Theme 3

• Market capitalisation Profit satisficing the principle agent problem and Public and private sector key terms Market capitalisation is the monetary value of a business Profit satisficing is when enough profit is made to satisfy shareholders The principle agent problem is the divorce of ownership (shareholders) and control(managers) The public sector are government run and government funded organisations The private sector are organisations not run or funded by the government
• 5 reasons that firms grow 1. Profits- Growing larger is likely to result in higher sales and profits which results in better returns for firms meaning that the share price will increase and positively affect the value. Investors would assess likely returns so will affect the ability to raise share capital in future. 2. Costs- Growth means increased output which results in greater economies of scale. Lower average costs make the firm more price competitive and may allow firms to enter foreign markets. Reducing AC can also make a firm more aggressive with their pricing strategy. 3. Market power- This is concerned with market dominance and the benefits include: increased ability to set price increased barriers to entry decreased threat of competition increased chance of survival increased chances of profit maximisation and decreasing PED making it more inelastic. 4. Decreased risk- Larger firms are more likely to be able to take out loans as they pose lower risk of defaulting. This means they can cope with making a loss in the SR to adopt aggressive pricing strategies. This can lead to having a greater access to funds for innovation resulting in more inelastic PED. 5. Managerial motives- Managers are motivated by their pay so are likely to want to grow the business to justify higher pay. Shareholders want to maximise profit and managers want to maximise growth. This results in conflict and the principal agent problem.
• Profit satisficing diagram Q1 is the lowest level of output while profit satisficing q2 is where profit maximisation occurs q3 is the highest level of output while profit satisficing
• Why do some firms stay small 1. Lack of finance 2. Avoiding diseconomies of scale 3. Providing niche products 4. Offering a more personal service to customers 5. Acting as suppliers 6. Acting as local monopolies at specific times 7. Lifestyle choice of the owner
• Not for profit organisations These are organisations tht prioritise providing a service rather than making a profit They exist to serve its members or the community and general public. Charities are the most famous type of not for profit and they are regulated by the charities commission
• Mutual businesses Mutual businesses dont have shareholders or other owners and only exist to serve their members Examples include RAC and john lewis
• Social enterprises These are businesses with social objectives whose surpluses are reinvested for that purpose in the business or community. This is a proper business that makes its money in a socially responsible way Examples include the Eden project and fair trade coffee company cafedirect.
• The CMA vertical integration horizontal integration and conglomerate merger key terms The CMA is a government funded body that regulates levels of competition in markets and has power to intervene Vertical integration is where two firms in the same industry but at different points in the supply chain merge Horizontal integration is where two firms at the same point in the supply chain and same industry merge Conglomerate merger is where two firms in different industries merge
• Organic growth and reasons for organic growth This is where a business grows internally by reinvesting profits or borrowing from banks This is internal growth Reasons: 1. Increase market share 2. Develop innovative products 3. Find new markets to sell to 4. Increase sales to existing customers 5. Invest in new capital or technology
• Vertical integration forward and backward and benefits and drawbacks Forward Vertical Integration is where one firm integrates with a firm in a stage of production closer to the customer Backward vertical integration is where one firm integrates with a firm in a stage of production further away from the customer Benefits: Increased control over the supply chain Decreased costs Increased quality Increased access to raw materials Drawbacks: Diseconomies of scale Different cultures leading to culture clashes
• Benefits and drawbacks to horizontal integration Benefits: Economies of scale Spread risk Decreased competition Increased barriers to entry Drawbacks: Different cultures leading to culture clashes Diseconomies of scale Attracts attention from the CMA
• Benefits and drawbacks to conglomerate mergers Benefits: Spreads risk Knowledge from other markets Potential for Eos increased market power Drawbacks: Need for different skills Risk of disEos Cultural differences Attracts attention from govt
• Constraints on business growth Size of market Access to finance Owner objectives Regulation Competition Potential growth of market Availability of necessary labour Protectionism
• Demerger culture Efficiency dynamic efficiency and static efficiency key terms Demerger is when a firm sells off one or more of the businesses that it owns into a separate company Culture is the way things are done in a business Efficiency is a measure of the level of waste Dynamic efficiency is efficiency achieved over time Static efficiency is efficiency at a point in time
• Reasons for demergers. 1. Cultural differences- This is an important influencer on the way a business operates as it is the way things are done in a business. Two businesses in a merger may have different cultures so may experience culture clashes and feel the need to demerge. 2. Focusing on core activities- This is focusing on goods and services that are most important to the business. This results in more focused firms which perform better in markets and achieve market dominance which makes PED more inelastic. Better quality= better customer experience Increased specialisation= increased efficiency and competitiveness. 3. Protecting the value of the firm- A firm may demerge and sell off one of its businesses to protect its overall value. This is because a loss making business can impact the firm negatively. E.g: Firm loses value which means its more difficult to attract investment meaning it is more difficult to borrow from banks which leads to a run on shares 4. Reduce the risk of DisEos- Reducing the range of functions of a firm can help to decrease costs. This helps to avoid diseconomies of scale. 5. Raise money for shareholders- Demerging brings financial rewards for shareholders which makes investment in the firm more attractive and might raise the share price 6. Comply with the CMA- Firms must comply with the CMA as their rulings are legally binding. This may force a firm to demerge and sell off one or more businesses. This is because the firm has become too dominant in the market.
• Impacts on firms of demergers 1. Allows the firm to focus on its core activities 2. Can raise funds 3. Removes loss making businesses 4. Higher returns in the LR as costs are decreased and efficiency is increased 5. Higher costs in the SR as there are high admin costs associated with demerging.
• Impacts on workers of demergers 1. Increased job security if loss making businesses are removed. 2. Decreased conflicts due to culture clashes 3. Increased focus on core activities means increased profitability meaning more scope for wage increases 4. Expected job losses 5. Opportunity for a management buyout.
• Impacts on consumers of demergers 1. Increased competition and decreased prices should raise consumer welfare 2. Better quality goods and services as businesses are more focused on core activities increases utility 3. Increased innovation 4. If average costs decrease then price may also decrease. reducing the O.C for consumers
• Aim Objective stakeholder and fringe benefits key terms An aim is an overall target An objective is a step taken in order to achieve aims Stakeholders are any individual group or organisation that has an interest in the activities of the business Fringe benefits are an extra benefit supplementing an employees salary
• Stakeholder objectives of shareholders managers workers and consumers Shareholders want to maximise their profits to maximise utility Managers want to maximise their wages to maximise their utility Workers want to maximise their wages to maximise their utility Consumers want to pay the lowest price to maximise their utility
• Consequences of altering price frequently to maximise profit Consumer dissatisfaction Loss of sales and market share perception that the firm may be in trouble
• Keynesian economists view on price changes to maximise profits They believe that firms will try to maximise their profits in the long run rather than the short run Rapid and frequent price changes have more drawbacks than benefits Therefore a firm will most likely accept losses in the SR but adjust prices in the LR to the profit maximising level of output
• Illustrating objectives on a cost revenue diagram MC=MR is profit maximisation MR=0 is revenue maximisation AC=AR is sales maximisation MC=AC is productive efficiency MC=AR is allocative efficiency
• Marginal revenue key term This is the change in total revenue from selling one more unit of output It is calculated by doing Change in total revenue / change in quantity
• Calculating TR from a revenue diagram
• Relationship between AR and MR when constant The relationship between these curves changes with price. When price stays the same MR and AR are equal. This means MR and AR are constant and therefore AR=MR. When this occurs the curve is drawn horizontal . AR represents the demand curve so in this case AR=MR=D
• Relationship between AR and MR when AR is falling In reality firms must reduce price to achieve more sales which means that reducing AR will incentiveise consumers to buy. As AR falls so does MR which means that AR does not equal MR now MR falls twice as fast as AR
• PED and total revenue (revenue rules) When demand is inelastic a firm should increase price to increase total revenue When demand is elastic a firm should decrease price to increase total revenue
• PED values along the AR=D curve The top half of the curve is price elastic so reducing price would increase total revenue Halfway along the curve it is unit elastic The bottom half of the curve is inelastic so reducing price this low would reduce total revenue
• Reasons for PED values along the AR=D curve The top half is elastic because changes in price in the top half have a bigger impact on consumers. This is because price changes when price is high act as a bigger incentive meaning there will be a larger percentage change in QD than in price in the top half of the demand curve The opposite is true for the bottom half
• Why is MR=0 the revenue maximising position When MR is positive the PED along AR=D is elastic When MR=0 the PED along AR=D is unit elastic When MR is negative the PED along AR=D is inelastic Therefore TR is maximised when MR=0 TR rises along the elastic part if P is decreased TR falls along the inelastic part if lowering P
• Competitive advantage price competitive diminishing marginal returns and diminishing average returns key terms A competitive advantage is when a firm has an advantage over its rivals impacting on its success Price competitive is when a firm is able to compete more effectively on price Diminishing marginal returns is output beyond the lowest point on the MC curve Diminishing average returns is output beyond the lowest point on the AC curve
• DIminishing marginal productivity Inputs are factors such as land labour and capital Outputs are the finished goods Diminishing marginal productivity is a situation where additional inputs reduce productivity This causes AVC and average total cost to rise when output goes beyond the optimum level. Marginal productivity increases as AC decreases but when AC increases marginal productivity decreases
• Graphing AC in the short run and long run The SR is when at least one factor of production is fixed which limits the firms ability to achieve Eos In the long run all factors of production are variable which makes Eos more attainable
• Internal Eos External Eos and the minimum efficient scale key terms Internal Eos are economies of scale experienced by an individual firm External Eos are economies of scale experienced by all firms within a market The minimum efficient scale is the level of output where AC is at its lowest.
• Internal economies of scale These are Eos achieved by an individual firm Eos take a long time to fully utilise and are therefore a long run concept This is because they may require investment or contracts to be organised **Good EV
• 6 Types of internal economies of scale. 1. Purchasing/procurement (financing suppliers and bulk buying reduces AC) 2. Marketing/advertisement (reducing advertising costs reduces AC) 3. Managerial (Specialist staff division of labour increases productivity and output so AC decreases) 4. Financial (when a firm is larger there is a smaller chance of failure making it easier to borrow and allowing for a higher availability of credit) 5. Technical ( specialist equipment and technological advancements means higher productivity and greater output) 6. Risk bearing ( multiple revenue streams reduces the chance of failing)
• Illustrating Eos using LRAC curves Initially a firm will achieve Eos however it will start to experience diseconomies of scale where average costs increase as output increases This is because of scarcity and inefficiency The minimum efficient scale is the level of output at which AC is lowest X is the MES
• Illustrating external economies of scale This is when all firms within the industry experience lower LRAC This means it does not result in any firm gaining a cost advantage over its rivals Examples of external Eos are improvements to infrastructure
• Normal profit Supernormal profit SR shut down point and LR shut down point key terms Normal profit is the amount of profit needed to keep a firm within its market in the long run Supernormal profit is the amount of profit above normal profit SR shut down point is where AVC=AR LR shut down point is where AC=AR