pay rise of 79%


Extent to which NMW leads to unemployment affected by three factors

1. Difference between the new rights and existing free market rights
2. Elasticities
3. Different industries affected differently by NMW change


Why will there be net equality in pay rises between public and private sector

Differences in pay rises will result in net movement between sectors


Labour market issues

- skill shortages
- young workers
- raising the length of time spent in education
- retirement
- temporary work
- zero-hour contracts
- migration
- wage inequality