Unit 3 Edexcel

1. A firms is a production unit which transforms resources into goods and services. Firms aim to make profit and can make more by growing.
   1. how firms grow externally: Horizontal integration( a merger between two firms at the same stage of production e.g. two banks. occurs mainly to achieve economies of scale or increase market share)

      Annotations:

      • firms can grow internally or externally. Internal growth is when a firm grows by investing in its own current operations, or by expanding its range of operations under the current system of operation. External growth is when a firm grows by joining with other firms usually by a merger or take over
   2. why do firms grow? To increase market share, to benefit from greater profits, to increase sales, to increase economies of scale, to gain power, to satisfy managerial ambitions
      1. Why do firms break up? some firms may grow and experience diseconomies of scale. The business and managers may lose focus and control over daily management and therefore long-run average costs increase. to avoid this a firm may demerge

Annotations:

• two types of costs: fixed costs which do not change with output and can only apply when at least one factor of production is fixed in the short run. Variable costs do change with output and can occur both in the short and long term. Both total fixed costs+ total variable costs= total costs

1. costs
   1. AFC: fixed costs/ output

      Annotations:

      • As output increases, AFC will always continue to fall, because the fixed cost is being spread across greater output
   2. AVC: Variable costs/ output
   3. Marginal costs: is the change in total costs when one additional unit of output is produced(change in total cost divided by a one unit change in output MC curve always goes through the minimum point of the AVC curve and the AC curve

      Annotations:

      • if MC is greater than AC the average must rise.
   4. Efficency
      1. Allocative efficiency occurs when the cost of production and the demands of consumers are taken into account to maximise welfare. firms will charge a price equal to the marginal cost P=MC

         Annotations:

         • price equals marginal cost. in other words, the price paid for a good is equal to the cost of the factors of production
      2. Productive efficiency: occurs at the lowest cost per unit of output or at the lowest point of the average cost curve. it is where MC=AC
   5. Economies of scale: refers to the falling long-run average costs associated with an increase in output

      Annotations:

      • Types of economies of scale financial economies i.e. easier access to loans at low costs Risk-bearing economies: easier to develop a range of products and wider customer base to spread risks. Marketing economies: central brand marketing for as firm expands range therefore little cost. managerial economies: more specialist managers=increase productivity and lower long term costs. also an industry may benefit from innovation by other firms. therefore average cost of production falls. A group of small firm are able to share facilities and therefore lower its long-run costs per unit.
   6. Diseconomies of scale occurs when a firm grows too large and moves beyond its minimum efficient scale. It may result from a breakdown In communication or other managerial difficulties and will result in long-run average cost increasing as output increases
2. Revenues
   1. Total revenue is the amount the firm receives from all its sales over a certain period. TR=price* quantity
   2. average revenue is how much people pay per unit(price) and also the demand curve. AR=total revenue/ quantity

      Annotations:

      • AR curve is also the firms demand curve
   3. Marginal revenue is the revenue associated with each addition unit sold.

      Annotations:

      • MR is the change in total revenue from selling one more unit. both the AR and MR curve are downwards sloping. unless the firm is operating under conditions of perfect competition with a horizontal curve.

1. Profit maximization occurs at the output level where supernormal profits are at their greatest. This occurs where MC=MR

   Annotations:

   • when MC=MR , no more profit can be made, either by increasing or decreasing output. marginal profit is zero
2. Revenue maximization occurs when a firm seeks to make as much revenue as possible. firms are willing to sell products until last unit sold adds nothing to total revenue MR=0

   Annotations:

   • firms choose to operate at revenue maximization point because if a firm has stock left over at the end of the day and it is going pass its sell-by date, this is a rational policy. it is also rational for directors of firms to revenue maximize if their pay is linked to sales revenue rather than profit.
3. Sales maximization(AC=AR) occurs when a firm attempts to sell as much as it can without making a loss, selling as much as it can subject to the constraint of making normal profits.

   Annotations:

   • Must make normal profit
4. Satisficing: This means making enough profits to keep the stakeholders happy
5. Long-run profit maximization with short-term increased market dominance as a primary motive, which may lead to higher profits over time
   1. Strategies to gain market share or increase profitablilty
      1. Pricing strategies this include predatory pricing( pricing below costs to drive out other firms.) and Limit pricing(pricing at a level low enough to discourage entry of new firms that is, ensuring that the price of a good is below that which a new firm entering the industry would be able to sustain.

         Annotations:

         • with predatory pricing the firm makes a loss. other pricing strategies a firm can use include cost-plus pricing(making a fixed percentage mark-up on average costs), price discrimination and discount pricing i.e. buy one get one free. these can lead to increased consumer loyalty thereby increasing long-run profits.
      2. Non-pricing strategies: The aim of non-price strategies is to increase demand for the good being sold and to reduce the PED by reducing the availability of substitutes, without changing price.

         Annotations:

         • some firms use this method as pricing strategies lead to price wars. examples of this non pricing methods include marketing (advertising), increased investment in branding ie loyalty cards, packaging, after care, product development , quality and innovation and mergers to remove competition.

Annotations:

• the number of firms in a market may vary from one (monopoly) to Several (oligopoly) to a large number (monopolistic/perfect competition). barriers to entry prevent potential competitors from entering a market. industries may produce homogeneous goods or different (branded) goods. perfect/imperfect knowledge may exist in a industry. firms may be independent or interdependent. high concentration ratio means that a few firms dominate the market.
• barriers to entry capital costs sunk costs scale economics natural cost advantage e.g location legal barriers i.e. patent laws marketing barriers i.e high spending on advertising and marketing creates a powerful brand image. Hence, it is difficult for new entrants. Limit pricing i.e. firms set lower prices in the short-run. this is done to keep out new entrants Anti-competitive practices e.g.  a manufacturer may refuse to sell goods to a retailer which stocks the product of a competitor.

1. perfect competition : In perfect competition there are many small firms which means there is a low concentration ratio. They produce homogenous products. there is perfect knowledge of price in the industry, and there are no barriers to entry or exist. firms are all price takers

   Annotations:

   • perfect knowledge means firms have access to information about rival firms. this includes the latest technology and techniques and information on who makes supernormal profits. industries such as the foreign exchange & agricultural goods fit into this category.perfectly competitive firms cannot maintain supernormal profits in the long run, because rival firms will see that supernormal profit are being made and enter the industry. therefore market supply curve shifts to the right and the price falls. The shut down point for a perfectly competitive firm occurs when the firm is not covering average variable costs
2. monopolistic competition: many small firms with a low concentration ratio, produce similar goods, imperfect information, very low barriers to entry, there is some degree of price setting power in local markets

   Annotations:

   • they have some price setting power because the products they produce are not completely the same and customers have some loyalty in a market and the demand curve is not perfectly price elastic
3. oligopoly: A few large firms dominate with a high concentration ratio, some distinct characteristics in the products, imperfect knowledge, high barriers to entry/exit, and a significant price setting power, but they are also interdependent

   Annotations:

   • collusion is an agreement between two or more firms to limit competition and therefore divide the market, set prices or output and increase the welfare gains of the firms concerned. it is illegal due to the impact on firms and consumers. the two types of collusions are Overt collusion: firms openly fix prices, output, marketing or the sharing out of customers an extreme form of this is a cartel. Tacit collusion is quiet or done behind the scenes. has the same outcome as overt.  there is a temptation of braking agreement either to maximize a firms sales by lowering prices and catching a rival unaware or to gain immunity from prosecution by acting as a whistleblower
4. monopoly one firms has 100% concentration ratio. with 25% of the market share. products produced are unique and there is imperfect knowledge. there are high barriers to entry and they are price makers. a monopolist is a short-run profit maximiser producing where MC=MR. the demand curve is also the average revenue curve of the firm. if AR is falling MR must be falling too and at a faster rate and becomes zero when total revenue is maximized

   Annotations:

   • ways in which monopolists choose to discriminate: time: charging different prices at different time or seasons. Place: price may vary according to location. Income: charge higher prices to those with higher incomes. conditions for price discrimination include: the ability to split the market into different segments. the elasticity of demand must I differ. monopolist must be able to keep the markets separate at relatively low costs Degrees of price discrimination first degree: occurs when the monopolist charges each customer a different price and that price being the profit maximizing price. second degree: occurs when the monopolist price discriminates according to the volume of purchase by a particular consumer. third degree: occurs when the monopolist splits customers into two or more separate groups 
5. monopsony exists when sellers face powerful buyers A number of firms could act together (collude) to increase buying power. this sort of power may allow a firm to exploit its suppliers in the knowledge that the suppliers has few options beyond selling to the sole buyer

   Annotations:

   • advantages of monopsony include: lower prices passed down to consumers, and quality might be better that if there was perfect competition in buying resources
6. A competitive market has many firms in the market, keeping prices low and output high. A contestable market has low barriers and behaves in response to the threat of competition, rather than the competition itself

Annotations:

• Competition policy is enforcing competition law which prevents abuse of market dominance and acts that prevent competitiveness. Regulation is introducing direct controls on firms such as price caps, where increasing competition does not solve market failure

1. Mergers and acquisitions (takeovers): they minimum condition for investigation is if a merger of firms will result in a market share greater than 25% or if it meets the 'turnover test' of a combined turnover of £70 million or more.