Business Economics

1. Profit maximisation

1.1. Normal profit: is that level of profit which is just sufficient to keep all factors of production in their present use. It occurs where AC = AR.

1.2. Supernormal profit is anything in the excess of normal profit.

1.3. Profits are maximised when MC = MR

1.4. Functions of profit are: allocation of factors of production, signal for market entry, promotes innovation, investment, rewards entrepreneurs risk, economic performance indicator.

1.5. Alternative goals: managerial status, market share, revenue maximisation

1.6. Principal agent problem in asymmetric information

1.7. Traditional view owners are managers, managerial view of divorce between ownership and control.

2. Perfect Competition

2.1. Assumptions: 1. Many buyers and sellers

2.2. 2. No barriers to entry or exit

2.3. 3. Identical products

2.4. 4. Perfect information

2.5. 5. No externalities

2.6. 6. No economies of scale

2.7. Sunk costs: are those costs that cannot be recovered e.g. highly specialised capital equipment

2.8. Shutdown condition: short run shutdown where P < AVC , long run shutdown where P < AC

2.9. The long run: is that period of time where all factors are variable implying that new firms are able to enter the industry.

2.10. Factors which firms compete in imperfect competition: brand, quality, delivery times, location, differentiation, innovation, range, customer service

2.11. Benefits of competition are: lower prices, low barriers to entry, lower total profits, economic efficiency

2.12. New node

3. Costs and revenues

3.1. Fixed costs: A fixed cost is one that does not change with output e.g. rent, taxes, loan payments

3.2. Variable costs: variable costs are ones that change with output e.g. component parts, workers

3.2.1. New node

3.3. Total costs = FC plus VC

3.4. Average cost = TC / Quantity

3.5. The short run: Is that period of time where at least one factor of production is fixed, usually capital.

3.6. The law of diminishing returns: states that as more of a variable factor is added to a fixed factor marginal product will initially rise owing to specialisation but marginal product will fall as diminishing returns set it.

3.7. Marginal product: is the addition to total product from the production of one extra unit of output.

3.8. Increased productivity, decreases cost per unit.

3.9. AC= AFC plus AVC

3.10. Average product is output per worker

3.11. Economies of scale: exist where an increase in all factors of production lead to a more than proportionate increase in output. There are technical and financial economies of scale.

3.12. Minimum efficient scale: is the point where the lowest average cost is first reached on the LRAC curve. It is the point where all economies of scale are exhausted.

3.13. TR = P times Q

3.13.1. AR = TR/Q

3.13.1.1. P= AR

3.14. Marginal revenue: is the addition to total revenue from the sale of one extra unit of output.

4. Efficiency,

4.1. Consumer surplus: the difference between the price the consumer is prepared to pay and the price they actually pay.

4.2. Producer surplus: the difference between the price at which the producer is prepared to supply and the price they actually recieve

4.3. Static efficiency: (allocative, productive, x) occurs at a given moment in time.

4.4. Dynamic efficiency: ( product, process) occurs over time.

4.5. Allocative efficiency: occurs where goods are produced in line with consumer preferences, technically its where P= MC

4.6. Productive efficiency: occurs at the lowest point on the average cost curve.

4.7. X inefficiency: exists where firms are not on the average cost curve due to organisational slack ( associated with a monopoly).

4.8. Policies that encourage innovation are tax credits, entrepreneurship policies, competition policy.

4.9. Deadweight loss: is the loss of welfare associated with monopoly power.

5. Concentrated markets

5.1. Concentration ratio is the value of output from firms in the industry.

5.2. Firms grow to: increase market power, objective of managers, profit motive, economies of scale, risk motive.

5.3. Internal growth uses the retained profits or loans of a company to finance expansion by increasing fixed and variable factors.

5.4. External growth provides a rapid route for expansion and occurs through acquisitions and mergers.

5.5. Horizontal integration: occurs when two businesses in the same industry and point of production merge.

5.6. Vertical integration: involves acquiring a business in the same industry but at different stages of the supply chain.

5.7. Lateral merger: is a merger between companies that are related not identical.

5.8. Conglomerate merger: is a merger between firms in unrelated business

5.9. Monopoly power comes from: patents protection and exclusive ownership.

6. Price discrimination

6.1. First degree price discrimination: is charging each individual consumer the maximum they are prepared to pay, so charging a unique price for every individual unit.

6.2. Second degree price discrimination: involves selling batches of a product at lower prices than previous.

6.3. Third degree price discrimination: involves charging different prices for the same product in different segments of the market. Either by time, location, or status.

6.4. Consequences: consumer surplus is reduced in most cases - representing a loss of economic welfare. As the price charged is above the marginal cost of production.

6.5. Price discrimination is extracting consumer surplus and changing it to supernormal profit.

6.6. Pros: Lower prices, output higher than a single price monopoly, dynamic efficiency from reinvested profits.

7. Monopoly

7.1. Monopoly exists where there is only one firm in the industry

7.2. Or a firm that has a greater than 25% market share.

7.3. Absence of competition means a monopoly is a price maker, and demand is relatively price inelastic

7.4. Barriers to entry block potential entrant,they seek to protect existing firms and maintain supernormal profits and increase producer surplus.

7.5. Examples of barriers: High fixed costs, economies of scale, brand loyalty, legal barriers, control over factors of production & retail outets, predatory pricing.

7.6. First mover advantage

7.7. Strategic barriers: hostile takeovers and acquisitions, brand proliferation and product differentiation, capacity expansion, predatory pricing.

7.8. Monopoly is allocatively inefficient as p > mc, productively inefficient as it is not on the lowest point of the average cost curve. X inefficient also. Is dynamically efficient.

7.9. Costs: higher prices and lower output, reduced consumer surplus.

7.10. Benefits: economies of scale with lower prices, reach M.E.S, international competitiveness.

8. Contestable markets

8.1. Existing firms set their prices at competitive levels

8.2. Market is perfectly contestable when the costs of entry an exit by potential rivals are zero

8.3. Increase in consumer surplus and lower profit margins

8.4. Evaluation: no market is perfectly contestable, hit and run competition, strategic entry barrier,

8.5. Increase in contestable markets: entrepreneurial zeal, deregulation of markets, competition policy, european single market, technological change

9. Oligopoly

9.1. Oligopoly is a market dominated by a few producers, each with a degree of market control.

9.2. Strategic interdependence

9.3. Features of an oligopoly: interdependence and uncertainty, entry barriers, product branding, non-price competition.

9.4. Compete or collude?

9.5. Kinked demand curve

9.6. Price leadership and tacit collusion

9.7. Price fixing cartels

9.8. Collusion easier when: small number of firms, marker demand stable, demand fairly price inelastic, firm output easily monitored.

9.9. Problems:enforcement problems, falling market demand, entry of non-cartel firms into industry, exposure of illegal price fixing by regulators

9.10. Benefits: joint R & D projects, shared facilities and information exchange, adoption of common standards.

9.11. Game theory

10. Market structure and technology

10.1. Features of market structure: number of firms, market share of the largest firms, nature of costs, degree of vertical integration in industry, extent of product differentiation, structure of buyers, turnover of customers.

10.2. Government policy and innovation

10.3. Market structure: perfect competition, pure monopoly, oligopoly, contestable markets.

10.4. Price and cross elasticity of demand

10.5. Product differentiation

10.6. Regulatory system

10.7. International environment

10.8. Economic cycle

10.9. Factor's affecting firms pricing power: costs, competitors, customers, business objectives

10.10. Technology reduces average costs of production, and optimal methods of production.

10.11. Technology improves quality of new products

10.12. Increases dynamic efficiency

10.13. Promotes competition by reducing entry barriers, reducing concentration, increasing the degree of market contestability. Also challenge the power of established monopolies.

10.14. Can promote monopoly if firms patent their innovations.