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Firms and Decisions: Firms and how they operate (Economies of Scale…
Firms and Decisions:
Firms and how they operate
Very basic terms:
Industry
Firm I
Plant 1
Plant 3
Plant 2
Firm II
Plant 1
Plant 2
Plant 3
Firm III
Plant 2
Plant 3
Plant 1
Production: It is the process of combining certain factors of production by a firm and converting them into goods and services to satisfy human wants.
Traditional objective of all firms: to maximise
profit
.
Normal Profit
TR=TC (zero economic profits)
Supernormal profit
TR>TC (economic profits>0)
Subnormal Profit
TR<TC (economic profits<0)
Profits=TR-TC
TR= Price per unit x Quantity sold
Thought process:
Firms
Makes decision to produce goods and services
Output Decision+ Price Decision
Depends on objectives of firms
Profit Maximisation (traditional objective)
Profit is maximised when MR=MC (only when MC is rising)
Firms will produce up to the output level where MR=MC
Loss Minimisation
SR:
Firms might make losses/subnormal profit (TR<TC)
They seek to minimise loss
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Entry Deterrence
May be adopted by large incumbent firms who feel threat from potential competitors
By setting the price of their goods at a level which potential competitors may find it hard to compete with (pricing decision)
Engage in extensive R&D to differentiate firm's goods and services (non-pricing decision)
Intended outcome: to retain market share and prevent the entry of new firms.
Revenue Maximisation
Taken on by sales managers/commission-based employees whose income is dependent on the TR earned by firm.
Results in higher personal incomes for them.
Profit Satisficing
Firms could produce within a range of output levels that achieve a given level of profit deemed
acceptable
by the shareholders rather than the profit maximising output.
May be adopted in cases where the
cost of obtaining sufficient information to make profit-maximizing decisions is significantly high
, such as firms that have multiple product offerings or have plants located in different countries.
To avoid the undue
stress
or perceived
challenges of expansion
Market share Dominance
Done to increase firm's share of the market
Aims to drive rival firms out of the market
Predatory Pricing:
Pricing goods at a level which competitors find it hard to compete with
Rivals firms may not be able to cope with losses incurred due to matching the low prices set and choose to exit the market.
End result: Firm gains a larger market share -> market power.
Growth Maximisation
Size of firms can be measured by:
Plant number and sizes
Sales
Number of workers employed
Larger firms account for larger proportion of total employment in the industry.
Market share
Proportion of total production within the industry.
Firms can expand and grow through:
Internal expansion
Increasing demand
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Increasing supply
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(of firm's products, either locally or globally)
Mergers and Acquisitions
Merger
: a legal consolidation of two firms into one entity through mutual agreement between the two firms.
Acquisition
: It occurs when one firm takes over another and completely establishes itself as the new owner. The target firm still exists as an independent legal entity controlled by the acquirer.
Different forms of integration of firms:
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Benefits
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Instead of aiming for growth maximisation, firms may also choose to remain small:
Either by choice, or by circumstances beyond their control.
Small firms exist in face of competition from large firms at both international and national level.
Demand side factors:
Limited/small demand
Personal services
Product differentiation
Localised demand
Supply side factors:
Initial capital outlay
Availability of capital
Managerial attitude
Government policies
Small optimum size: economies of scale??
Social Objective:
Cost of Production:
Meaning of cost:
Economist's view
Accountant's view
Opportunity Costs
Explicit Costs
Short-run (SR) or Long-run (LR)
Short Run
Short Run Costs:
Total Cost (TC)
Average Costs
Average Fixed Cost (AFC)
Average Variable Cost (AVC)
Average Total Cost/ Average Cost (AC)
Marginal Cost (MC)
The Cost Curves
Total Variable Costs (TVC)
Total Fixed Costs (TFC)
Long Run
Long Run Costs
Economies of Scale (under cost of production too)
Internal economies of scale
Types!!!
Financial Economies of Scale
Managerial Economies of Scale
Commercial/ Marketing Economies of Scale
Risk-bearing Economies of Scale
Technical Economies of Scale
Indivisibilities
Greater efficiency of large machines
Specialisation and division of labour
Minimum Efficient Scale (MES)
Internal Diseconomies of Scale (MES)
Occur when increasing the scale of production leads to a higher cost per unit of output.
The above can be due to:
High cost of monitoring and management
X-efficiency
Low morale of employees
External Economies of Scale
Factors resulting in External Economies of Scale :
Availability of shared resources
Availability of infrastructure
Availability of industry-specific skilled labour
External Diseconomies of Scale
Could occur due to:
Strain on physical infrastructure
Shortage of industry-specific resource
Revenue
Total Revenue (TR)
Average Revenue (AR)
Marginal revenue (MR)