Business Economics and the Distribution of Income

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Business Economics and the Distribution of Income by Mind Map: Business Economics and the Distribution of Income

1. Costs and Revenues

1.1. Fixed and Variable Costes

1.1.1. A fixed cost is one that does not change with output

1.1.2. A variable cost is one that changes with output

1.2. The Short-Run Average Cost Curve

1.2.1. Average cost =

1.2.1.1. Average fixed cost + average variable cost

1.2.1.2. Total cost / quantity

1.2.2. The short run is that period of time where at least one factor of productions is fixed, usually capital

1.2.3. Fixed costs diluted (spread out) as production increases

1.2.4. 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 sets in

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

1.2.6. Productivity

1.2.6.1. Increased productivity leads to falling costs per unit

1.2.6.2. If low labour productivity leads to higher costs per unit, firms will substitute away from labour towards capital

1.3. The Long-Run Average Cost Curve

1.3.1. Economies of scale

1.3.1.1. Economies of Scale exist where an increase in all factors of production (labour AND capital) lead to a more than proportionate increase in output i.e. falling long-run average costs

1.3.1.2. Technical economies of scale

1.3.1.2.1. Expensive capital

1.3.1.2.2. Specialisation of the workforce

1.3.1.2.3. Increased dimensions (or the "container principle")

1.3.1.3. Purchasing economies

1.3.1.4. Financial economies of scale

1.3.1.5. Administrative economies of scale

1.3.2. Diseconomies of scale

1.3.2.1. Caused by

1.3.2.1.1. Control

1.3.2.1.2. Co-ordination

1.3.2.1.3. Co-operation

1.3.3. Economies of scope

1.3.3.1. These occur when the total average cost of production decreases as a result of increasing the NUMBER of different goods produced

1.4. The Minimum Efficient Scale

1.4.1. The 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 all exhausted

1.5. External Economies and Diseconomies of Scale

1.5.1. Cheaper raw materials

1.5.2. Labour with specific skills

1.5.3. Banks and financial institutions with industry-specific expertise

1.5.4. Facilities, support services, skills and experiences can be shared

1.6. Total, Average and Marginal Revenue

1.6.1. Total revenue = price x quantity

1.6.2. Average revenue = total revenue / quantity = price

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

2. Profit Maximisation

2.1. What is Profit?

2.1.1. 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

2.1.2. Supernormal profit (sometimes referred to as abnormal profit) is anything in excess of normal profit

2.2. Maximising Profit

2.2.1. Profits are maximised at the point where MC = MR

2.3. The Role of Profit in the Economy

2.3.1. Allocation of factors of production

2.3.2. Signal for market entry

2.3.3. Promotes innovation

2.3.4. Investment

2.3.5. Rewards entrepreneurs for bearing risk

2.3.6. Economic performance indicator

2.4. Alternative Goals

2.4.1. Managerial theories

2.4.1.1. Managerial status

2.4.1.2. Market share or sales growth

2.4.1.3. Revenue maximisation

2.4.2. Prinicipal-agent problem

2.4.3. Behavioural Theories

3. Perfect Competition

3.1. Perfect Competition

3.1.1. Many buyers and sellers

3.1.2. No barriers to entry or exit

3.1.3. Sunk costs are those costs that cannot be recovered e.g. highly-specialised capital equipment, training, advertising

3.1.4. Identical products

3.1.5. Perfect information

3.1.6. No externalities

3.1.7. No economies of scale

3.2. The Short Run

3.2.1. The short run is that period of time where at least one factor of production is fixed implying that new firms will be unable to enter the market

3.2.2. The shutdown condition

3.2.2.1. Short run shutdown = price < average variable costs

3.2.2.2. Long run shutdown = price < average costs

3.3. The Long Run

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

3.4. Theory and Reality

3.4.1. Imperfect information

3.4.2. Persuasive marketing and advertising

3.4.3. Asymmetric information

3.4.4. Negative and positive externalities

3.5. Benefits of Competition

3.5.1. Lower prices

3.5.2. Low barriers to entry

3.5.3. Lower total profits

3.5.4. Greater entrepreneurial activity

3.5.5. Economic efficiency

4. Efficiency

4.1. Consumer and Producer Surplus

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

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

4.1.3. Static efficiency

4.1.3.1. Allocative

4.1.3.2. Productive

4.1.3.3. X

4.1.3.4. Occurs at a given point in time

4.1.4. Dynamic efficiency

4.1.4.1. product

4.1.4.2. process

4.1.4.3. Occurs over time

4.2. Allocative, Productive and X Efficiency

4.2.1. Allocative efficiency occurs where goods are produced in line with consumer preferences. Technically it's where price = marginal cost

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

4.2.3. X inefficiency exists where firms are not on the average cost curve, owing to organisational slack (normally associated with monopoly)

4.3. Dynamic Efficiency and Technological Change

4.3.1. Factors likely to lead to improvement in dynamic efficiency

4.3.1.1. Research and development

4.3.1.2. Technological change

4.3.1.3. Increased physical capital

4.3.1.4. Increased human capital through education and training

4.3.2. Product innovation

4.3.2.1. Sustaining innovations

4.3.2.2. Disruptive innovations

4.3.3. Process innovation

4.3.3.1. Involves changes to the way in which production takes place

4.3.3.2. Results in

4.3.3.2.1. Outward shift in market supply

4.3.3.2.2. Higher profit margins

4.3.3.2.3. More efficient use of resources

4.3.3.2.4. Producer and consumer surplus

4.3.3.2.5. Real income

4.4. Government Policy and Dynamic Efficiency

4.4.1. Supply-side strategies

4.4.1.1. Tax credits/capital investment allowances

4.4.1.2. Policies to encourage small business creation and entrepreneurship

4.4.1.3. Toughening up of competition policy to expose cartel behaviour, but to allow and promote joint ventures to fund research and development

4.4.1.4. Lower corporation taxes to encourage innovative foreign companies to establish in Britain

4.4.1.5. Increased funding for research in our universities

4.4.2. Important developments

4.4.2.1. Increasingly most innovation is done by smaller firms and entrepreneurs

4.4.2.2. Innovation is now a continuous process

4.4.2.3. Innovation is not something left to chance

4.4.2.4. Demand innovation is becoming more important

5. Concentrated Markets

5.1. Concentration Ratio

5.1.1. C.R.5 = value of output from the 5 largest firms/value of output for the industry

5.2. Why Do Firms Grow Larger?

5.2.1. Market power motive

5.2.2. Objectives of managers

5.2.3. Profit motive

5.2.4. Economies of scale

5.2.5. Risk motive

5.3. How Do Firms Grow Larger?

5.3.1. Internal growth

5.3.2. External growth

5.3.2.1. Horizontal integration

5.3.2.1.1. At same stage of production

5.3.2.2. Vertical integration

5.3.2.2.1. At different stages of supply chain

5.3.2.3. Lateral merger

5.3.2.3.1. Related but not identical

5.3.2.4. Conglomerate merger

5.3.2.4.1. Unrelated businesses

5.3.3. Outsourcing

5.3.3.1. Technological change

5.3.3.2. Increased competition

5.3.3.3. Pressure from the financial markets

6. Price Discrimination

6.1. Price Discrimination

6.1.1. Price discrimination occurs when a producer sells an identical product to different buyers at different prices for reasons unrelated to costs

6.2. Conditions Necessary for Price Discrimination to Occur

6.2.1. Differences in price elasticity of demand

6.2.2. Barriers to prevent "market seepage"

6.3. Types of Price Discrimination

6.3.1. First degree price discrimination (or perfect price discrimination)

6.3.1.1. Charging each individual consumer the maximum they are prepared to pay

6.3.1.1.1. Pyschotherapist

6.3.1.1.2. Market stall

6.3.1.1.3. Car salesman

6.3.1.1.4. eBay

6.3.2. Second degree price discrimination

6.3.2.1. Selling batches of a product at lower prices than previous batches

6.3.2.1.1. Crisps - multipacks

6.3.2.1.2. Photocopier

6.3.3. Third degree (multi-market) price discrimination

6.3.3.1. Charging different prices for the same product in different segments of the market

6.3.3.1.1. Status

6.3.3.1.2. Time

6.3.3.1.3. Location

6.4. The Consequences of Price Discrimination

6.4.1. The impact on consumer welfare

6.4.1.1. Consumer surplus reduced in most cases

6.4.1.2. However may "price some lower-income consumers into the market"

6.4.2. Producer surplus and the use of profit

6.4.2.1. Extracting consumer surplus and turning it into supernormal profit

6.4.2.2. Improve dynamic efficiency

6.4.2.3. Predatory pricing tactic

7. Monopoly

7.1. Defining Monopoly

7.1.1. Exists where there is only one firm in the industry - the firm is the industry

7.1.2. Greater than 25% of market share

7.2. Barriers to Entry - Protecting Monopoly Power in the Long Run

7.2.1. High fixed costs

7.2.2. Economies of scale

7.2.3. Brand loyalty

7.2.4. Legal barriers

7.2.5. Control over the factors of production

7.2.6. Control over retail outlets

7.2.7. Predatory pricing

7.2.8. Strategic entry deterrence

7.2.8.1. Hostile takeovers

7.2.8.2. Product differentiation through brand proliferation

7.2.8.3. Capacity expansion

7.2.8.4. Predatory pricing

7.3. Monopoly and Efficiency

7.3.1. Statically inefficient

7.3.1.1. Allocatively inefficient because price > marginal cost

7.3.1.2. Productively inefficient because it is not producing on the lowest point of the average cost curve

7.3.1.3. Likely to be X inefficient because monopolist is protected by entry barriers and the absence of competitive forces means that there is no mechanism in a monopoly to eliminate organizational inefficiency

7.3.2. Dynamically efficient

7.3.2.1. Supernormal profits reinvested into research and development

7.4. Costs and Benefits of Monopoly

7.4.1. Costs

7.4.1.1. Abnormal (supernormal) profits earned at expense of efficiency

7.4.1.2. Loss of allocative efficiency and a failure of the market

7.4.1.3. Productive and X inefficiency

7.4.2. Benefits

7.4.2.1. Economies of scale

7.4.2.2. Natural monopoly

7.4.2.3. Faster rate of technological development, thereby increasing dynamic efficiency

7.4.2.4. Internationally competitive

8. Oligopoly

8.1. Defining Oligopoly

8.1.1. Interdependence and uncertainty

8.1.2. Entry barriers

8.1.3. Product Branding

8.1.4. Non-price competition

8.2. Kinked Demand Curve

8.2.1. Limited real world evidence

8.3. Importance of Non-Price Competition Under Oligopoly

8.3.1. Better quality of service

8.3.2. Longer opening hours

8.3.3. Discounts on product upgrades

8.3.4. Contractual relationships with suppliers

8.3.4.1. Exclusive distribution agreements

8.3.5. An increased range of services

8.3.6. Advertising and loyalty cards

8.4. Price Leadership, Tacit Collusion and Price Fixing

8.4.1. Price leadership/tacit collusion

8.4.1.1. Where prices and price changes are established by a dominant firm

8.4.1.2. Barometric price leadership

8.4.2. Explicit collusion under oligopoly

8.4.2.1. Easier to achieve when:

8.4.2.1.1. Small number of firms in the industry

8.4.2.1.2. Market demand is not too variable

8.4.2.1.3. Demand is fairly price inelastic

8.4.2.1.4. Each firm's output can be easily monitored

8.4.2.2. Problems

8.4.2.2.1. Enforcement problems

8.4.2.2.2. Falling market demand

8.4.2.2.3. The successful entry of non-cartel firms into the industry

8.4.2.2.4. The exposure of illegal price fixing by market regulators

8.4.2.3. Benefits from collusion

8.4.2.3.1. Joint research and development projects

8.4.2.3.2. Shared use of common facilities and the beneficial exchange of information

8.4.2.3.3. The adoption of common standards

8.4.3. Game Theory

8.4.3.1. The Prisoner's Dilemma

9. Contestable Markets

9.1. Level of barriers of entry to an industry that influences conduct and performance

9.2. Evaluation

9.2.1. No market is perfectly contestable

9.2.2. Influence of hit-and-run competition?

9.2.3. Aggressive reactions

9.3. Increasing Contestability of Markets

9.3.1. Entrepreneurial Zeal

9.3.2. De-regulation of Markets

9.3.3. Competition Policy

9.3.4. The European Single Market

9.3.5. Technological Change

9.3.5.1. Emergence of e-commerce

10. Market Structure and Technology

10.1. Summary of Market Structures

10.1.1. The number of firms

10.1.2. The market share of the largest firms

10.1.3. The nature of costs

10.1.4. The degree to which the industry is vertically integrated

10.1.5. The extent of product differentiation

10.1.6. The structure of buyers in the industry

10.1.7. The turnover of customers

10.1.8. Perfect Competition/Oligopoly/Monopoly

10.1.9. Innovation

10.2. Price Makers VS. Price Takers

10.2.1. Two driving forces

10.2.1.1. Market structure

10.2.1.2. Objectives

10.2.2. Price and cross-price elasticity of demand

10.2.3. Product differentiation

10.2.3.1. Moving away from homogenous products

10.2.4. The regulatory system

10.2.5. The international environment

10.2.6. The economic cycle

10.2.7. Factors affecting a firm's pricing power

10.2.7.1. Costs

10.2.7.2. Competitors

10.2.7.3. Customers

10.2.7.4. Business Objectives