Economics Theme 3

• Productive efficiency 


  When average cost is lowest. Where MC=AC.
• Allocative efficiency


  Welfare maximised. MC = Price or MC = AR or MC = D
• X - Efficiency 


  When a firm is producing above its average cost curve for a given level of output.
• Dynamic Efficiency 


  When a firm making supernormal profit invests in R&D.
• Legal barriers include patents, trademarks and copyright - and they allow firms to legally prevent other firms from stealing their ideas and entering their market.
• Sunk costs are costs that cannot be recovered (e.g. advertising).
• High sunk costs are a barrier to entry: they deter new firms from entering because firms know that if they fail, they won’t be able to recover any of their sunk costs. 
• Risk bearing, managerial, financial, purchasing (Bulk-buying), technical, marketing are all types of what?

  Internal economies of scale
• Overt Collusion is a formal agreement between firms.
• Collusion is when two or more firms agree to limit competition.
• Tacit collusion is an unspoken agreement between firms.
• How might a firm compete on price?

  1. Price wars
  2. Predatory Pricing
  3. Limit Pricing
• Price wars 


  When firms try to undercut each other with lower prices to steal the other firms’ consumers.
• Predatory pricing 


  When a firm aggressively cuts its prices below AVC to force out competitors from the market. 
• Limit pricing 


  When an incumbent firm uses its economies of scale to set a price low enough to limit new firms from entering. 
• Deregulation 


  Involves reducing or removing government-imposed restrictions and regulations on businesses, with the aim of promoting competition, efficiency and innovation.
• Privatisation 


  The transfer of ownership of a state-owned enterprise to the private sector.
• The principal-agent problem is when the agent (e.g. the manager who runs and controls the business) pursues different objectives to the principal (e.g. the shareholders who own the business)
• Organic growth is when a firm grows by investing in itself to increase output.
• Inorganic growth is when a firm grows by acquiring, or merging with, another firm.
• Vertical integration is the integration of firms in the same industry but at different stages in the production process.
• If the merger takes the firm back towards the supplier of a good, it is backwards integration.
• Forward integration is when the firm is moving towards the eventual consumer of a good.
• Conglomerate Integration 


  This is where firms in different industries with no obvious connections integrate.
• Constraints of business growth:

  • Size of the market.
  • Access to finance.
  • Owner Objectives.
  • Regulation
• Reasons for demergers:

  • Lack of synergies.
  • Value of the company/share price.
  • Focussed companies.
  • Avoid attention from competition authorities.
• To profit maximise, firms would produce where MC=MR.
• To revenue maximise, firms would produce where MR=0.
• To sales maximise, firms would produce where AC = AR.
• What does producing at Q2, mean that the firm is maximising?

  Sales

  
• What does producing at Q2, mean that the firm is maximising?

  Revenue

  
• What does producing at Q1, mean that the firm is maximising?

  Profit

  
• Marginal Revenue = Change in total revenue / Change in output
• Label this costs graph...

  A) MC

  B) ATC

  C) AVC

  D) AFC

  
• Short-run average cost (SRAC) curves are U-Shaped because of the law of diminishing returns whilst long-run average cost (LRAC) curves are U-Shaped because of economies and diseconomies of scale.

  
• Internal economies of scale:

  • Technical Economies
  • Financial Economies
  • Risk-bearing Economies
  • Managerial Economies
  • Marketing and Purchasing Economies
• If AVC < AR, then firms should continue production.
• If AVC > AR then producing more goods will increase the loss.
• Characteristics of perfect competition:

  • Many buyers and sellers.
  • Freedom of entry and exit from the industry.
  • Perfect knowledge.
  • Homogenous (Identical products)
• Integration is growth through amalgamation, merger or takeover. A merger or amalgamation is where two or more firms join under common ownership whilst a takeover is when one firm buys another.