Economics Edexcel A A Level: Theme 3 Factors / Impacts / Pros & Cons

Constraints of Business Growth

- Size of the market - not all businesses are able to mass produce because their goods would not be bought by consumers. In particular, niche markets (specific products that few people want) & markets for luxury items / restricted prestige markets make it difficult for businesses to grow. - Access to finance - 2 main ways to finance growth: retained profits and loans. If firms do not make enough / have to give out too much to shareholders, they will not be able to use retained profits to grow. Banks may be unwilling to lend firms money, so firms will be unable to grow as they can't finance it. - Owner objectives - some owners may not want business to grow any further as they are happy with current profits & don't want extra risk / work that comes with growth. - Regulation - in some markets, government may introduce regulation preventing businesses from growing

Characteristics of Monopolistic Competition

MANY BUYERS & SELLERS - each of whom are relatively small and act independently meaning no one buyer / seller has a large price setting power. FREEDOM OF ENTRY & EXIT INTO INDUSTRY - allows new firms to enter when supernormal profits are being made & some to leave in the case of losses. As a result, only normal profits can be made in the LR. NON-HOMOGENOUS PRODUCTS - means that individual firms do have some price setting power, so the curve is downward sloping.

Reasons for Demergers

- Lack of synergies - when different parts of the company have no real impact on each other & fail to make each other more efficient. Managers are splitting time between areas which are so different it could lead to diseconomies of scale; firms may split in order to avoid these. - Value of the company/share price - some companies demerger because the value of the separate parts of the company is worth more, because some parts of business are operating well & have potential to grow but the overall value is brought down by lack of success / potential for growth of other parts of the business. Financial markets talk about 'creating value' by splitting up companies like this. - Focussed companies - some believe if company & management are more focussed on individual markets they become more efficient & successful, & make higher profits. Management have limited time & skills & they're unable to spend the required time to make all areas of a huge diverse business successful. Focusing on one area, managers can improve skills & knowledge & become more successful. - may also want to avoid attention from the competition authorities.

Intentions of Other Aims in a Business

- Managerial utility maximisation - Oliver Williamson said managers will decide to maximise own satisfaction, which will be dependent on their salary, no. of staff they control, power over decision-making, & other benefits. - Marginal cost pricing / allocative efficiency - particularly nationalised industries, aim to maximise social welfare, by producing where the value society places on good = extra cost of producing it.

Conditions of Profit Maximisation

- Profit is maximised when TR & TC are furthest apart, with TR above TC. - also occurs when MC=MR: this will always be true because if producing 1 more adds more to R than it does to C (i.e. MR > MC), producing that must have increased profit & vice versa. Sometimes, MR & MC may cross at two points & thus profit maximising point is where marginal cost rises as it crosses MR line.

Intentions of Sales Maximisation

- Robin Marris suggested that managers aim to maximise the growth of their company above any other objective, because salary may be linked to the size of the company. - it's often easier for people to judge level of growth achieved rather than level of profit > increases prestige of business. - size is often linked to security, as it's believed large firms can survive rough periods much easier & are less likely to get into financial trouble overnight. - growth will also increase market share, & may push other firms out of business > enables firm to have more market power & more power over prices. - tends to be a SR strategy, & in the LR firms are more likely to profit maximise.

Intentions of Revenue Maximisation

- William Baumol suggested managers are most interested in level of revenue since this is what their salary depended on. - even when salary isn't directly connected to sales revenue, they knew that growth in revenue was always likely to be positive for business, as it increases prestige & is used as justification to shareholders for managerial rewards. - fall in revenue would be negative as it wouldn't only reduce salary, but could signal start of downward spiral for company > fall in staff & financial institutions may be worried & less willing to lend money. - as a result, many firms may aim to revenue maximise as long as they provide some profit for the owners.

Intentions for Satisficing

- managers are likely to follow the objective of profit satisfying, if they have different objectives to other stakeholders. They'll make enough profit to keep owners happy whilst following other objectives & not profit maximising. These objectives are likely to be their own benefits. - amount of profit needed will change year on year & depends on level of profit made by other firms: if everyone else is making loss, & firm only manages normal profit then this will be good enough for shareholders, but if other firms are making huge profits, shareholders too will expect huge profits.

Intentions of Profit Maximisation

- neo-classical economics assumes that the interests of owners / shareholders are the most important & therefore goal of firms is to profit maximise in the SR, in order to maximise owners' returns. - by SR profit maximising, firms can generate funds for investment & help them survive a slowdown during a recession.

SR & LR Shutdown Points

- when business is making a loss, it may not necessarily be the best decision to shut down straight away: this depends on the AVC. - if AVC < AR firms should continue production. Each good they make will generate more R than it costs for them to make it, so this will help them to reduce the size of the loss by covering some of the FC. In this case, they should only shut down when their FC increase - if AVC > AR producing more goods will increase loss, so they should leave the industry immediately. - in LR, firm needs to make at least normal profit for them to stay in industry, but in the SR they should produce as long as their R covers their VC. Hence, the SR shut-down point is where AVC = AR. - firms tend to produce on the SR point even though it doesn't affect their losses, as they don't want to let go of workers / let down customers.

Reasons for Growth of a Firm

1. economies of scale > decreasing costs of production > sell more goods > make more revenue > together, helping to make a larger profit, which many firms are motivated by. 2. greater market share > ability to influence prices & restrict ability of other firms to enter the market > helping make profits in the LR. 3. monopoly power often means firms have monopsony power > reduce costs by driving down the prices of raw materials 4. more security as able to build up assets & cash to be used in financial difficulties 5. likely to sell bigger range of goods in more than one local/national market > less affected by changes to individual products or places. - HOWEVER, some remain small due to constraints on growth: market size, access to finance, owner objectives and regulation. Not all firms want to grow.

Types of Non-price Competition in Oligopoly

ADVERTISING - creates an awareness of the company/product & can persuade a customer to purchase the product. If advertising is successful, it can increase sales & market share for a business which in the LR can increase profits. Advertising can also make the demand for a product/service more inelastic. LOYALTY CARDS - encourage repeat purchases by rewarding customers for their loyalty. They also provide firms with lots of data on consumers' buying habits, which the firm can use to increase sales. BRANDING - successful brand can help increase loyalty & repeat purchases for a business. People will trust the brand & quality it represents so will more likely keep buying from them. An established brand should find it easier to release new products. QUALITY - firm that is known for good quality may be able to charge higher prices, & is likely to have strong brand loyalty. They are likely to have good reputation and benefit from positive recommendations. CUSTOMER SERVICE - encourage loyalty amongst customers & give business a more positive reputation. PRODUCT DEVELOPMENT - business that invests in product development will have a competitive advantage over rivals. If they're the first firm to release a new product, they would see an increase in sales & this is likely to help with branding. - Problem with these methods is that they're often expensive & so firms need money before they're able to undertake the competition. Similarly, only large firms will be able to do large scale advertising, R&D etc.. There is no guarantee that it will be successful.

Costs & Benefits of Monopoly

C&B to Firms: - Monopolists have potential to make huge profits for their shareholders through profit maximisation. - Existence of supernormal profits means firms will have finance for investments & will be able to build up reserves to overcome SR difficulties. - Firms with monopoly power will be able to compete against large overseas organisations. - Large firms will be able to maximise economies of scale, reducing costs & increasing profit further. - However, firms may not always choose to profit maximise because of X-inefficiencies / sales / revenue maximising / profit satisfying / contestability leading to limit pricing. In the LR, lack of competition may mean that firms become complacent & so they may not make maximum profits. C&B to Employees: - Monopolists produce at lower outputs, so will employ fewer workers . - However, inefficiency of monopoly may mean employees receive higher wages, particularly directors & senior managers. Profit satisfying / sales/revenue maximising may mean output is higher & so more employees are employed. C&B to Suppliers: - the impact of a monopolist will depend on the extent to which monopolist is also a monopsonist. If the monopolist buys all or most of the suppliers' goods (so is a monopsonist), it will reduce the suppliers' profits as the monopolist will decrease prices. C&B to Consumers: - With a natural monopoly, consumers tend to be better off than if there was competition. - When firms enjoy E.O.S, they will be more efficient & customers will enjoy a higher consumer surplus. - Monopolists may produce an increased range of g/s due to cross subsidisation. - Use of price discrimination will allow for survival of a product / service, & benefits some customers (those in the cheap market) whilst is negative for others. - Consumers may pay higher prices & see a poorer quality service, due to a lack of competition. - There is less choicer consumers, since there is only one firm producing the good.

Characteristics of Perfect Competition

MANY BUYERS & SELLERS - no one firm / customer will be able to influence the market. FREEDOM OF ENTRY & EXIT INTO INDUSTRY - when a business is making profits anyone can enter that market & start producing that product for themselves. As a result, businesses are unable to make huge profits in the LR & if they are making losses they are able to leave. In the LR, they make normal profits. PERFECT KNOWLEDGE - enables firms to know when other firms are making profits attracting them to join market. Moreover, all firms have same costs as they can use same production techniques. It also means that any attempt to raise prices above level determined by market will lead to no sales, as customers will be aware they can buy the same good for a lower price & firms know there's no point lowering price as they will sell all goods at higher price determined by market. HOMOGENOUS PRODUCTS - means if a firm raises it price above the competitors', no one will buy it & they will not gain from lowering their price because they can sell all of product at the same price as everyone else.

Characteristics of Oligopoly

NON-HOMOGENOUS PRODUCTS - means that individual firms do have some price setting power, so the curve is downward sloping. HIGH CONCENTRATION RATIO - supply in the industry must be concentrated in the hands of a relatively small number of firms. INDEPENDENT FIRM - so the actions of one firm will directly affect another. BARRIERS TO ENTER & EXIT

Characteristics of Monopoly

ONE SOLE SELLER - pure monopoly exists where one firm is the sole seller of a product in a market. HIGH BARRIERS TO ENTRY - in the real world, pure monopoly rarely exists but a firm can be legally considered as having monopoly power if it has more than 25% of the market. The model assumes there is only one firm in the industry, they SR profit maximise & there are high barriers to entry.

Types of Price Competition in Oligopoly

PRICE WAR - occur in markets where non-price competition is weak; where goods have weak brands & consumers are price conscious. They also occur when it is difficult to collude. They will drive prices down to levels where firms are frequently making losses. In the SR, firms will continue to produce if their AVC < AR but in the LR, they will leave market & prices will have to rise since supply falls. It lowers industry profits. PREDATORY PRICING - occurs when an established firm is threatened by a new entrant / if one firm feels that another is gaining too much market share. The established firm will set such a low price that other firms are unable to make a profit so will be driven out the market. The existing firm is then able to put their price back up. This is illegal & only works when one firm is large enough to be able to have low prices & sustain losses. LIMIT PRICING - in order to prevent new entrants, firms will set prices low (the limit price). The price needs to be high enough for them to make at least normal profit but low enough to discourage any other firm from entering the market. The greater the barriers to entry, the higher the limit price. It is mainly used in contestable markets. The drawback of this is that it means firms cannot make profits as high as they would be otherwise be able to. COST PLUS PRICING - where firms work out AC & add % increase, determining level of profit they make. Size of increase spends on level of competition & barriers to entry. Problem is that it doesn't consider market. PSYCHOLOGICAL PRICING - firms use non-rounded prices to give impression that price is cheaper in order to encourage consumption, e.g. 99p. MARKET-LED PRICING - prices set by looking at prices charged by competition. They price close to other firms to avoid lower or higher prices, but the problem is that there's no consideration of costs. PRICE SKIMMING - when product is initially launched, firms set high prices to cover R&D costs & manage demand. Once product is no longer newest / best, price is lowered. This is mainly used by technology firms. PENETRATION PRICING - when product is first introduced, firms set prices low to encourage people to use it first time. Hopefully consumers will continue to consume it, even at higher price, after first liking it. Opposite to price skimming.

Pros & Cons to Organic Growth

PROS: - cheaper, less time-consuming, & lower risk than integration, as LR share price of the company falls following integration, firms often pay too much for takeovers & integration is often poorly managed. - firm is able to keep control over their business. CONS: - sometimes another firm has a market / asset which the company would be unable to gain through organic growth. - may be too slow for directors who wish to maximise their salaries. - it will be more difficult for firms to get new ideas.

Pros & Cons of Forward Backward Vertical Integration

PROS: - increased potential for profit as the firm takes the potential profit from larger part of the chain of production. - less risks as suppliers don't have to worry about buyers not buying goods & buyers don't have to worry about suppliers not supplying goods. - with backward integration, businesses can control the quality of supplies & ensure delivery is reliable > they don't have to worry about being charged high prices for supplies > costs kept low, allowing lower prices for consumers > can increase competitiveness & sales. - forward integration secures retail outlets & can restrict access to these outlets for competitors. CONS: - may have no expertise in the industry they took over

Pros & Cons of Horizontal Integration

PROS: - helps to reduce competition as competitor is taken out & increases market share, giving firms more power to influence markets. - able to specialise & rationalise, reducing the areas of the businesses which are duplicated. - able to grow in market where it already has expertise, which is more likely to make the merger successful. CONS: - it will increase risk for the business as if that particular market fails, they have nothing to fall back on and will have invested a lot of money into that area.

Pros & Cons of Conglomerate Integration

PROS: - useful for firms where there may be no room for growth in the present market. - range of products reduces the risk for firms & if a whole industry fails, they'll still survive due to the other parts of the business. - makes it easier for each individual part of the business to expand than if they were on their own as finance can be easily obtained & managers can be transferred from company to company within the firm. CONS: - firms are going into markets in which they have no expertise. It can often be damaging for the business.

Impacts of Demergers

Workers - could gain / lose through demerger. Separate firms may need own managers & leaders so people could get promotion, but goal of making firm more efficient may result in job losses. Businesses - concentrating on smaller core business may enable it to be more efficient & concentration may lead to more innovation & surviving higher competition, but smaller size of the business could lead to loss of economies of scale & reduce efficiency. Consumers - could gain / lose. They may gain from innovation & efficiency, leading to better products & cheaper prices, but demerger firms may be less efficient through loss of economies of scale / raised prices / reduce quality or range of goods as they become motivated by profits.